Savings Cap Could Affect Up to 5% of Participants

In statements released ahead of its official publication, the White House has noted that the budget will include a new proposal that prohibits individuals from accumulating more than $3 million in individual retirement accounts (IRAs) and other tax-preferred retirement accounts. Analyses from the Employee Benefit Research Institute (EBRI) suggest this could potentially affect up to 5% of retirement plan participants.  

In the EBRI IRA database at year-end 2011, approximately 0.03% of the approximately 20.6 million accounts had more than $3 million in assets. About 0.06% of the total account holders (some individuals own more than one account), and about 0.11% of account holders who are age 60 or older surpass the threshold. Of the individuals with IRA balances above $3 million, 37% were age 70 or older and another 20% were ages 65 to 69 (50% and 26%, respectively, for those with known ages in the database).     

Individual savers increasingly find themselves having not only a 401(k), but an IRA as well, and in many cases multiple savings accounts. Taking into account combined IRA and 401(k) balances, a review of the integrated EBRI IRA/401(k) database as of year-end 2011 for individuals age 60 or older who had at least one IRA or 401(k) in 2010 and at least one IRA or 401(k) in 2011 finds that about 0.107% of these individuals had balances totaling $3 million or more.    

EBRI said it should be noted that these numbers are at a particular point in time, based on the most current data available. Those balances will change over time, and inflation is expected to increase the level of the cap. The Employee Benefit Research Institute’s Retirement Security Projection Model (RSPM) allows EBRI to estimate what the potential future impact could be, particularly for younger workers not currently on the cusp of retirement.     

Looking at participants in the EBRI/ICI 401(k) database with account balances at the end of 2011 and contributions in that year, assuming no change in asset allocation over their future career, real returns of 6% on equity investments, and 3% on non-equity investments, 1% real wage growth, and no job turnover, 0.9% of those 401(k) account balances would be affected by a $3 million cap (adjusted for inflation).    

However, EBRI said, it is not enough to examine just those balances that are at a specific point in time. The retirement plan account savings cap in the White House budget proposal is reportedly tied, not to a hard dollar limit, but rather one that would finance, in 2013, an annuity of $205,000 per year in retirement, the current IRC 415(b) annual benefit limit for defined benefit pension plans. The corresponding account balance threshold would fluctuate over time, based on discount rates—and that means that the number of accounts that could exceed the threshold in the future could be significant. For example, based on a time series of annuity purchase prices for males age 65 going back to late 2006, the actuarial equivalent of the $205,000 threshold could be as low as $2.2 million.  

At that level, 2.99% of 401(k) accounts are projected to be impacted. Of course, a higher interest rate environment could result in an even lower cap threshold. Time, which allows savings to accumulate in these accounts, tends to increase the probability that younger workers will reach the inflation adjusted limits by the time they reach age 65, with 2.2% of those currently ages 26 to 35 affected by the $3 million cap (adjusted for inflation), compared with just 0.1% of those ages 56 to 65.   

At the $2.2 million level cited above, 6% of younger retirement savers would be affected by age 65, compared with 0.3% of those ages 56 to 65. Additionally, when age adjustments are factored into asset allocation, 4.2% of those ages 26 to 35 would be affected by a $2.2 million cap. Those closer to retirement would be less likely to exceed the threshold by the time they reach age 65.     

The impact of the proposed cap also varies by age and tenure. For example, at the $3 million level (adjusted for inflation), 1.4% of workers currently ages 26 to 35 with five to nine years of tenure would be affected, while 5.2% of workers in that age and tenure cohort would be affected by a $2.2 million cap (adjusted for inflation).  

EBRI noted that its analysis does not yet consider the administrative complexities of implementation and monitoring such a cap, nor does it take into account the potential response of individual savers and their employers to such a change in tax policy. The latter consideration is of particular importance in considering the implications of tax policy changes to the current voluntary retirement savings system.       

Once details of the proposal are available, EBRI will perform additional analysis on these additional considerations.