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Defined Contribution Retirement Accounts: The New Normal

In 2014, the Bipartisan Policy Center (BPC) launched the Commission on Retirement Security and Personal Savings, led by former Senator Kent Conrad and WL Ross & Co. Vice Chairman Jim Lockhart. The commission will consider and make recommendations regarding Social Security, pensions, defined contribution savings vehicles, strategies to generate lifetime income and other factors that affect retirement security.

This BPC-staff authored post is the first in a series that will outline the state of retirement in America and provide a sense of the challenges that the commission seeks to address in its 2015 report.

Defined Contribution (DC) accounts, such as 401(k)s and Individual Retirement Arrangements (IRAs), make up a large and growing part of retirement security for those employed in the private sector. In general, workplace DC retirement accounts are those that take employee and/or employer contributions and credit them to an individual account; investments and withdrawal are managed by the individual. The name “defined contribution” refers to the fact that employer-sponsored DC accounts are structured with a guaranteed initial contribution for the worker and then income in retirement that depends on the individual’s investment returns and withdrawal choices. This is in contrast to a defined benefit (DB) plan, in which the worker’s income in retirement is guaranteed and investments are managed by the employer.

Current Status

The most recent data from the National Compensation Survey show that out of 64 percent of private-sector workers offered any sort of plan in 2013, 92 percent of them were offered a DC plan.1 A large majority (71 percent) of those offered a DC plan contributed. DC accounts (mostly 401(k)s and IRAs) amounted to $12.6 trillion dollars in the first quarter of 2014 – an overwhelming majority of private retirement plan assets.

Defined contribution retirement plan

The 401(k) is the most common type of employer-based DC account, though there are several others.2 These plans vary by their structure and type of participating employer. In 2007, 75 percent of all private retirement plan contributions were to 401(k)s.3

401(k)s allow for voluntary contributions from employees and contributions from employers that may be contingent on some level of employee contributions (i.e., structured as a match). Employee contributions to all of these employer-based accounts are made through payroll deductions. IRAs allow workers to save for retirement in a personal tax-advantaged account even if they do not have access to a workplace retirement plan, but annual contribution limits ($5,500, or $6,500 if age 50 or older) are much lower than for 401(k)s ($52,000, counting both employee and employer contributions).5

Most of the growth in funds entering IRAs is from individuals who (upon leaving their employers) either roll over their 401(k) account balances or take lump-sum distributions from DB plans (which is how most workers in private-sector DB plans receive their benefits).6 Because of this, much of the $6.6 trillion in IRAs is actually the result of savings from workplace-based DB and DC plans.

Private U.S. retirement assests

Both employer and employee contributions and investment returns in 401(k)s and traditional IRAs are not taxed as income until withdrawal, at which point they are subject to ordinary income tax rates (unless the withdrawals are taken as pre-retirement distributions, in which case they are subject to an additional 10-percent excise tax). Employer contributions (but not employee contributions) are also exempt from employment-related taxes (i.e., payroll and self-employment taxes).

Contributions to Roth IRAs and Roth 401(k)s are made on a post-tax basis, and withdrawals (and thus investment returns) are not taxed. The tax deduction for traditional IRAs and contributions to Roth IRAs are restricted for those with higher incomes and who have access to employer-sponsored retirement plans.


On the employer side, a big challenge for DC plans is that they can be administratively complicated to set up and run. Employers who establish them must select from a variety of plan designs, document the plan, hire a trustee, establish a recordkeeping system (or hire a recordkeeper), and accept a degree of fiduciary responsibility. In addition to documenting and disclosing the elements of plan operation, most employers are required to conduct annual non-discrimination tests to demonstrate that the benefits of the plan are not disproportionately benefiting highly compensated employees.

