"We tell people to build a foundation for retirement, but we don't give them all the tools they need to do it," Grassley said. "The legislation I'm introducing today will make it easier for working Americans to save money for retirement. It will help them set aside money from each paycheck with a smaller bite from the IRS."
Grassley introduced the Enhanced Savings Opportunities Act as chairman of the Senate Special Committee on Aging. The bill lifts the limit on employer and employee contributions to pension plans. Under the Internal Revenue Service code, contributions to a pension plan are limited to 25 percent of compensation or $30,000 for each participant, whichever is less. That limitation applies to all employees. If the total additions to the pension plan exceed the lesser of 25 percent or $30,000, the excess money is subject to income taxes and a penalty in some cases.
The 25 percent limit impacts low and mid-salary workers unfairly, Grassley said. He gave two examples:
Example #1: Bill's employer sponsors a 401(k) plan and a profit-sharing plan to help employees save for retirement. Bill makes $25,000 a year and elects to put in 10 percent of his compensation into the 401(k) plan, which amounts to $2,500 per year. His employer will match the first 5 percent of his compensation, which comes out to be $1,250, into the 401(k) plan. Bill's employer also sets aside profits to the profit-sharing plan, which results in an allocation to Bill's account in the profit-sharing plan the sum of $3,205. This brings the total contribution into Bill's retirement plan this year up to $6,955.
Unfortunately, because of the 25 percent of compensation limitation, only $6,250 can be put into Bill's account for the year. The amount intended for Bill's account exceeds that limitation by $705. Hence, the profit-sharing plan administrator must reduce the amount intended for allocation to Bill's account by $705 in order to avoid a penalty. Bill's retirement savings is shortchanged by $705 plus the tax-deferred earnings it would have generated.
Example #2: Irene works for the same company, but she makes $45,000 a year. She also puts in 10 percent of her compensation into the 401(k) plan, and her employer matches 5 percent of her salary into the account. That brings the combined contribution of Irene and her employer up to $6,750. She would also receive a contribution of $3,205 from the profit-sharing plan. This brings the total contribution into Irene's pension plan for that year to $9,955. She is also subject to the 25 percent limit, but for Irene, her limit would not be reached until $11,200. She is able to put in her 10 percent, receive the 5 percent match and receive the full amount from the profit share because her amount doesn't exceed the limit.
"Despite the fact that in these examples Bill and Irene have the same discipline to add to their pension plans and save for their retirements, Bill is penalized by the 25 percent limit," Grassley said. "By lifting the 25 percent limit, we can provide a higher threshold of savings for those who need it most."
Under current law, employees making $120,000 or more have their pension contributions capped at the fixed $30,000 limit, Grassley said. The 25 percent limit only applies to those who make less than $120,000. This results in lower paid employees not being able to save as much for their retirement as their high paid counterparts, he said.
Lifting the 25 percent limit also will help women catch up on their retirement savings, Grassley said. Studies show that women are more likely than men to live out the last years of their retirement in poverty for a number of reasons, including that women live longer than men and traditionally have been paid less money than men.
"This legislation is an important step in helping Americans reach their goals for retirement," Grassley said. "I look forward to continuing my work to help individuals improve their income security and quality of life in retirement."
Sens. Orrin Hatch of Utah, John Breaux of Louisiana, Bob Graham of Florida, Max Baucus of Montana, and Jim Jeffords of Vermont co-sponsored the bill Grassley introduced today.