According to one study, in 2011, 54 percent of wage and salary workers aged 21-64 worked for an employer that sponsored a pension plan, such as a defined benefit (DB) plan or a DC plan, but only about 45 percent of wage and salary workers aged 21-64 actually participated in the plan. DB plans provide periodic benefits in retirement that are generally based on employees’ salaries and years of service. Employers may also choose to sponsor DC plans, under which both employers and employees can make contributions to the plan. Distributions in retirement are, in turn, based on contributions and investment returns in these accounts. Private sector employer-sponsored DB and DC plans are generally subject to the Employee Retirement Income Security Act of 1974 (ERISA), as amended, which establishes standards for private sector pension plans and sets forth protections for participants in these plans. The Department of Labor’s Employee Benefits Security Administration (EBSA) generally administers and enforces the Title I provisions of ERISA. These employer-sponsored plans must also meet certain requirements in the Internal Revenue Code (IRC), which are enforced by the Internal Revenue Service (IRS). Individuals can also save for retirement through IRAs, which allow individuals to make contributions for retirement regardless of whether The IRS has primary they are covered by an employer-sponsored plan.responsibility for ensuring that IRAs meet IRC requirements necessary to qualify for preferential tax treatment. Employers are continuing to shift away from sponsoring DB plans toward sponsoring DC plans. Data from the Department of Labor show that over the past few decades, DC plans have become the predominant plan type offered by private sector employers. Indeed, in 2010, over 90 percent of all employer-sponsored plans were DC plans. IRAs have also grown in importance in recent years and are a key retirement savings vehicle for many individuals. According to data from the Investment Company Institute, in the first quarter of 2013, IRA assets represented a larger portion of total U.S. retirement assets than 401(k) plans, the main type of DC plan. Specifically, IRA assets totaled almost $5.7 trillion, which represents about 27 percent of U.S retirement assets. In comparison, 401(k) assets accounted for about $3.8 trillion, or 18 percent, of U.S. retirement assets. Rollovers from 401(k) plans and other employer- sponsored plans are the predominant source of contributions to IRAs. Approximately 95 percent of money contributed to traditional IRAs in 2008 was attributable to rollovers, primarily from employer-sponsored plans.The greater reliance on DC plans and IRAs in the current retirement landscape indicates that the tax incentives are increasingly relevant for promoting retirement saving. Tax preferences for pension plans are structured to encourage individuals to save for retirement. Contributions to DC plans that fall within certain limits and investment earnings on assets are not taxed until distributions are paid to participants. Further, there are tax incentives for contributions to IRAs. There are two main types of IRAs: traditional and Roth. A traditional IRA allows individuals to make tax deductible contributions to their accounts, and distributions are generally subject to income tax. For traditional IRAs, deductions for contributions are subject to limits based on income and pension coverage. Distributions made prior to age 59 ½, other than under specific exceptions, are generally subject to additional 10 percent tax. A Roth IRA allows individuals to make after-tax contributions to their accounts, and generally distributions after age 59 ½ for accounts at least 5 years old are not subject to income tax. For Roth IRAs, distributions prior to age 59 ½ are taxable on portions attributable to earnings on contributions with an additional 10 percent tax on distributions other than for specified purposes. To further encourage low- and middle-income individuals and families to save for retirement, the Economic Growth and Tax Relief Reconciliation Act of 2001 authorized a nonrefundable tax credit (the Saver’s Credit) of up to $1,000 against federal income tax. Eligibility is based on a worker’s adjusted gross income (AGI) and contributions made to qualified pension plans and IRAs. The credit rate phases out as AGI increases, and the rate is applied to qualified contributions up to $2,000 for individuals and $4,000 for households. The total Saver’s Credit amount is equal to the amount of contributions multiplied by the credit rate (see table 1). Because the credit is nonrefundable, the ability to receive the full amount of credit is limited not only by income eligibility, but also by whether the taxpayer’s tax liability is large enough. In fiscal year 2012, the Saver’s Credit cost the federal government about $1.1 billion in revenue forgone, and revenue losses are estimated to amount to $6.2 billion for fiscal years 2013-2017, according to the Department of the Treasury. To expand retirement savings incentives for working families, the President’s fiscal year 2010 and 2011 budgets proposed modifying the Saver’s Credit. These modifications included: (1) making the credit refundable, (2) eliminating phase-out of the credit rate so that all eligible households would receive a 50 percent credit rate, and (3) extending the AGI limit to $85,000 for married couples filing their federal income taxes jointly. The estimated cost for this expansion of the Saver’s Credit was $323 million for fiscal year 2011 and $29.8 billion