WASHINGTON—Many 401(k) participants likely would see lower account balances if federal lawmakers implement a pair of proposals aimed at changing the tax treatment of 401(k) retirement plans, according to a study by the Employee Benefit Research Institute.

The proposals, drafted by the bipartisan National Commission on Fiscal Responsibility and Reform and members of the Senate Finance Committee, are being promoted by supporters as mechanisms to help reduce the federal deficit and boost tax revenue.

In a December 2010 report, the NCFRR proposed a “20/20 cap” that would limit employee contributions to 401(k) contributions to $20,000 or 20% of salary, whichever is lower. Additionally, the members of Senate Finance Committee recently introduced a plan to end tax deductions for 401(k) contributions in favor of a flat-rate refundable credit that would function as a matching contribution to a retirement savings account.

Worker and employer contributions to a 401(k) plan are capped at $49,000 or 100% of a worker's pay, whichever is lower, under the current federal tax code.

Could erode retirement accounts

Jack VanDerhei, EBRI research director and author of Thursday's report on the net effect of both proposals, said the measures could significantly erode retirement accounts for American workers and force low-income households to decrease or eliminate future retirement contributions.

“Defined contribution plans, such as 401(k)s, and the IRA rollovers they produce, are the component of retirement security that seems to be generating the most non-Social Security retirement wealth for baby boomers and Gen Xers,” Mr. VanDerhei said.

In his report, Mr. VanDerhei predicted that eliminating existing tax exclusions for worker contributions to their retirement plans in favor of a refundable credit would result in average reductions in retirement accounts between 11.2% for workers ages 26-35 in the highest-income groups to 24.2% for workers in the same age range in the lowest-income group.

Highest income would be hit hardest

While the “20/20 cap” would be most impactful to workers in the highest income groups, the report notes that the measure also could drastically reduce average contributions among the lowest-income workers, and that younger workers in those groups were even more likely to draw down their contributions, “given their increased exposure to the proposal.”

If the cap were to be enacted in 2012, account balance reductions likely would range from 15.1% for top-earning workers ages 36-45 and 8.6% for top earners ages 56-65. After top earners, workers in the lowest-income bracket showed the highest potential average percentage decrease in their account balances, the report said.

Copyright © 2011. Crain Communications, Inc.