"Increasing Retirement Savings"

Before the Committee on Finance
United States Senate

Statement of 
Matthew P. Fink
President
Investment Company Institute

February 24, 1999

Table of Contents
Oral Statement
Introduction
Utilization of Retirement Savings Programs
Legislative Initiatives Would Increase Retirement Savings Opportunities
Conclusion

Oral Statement of Matthew P. Fink

I am Matthew Fink, President of the Investment Company Institute, the national association of the mutual fund industry. We appreciate this opportunity to testify at today’s hearing on increasing savings for retirement and the proposed "Retirement Savings Opportunity Act of 1999."

We commend the Committee for holding hearings on this topic, and recognize the Chairman’s leadership on this issue.

Americans face a profound challenge in preparing to meet their financial needs in retirement. This challenge is particularly pressing in light of the aging of the Baby Boom generation, and the fact that Americans today are living longer.

Providing additional opportunities for Americans to save for retirement is therefore an extremely important national policy objective.

I would like to emphasize two points:

First, based on evidence the Institute has gathered, it appears that Roth IRAs and SIMPLE plans are successfully creating new savings and extending plan coverage. Second, I will identify specific legislative initiatives that would make existing retirement savings programs far more effective.

The new Roth IRA and SIMPLE programs are creating new long-term investors and encouraging people to save for retirement. Although comprehensive data is not yet available, there is significant anecdotal evidence.

We can report the following information with respect to the Roth IRA:

First, we estimate that 3% of all households owned a Roth IRA within the first five months of the Roth IRA program.

Second, 30 percent of Roth IRA owners who were surveyed in May indicated that the Roth IRA was the first IRA they had ever owned.

Third, traditional IRA activity increased in early 1998 by an estimated 12% over the prior year—a positive result that is attributable, I believe, to the intensive educational campaigns about the Roth IRA conducted by financial institutions.

And fourth, the rate at which individuals are establishing Roth IRAs appears to have continued throughout 1998. For instance, one mutual fund firm, which had reported the establishment of 142,000 Roth IRAs as of April 15, had more than tripled that number to 512,000 accounts as of year-end 1998.

Similarly, SIMPLE plans are also being formed and funded at an impressive rate—especially among the smallest of the nation’s employers. Our surveys indicate that 90% of the employers establishing SIMPLE plans had 10 or fewer employees.

The information we have collected suggests that new SIMPLE plan formation has continued unabated in its second year of availability. For instance, at year-end 1998, one mutual fund firm was managing an estimated 23,000 SIMPLE plans and 219,000 accounts. This is more than double the number of SIMPLE plans and four times the number of SIMPLE accounts it had managed a year earlier.

Simplicity and common sense are the keys to the success of SIMPLE plans. This should be kept in mind as Congress reevaluates the complex eligibility requirements for IRA and Roth IRA participation under current law.

The "Retirement Savings Opportunity Act of 1999" contains three highly desirable initiatives.

First, the legislation would restore the simple, universal IRA. The IRA’s extremely complex eligibility rules are a source of confusion and a significant deterrent to broader participation by the public. For example, when Congress restricted the deductibility of IRA contributions in 1986, IRA participation rates declined by 40% among those families who continued to be eligible to fully deduct their contributions.

The lesson is clear. When tax rules are complicated, individuals stop investing. Therefore, we strongly support restoration of the simple, universal IRA.

Second, the legislation would adjust the IRA contribution limit for inflation. If adjusted for inflation, the $1,500 IRA of 1974 would be about $5,000 today. We fully endorse the proposal to increase the IRA limit to that amount.

Third, the legislation establishes a catch-up rule for IRAs and 401(k)s. Many Americans find it difficult to save for retirement when they have more pressing financial obligations. There is a need to create a "catch-up" rule whereby individuals who may have been unable to save during their early working years are able to "catch up" during their remaining working years.

We thank you for the opportunity to present our views on the new Roth IRA and SIMPLE plan programs, and to offer our support for the proposals in the "Retirement Savings Opportunity Act of 1999." We look forward to working with you and the Congress as this legislation moves toward enactment.

