A White House budget proposal to cap individual retirement accounts at $3 million would have a minor effect on current account holders but could have a bigger impact on younger workers, according to an analysis by the Employee Benefit Research Institute released Wednesday.
The proposal based the $3 million cap for 401(k) and individual retirement accounts on a calculation of $205,000 annual retirement income, to mirror the limit for defined benefit pension plan annuities.
But the “point in time” formula the proposal uses does not account for changes in discount rates that are used to calculate those annuity purchases, said Jack VanDerhei, EBRI research director. As interest rates rise, a cap based on an assumed $205,000 annual retirement income would fall, affecting more workers.
“To look at who is over the limit is very, very, very misleading because the $3 million limit is just a historical accident because we happened to have interest rates this low. It’s much more likely to be closer to a $2.2 million cap.”
That $2.2 million figure was calculated on EBRI’s review of annuity prices going back to late 2011, which found that at the $205,000 threshold, 2.99% of 401(k) accounts would be affected due to higher interest rates over those years.
When interest rates start rising in the future, “you’re likely to have individuals where a significant number of them could end up triggering that limit,” Mr. VanDerhei said in an interview.
The potential impact is even greater for younger workers, EBRI found. For those currently age 26 to 35, 2.2% would be limited by the cap, compared to just 0.1% of workers age 56 to 65. If higher interest rates drop the cap to closer to $2.2 million, 6% of younger workers would be affected by age 65.
When accounting for age and tenure, for younger workers with five to nine years of tenure, a $3 million cap would affect 1.4%, while a $2.2 million cap would affect 5.2%. “If you’re 25 years old, you have 40 years ahead of you to worry about interest rates rising,” Mr. VanDerhei said.
Another unanswered question is how the caps would be administered and enforced each year. “Until you see how it’s going to be administered, you have no idea how complicated it’s going to be for the employers,” which could have a negative impact on employers’ willingness to offer the accounts, Mr. VanDerhei said.