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Submitted to the President’s Advisory Panel on Federal Tax Reform
Investment Company Institute
March 18, 2005
The Investment Company Institute,1 the national association of mutual funds, is pleased to contribute to the work of the President’s Advisory Panel on Federal Tax Reform pursuant to the Panel’s February 16 request for comments. This statement addresses the tax system’s unnecessary complexities and burdens from the perspective of over 90 million individuals who invest in mutual funds directly, through retirement savings vehicles such as IRAs and 401(k)s, and through education savings vehicles such as Section 529 savings plans. For those mutual fund investors who are saving for long-term needs like retirement, education and health care, there are ways in which the Internal Revenue Code (“the Code”) makes these challenging goals even more difficult to achieve. The difficulties come primarily from: (I) constantly changing rules governing the tax treatment of savings; (II) the premature “tax-as-you-go” treatment of capital gains distributions automatically reinvested into mutual funds; (III) complex requirements regarding eligibility for different kinds of savings; (IV) the absence of savings assistance for long-term health care, a challenging component of retirement security; and (V) the mandatory distribution at age 70 and a half of savings that lawmakers are trying to encourage and responsible savers and investors are trying to achieve.
Constantly Changing Rules Create Complexities for Savers
Uncertainty about the future applicability of current law complicates greatly the short-term and long-term savings strategies of American families. Considerable uncertainty exists today, for example, regarding the future of significant savings incentives only recently enacted. The retirement and education savings incentives enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)2 expire after 2010; the capital gains and dividend tax rate cuts enacted in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”)3 expire after 2008. These uncertainties undermine the important objectives of these laws and inhibit the growth of individual savings and financial predictability and security.
Individuals and families planning for their retirement years cannot project savings goals without a reliable sense of the tax treatment that will be applied both to savings throughout their working lives and to distributions as they enter retirement. For those saving for a child’s college education, the savings time horizon is shorter, and the uncertainty is even more challenging; most children age 16 or younger (and many older ones) will not have graduated from college by 2011, yet the withdrawals they need from Section 529 savings plans to pay college expenses will be reduced by the tax imposed on account earnings unless EGTRRA is extended.
Giving permanence to the important savings incentives that have already been enacted in 2001 and 2003 will reduce the discouraging complexity and confusion facing taxpayers and will encourage long-term savings and economic growth.
Long-Term Savings are Discouraged by Current Taxation of Mutual Fund Capital Gain Dividends that are Reinvested
Mutual fund investors typically choose to have any capital gain distributions they otherwise would receive from the fund automatically reinvested. Every year, mutual fund investors perceive unfairness in being taxed on reinvested gains now rather than when they sell their shares. Tens of millions of working Americans benefit greatly from the efficiency and diversification of investing for their future through mutual funds. Imposing tax on reinvested capital gains when the fund shares are ultimately sold would eliminate a discouraging element of current law and would instead encourage the long-term savings behavior that so many other Code provisions are intended to promote.
Complicated Rules Regarding Eligibility Inhibit Savings
Retirement security depends in large part on what families are able to save in order to supplement Social Security and any job-based pension that family members might earn. Yet, complicated rules governing income eligibility—e.g., for deductible IRA contributions, Roth IRA contributions, and conversions of traditional IRAs to Roth IRAs—confuse workers and thereby inhibit savings.
IRA eligibility rules are so complicated that even individuals eligible to make deductible IRA contributions often are discouraged from doing so. When Congress imposed the current income-based eligibility criteria in 1986, IRA contributions declined dramatically, even among those who remained eligible for the program. Simpler IRA rules are needed to remove the headaches and complexity individuals perceive in the current tax system, and to promote the retirement savings that such accounts were intended to facilitate.
Long-Term Health Savings Vehicles Are Needed to Assist Retirement Savings
The lack of a dedicated savings incentive for one of our most important national needs—long-term health care—is a significant omission from the Code. Existing vehicles are essentially targeted at more immediate, shorter-term health care needs. The Code recognizes in some ways the importance of saving for retirement. But the adequacy of retirement savings must consider whether and how the saver’s health and long-term care needs will be met. Adding an enhanced long-term health savings vehicle to the Code would recognize this important interaction and greatly assist those working so hard to save for retirement.
Complicated Retirement Account Distribution Rules Diminish Savings
Complicated rules that force older Americans to take required minimum distributions (“RMDs”) from retirement plans and IRAs cause significant confusion (e.g., distributions begin after attaining age 70½) and deplete long-term savings. Many retirees prefer to keep their retirement plan and IRA assets untapped as long as possible to fund costly health care and assisted living expenses. Others who work beyond age 65 and can anticipate a lengthy retirement are anxious to conserve savings that will be needed for years the ahead. Forced distributions distort seniors’ ability to plan appropriately for their own financial independence.
Goals for Evaluating the Current System
We are keenly aware of the difficulties that mutual fund investors face when trying to understand and apply our tax laws as they seek to achieve important financial goals such as education and health and retirement security. We urge the Panel to improve the promise of Code provisions intended to assist Americans’ ability to reach those savings goals, and to eliminate the barriers that stand in the way. Reforms that add continuity to the tax treatment of savings, and a simpler, more common sense approach to rules determining who is eligible to contribute what, and when will they be taxed, will be effective and powerful contributions to the President’s call for a U.S. tax system that is simpler, fairer and more growth-oriented. The Institute looks forward to the Panel’s continued work and stands ready to assist in any way possible. Thank you.
1The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,546 open-end investment companies ("mutual funds"), 644 closed-end investment companies, 144 exchange-traded funds, and 5 sponsors of unit investment trusts. Its mutual fund members manage assets of about $7.890 trillion. These assets account for more than 95% of assets of all U.S. mutual funds. Individual owners represented by ICI member firms number 87.7 million as of mid 2004, representing 51.2 million households.
2Among other things, EGTRRA increased contribution limits to IRAs and employer-sponsored retirement plans and provided for "catch-up" contributions to be made by individuals age 50 or older to employer-sponsored plans and IRAs. EGTRRA also made retirement assets significantly more portable among different types of retirement plans and created additional long-term savings incentives for education savings vehicles such as Section 529 savings plans.
3Among other things, JGTRRA reduced the maximum tax rate on long-term capital gains and qualified dividend income to 15 percent.