Introduction

The Investment Company Institute ("Institute"),¹ the national association of the American investment company industry, appreciates this opportunity to testify at today’s hearing on the "Retirement Savings Opportunity Act of 1999." This bill would expand the opportunities for Americans to save for their retirement in IRAs, 401(k)s and other retirement saving vehicles, simplify rules that have inhibited many Americans from taking advantage of the IRA program, and provide a way for older Americans who may have been unable to save when younger, to "catch up."

Retirement savings are of vital importance to our nation’s future. We commend the Committee for holding hearings on this topic, and recognize the Chairman’s continued leadership on this issue.

The challenge facing 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. These demographic trends will place an enormous strain on the Social Security program in the near future.³ In order to ensure that individuals have the financial resources to support themselves in their retirement years, they will need to actively save for these years. Much of this savings will need to come from individual savings and employer-sponsored plans. Providing additional opportunities for Americans to save for retirement and removing barriers that limit the ability of many individuals to save are, therefore, very important policy goals.

The U.S. mutual fund industry serves the needs of American households investing for their retirement and other long-term financial goals. By permitting millions of individuals to pool their investments in a diversified fund that is professionally managed, mutual funds perform an important financial management role for middle-income families. An estimated 66 million shareholders, representing about 37 percent of all U.S. households, owned mutual funds at year-end 1997.⁴ Many shareholders invest in mutual funds through their retirement plans. Approximately 35 percent of all mutual fund assets are held in tax-qualified retirement plans, of which an estimated $822 billion are IRA investments and $444 billion are 401(k) plan investments. These amounts, measured at year-end 1997, constituted approximately 42 percent of all IRA and 401(k) plan investments.⁵

These programs have been enormously effective for millions of Americans. As I will explain further below, the two newest retirement saving vehicles, the Roth IRA and the SIMPLE plan, also have been successful programs. They are creating new investors saving for retirement and expanding retirement plan coverage. Nevertheless, even with the success of each of these programs—the Roth and traditional IRAs, the 401(k) and SIMPLE plans—specific legislative initiatives would make them even more effective.

The "Retirement Savings Opportunity Act of 1999" contains several of these important initiatives. In particular, the Institute strongly supports those provisions that would (1) eliminate complicated IRA eligibility requirements by restoring the universal IRA, (2) raise IRA contribution limits to account for inflation, and (3) create a "catch-up" rule that would accommodate the actual savings patterns of Americans, many of whom must balance retirement saving activity with the financial obligations of raising a family. These measures would increase IRA and employer-sponsored plan participation and contribution rates and greatly assist individuals seeking to obtain adequate retirement income security.

My testimony will address each of these initiatives in greater detail. I would also like to give some background information on the use of existing retirement savings programs including, in particular, Roth IRAs and SIMPLE plans.

Utilization of Existing Retirement Savings Programs Traditional IRAs and 401(k) Plans

The IRA and 401(k) plan programs have proven to be enormously effective for millions of Americans. A 1998 Institute survey found that an estimated 26 percent of American households now own a traditional IRA, the median account balance of which is $17,500. In those households where the head of household is sixty years old or older, the median account balance is $30,900.⁶ In 1993, the most recent year for which comprehensive, aggregate data (based on tax return information) is available, 52% of all IRA owners earned less than $50,000.⁷ This same group made about 65 percent of all IRA contributions in 1993 (measured in dollars).

An estimated 35.4 million Americans are eligible to participate in 401(k) plans. Based upon accounts of 6.6 million participants in over 27,700 401(k) plans in 1996, the average account balance of a 401(k) plan participant was in excess of $37,300, and the median balance was about $11,600. More than one out of every four participants in their sixties had an account balance in excess of $100,000.⁸

Evidence shows that Americans choose long-term investments for their 401(k) plans and IRAs. For instance, a review of the investment allocations in 6.6 million 401(k) plan accounts indicates that 401(k) plan participants, on average, had invested two-thirds of their account balances in equity securities in 1996.⁹ And according to the Institute’s household survey, two-thirds of traditional IRA owners invested a portion of their IRA in equities, including mutual funds and individual stock.¹⁰ More specifically, of those IRA assets invested in mutual funds, about two-thirds are in stock funds.¹¹

Roth IRA Formation Has Exceeded Expectations and Created New Savers

The Roth IRA, established by the Taxpayer Relief Act of 1997, became available on January 1, 1998. Comprehensive year-end 1998 data on the mutual fund industry’s share of Roth IRA activity, which the Institute presently is collecting from its members, are not yet available. (We will share the data with the Committee as soon as it becomes available.¹² ) We nonetheless can provide evidence of robust use of the Roth IRA from two "snapshots" over the past year. First, Roth IRA account establishment at mutual fund firms in the first quarter of 1998—at the outset of the program—was quite strong. Second, in the final weeks of 1998, when a deadline to convert traditional IRAs to Roth IRAs approached,¹³ members reported unusually heavy volume.

