Statement of the
Investment Company Institute

For the Hearing on
Tax Code Simplification

Submitted to the
House Committee on Ways and Means
Subcommittee on Oversight
Subcommittee on Select Revenue Measures

July 31, 2001

The Investment Company Institute (the "Institute")¹ is pleased to submit this statement to the House Committee on Ways and Means Subcommittee on Oversight and Subcommittee on Select Revenue Measures for the first in the series of hearings on the need for simplification of the Internal Revenue Code and review of the Joint Committee on Taxation's study of the overall state of the Federal tax system. In its study, the Joint Committee recommended a number of simplifications that would affect retirement savings vehicles and other long-term savings vehicles, including education savings vehicles. The Institute strongly supports efforts by Congress to simplify the rules applicable to retirement and other long-term saving incentives, thereby increasing opportunities for Americans to save for their retirement and other long-term goals, including saving for their children's education.

Approximately 88 million Americans use mutual funds to save for retirement and other long-term financial needs. Two-thirds of all mutual fund owners have household income under $75,000.² Mutual funds are a significant investment medium for employer-sponsored retirement programs, including section 401(k) plans, 403(b) arrangements and the Savings Incentive Match Plan for Employees ("SIMPLE") used by small employers, as well as for individual savings vehicles such as the traditional and Roth IRAs. As of December 31, 2000, mutual funds held about $2.4 trillion in retirement assets, including $1.2 trillion in Individual Retirement Accounts ("IRAs") and $766 billion in 401(k)s. We estimate that about 46% of all IRA assets and 45% of all 401(k) assets are invested in mutual funds.³

For savings incentives to work, the rules need to be simple. All too often, however, frequent legislative changes have led to complicated tax rules that are extremely difficult for taxpayers to understand. Frequent changes in law also create uncertainty. These considerations are important not only to taxpayers, but to financial institutions when they are considering whether to make long-term business commitments. Take, for example, changes to pension laws. Since the passage of the Employee Retirement Income Security Act in 1974, there have been over a dozen major amendments to pension laws and the related tax code sections. Since 1994 alone, Congress has passed five substantial pieces of pension-related tax legislation-the Uruguay Round Agreements Act of 1994, the Uniform Services Employment and Reemployment Rights Act of 1994, the Small Job Protection Act of 1996, the Taxpayer Relief Act of 1997 and the Economic Growth and Tax Relief Reconciliation Act of 2001. A number of these legislative changes, many supported by the Institute, have provided new opportunities for saving by increasing contribution limits to plans and IRAs and creating new savings vehicles, including Roth IRAs, SIMPLE plans and 529 plans. Many amendments to our pension laws, however, also have added unnecessary complexity and administrative burdens that serve as a disincentive to employers to sponsor retirement plans and to individuals to save for retirement. Easing these burdens will promote greater plan coverage and result in increased retirement savings.

The Institute has long supported efforts to enhance retirement savings and other long-term savings for Americans, including efforts that would simplify the rules applicable to IRAs and qualified plans, and enable individuals to better understand and manage their retirement assets. In general, we support the recommendations contained in the Joint Committee's report regarding simplification of various retirement and education savings vehicles. While the report made numerous recommendations worthy of support, we focus our testimony on three basic areas: (1) IRA eligibility rules; (2) individual account plan rules; and (3) education savings vehicles.

I. IRA Eligibility Rules
The Joint Committee's report recommends eliminating phase-outs relating to IRAs and eliminating the income limits on the eligibility to make deductible IRA contributions, Roth IRA contributions and conversions of traditional IRAs to Roth IRAs. The Joint Committee also recommends that the age restrictions on eligibility to make IRA contributions should be the same for all IRAs. Further, the Joint Committee recommends eliminating the nondeductible IRA. The Joint Committee's report states that the IRA recommendations would reduce the number of IRA options and conform the eligibility criteria for remaining IRAs, thus simplifying taxpayers' savings decisions. We strongly support these changes. We wish to emphasize, however, that the nondeductible IRA should be eliminated only if the other recommended changes are made.

Simplification of the IRA rules responds to an urgent need. Current IRA eligibility rules are so complicated that even individuals eligible to make a deductible IRA contribution are often deterred from doing so. When Congress imposed the current income-based eligibility criteria in 1986, IRA participation declined dramatically-even among those who remained eligible for the program. At the IRA's peak in 1986, contributions totaled approximately $38 billion and about 29% of all families with a household under age 65 had IRA accounts. Moreover, 75% of all IRA contributions were from families with annual incomes of less than $50,000.⁴ However, 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 1995.⁵} Even 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.}⁶ The number of IRA contributors with income of less than $25,000 dropped by 30% in that one year.⁷

Indeed, fund group surveys show that almost fifteen years later, many individuals continue to be confused by the IRA eligibility rules. For example, in 1999 American Century Investments surveyed 753 self-described retirement savers about the rules governing IRAs. The survey found that changes in eligibility, contribution levels and tax deductibility have left a majority of retirement investors confused.⁸ This confusion is an important reason behind the decline in contributions to IRAs from its peak in 1986.

For these reasons, the Institute strongly supports a repeal of the IRA's complex eligibility rules, which serve to deter lower and moderate income individuals from participating in the program. A return to the "universal" IRA would result in increased savings by middle and lower-income Americans.