Fees are another challenge in the DC world. Because employers hire trustees and recordkeepers and select investment options, they are responsible for negotiating and shaping the fees associated with workplace accounts. While employers incur some administrative costs, other costs may be passed on to accountholders, such as administration and investment fees, which vary widely. Employees generally have little ability to mitigate plan administration fees (at least during employment), since plans are selected by the employer. The employer also selects the investment options, meaning that low-fee choices may or may not be available.

Furthermore, the profusion of different kinds of DC accounts can prove confusing to employers and individuals who have to choose from a list that includes 403(b)s, 457s, 403(a)s, payroll-deduction IRAs, Savings Incentives Match Plan for Employees (SIMPLE) 401(k)s, SIMPLE IRAs, and Simplified Employee Pension (SEP) IRAs. The sheer number of different options on the employer side and the lack of any one “easy path” for employees can make saving for retirement more confusing than it needs to be.

The tax treatment of DC plans is also a subject of some debate. The Congressional Budget Office (CBO) estimates that the tax exclusion for net pension contributions and earnings (which includes both DB and DC plans) is one of the largest tax expenditures. But the fact that taxable withdrawals from DC accounts often occur long after the funds were contributed on a pre-tax basis distorts the measurement of the tax expenditure.7 We will discuss this issue in further detail in future posts.

Those tax incentives for retirement savings also have distributional consequences. Although properly measuring the magnitude of the tax incentives is difficult, those with higher incomes are more likely to contribute, and because the incentives operate as an exclusion (or a deduction in the cases of contributions to IRAs), the tax preferences provide greater benefits to individuals in higher tax brackets. Many lower-income Americans experience little or no incentive from tax deferral since they generally do not pay income taxes and individual/employee contributions to plans are made after payroll taxes.

The Saver’s Credit – a non-refundable tax credit for low-income workers that is worth 50 percent of individual contributions to retirement accounts up to $2,000 – was intended to create stronger incentives for those individuals to save for retirement. But the credit’s effect has been limited because it is non-refundable, and many of the taxpayers in the relevant income range have no income-tax liability to begin with.

The Bottom Line

DC accounts are working well for many Americans. But the array of plans and options is complex and difficult to understand, and it’s easy to fall through the cracks – especially for those not offered a payroll-deduction plan at work. As part of its purview, BPC’s commission will explore potential reforms to DC plans and other savings vehicles to improve Americans’ retirement security.

Alex Gold contributed to this post.

View all posts in BPC’s Retirement in America series under Related Stories below.

1 Some were offered both DB and DC plans.

2 Other workplace DC plan types include 403(b)s (offered by certain not-for-profit and educational organizations), 457s (for employees of state and municipal governments), Savings Incentives Match Plan for Employees (SIMPLE) IRAs, and Simplified Employee Pension (SEP) IRAs.

3 Schieber, Sylvester. The Predictable Surprise (2012). pp. 203.

4 Contributions to 401(k)s in 2014 are limited to $52,000 for employees under age 50. Only $17,500 of that may come from the employee. Total IRA contributions are limited to $5,500 per person in 2014. Limits for both 401(k)s and IRAs are indexed to inflation (in $500 increments). Both IRAs and 401(k)s do not allow individuals to contribute more than their annual compensation and feature higher “catch-up” limits for employees over age 50. For IRAs, the additional catch-up contribution is limited to $1,000; for 401(k)s, the catch-up is limited to $5,500.

5 Some of the variations on IRAs and 401(k)s have different contribution limits.

6 Schieber, pp. 203-4.

7 These estimates of revenue loss are relative to a hypothetical world where all contributions to retirement accounts are post-tax, asset growth in those accounts is taxed as regular investment earnings, and all withdrawals during retirement are tax free. For more information, see pp. 16 of the CBO report. The ten-year budget scoring window used by Congress, however, overstates the revenue losses of traditional accounts and understates those from Roth accounts. Ten-year estimates ignore the facts that contributions to traditional accounts are eventually taxed (at withdrawal) and that Roth accounts leave investment income untaxed when they are withdrawn by the account holder.

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