Tax Bill Expands Limits on Retirement Savings

By: David Cay Johnston
The New York Times, May 28, 2001 

The tax cut bill that Congress passed on Saturday provides several new and expanded benefits for retirement savings. People, especially those age 50 and older, will be able to save significantly more in tax-deferred retirement accounts. Some of the working poor will get a tax credit to help them save for retirement, but only for five years.

The value of the increased savings limits is less than they appear, however, because of inflation. Critics of the legislation also warn that it will hurt some lower-income workers in small businesses by discouraging their employers from offering plans and by encouraging some others to cut future benefits.

The leading sponsor of the changes in retirement plans, Representative Rob Portman, Republican of Ohio, says such concerns are overblown.

The greatest effect of the bill is to raise the maximum that can be contributed to an individual retirement account to $5,000 from the $2,000 limit in effect since 1981.

The maximum will rise to $3,000 beginning next year through 2004, to $4,000 in 2005 through 2007 and then to $5,000 in 2008, and thereafter with increases for inflation in $500 increments.

In real terms, however, these adjustments will only allow retirement savers to catch up with inflation. 

The new $5,000 limit in 2008 would be worth only $2,014 in 1981 dollars, virtually the same as the current limit when it was adopted.

The maximum contribution to 401(k), 403(b) and 457 plans, or tax- deferred retirement savings plans offered by employers, would be increased from the $10,500 limit this year to $11,000 next year, $12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and $15,000 in 2006, with the maximum indexed for inflation in later years.

The bill would also allow those age 50 and over to make extra contributions to both individual retirement accounts and to plans like 401(k)'s.

Older savers could put an extra $500 in their I.R.A. next year and $1,000 each year after that.

For plans like the 401(k), those 50 and over could save an extra $1,000 next year, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005 and $5,000 in 2006 and subsequent years. Because of inflation, these increases will be worth less than their surface value.

Mr. Portman, Republican of Ohio, has promoted this benefit for older people as a matter of fairness to women who were out of the work force raising children. But both men and women could take advantage of the increase, even if they worked continually, so long as they are age 50 or older.

Congress also raised the maximum amount of income that can be counted for retirement benefits.

Raising the maximum savings and the amount of income that can be counted primarily benefits owners and highly paid workers, said Karen Ferguson, director of the Pension Rights Center in Washington, a nonprofit group representing the interests of workers. It helps only the relatively small number of workers now saving the $10,500 maximum in 401(k) plans and the maximums in a variety of other retirement savings plans, she said. She noted that half of all 401(k) individual accounts contain less than $16,000.

"What we need is money for those who are not now benefiting, not more for those who are already saving the maximum," she said. 

About 60 percent of people with I.R.A.'s contribute the $2,000 maximum each year, said Dallas L.Salisbury, president of the Employee Benefits Research Institute in Washington. He said a study of three large companies found that about one in five workers was saving the maximum allowed in their 401(k) plans.

Mr. Portman and representatives of the retirement investment industry say that higher savings limits are vital to persuading more small employers to adopt retirement plans. He said Ms. Ferguson and other critics miss this larger picture. 

"The percentage of workers covered by any retirement plan is basically what it was in 1974," when the Employee Retirement Income Security Act, which governs retirement plans, was adopted, Mr. Portman said.

Mr. Portman said that raising the limits on 401(k) savings permits business owners to save more, encouraging them to provide such plans for themselves and their workers. About 70 million people, roughly half the nation's work force, are without retirement plans, he said.

When a plan is offered, more than two-thirds of workers typically participate, Mr. Salisbury said.

Daniel Halperin, a Harvard University pension expert, said that the higher savings limits for all retirement plans will mean nearly $50 billion less in tax revenues over the next decade. Most of the tax savings will benefit owners and highly paid workers, he said.

"We can spend that, but we ought to buy something for it, and we're not buying anything in terms of expanded coverage for workers," he said. 

When Congress raises the income levels that can be used for calculating all kinds of retirement benefits, he said, some business owners respond by lowering the percentage of workers' pay that the employers contribute.

Mr. Halperin said he doubted that many new 401(k) plans would be created by small businesses. When I.R.A. contribution limits are raised, he said, some employers may decide not to offer plans like the 401(k) because they can save enough for themselves through an I.R.A..

Ms. Ferguson said she thought many new plans would be created, but that the primary beneficiaries would be owners, not their employees.