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How Much Would You Pay?

Growing up, I remember late night TV programs being punctuated by commercials touting a series of interesting products — everything from a rod-and-reel contraption that would fit in your pocket to a special set of knives that would, apparently, slice through any substance in the known universe without ever having to be sharpened. But unlike the commercials that ran during prime time, having made the pitch, the announcer would lead viewers through a series of additional product extensions, generally with the admonition, “but wait, there’s more …”

Even with all that buildup, as the commercial closed, viewers were reminded of the features of the product and asked, “Now, how much would you pay?” Several possible prices were suggested, then crossed out before the actual price (“plus shipping and handling”) was revealed. Then, to close the deal, viewers were told repeatedly that they could have a second of the same item for the same price (“just pay shipping and handling”).

I’m happy to report that I considered buying more of those offerings than I actually did (albeit somewhat embarrassed to admit to how many I have purchased over the years). The lessons I learned early on were that the product never worked nearly as well at home as it did on television; that you almost never had a good use for the second, “no additional charge” item; and that when you added up all the costs, you frequently found a sizeable gap between what you thought you were paying and the actual bill.

Earlier this year, as part of its 2014 budget proposal, the Obama administration included a cap on tax-deferred retirement savings that would limit the amounts accumulated in specified retirement accounts, including most of the ERISA qualified plan universe (401(a), 401(k), 403(b), certain 457(b), IRAs and — to the surprise of many — defined benefit plan accruals as well).

The proposal would limit the amount(s) accumulated in these accounts to that necessary to provide the maximum annuity permitted for a tax-qualified DB plan under current law, which is currently an annual benefit of $205,000 payable in the form of a joint and 100% survivor benefit commencing at age 62. This, in turn, translates into a maximum permitted accumulation for an individual age 62 of approximately $3.4 million at the interest rates prevailing when the proposal was released. That was the number that many of the initial media reports carried, and that retirement plan advisors (and your plan sponsor clients) may have seen. And, certainly initially, most of the analysis of the proposal’s impact, including that from EBRI’s own unique and extensive databases, was focused on how many individuals had accumulated account balances in excess of $3.4 million — as of today, that is.

However, taking a longer view, and using our proprietary Retirement Security Projection Model,® EBRI’s simulation results for 401(k) participants (assuming no defined benefit accruals and no job turnover) show that more than 1 in 10 current 401(k) participants are likely to hit the proposed cap sometime prior to age 65 — even at today’s historically low discount rates. If you assume discount rate assumptions closer to historical averages, the percentage likely to be affected increases substantially.

As part of the EBRI analysis, EBRI research director Jack VanDerhei also looked at the potential impact of the proposed cap based on two stylized, final-average DB plans and a stylized cash balance plan, along with a number of different discount rate assumptions. As an example, assuming coverage by a DB plan providing 2%, three-year, final-average-pay benefits, with a subsidized early retirement at 62, and assuming an 8% discount rate, nearly a third are projected to be affected by the proposed limit.

VanDerhei also looked at something of particular interest to retirement plan advisors: the potential response of plan sponsors, specifically smaller 401(k) plans (those with fewer than 100 participants), whose owners might reconsider the relative advantages of continuing the plans, particularly in situations where the owner believes that the relative cost/value of offering the plan is significantly altered such that the benefit to the owner is reduced. Since these owners (and their personal circumstances) can’t be gleaned directly from the data, some assumptions had to be made. But, depending on plan size, the EBRI analysis indicates this could involve as few as 18% of small firms (at a 4% discount rate) or as many as 75% of them (at an 8% discount rate).

The administration’s budget proposal estimated that the retirement savings cap would generate an additional $9 billion in revenue. But the question — and one that the EBRI analysis helps policy makers answer, and for a wide range of possible outcomes — is, “How much would it cost?”

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