The return of the "universal IRA," together with the availability of the Roth IRA, would eliminate the need for the nondeductible IRA-thus, further simplifying the IRA program. However, it is important to note that, in the absence of the Joint Committee's other changes, the nondeductible IRA serves an important purpose-enabling those individuals not eligible for a deductible or Roth IRA to save for retirement. Consequently, the nondeductible IRA should be eliminated only if Congress repeals the income limits for traditional and Roth IRAs.

II. Individual Account Plan Rules
Employer-sponsored retirement plans are a key part of the system of incentives and opportunities we provide for American workers to save for their retirement. However, as is the case with IRAs discussed above, the complexity of the rules applied to employer-sponsored plans frequently deters employers from establishing plans and workers from using them. By simplifying the rules governing retirement plans, Congress would encourage retirement savings.

The Joint Committee's recommendations, in part, focus on the rules applicable to various individual account type programs. This is a good place to start, as many Americans are confused by the various plan types, each with its own set of rules. Specifically, the Joint Committee recommends conforming the contribution limits of tax-sheltered annuities to the contribution limits of comparable qualified retirement plans. The Joint Committee notes that conforming the limits would reduce the recordkeeping and computational burdens related to tax-sheltered annuities and eliminate confusing differences between tax-sheltered annuities and qualified retirement plans. The Joint Committee also recommends allowing all State and local governments to maintain 401(k) plans. This, according to the Joint Committee's report, would eliminate distinctions between the types of plans that may be offered by different types of employers and simplify planning decisions. Indeed, Congress recently acted on some of these recommendations in recently enacted tax legislation.⁹ More, however, can be done to simplify these plans and their rules.

The Institute supports such efforts to reduce the complexity associated with retirement plans-especially for workers, who struggle to understand the differences between 401(k), 403(b) and 457 plans. The ability of workers to understand the differences among plan types has become even more important as a result of the enactment of the portability provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001.¹⁰ These provisions 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 and 457 state and local government plans and IRAs. The Institute strongly supports efforts by Congress to simplify and conform rules that apply to different plan types in order to assist workers in understanding their retirement plans.

III. Education Savings Vehicles
The Joint Committee recommends several simplifications related to education savings vehicles. First, the Joint Committee recommends eliminating the income-based eligibility phase-out ranges for the HOPE and Lifetime Learning credits. As with IRAs, we believe the phase-outs unnecessarily complicate these programs and serve to deter participation among those eligible.

Second, the Joint Committee recommends that a uniform definition of qualifying higher education expenses should be adopted. A uniform definition would eliminate the need to taxpayers to understand multiple definitions if they use more than one education tax incentive and reduce inadvertent taxpayer errors resulting from confusion with respect to the different definitions.

Third, the Joint Committee also supports simplifying the HOPE and Lifetime Learning credit programs by combining them into a single credit. Combining the two credits would reduce complexity and confusion by eliminating the need to determine which credit provides the greatest benefit with respect to one individual and to determine if a taxpayer can qualify for both credits with respect to different individuals. If Congress considers implementing this recommendation, it should take care not to reduce the total benefits available to individual taxpayers under the programs.

Finally, the Joint Committee recommends eliminating the restrictions on the use of education tax incentives based on the use of other education tax incentives and replacing them with a limitation that the same expenses could not qualify under more than one provision. The Joint Committee states in its study that this recommendation would eliminate the complicated planning required in order to obtain full benefit of the education tax incentives and reduce "traps for the unwary." We note, however, that Congress has improved the coordination of the HOPE and Lifetime Learning credits as a result of the recently passed tax legislation.¹¹

We support Congress's efforts to simplify the rules applicable to various education savings vehicles. Savings for their children's education is a top priority for many working Americans. We applaud efforts to streamline the rules relating to education tax incentives. By reducing the complexity surrounding these various tax incentives and education savings vehicles, Congress will enable more Americans to take advantage of opportunities to save for their children's education.

IV. Conclusion
Today's individual and employer-sponsored retirement system has evolved into a complex array of burdensome requirements and restrictive limitations that can serve as barriers to retirement savings. The same holds true for education savings programs. Simplifying the rules relating to retirement and education savings vehicles would encourage greater savings by American workers.

¹ The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,444 open-end investment companies ("mutual funds"), 490 closed-end investment companies and 8 sponsors of unit investment trusts. Its mutual fund members have assets of about $6.868 trillion, accounting for approximately 95% of total industry assets, and over 83.5 million individual shareholders.

² "U.S. Household Ownership of Mutual Funds in 2000," Fundamentals, Vol. 9, No. 4 (Investment Company Institute, August 2000).

³ "Mutual Funds and the Retirement Market," Fundamentals, Vol. 10, No. 2 (Investment Company Institute, June 2001).

⁴ Venti, Stephen F. "Promoting Savings for Retirement Security," Testimony prepared for the Senate Finance Subcommittee on Deficits, Debt Management and Long-Term Growth (December 7, 1994).

⁵ Internal Revenue Service, Statistics of Income.

⁶ Venti, supra at note 4.

⁷ Internal Revenue Service, Statistics of Income.

⁸ American Century Investments, as part of its "1999 IRA Test," asked 753 self-described retirement "savers" ten general questions regarding IRAs. Only 30% of the respondents correctly answered six or more of the test's ten questions. Not a single test participant was able to answer all ten questions correctly.

⁹ See, for example, Sections 611 and 615 of the Economic Growth and Tax Relief Reconciliation Act of 2001.

¹⁰ See Sections 641 - 643 of the Economic Growth and Tax Relief Reconciliation Act of 2001.

¹¹ See Sections 401(g) and 402(b) of the Economic Growth and Tax Relief Reconciliation Act of 2001.