The U.S. retirement market is set to experience a cumulative asset gain of nearly US$1 trillion between years-end 2001 and 2011 thanks to the Bush Administration’s tax reform initiatives. (Cerulli Associates’ most conservative projection assumes gradual implementation and only partial use of the newly expanded tax-deferral limit.) Some 88% of those extra assets will reside in corporate defined contribution (DC) schemes and the rest will fall into individual retirement accounts (IRAs). The Economic Growth and Tax Relief Reconciliation Act (EGTRRA), in effect since January 2002, includes some of the most sweeping reforms to U.S. pension laws since the Reagan-era Tax Reform Act.

EGTRRA boosts the 10-year projected compound annual growth rate (CAGR) for DC assets to 9.6% from 7.9%—a substantial and needed jump. (Cerulli Associates notes that 401(k) plans, which use a pre-tax salary-reduction contribution, are the true growth engine in DC plans and slated to grow 10.3% per annum through 2011 in a post-EGTRRA environment. Other corporate DC vehicles generally have older participant bases and fail to significantly increase asset growth potential.)

Impact will not be immediate. Plan sponsors must implement the myriad changes, many of which have detailed tax implications that the Internal Revenue Service, the U.S. tax authority, has yet to clarify fully. In addition, some U.S. states require their legislatures to approve any changes to federal tax code; as of this issue’s publication, at least eight states, including New Jersey and Texas, had yet to fully do so.

EGTRRA increases the maximum tax-deferred contribution U.S. DC plan participants can make. Annual limits of US$10,500 during 2001 will rise to US$11,000 in 2002 and US$1,000 per year thereafter to 2006, after which the cap will rise in correlation with an index. And participants aged 50 and over can defer additional ‘catch-up’ contributions on top of this limit: US$1,000 extra in 2002 and rising by US$1,000 per year thereafter until 2006, after which the catch-up limit will also match an index.

EGTRRA also raised contribution limits for IRAs, the U.S. third-pillar retirement savings vehicle. In 2002, the annual contribution cap will rise to US$3,000 from US$2,000; in 2005, it will jump to US$4,000 and then to US$5,000 in 2008. After 2008, the annual limits will rise US$500 per year. In addition, citizens aged 50 and over can now make ‘catch-up’ contributions, equal to an extra US$500 annually through 2005 and US$1,000 per year thereafter.

The act also significantly eases restrictions on rollovers—tax-protected transfers between retirement savings vehicles. In addition, it permits corporate pension schemes to build links with IRAs, permitting direct payroll deduction of after-tax contributions into an IRA. The new laws could also make defined benefit (DB) plans more attractive. The act increases the maximum pension allowed, provides relief from excise taxes on excess (i.e. non-deductible) contributions and starts to phase out limits on a DB plan sponsor’s ability to deduct funding obligations from tax due.

Discussions about the future of the slowing U.S. asset management industry often focus on new product creation, with hype centring on broker/dealer separate accounts (deservedly so) and retail-orientated hedge funds (not so deservedly). But the more attractive aspects of the U.S. fund management industry are less about sexy new vehicles than they are about the old, reliable station wagon: DC and rollover market places remain crucial to the future health of the U.S. asset management industry.

EGTRRA only postpones the inevitable, unfortunately. The U.S. 401(k) marketplace CAGR was 14% between 1991 and 2001; such expansion potential is long gone. By 2035, distribution levels will rise dramatically and asset levels will plateau and shrink and already retirement fund vendors are watching products and ser-vices begin to shift away from asset accumulation and toward income management.

EGTRRA may provide relief from tax; it cannot provide relief from time.

Source: Cerulli Edge Retirement Issue – August 2002