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WASHINGTON-With Congress poised to give individual retirement accounts new tax breaks, employers will have to do an even better job of communicating the advantages of 401(k) plans to keep up participation levels.
Tax bills passed by the Senate and the House are chock-full of provisions that would make it easier for employees to gain access to funds they have contributed to IRAs without being smacked with tax penalties. The legislation also would give millions of people-specifically the spouses of higher-income employees covered by pension plans-the ability to make tax-deductible IRA contributions.
While some of the proposed IRA tax breaks may be cut back as congressional conferees try to iron out differences in the two bills, the betting is that many of the breaks will remain because of a long-standing congressional interest in boosting retirement savings.
"There is a strong belief among many members of Congress that something has to be done to encourage the personal savings rate," said Stuart J. Brahs, vp-federal government relations with The Principal Financial Group in Washington.
The Clinton administration, though, has expressed concerns about the IRA provisions, especially those relating to IRAs with deferred tax breaks.
The administration believes these so-called back-loaded IRAs would reduce tax revenue too much while disproportionately benefiting higher-income taxpayers.
The popularity of IRAs would be boosted by:
Provisions in both the Senate and House bills that would exempt the current 10% penalty tax on pre-retirement distributions from tax-deductible IRAs if the money is withdrawn to pay for higher educational expenses, such as a child's college tuition. The Senate bill also would waive this penalty for up to $10,000 in funds withdrawn to pay for the purchase of a first home.
Provisions that would allow annual non-tax-deductible contributions of $2,000 a year to a new savings vehicle known as IRA Plus in the Senate bill and American Dream Savings Accounts in the House bill. Funds and accumulated interest in these accounts could be withdrawn tax free if held in the account for at least five years and used for certain purposes, such as purchase of a first home.
A provision in the Senate bill that would make more people with employer-provided pensions eligible to make tax-deductible contributions to IRAs. Under current law, the full $2,000 tax deduction for IRA contributions only is allowed for individuals with adjusted gross incomes of less than $25,000 and joint filers with adjusted gross incomes, or AGI, of less than $40,000.
The $2,000 tax deduction under current law is reduced, based on a sliding scale, for individuals with an adjusted gross income of between $25,000 and $35,000 and joint filers with an AGI of between $40,000 and $50,000.
Under the Senate bill, the income threshold for making the full $2,000 tax-deductible contribution to an IRA would be gradually raised over the next six years. By 2004, an individual with an AGI of up to $50,000 could make the full $2,000 deduction, while a couple filing a joint return with an AGI of $80,000 could make the maximum tax-deductible IRA contribution.
A provision in the Senate bill that individuals without pension coverage would qualify for a tax-deductible IRA regardless of household income or whether the individual's spouse was covered under a pension plan.
Currently, a person without pension coverage is ineligible to maintain a tax-deductible IRA if the individual's spouse is covered by a pension plan and income is above a certain level.
While lawmakers appear ready to bestow a raft of new tax breaks for individuals investing in IRAs, that congressional beneficence doesn't extend to 401(k) plans offered by employers.
Neither the House nor Senate bill, for example, would waive the 10% penalty tax that applies to all withdrawals from 401(k) plans before age 591/2. Indeed, the Senate bill actually would decrease the attractiveness of 401(k) plans for some employees.
The Senate measure now includes an amendment by Sen. Carol Moseley-Braun, D-Ill., that would require written spousal consent before an employee could take money out of a 401(k) plan in any form other than an annuity (BI, June 30).
Despite the boost to IRAs and the slap at 401(k) plans, benefit experts doubt that employees would shun 401(k) plans in favor of IRAs.
"The 401(k) plan still should be on top," said Richard Koski, a benefit consultant at Buck Consultants Inc. in Secaucus, N.J.
That is because most employers match-typically at a rate of 50%-employees' 401(k) salary deferrals, which is a financial windfall that IRAs cannot touch, he said.
"My gut tells me that 401(k)s will remain more attractive than IRAs, especially when there is an employer match," agreed Frank McArdle, a consultant with Hewitt Associates L.L.C. in Washington.
Still, with IRAs becoming more attractive, some employers will have to beef up their 401(k) plans to maintain participation levels.
"There will be more pressure on employers to make 401(k) plans more competitive, such as by adding or improving matches, as well as more investment options," said Ted Benna, president of The 401(k) Assn. in Langhorne, Pa.
Benefit experts say they are concerned, though, about liberalizing rules that limit the pre-retirement withdrawal of funds contributed to an IRA. They say that if access to IRA funds is eased, individuals may not put away enough savings for retirement.
"The problem is we don't save enough for retirement. These proposals are geared to taking money out before retirement," said Margaret-Ann Cole, a principal at The Kwasha Lipton Group in Fort Lee, N.J.
There also is a concern that even if Congress liberalizes IRA contribution rules now, there is no certainty legislators won't change their minds a few years down the road and withdraw any tax advantages.
"While IRAs have been attractive to members of Congress, they have had a real roller coaster history," Mr. McArdle notes.
For example, in 1981, Congress opened up tax-deductible IRAs to virtually all employees. But just five years later-to cut revenue losses against a swelling federal deficit-legislators adopted the current rules that restrict tax-deductible IRA availability to lower-income individuals and those without pension coverage.