for fiscal years 2011- 2020, according to the President’s 2011 budget proposal.Committee on Taxation estimated that the Administration’s 2011 proposal The Joint would have cost about $27.5 billion for the same period. These modifications were not adopted and were not included in the President’s budget proposals for fiscal years 2012 through 2014. Bills introduced during the current and immediately preceding legislative sessions include provisions for similar modifications to the Saver’s Credit, including making the credit refundable and increasing the AGI range for taxpayers eligible for the 50 percent credit rate. Automatic enrollment has been advocated as a way to encourage greater participation in 401(k) plans. Our past work has shown that automatic enrollment policies considerably increased 401(k) participation rates for plans that adopted them. Automatic IRAs would similarly extend the benefits of payroll-deduction savings and automatic enrollment. Legislative proposals to establish automatic IRAs have been introduced in both the House of Representatives and the Senate in recent legislative sessions.through 2014 included a proposal to establish automatic IRAs. Additionally, the President’s budgets for fiscal years 2010 Under the 2012 automatic IRA legislative proposal, certain employers who do not maintain a qualified pension plan would be required to make available an automatic IRA arrangement to eligible employees. Typically, under this proposal, 3 percent of the employee’s salary would be automatically contributed to an IRA through payroll deduction, unless the employee elects to terminate his or her participation. Investment options for automatic IRAs would be limited to certain types of funds, such as principal preservation and target-date or life cycle funds, and target-date funds would be the default investment option. If the employer elects, employees would also have the option of using their contributions to purchase a retirement bond, which would provide a low-cost investment option where small account balances are pooled together until they are large enough to be profitable in the private market. This proposal also includes a provision for a tax credit for small employers to recoup start-up costs of establishing and maintaining automatic IRAs, such as setting up an automatic payroll deduction for employees. Automatic IRAs would also introduce costs to the federal government through the loss of federal income tax revenue. According to the President’s 2014 budget proposal, losses for automatic IRAs are estimated to amount to $1.1 billion for fiscal year 2015 and $17.6 billion for fiscal years 2014 through 2023, if the proposal were to be enacted. We found that households that do not save for retirement had lower AGI than those that do, regardless of age group or tax filing status (see fig. 1). Based on our analysis of the SCF data, we estimate that in 2010 approximately 43 percent of households working in the private sector did We also estimate that the median AGI of all not have a DC plan or IRA.households that did not have a DC plan or IRA was $32,000, compared to $75,000 for those that did—a difference of about 43 percent. These trends hold across age groups and tax filing statuses in 2010. In addition, we estimate that 56 percent of single households did not have a DC plan or IRA, while 36 percent of married households did not and married household AGI was consistently higher than single household AGI. In addition, households without DC plans or IRAs have lower median marginal tax rates than households with DC plans or IRAs. A marginal tax rate is the rate of tax paid on the next dollar of income that a taxpayer earns. Generally households with higher earnings have higher marginal tax rates, and tax incentives are worth more to these households. Based on our analysis of the 2010 SCF data, we estimate the median marginal tax rate for households with DC plans or IRAs to be 25 percent and 15 percent for households without such savings vehicles. Across age groups and tax filing statuses, more households with higher median marginal tax rates took advantage of tax incentives for retirement saving than households with lower median marginal tax rates (see fig. 2). For example, married households age 45 to 54 that did not have a DC plan or IRA had a median marginal tax rate of 15 percent, and those that did save had a median marginal tax rate of 25 percent. Single households age 45 to 54 that did not have a DC plan or IRA had a median marginal tax rate of 15 percent, compared to 22 percent for those that did save. As mentioned previously, DB plans typically provide a monthly benefit once an individual reaches retirement age and could be a source of retirement income for households without DC plans or IRAs. However, the prevalence of DB plans has declined over the past few decades. Consistent with overall trends, we found that few households without DC plans or IRAs have a DB plan (see fig. 3). Only 15 percent of married households and 11 percent of single households without a DC plan or IRA had a DB plan. Although most households without a DC plan or IRA also do not have a DB plan, the first earnings quartile is worse off. For example, an estimated 5 percent of married households in the first earnings quartile had a DB plan, compared to an estimated 27 percent and 31 percent of married households in the third and fourth earnings The shift away from DB plans and the limited quartiles, respectively.number of households that have them highlights the importance of other retirement savings