Evidence from First Quarter 1998. As noted above, the Institute conducted a household survey in May 1998. Based on that survey, we estimate that less than five months after the Roth IRA became available, about 3% of all American households owned a Roth IRA.¹⁴ Two-thirds of these accounts were established with new contributions; the remainder were conversions from traditional IRAs. Most significantly, the survey found that the typical Roth IRA owner was 37 years old, significantly younger than the traditional IRA owner, who is about 50 years old, and second, that 30 percent of Roth IRA owners indicated that the Roth IRA was the first IRA they had ever owned. The survey also found that Roth IRA owners typically expected to contribute $2,000—the maximum IRA contribution—to their Roth IRAs in the 1998 tax year.¹⁵

The Institute also polled some of its members to gauge the number of Roth and SIMPLE IRAs established by April 15, 1998. We can share with you examples of individual member responses. One fund complex reported that individuals opened approximately 157,000 contributory Roth IRAs and 95,000 conversion Roth IRAs in first quarter 1998; another fund group reported over 110,000 contributory accounts and 36,000 conversion accounts for this period.

We also found that traditional IRA activity increased in early 1998 by an estimated 12% over the prior year in the period January 1998 through April 15, 1998. This increase can be attributed to three facts. First, financial services organizations have conducted intensive education campaigns about the Roth IRA in all media outlets—TV, radio, print and internet—and this has raised substantially the public’s awareness of IRAs generally. Second, as noted above, the Roth IRA is attracting many new investors, and there has not been any substantial substitution of the Roth IRA for traditional IRAs. Third, there is a general increase in the public’s awareness of the need to accumulate retirement savings.

Evidence from Year-End 1998. Similar reports indicate that activity in December 1998 was strong. In the absence of comprehensive year-end data, we have collected data from specific firms and obtained an anecdotal impression of the strength of consumer interest in this time frame. Based on these data, it appears that the rate of Roth IRA establishment continued through year-end. For instance, one firm, which had reported 142,000 Roth IRA accounts as of April 15, 1998 had more than tripled that number to 512,000 accounts as of year-end 1998. Similarly, another fund complex reported $655 million in Roth IRAs under management as of April 15 and reported $3.7 billion, more than five and one-half times that amount, at year-end. Seven fund groups that have reported year-end data to the Institute themselves have about $12 billion in Roth IRA assets. In addition, one research consultant has estimated that $47 billion flowed into Roth IRAs at mutual funds and other financial institutions in 1998.¹⁶

Consistent with first quarter 1998 findings, firms continue to report that new customers represent a substantial portion of the individuals establishing Roth IRAs. Indeed, one large Institute member indicated that 50% of its Roth IRAs were established by new customers. Similarly, members with both 401(k) and IRA businesses report that it does not appear that individuals are reducing their 401(k) contributions in order to fund Roth IRAs.

In brief, although information is anecdotal at this time, it consistently points to the success of the Roth IRA program and provides an important sign that, although still in its infancy, the Roth IRA attracts new savers and new retirement savings.

SIMPLE Plan Formation Remains Strong Among the Smallest of the Nation’s Employers

Congress established the SIMPLE plan program in the Small Business Job Protection Act of 1996 to make available a simple, easy to use, low-cost retirement plan for the nation’s smallest employers, i.e., those with less than 100 employees.¹⁷ The Institute has found a continued pattern of strong small employer interest in SIMPLE plans over the program’s two-year history. Available data¹⁸ demonstrates two things. First, the SIMPLE plan has been especially popular with the nation’s smallest employers. Institute surveys have indicated that about 90% of those employers establishing SIMPLE plans had 10 or fewer employees. Employers with 25 or fewer employees constitute nearly the entire market.¹⁹ These figures have remained constant across two informal Institute polls, one identifying SIMPLE plan formation as of July 31, 1997 and the other identifying SIMPLE plan formation as of December 31, 1997 and March 31, 1998.

