Credit boosts plan participation among low-income workers

Author: Kevin Sweeney

Published: September 15, 2003

Though it has received little fanfare amid other retirement initiatives, a provision of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) has garnered significant attention from non-highly compensated employees.

Contingent on the contribution to a 401(k) or IRA, certain segments of this population are eligible for the "saver's credit," a federally funded match of up to $1,000. According to the Brookings Institution, the credit was claimed on almost 3.5 million income tax returns in 2002, the first year that it was available.

One of the credit's main purposes - to drive retirement participation among low- and middle-income workers - is apparently coming to realization. A June 2002 survey by Diversified Investment Advisors found that 71% of plan sponsors associate the provision with higher participation. Of those, 18% reported a major participation surge. "I personally thought it would not be enough to suddenly motivate someone to participate in a retirement vehicle," notes Laurie Fleischman, VP of Marketing for Diversified Investment Advisors. "But plan sponsors are dealing with more participants asking about this legislation."

In fact, the legislation originally was written to benefit more people. It underwent final tweaks to satisfy the corporate and financial communities, eliminating some key components that would extend the benefit to a broad employee base.

"The credit was intended to be available to virtually every moderate- and lower-income worker who is saving," says Mark Iwry, former Treasury benefits tax counsel and a current senior fellow at the Brookings Institution. "A majority of that population pays employment taxes but has no income tax liability. In order to reach this large target population, the credit was designed to be refundable. Unfortunately, that feature was dropped during the legislative process. It needs to be restored."

Fleischman, however, questions the overall impact that extending the provision to all low-income workers would have, noting "if you are not making enough money to [pay] income taxes, you are probably not looking at tax-advantaged ways to retire."

Through the saver's credit, eligible taxpayers obtain a dollar-for-dollar tax credit worth 10%, 20% or 50% of the amount they contribute to a retirement savings account such as a 401(k) or IRA (limit of $2,000). The percentage is determined by filing status and income level.

Tax services provider H&R Block claimed the saver's credit tax for roughly 1.3 million of its clients in 2002. The company estimates the credit generated $231 million in savings for its clients. To spread the word, H&R Block enlisted its tax professionals to communicate the savings potential to eligible employees.

"In one regard, the financial services market is not very efficient, so you don't hear a lot of broad advertising," indicates Bernie Wilson, VP of product management for H&R Block. "The majority of our clients learned of the provision through tax preparer relationships."

Expansion and extension

Aside from the savers' credit, all of the EGTRRA provisions were granted a 10-year life. As it currently stands, the saver's credit is set to expire after 2006.

Iwry contends that the credit was only given a five-year window because it had less financial political backing than other EGTRRRA provisions. He argues that for the benefit to have real impact in the long-term, an extension is necessary.

"Ironically, the one pension provision of EGTRRA that was actually targeted to the majority of the working population was also the only provision singled out to sunset after five, rather than 10 years," Iwry says. "Yet the saver's credit was not designed to be a short-term or temporary provision any more than any other saving incentive."

Iwry says there is widespread support for expansion of the main objectives of the credit. They are:

• To help address the fact that some 75 million workers and their spouses have no employer plan coverage
• To help adjust top-heavy distribution of benefits in our current pension system
• To counteract what might be the central defect of our pension tax incentive structure - incentives (mainly exclusions from income of contributions and earnings and tax deductions) based on the individual's marginal income tax rate.

Iwry contends that if the saver's tax credit were refundable (the credit can be paid in cash if it surpasses the tax bill), it would put low- and middle-income workers on a more level playing field with highly compensated employees.

While the credit was designed to boost employee participation, it was also enacted to encourage the establishment of 401(k) plans among new employers. Companies reluctant to adopt 401(k) plans due to the inability to provide a match can consider the saver's credit as having the same effect.

"I think there is broad support for expansion and extension of the saver's credit," Iwry explains. "People recognize its importance in furthering the central purpose of our pension tax expenditure: providing retirement security and encouraging long-term saving by those who need it the most."

As a result of the saver's credit, this segment of the employee population may feel more retirement empowered and continue to boost overall participation in retirement vehicles.

"As you look at [past] studies, participation has decreased because many workers feel they don't have a stake in the stock market or they feel tight financially," observes Kathy Burlison, H&R Block's program manager for product development. "This provision makes employees feel good about themselves because they started an IRA [or are contributing to a 401(k)]."

Wilson predicts that as awareness of the provision begins to spread, heightened participation in 401(k) plans will continue. Iwry says sponsor communication will be key to the continued early success of the saver's credit.

"Sponsors are encouraged to notify employees that the credit is available as part of their efforts to encourage 401(k) participation, and Treasury/IRS has issued a model notice employers can use if they wish," he notes. The IRS even put out a Spanish language version. And the plan sponsor has no additional costs, administrative burdens or responsibilities. Indeed, the credit was designed to be the proverbial "win-win" arrangement."