The National Commission on Fiscal Responsibility and Reform has floated an idea to raise revenue. The proposal is to limit 401(k) contributions, actually contributions to all defined contribution retirement plans, to the lesser of 20% of pay or $20,000. The proposal is being referred to as "the 20/20 cap". Unfortunately, this idea was not constructed with 20/20 vision.

Why should this be of concern? First, while looking at only 401(k) plans, it will hurt not only the intended target - the highly compensated, but also low and middle income wage earners. Second, many companies have replaced their defined benefit plans with defined contribution plans - using either a larger match to a 401(k) plan or a contribution to a new separate plan. These new pension plan replacement contributions may typically range from 4% to 12% of pay. The combination of employee and employer contributions to all of these defined contribution plans has a real potential to exceed the 20/20 cap no matter the income level.

While the purpose of the new limits is to increase revenue from the highly compensated, when looking at the real world, it may penalize lower income earners as well. The Employee Benefit Research Institute (EBRI) has stated that the percentage cap and not the dollar cap could hit even the lowest paid wage earners. To illustrate this, let's assume an employee earning $30,000 contributes 10% of pay (not a surprising percentage when looking at dual income families with no or grown children) or $3,000, and the company matches the first 6% of the employee's contribution at 100%, producing a 6% match or $1,800. The company just replaced its pension plan with a new defined contribution plan with contributions of 8% of pay or $2,400. The total is 24% or $7,200, or $1,200 more than the proposed 20% cap of $6,000.

The 20/20 cap also affects middle income earners as well. Let's look at a manager making $130,000, in the same plan as above, who contributes 12% of pay or $15,600. The company's contribution of 6% of pay is $7,800. The contribution to the new defined contribution plan is 8% or $10,400 for a total of $33,800. This would have to be cut back to $20,000. This individual is not the "rich" person with family income of $250,000 as defined by the President.

The current defined contribution limits which include 401(k) plans (employer and employee together) are: 100% of pay not to exceed $49,000 for 2011 and $50,000 for 2012. This breaks down as follows: 1) employee contributions: 100% of pay not to exceed $16,500 for 2011 and $17,000 for 2012. Many plans do not permit an employee to contribute more than 15% of pay. If the employee is age 50 or older, the employee may contribute an additional $5,500 "catch-up" contribution which falls outside the limits; 2) employer contributions: these are usually a percentage of the employee's contribution such as 50% of the first 6% of the employee's contribution.

There is a shadow proposal made by the Brookings Institution that would replace existing 401(k) tax deductions with a flat-rate refundable credit that serves as a matching contribution in a retirement savings account, using either an 18 percent credit or a 30 percent credit. This too has the possibility of penalizing employees.

Please inform your congresspersons of your reaction to the 20/20:  

Senate -  http://www.senate.gov/general/contact_information/senators_cfm.cfm

House -  https://writerep.house.gov/writerep/welcome.shtml