vehicles such as DC plans or IRAs. We also analyzed the net worth—the difference between gross assets and liabilities—of single and married households without DC plans or IRAs by income quartile. Our evidence suggests that in addition to some households not having a DC plan or IRA, these households also may have limited additional assets to draw upon in their retirement years. For example, single households in the first income quartile without a DB plan had an estimated average net worth of $17,164. Married households in the first income quartile without a DB plan had an estimated average net worth of $70,485. The Saver’s Credit could increase retirement income for a sizeable portion of the population, especially if modifications, such as making it refundable and expanding eligibility, are included in its design. To analyze the effect of the credit on retirement income, we modeled two different Saver’s Credit scenarios: the existing credit and a modified refundable credit. (See “Saver’s Credit Modeling Scenarios” text box and app. II for detailed descriptions of these scenarios and the underlying assumptions). Specifically, we projected the effects of the two different Saver’s Credits for a cohort of individuals born in 1995 (see fig. 4). We assumed that all eligible taxpayers claimed the credit, and found that under the existing Saver’s Credit, just over a third of all individuals would be projected to receive the credit at some point during their working years. In contrast, we projected that about half of all individuals would receive the credit at some point during their working years if it were refundable. According to experts, the nonrefundable nature of the existing credit may limit its utility for low-income households. Specifically, many low-income households do not receive the full amount of the credit because their tax liability is not high enough. Our estimates show that changing the current design of the credit to make it refundable could substantially increase the percentage of individuals who would receive the credit. However, such modifications to the credit would also result in increased costs to the federal government through the loss of tax revenue and increased outlays. Under both scenarios, the lowest two earnings quartiles have the largest percentage of individuals who could receive the credit. For example, under the existing Saver’s Credit, about 45 percent of individuals in each of the lowest two earnings quartiles could receive it. Alternatively, a refundable Saver’s Credit could result in more middle-income workers receiving the credit, with an estimated 60 percent of individuals in the second earnings quartile potentially receiving it. Because we present our results across earnings quartiles that were based on lifetime earnings, these results reflect individuals who could have received the credit while they were lower earners but subsequently became higher earners. Households could experience larger retirement annuity increases from a refundable Saver’s Credit than the existing credit, according to our projections (see fig. 5). For the purposes of this report, household retirement annuities include all annual retirement income received from DC or DB plans and represent income that the household receives in retirement. DB plans typically provide benefits in the form of periodic payments which can be summed together into one annual payment. DC account balances represent a worker’s DC or IRA savings from past jobs, and we assumed that at retirement, workers used their entire DC account balance to purchase an annuity. We estimate that the median increase in households’ retirement annuity under the existing credit could be $103 per year. In contrast, under a refundable Saver’s Credit, the median increase could be $655 per year, according to our simulations. For both Saver’s Credit scenarios, low- and middle-earning households could For households in the lowest receive the largest benefit from the credit.earnings quartile, we projected that the median increase in annuity under the existing Saver’s Credit would be $155 per year, while the median increase in annuity under a refundable credit would be $876 per year. In addition, about 21 percent of households in the lowest earnings quartile could see an additional $1,000 to $1,999 per year in their retirement annuities under a refundable credit. Under the existing credit, only 6 percent of households could potentially receive an increase in annuity of this size. Our estimates of the percent change in median household retirement annuities show similar trends. The refundable Saver’s Credit results in a larger percent increase in the median household retirement annuity at all earnings levels. In both scenarios, the projected percent increase in the median household retirement annuity for the lowest earnings quartile was larger than the increase for other earnings quartiles. According to our projections, the percent increase in the median retirement annuity for low- earning households would be 4 percent under the existing Saver’s Credit and 15 percent under a refundable credit. Automatic IRAs provide a new opportunity to increase the number of households saving for retirement at all earnings levels. We project that 7 percent of all households had no retirement annuities from DB or DC plans but could receive annuity income from automatic IRAs. (See “Automatic IRA and Saver’s Credit Modeling Scenarios” text box and app. II for detailed descriptions of the scenarios we modeled and their underlying assumptions.) Based on our projections, more