GAO report -- who benefits from retirement plan tax incentives?

May 11, 2011

On April 29, 2011, the Government Accountability Office (GAO) released a report PRIVATE PENSIONS Some Key Features Lead to an Uneven Distribution of Benefits. The report explicitly addresses issues that critics have raised, focusing on the issues of who benefits from current retirement savings tax incentives and whether the incentives achieve certain goals, including increased retirement plan formation. In this article we review the report in detail.


The report was requested by Congressmen Charles Rangel (D-NY), Sander Levin (D-MI) and Richard Neal (D-MA) in 2008, at which time Congressman Rangel was Chairman of the House Ways and Means Committee. Congressman Rangel has since resigned from the chairmanship and political control of the committee has changed hands. The report is therefore in the form of a letter to the three Congressmen, all of whom remain members of Ways and Means. (Congressman Levin is the ranking member of the Ways and Means Committee and Congressman Neal is the ranking member on the Subcommittee on Select Revenue Measures of the Ways and Means Committee.)

The report addresses four issues:

1. What has been the trend in new private pension plan formation in recent years?

2. What are the characteristics of DC participants contributing at or above the statutory DC contribution limits and how might this have changed as the limits have increased?

3. How might incentives to increase retirement saving by low-income workers through modifications of the Saver's Credit affect retirement income?

4. What might be the long-term effect of the recent financial crisis on retirement savings for U.S. workers?

For the most part, the report focuses on data, although, with respect to item 3, it does discuss policy alternatives. But the data clearly "tells a story."

What has been the trend in new private pension plan formation in recent years?

GAO surveyed data for plan formation/termination for the period 2003 to 2007 (the most recent data available to it). With respect to the total number of plans, GAO found: "Each year [during that period] private employers created thousands of new retirement plans. However, the total number of private employer-sponsored retirement plans has increased only slightly because the gains from these newly formed plans were largely offset by other plan terminations."

Not surprisingly, most plan formation and plan termination activity is among small plans. Overwhelmingly (92 percent) of the new plans being formed are defined contribution plans. And the formation of new defined benefit plans is concentrated in "just four kinds of professional businesses -- doctor's offices, dentist's offices, lawyer's offices, and noncategorized professional services ...."

You would think that the most obvious and significant coverage statistic would be how many workers participated in a retirement plan over the relevant period. The report does not address that question.

What are the characteristics of DC participants contributing at or above the statutory DC contribution limits and how might this have changed as the limits have increased?

Let's begin the discussion of this section of the report with some context: As part of the 2001 Tax Relief Act (the "Bush tax cuts"), limits on contributions to 401(k) plans were increased, and participants 50 and over were allowed to make additional "catch-up" contributions. The Congressmen requesting the GAO report clearly were interested in whether those increases "paid off" and who they paid off for. GAO's conclusion is: "DC Participants with High-Incomes and Other Assets Benefited the Most from Increases in Contribution Limits."

GAO offers a variety of data in support of this conclusion.

"Most of these participants whose contributions [to DC plans] were at or above the [Tax Code contribution] limits were high-earners .... We estimated that about 72 percent of them had individual earnings at the 90th percentile ($126,000) or above for all DC participants."

"We also found that most DC participants who made contributions at or above the 2007 statutory limits came from households with other assets in addition to their DC accounts. ... For example, 90 percent of these participants came from households that owned a home and 60 percent came from households holding stocks."

"Thirty-eight percent of [participants benefiting from the 2002 increase in 401(k) contribution limits] had individual earnings at the 90th percentile ($126,000) or above and 20 percent had individual earnings at the 95th percentile or above ($180,000)."

"[W]e found that the savings of those who made contributions at or above the [contribution] limits represented a substantial portion of all savings among DC participants .... When we compared 2007 contributions to the 2001 limits, we found that an estimated 14 percent of participants in 2007 contributed at or above the 2001 limits and these participants held an estimated 41 percent of all DC savings in 2007."

In addition, GAO tentatively concluded that the Tax Relief Act contribution limit increases did not increase plan formation:

"Some industry groups have suggested that the increases in the contribution limits could motivate employers to sponsor new pension plans, according to our past work. While the number of new plans formed has risen since 2003 ... the rate of increase has been small overall, and the total number of plans actually declined from 2003 to 2005 .... Further, from 2003 to 2007 the total number of pension plans has remained relatively constant at about 700,000 plans, suggesting that there is no net increase in plans. Other factors may have been at work, but at a minimum, the number of pension plans and the number of workers covered by pension plans has remained relatively steady."

