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Changing Taxation of 401(k)s Could Discourage Savings, Sponsors

Many companies would drop 401(k) plans or consider dropping them, according to American Benefits Council survey. (Robyn Credico of Towers Watson)

By Susan Kelly | Updated on December 14, 2012
James Klein of American Benefits councilAs politicians search for a way to avoid the fiscal cliff, the tax benefits awarded to defined-contribution retirement plans such as 401(k)s look like a tempting source of new revenue. But a recent survey shows changes in the tax treatment of 401(k) plans could discourage employees from saving and lead some companies to discontinue plans.

According to an American Benefits Council survey of more than 500 companies, 91% of those surveyed say the fact that employees’ 401(k) contributions are excluded from current income tax is either very important or somewhat important in their decision to contribute to the plan, and 73% say employees contribute more to the plan than they would otherwise because of the tax situation.

The survey asked companies about three different options for altering the tax treatment of 401(k) contributions. One would subject both the employer and employee contributions to income tax but give workers an income tax credit equal to some portion of their annual contribution; the survey used 25%. Another approach, the “20-20” proposal, would limit the total of the employee and employer’s contributions to the employee’s account to the lesser of $20,000 a year or 20% of the employee’s compensation. A third option, the tax exclusion limit, would affect only workers in the top, 35% tax bracket; by capping their tax benefit at 28%, it would require those employees to pay 7% tax on their 401(k) contributions.

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