Statement of the Investment Company Institute

Submitted to the
Subcommittee on Oversight,
Committee on Ways and Means
Hearing on Oversight and Pension Issues

May 19, 1998

The Investment Company Institute1 is pleased to submit this statement to the Subcommittee on Oversight of the House Committee on Ways and Means to indicate our strong support for many of the provisions of H.R. 3788, the Retirement Security for the 21st Century Act. The Institute commends the sponsors of this bill, as well as other members of this subcommittee, for their interest in retirement savings policy. As discussed below, the Institute believes that H.R. 3788 makes enormous strides in addressing current issues involving retirement savings by making the retirement plan system more responsive to the needs of Americans.

Retirement savings is of vital importance to our nation’s future. The challenge facing working Americans today is to ensure that they prepare adequately for their financial needs in retirement. This challenge is particularly pressing in light of two demographic events. First, members of the "Baby Boom" generation are rapidly approaching their retirement years. Evidence from recent studies strongly suggests that as a generation, they have not adequately saved for their retirement.2 Second, Americans today are living longer. Taken together, these trends will place an enormous strain on the Social Security program in the near future.3 In order to ensure that individuals have sufficient savings to support themselves in their retirement years, much of this savings will need to come from individual savings and employer-sponsored plans.

The mutual fund industry’s primary focus is on saving and long-term investment. The Institute has long supported efforts to enhance the ability of individual Americans to save for retirement in individual-based programs, such as the Individual Retirement Account or IRA, and employer-sponsored plans, such as the popular 401(k) plan. In particular, we have urged that Congress: (1) create and maintain appropriate individual and employer incentives to save; (2) reduce unnecessary and cumbersome regulatory burdens that deter employers from offering retirement plans; and (3) keep the rules simple and easy to understand.

It is our view that H.R. 3788 will make retirement plan rules more responsive to the needs of today’s workforce and the savings patterns of most Americans, ease the administrative complexity that employers—especially small employers—confront when seeking to establish retirement plans, and create significant incentives for individuals to save for retirement in their employer-sponsored plans.

I. Incentives to Save for Retirement
In order to increase retirement savings at every level to meet the retirement needs of the future, Congress must provide working Americans with the incentive to save and the means to achieve adequate retirement security. The current tax law imposes numerous limitations on the ability of retirement plans to deliver benefits to individual workers. One way to ease these limitations is for Congress to update the rules governing contribution limits to employer-sponsored plans. Increasing these limits will facilitate greater retirement savings and help ensure that Americans will have adequate retirement income.

The Institute strongly supports the provisions contained in H.R. 3788 that would address these issues. Section 101 of the bill would increase 401(k) plan and 403(b) arrangement contribution limits to $15,000 from the current level of $10,000; government-sponsored 457 plan contribution limits would increase to $15,000 from the current level of $8,000. Section 101 would also modify the section 401(a)(17) limit on compensation that may be taken into account to determine benefits under qualified plans by reinstating the pre-1986 limit of $235,000, indexed in $5,000 increments. The current limit is $160,000. Another important provision is Section 202 of H.R. 3788, which would repeal the "25% of compensation" limitation on contributions to defined contribution plans. These limitations can prevent low and moderate income individuals from aggressively saving for retirement. (As is noted below, the repeal of these limitations is also necessary in order to enable many individuals to take advantage of the "catch-up" proposal in the bill.)

In addition, Congress should create saving incentives that accommodate today’s work patterns. On average, individuals change jobs once every five years. Current rules restrict the ability of workers to roll over their retirement account from their old employer to their new employer. For example, an employee in a 401(k) plan who changes jobs to work for a state or local government may not currently take his or her 401(k) balance and deposit it into the state or local government’s pension plan. Thus, the Institute strongly supports Sections 301 & 302 of H.R. 3788, which would enhance the ability of American workers to take their retirement plan assets to their new employer when they change jobs by facilitating the portability of benefits among 401(k) plans, 403(b) arrangements, 457 state and local government plans and IRAs.