Second, data from this informal polling and more limited year-end 1998 information suggests that new SIMPLE plan formation has continued unabated in the second year of its availability. A comparison of available, firm-specific data indicates that there has not been any decline in the rate at which small employers are establishing SIMPLE plans and, in fact, suggests an increase in the rate of plan formation. For instance, although our poll was not intended to produce scientific estimates, the number of plans reported between year-end 1997 and first quarter 1998 increased over 45 percent; the number of accounts increased by over 60 percent.

More specifically, one firm had almost 10,000 SIMPLE plans and 47,000 SIMPLE accounts as of December 31, 1997. This increased by about 50 percent over the next quarter to about 14,000 plans and 72,000 accounts. By year-end 1998, the firm had an estimated 23,000 SIMPLE plans and 219,000 accounts. Thus, over one year the number of SIMPLE plans had more than doubled and the number of SIMPLE accounts had more than quadrupled. Other firms for which data is available demonstrate similar growth. For instance, for six mutual fund groups reporting year-end 1997 and year-end 1998 data, SIMPLE assets increased four times over the year. An Employee Benefit Research Institute study published in October 1998 similarly demonstrates the effectiveness of the SIMPLE, finding that 12% of small employers with a defined contribution plan report having established a SIMPLE plan over a period of less than 2 years. By comparison, only 9% of small employers surveyed sponsored a SEP, a program that has been available since 1979.²⁰

The success of the SIMPLE program is extremely significant, because the lack of retirement plan coverage in the small employer population has been stubbornly nonresponsive to previous policy initiatives and industry efforts. 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.²¹ Among the reasons for this discrepancy are that small businesses often have limited resources to identify appropriate retirement plan products and to establish and manage these plans.²²

The SIMPLE plan appears to be the solution for many of our smallest employers, because it is easy to explain to employers and employees and inexpensive to establish and maintain. Indeed, simplicity is the key to the SIMPLE’s success. That should be kept in mind as Congress reevaluates the complex eligibility requirements for IRA and Roth IRA participation under current law.

Legislative Initiatives Would Increase Retirement Savings Opportunities Restore the Simple, Universal IRA

We fully endorse proposals in the "Retirement Savings Opportunity Act of 1999" that would simplify the IRA rules by restoring the universal IRA through the elimination of the income limitations on deductibility and substantially raising the income limit applied to Roth IRA conversions. These changes will result in more individuals being eligible for deductible and Roth IRAs. More importantly, these changes will raise participation among those already eligible, but not participating in these programs.

The IRA’s extremely complex eligibility rules continue to be a source of confusion for many Americans and a significant deterrent to program participation. Notwithstanding the success of Roth and traditional IRAs, we believe that the IRA program would be much more effective—even among those now eligible—if these complicated rules were eliminated and the Roth and deductible IRAs were made universally available. Our long experience with the IRA and the SIMPLE teach that saving incentives work best if the rules are simple and consistent.

The original deductible IRA, established in 1974, was available to individuals not covered by an employer-sponsored retirement plan. When Congress introduced universal deductible IRAs in 1982 for all wage earners, IRA contributions grew, rising from less than $4 billion in 1980 to approximately $38 billion in both 1985 and 1986. Remarkably, at the IRA’s peak in 1986, about 29% of all families with a head of household under age 65 had IRA accounts, and 75% of all IRA contributions were from families with annual incomes less than $50,000.²³ Moreover, the median income of those making IRA contributions (expressed in 1984 dollars) dropped by 24 percent, i.e., from over $41,000 in 1982 to below $29,000 in 1986.²⁴ Thus, it is clear that the simple, universal IRA program increasingly was reaching middle-class Americans, and in our view would have continued to do so.

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. For example, contributions fell to $15 billion in 1987 and $8.6 billion in 1996.²⁵ As a result of the 1986 restrictions, many families no longer are able to deduct their IRA contributions, and many may deduct only a portion of their contributions. Even among those 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 technically affect them.²⁶

The lesson is clear. The universal IRA worked, but confusing rules can undermine even the powerful incentive of deductibility. When the tax rules are not simple, individuals are confused. A few years ago, 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."²⁷ Simply put, individuals, even eligible individuals, stop investing when a savings vehicle cannot be easily explained and readily understood.