Finally, let's note that this section of the report only addresses defined contribution plans. It appears likely that DC plans will be the focus of any tax reform effort. DB plans seem to be perceived as "broader based" and to some extent a legacy. Reading between the lines of the GAO report, if there is any DB plan tax incentive targeted in a tax reform project it would be those for doctors, dentists and lawyers.

How might incentives to increase retirement saving by low-income workers through modifications of the Saver's Credit affect retirement income?

The Tax Relief Act included a non-refundable income tax credit for contributions made by eligible taxpayers to a qualified retirement plan -- the "Saver's Credit." Generally, proposals to expand the Saver's credit include (1) making it a refundable credit (so participants paying no taxes can get a credit) and (2) raising the income limits (so more, slightly-higher income taxpayers can get a credit).

GAO modeled outcomes for three different Saver's Credit expansion proposals

Refundable Saver's Credit

Refundable Saver's Credit with an increase in the AGI limits

Refundable Saver's Credit with an increase in the AGI limits and automatic enrollment

Summarizing, GAO simulation model indicates that the annual benefit of relevant workers is increased under various Saver's Credit proposals from $204 on the low end to $917 on the high end. GAO's conclusion: "Under our three scenarios, the average increases for all Saver's Credit recipients were not substantial."

Critical to any discussion of the Saver's Credit is the issue of cost. Here's GAO's estimate:

"We found that the cost to the federal government of providing the credit for all qualified contributions to DC plans ranged from $6.7 billion to $14.8 billion under our three scenarios …. While the aggregate cost to the government of the refundable Saver's Credit scenario was about $6.7 billion, the cost more than doubled when the AGI limits were increased and automatic enrollment was added."

More relevant for any Saver's Credit legislation will be how the Congressional Budget Office "scores" the cost. It's unlikely that an expansion of the Saver's Credit will be adopted by Congress unless and until policymakers can determine a way to pay for it.

Finally, for background, here's GAO’s description of its methodology for modeling the effects of different changes to the Saver's Credit:

"To analyze how suggested incentives to increase retirement saving by low-income workers might affect retirement income, we used the Policy Simulation Group's (PSG) microsimulation models to run various simulations of workers saving in DC plans over a career, changing various inputs to model different scenarios for modifying the Saver's Credit. PSG's Pension Simulator (PENSIM) is a pension policy simulation model that has been developed for [the Department of] Labor to analyze lifetime coverage and adequacy issues related to employer-sponsored pensions in the United States."

What might be the long-term effect of the recent financial crisis on retirement savings for U.S. workers?

A lot of analysts have taken a crack at this question -- the long-term effect of the recent financial crisis on retirement savings. GAO's conclusion: it's still unclear. Quoting the report, "Relevant and up-to-date data on the effect of the financial crisis on retirement saving are limited and analyses to date have drawn varied conclusions." Specifically:

Changes in contribution rates or asset allocation: One large fund manager reported that both deferral rates and asset allocation remained relatively stable over the period following the crisis. "Other research, however, suggests that portfolio reallocations may have been more frequent during the last several years than otherwise believed."

Reduction in matching contributions: "As a result of the financial crisis and economic downturn some plan sponsors reduced or suspended employer matching contributions and a large number of employees have been affected by these reductions." But -- "[s]urveys of plan sponsors indicate that between 40-50 percent of plans that had previously suspended employer matching contributions, particularly those at large firms, have more recently reinstated their matches ...."

Leakage: "Data, including some plan data, indicate that while the percentage of participants taking out loans or hardship withdrawals from DC plans remains relatively small, it has increased in the past couple of years since the financial crisis." But -- "[w]hile the rates of loans and hardship withdrawals may not have increased sharply after the financial crisis, if the economy is slow to recover and unemployment stays high, this type of leakage may increase if participants experiencing reduced wages or facing other personal difficulties need access to any available financial resources."


As the GAO states in the first paragraph of the main body of the report, "Today, ... pension tax incentives are the second largest tax expenditure ...." As one industry group (the American Benefits Council) has put it, "the prominence in the federal budget of incentives to encourage sponsorship of, and participation in, health and retirement benefit plans means that the full range of these issues will be 'in play' as Congress examines budget and tax reform."

The data and conclusions provided by GAO in this report are likely to play a role in debates by policymakers about whether the current system of retirement savings tax incentives is "fair" and "worth it."

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