Finally, the laws governing pension plans must be flexible enough to permit working Americans to make additional retirement contributions when they can afford it. Individuals, particularly women, may leave the workforce for extended periods to raise children. In addition, many Americans are able to save for retirement only after they have purchased their home, raised children and paid for their own and their children’s college education. Section 201 of H.R. 3788 addresses these concerns by permitting additional salary reduction "catch-up" contributions. The catch-up proposal would permit individuals at age 50 to save an additional $5,000 annually on a tax-deferred basis. The idea is to let individuals who may have been unable to save aggressively during their early working years to "catch up" for lost time during their remaining working years. Section 202’s repeal of the "25% of compensation" limit could further enhance the ability of Americans to "catch-up" on their retirement savings.

II. Reduction of Regulatory Burdens
The current regulatory structure contains many complicated and overlapping administrative and testing requirements that serve as a disincentive to employers to sponsor retirement plans for their workers. Easing these burdens will promote greater retirement plan coverage and result in increased retirement savings.

The Institute believes that any meaningful pension reform legislation must focus on increasing pension plan coverage within the small business market. Small business represents the fastest growing employer sector in the economy today. Millions of Americans are employed by small businesses and it is imperative that Congress provide incentives to small businesses to sponsor pension plans for their workers. In general, under 20 percent of employers with less than 100 employees provide a retirement plan for their employees, as compared to about 84 percent of employers with 100 or more employees.4 The complexity of our pension system’s rules and regulations and the high administrative costs associated with pension plans act as barriers to small employers from establishing a retirement plan for their workers. As a result, millions of Americans are denied the ability to save adequately for their retirement.

The Institute strongly supports expanding current retirement plans targeted at small employers. Specifically, the Institute supports expansion of the SIMPLE plan, which was instituted in 1997 and offers small employers a truly simple, easy-to-administer retirement plan. The response from the small employer market for the SIMPLE has been overwhelming. The Institute estimates that as of July 31, 1997, after only seven months of availability, its members were custodians for an estimated 95,000 SIMPLE IRA accounts. The SIMPLE program is especially popular among the smallest employers—those with under 25 employees. Indeed, the vast majority of employers establishing these plans have under 10 employees. Our industry has found that small employers welcome the opportunity to sponsor a retirement plan for their workers that is low on administrative burdens and cost.

H.R. 3788 addresses these barriers to small business plan coverage—regulatory complexity and cost. For example, Section 104 of H.R. 3788 would modify the top-heavy rules.5 This rule, which was intended to assure that employer-sponsored plans equitably delivered benefits to the entire workforce and not just to business owners and key management personnel, is both costly and, in the context of 401(k) plans, completely unnecessary. A 1996 U.S. Chamber of Commerce survey found that the top-heavy rule is the most significant regulatory impediment to small businesses establishing a retirement plan.6 The rule imposes significant compliance costs and is particularly costly to small employers, which are more likely to be subject to the rule. It is also unnecessary because other tax code provisions address the same concerns and provide similar protections. We believe that Section 104 of the bill will substantially reduce the costs and burdens that prevent small employers from establishing plans. Section 101 would also benefit small businesses and their employees by increasing the contribution limits to SIMPLE plans from $6,000 to $10,000. H.R. 3788 also contains a provision (Section 103) that would establish a "salary reduction only SIMPLE." We recommend that the Congress allow more time for the development and growth of the employer contribution SIMPLE plans before creating a new type of SIMPLE plan in which the employer makes no contribution.

III. Simplification of Rules
Confusing rules make it difficult for individuals to manage their retirement assets; as a result, they are less likely to participate in retirement programs. An example of this are the rule changes associated with the IRA. When Congress introduced universal deductions for IRAs in 1982, IRA contributions skyrocketed, rising from less than $4 billion in 1980 to approximately $38 billion in both 1985 and 1986. At the IRA’s peak in 1986, about 29% of all families with a head of household under age 65 had IRA accounts. These were not mainly high-income families. In 1986, 75% of all IRA contributions were from families with annual incomes less than $50,000.7 Moreover, the median income of those making IRA contributions (expressed in 1984 dollars) dropped by 24 percent, from over $41,000 in 1982 to below $29,000 in 1986.8 The program was, indeed, primarily used by middle-class Americans.