The IRA program’s complexities continue to undermine its effectiveness. The IRS Publication 590, which explains the IRA program rules to lay persons, now has 82 pages, up from 12 pages in 1981. The numerous income limitations within the IRA program, which are different for the deductible IRA, the nondeductible IRA, the contributory Roth IRA and the conversion Roth IRA, are extremely confusing for lay people and undermine the ability of financial institutions to effectively explain the various types of IRAs to consumers.

The "Retirement Savings Opportunity Act of 1999" solves this problem by restoring the universal IRA. We strongly support this measure.

Adjust the IRA Contribution Limit for Inflation

The Institute endorses the proposal in the bill to raise the IRA contribution limit to $5,000 and to index future increases for inflation. (Similarly, the Institute endorses proposals in the bill that would permit individuals to defer more income into employer-sponsored retirement plans, including 401(k)s, SIMPLEs, and 403(b)s.)

Personal saving, including saving through the IRA program, is a core component of this nation’s retirement income security policy and plays an important role in assuring that individuals have adequate levels of income when they retire. Congress should assure, therefore, that meaningful contribution amounts can be put aside in the IRA program.

Unfortunately, the real value of IRAs has declined significantly over time. The IRA’s initial annual contribution limit was set in 1974 at $1,500 and increased to its current $2,000 level in 1981—eighteen years ago. If adjusted for inflation, the $1,500 IRA of 1974 would be about $5,000 today. The failure of the value of the IRA to keep pace with inflation has disabled many Americans, especially those with no employer-sponsored plan alternative,²⁸ from accumulating retirement savings that they will need to have a secure retirement.

Moreover, of those individuals actively contributing to an IRA in 1997, the median contribution was close to the $2,000 maximum.²⁹ This suggests that if the limit were raised, many individuals would take advantage of it.

Adopt Catch-Up Rules For IRAs And 401(k)s

Many Americans cannot always take full advantage of the IRA and employer-sponsored retirement saving programs for which they may be eligible. In particular, many Americans find it difficult to save for the long-term goal of retirement income security when they have more pressing financial obligations, including purchasing a home, raising a family, and providing college education for their children. Additionally, because of the demands of child-rearing, individuals often leave the workforce for extended periods. All these circumstances reflect the need to create a "catch-up" rule for employer- sponsored plans and IRAs whereby individuals age 50 and older can increase their annual contributions. The idea is to allow individuals who may have been unable to save during their early working years to "catch up" for lost time during their remaining working years.

The catch-up proposal is an excellent idea, because it responds directly to the needs of today’s workforce and the actual savings pattern of many Americans. The laws governing retirement saving vehicles must be flexible enough to permit working Americans to make additional retirement contributions when they can afford it. The bill contains such a provision, which the Institute strongly supports. Importantly, the proposal is commendable in that it provides a simple rule that will be easy to understand and administer.

Conclusion

Today’s targeted individual retirement vehicles, such as IRAs and 401(k) plans, help millions of Americans secure their future retirement through long-term investment. The new Roth IRA program is extremely popular. It has encouraged younger individuals, who have never before contributed to IRAs, to begin to accumulate personal retirement savings. Moreover, the successful appeal of the Roth IRA appears to have also had a positive effect on traditional IRA participation. Similarly, the IRA-based SIMPLE plan continues to be successful among the nation’s smallest employers. The SIMPLE has been successful because it is easy to explain, simple to establish, and inexpensive to maintain.

Lessons learned from the SIMPLE’s success and from the impact of complex eligibility limitations on all IRAs should encourage Congress to eliminate these confusing rules in order to encourage IRA participation. In addition, IRA contribution limits should be adjusted to keep pace with inflation and reflect the fact that the average IRA contribution is now close to the maximum limit. Adjusting this and other similar retirement plan limits will encourage individuals to save adequately. Finally, Congress should enact a "catch-up" rule that would respond directly to the needs of today’s Americans.

We are pleased that the "Retirement Savings Opportunity Act of 1999" contains all of the foregoing provisions, and we therefore enthusiastically support its enactment.

Endnotes