When Congress restricted the deductibility of IRA contributions in the Tax Reform Act of 1986, the level of IRA contributions fell sharply and never recovered—to $15 billion in 1987 and $8.4 billion in 1995.9 While many families no longer are able to deduct their IRA contributions as a result of the 1986 restrictions, they still may take advantage of the tax deferral for earnings on non-deductible IRA contributions. This incentive, however, has proved insufficient to induce continued participation in the IRA program. Moreover, among families retaining eligibility to fully deduct IRA contributions, IRA participation declined on average by 40% between 1986 and 1987, despite the fact that the change in law did not affect them.10

Indeed, fund group surveys show that even more than a decade later, individuals do not understand the eligibility criteria. American Century Investments surveyed 534 "savers" with respect to the rules governing IRAs. The survey found that "changes in eligibility, contribution levels and tax deductibility have left a majority of retirement investors confused."11 This confusion is an important reason behind the decline in contributions to IRAs.

H.R. 3788 recognizes the need to keep the rules simple in the case of both IRAs and employer-sponsored plans. Section 205 of the bill would simplify the required minimum distribution rules applicable to distributions from qualified plans and IRAs. The bill would raise the minimum distribution age to 75 from 70 1/2. In addition, the first $300,000 of assets in plans and IRAs would be exempt from the rule. This proposal recognizes that individuals live and work longer. In addition, it provides individuals with smaller account balances with relief from a complex and burdensome rule. Further, the changes to the contribution limits for various types of plans under Section 101 of the bill would result in consistent rules for 401(k), 403(b) and 457 plans. This, in turn, will make the pension system less confusing to plan participants and should result in greater plan participation.

IV. Conclusion
Today’s employer-sponsored retirement plan system has evolved into a complex array of burdensome administrative requirements and restrictive limitations that can serve as barriers to plan formation. Simplification of the rules applicable to employer-sponsored plans and individual retirement savings would result in a greater number of employer-sponsored plans, a higher rate of worker coverage by a pension plan and more opportunities for Americans to save effectively for retirement. The Institute strongly supports the provisions described above and commends the sponsors of H.R. 3788 for supporting reforms of the pension system that will increase plan coverage and encourage Americans to save for their retirement. In our view, passing this legislation is very important.

ENDNOTES

1 The Investment Company Institute is the national association of the American investment company industry. Its membership includes 7,024 open-end investment companies ("mutual funds"), 438 closed-end investment companies, and 9 sponsors of unit investment trusts. Its mutual fund members have assets of about $4.932 trillion, accounting for approximately 95% of total industry assets, and have over 62 million individual shareholders.

2 The typical Baby Boomer household will need to save at a rate 3 times greater than current savings to meet its financial needs in retirement. Bernheim, Dr. Douglas B., "The Merrill Lynch Baby Boom Retirement Index" (1996).

3 Social Security payroll tax revenues are expected to be exceeded by program expenditures beginning in 2013. By 2032, the Social Security trust funds will be depleted. 1998 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

4 EBRI Databook on Employee Benefits (4th edition), Employee Benefit Research Institute (1997).

5 The top-heavy rule is set forth at Section 416 of the Internal Revenue Code. The top-heavy rule looks at the total pool of assets in a plan to determine if too high a percentage (more than 60 percent) of those assets represent benefits for "key" employees. If so, the employer is required to (1) increase the benefits paid to non-key employees, and (2) accelerate the plan’s vesting schedule.

6 Federal Regulation and Its Effect on Business—A Survey of Business by the U.S. Chamber of Commerce About Federal Labor, Employee Benefits, Environmental and Natural Resource Regulations, U.S. Chamber of Commerce, June 25, 1996.

7 Venti, Steven F., "Promoting Savings for Retirement Security," Testimony prepared for the Senate Finance Subcommittee on Deficits, Debt Management and Long-Term Growth (December 7, 1994).

8 Hubbard, R. Glenn and Skinner, Jonathan, "The Effectiveness of Savings Incentives: A Review of the Evidence" (January 19, 1995).

9 Internal Revenue Service, Statistics of Income.

10 Venti, supra at note 7.

11 American Century Investments asked survey participants, who were self-described "savers," ten general questions regarding IRAs. One-half of them did not understand the current income limitation rules or the interplay of other retirement vehicles with IRA eligibility. "American Century Discovers IRA Confusion," Investor Business Daily (March 17, 1997). Similarly, even expansive changes in IRA eligibility rules, when approached in piecemeal fashion, require a threshold public education effort and often generate confusion. See, e.g., Crenshaw, Albert B., "A Taxing Set of New Rules Covers IRA Contributions," The Washington Post (March 16, 1997) (describing 1996 legislation enabling non-working spouses to contribute $2,000 to an IRA beginning in tax year 1997).