households in the lowest earnings quartile would benefit than in any other earnings quartile.or DC plan in the lowest earnings quartile could receive annuity income from automatic IRAs, according to our analysis. We analyzed H.R. 4049, the Automatic IRA Act of 2012 because it was the most recent legislative proposal at the time we conducted our analysis. On May 16, 2013, H.R. 2035, the Automatic IRA Act of 2013 was introduced before the House of Representatives. The differences between H.R. 2035 and H.R. 4049 are minimal and we determined that they would not have a significant effect on our simulation results. Under automatic IRAs, 36 percent of households could see modest increases in their retirement annuities, according to our projections. These households include workers who have not had access to a DB or DC plan as well as workers who had access to DB or DC plans at some jobs but not at others. Specifically, we projected that the median dollar increase in a household’s annuity was $1,046 (see fig. 6).projections show that those in the lowest earnings quartile saw the smallest median dollar increase in the household’s annuity ($479), the percent change in the median annuity was 66 percent. In addition, we estimate that 30 percent of households in this quartile saw an increase in their annuity of $1,000 or more. In comparison, the percent change in the median retirement annuity for households in the second earnings quartile was 16 percent and the median dollar increase in the household’s retirement annuity was $1,043. Almost 75 percent of households could experience an increase in their retirement annuity if the Saver’s Credit were made refundable at the same time automatic IRAs were implemented (see fig. 7). Further, according to our projections, making the Saver’s Credit refundable in addition to implementing automatic IRAs could double the number of households experiencing an increase in retirement income. Under this scenario, many more households could benefit than under automatic IRAs alone. Retirement annuities could increase if the household participated in automatic IRAs, was eligible to receive the refundable Saver’s Credit but not the existing Saver’s Credit, received a larger credit under the refundable Saver’s Credit, or some combination of these events. Further, under the proposals we used for our modeling, the refundable Saver’s Credit would be available for certain households with AGI of up to $85,000 a year, resulting in all lower and many middle- income households seeing an increase in their retirement savings. Households in the two lowest earnings quartiles could be most likely to benefit, with about 80 percent of households seeing an increase in their retirement annuities, according to our projections. Our projections show that households in the lowest earnings quartile could gain the most from the combination of automatic IRAs and a refundable Saver’s Credit. For these households, the percent increase in the median retirement annuity could be 21 percent, compared to a potential 2 percent increase for households in the highest quartile (see fig. 8). Furthermore, 48 percent of households in the lowest earnings quartile could see an increase in their retirement annuities of $1,000 or more. In general, under our projections, lower-earning households were more reliant on Social Security for income in retirement than higher-earning quartiles (see fig. 9). This may be because higher-earning households have the ability to save more for retirement, generating a larger retirement savings account at retirement. Further, Social Security benefits are progressive and replace a larger portion of lifetime earnings for people with low earnings than for people with high earnings. Thus, higher- earning households may receive a greater share of retirement income from annuitizing their retirement savings than from their Social Security benefits. The combined effects of automatic IRAs and a refundable Saver’s Credit could decrease lower- and middle-income household’s reliance on Social Security in retirement. Under our projections of automatic IRAs, the two lowest earnings quartiles relied on Social Security for 80 and 62 percent of their total household income, respectively. However, the percent of income derived from a household’s retirement annuity increased when we added a refundable Saver’s Credit. The two lowest earnings quartiles relied on retirement annuities for 31 and 46 percent, respectively, of their household’s total income. Concerns about retirement security have grown as private sector employers have shifted to predominantly sponsoring DC plans. First, despite existing tax incentives aimed at fostering plan formation and coverage, less than half of workers aged 21-64 were covered by an employer-sponsored plan in 2011 and the participation rate has barely changed over the last several decades. Second, despite significant tax incentives aimed at increasing retirement savings, many households enter retirement without adequate financial resources. Recent proposals, such as those that would establish the automatic IRA, could represent a significant step toward increasing participation to over 50 percent within the current framework of a voluntary system. Further, redesigning the Saver’s Credit could improve the retirement income and savings imbalance between lower and higher earners by giving lower- and middle-earning households an additional incentive to accumulate more in their retirement accounts or to start saving for retirement. By itself, increasing coverage through automatic IRAs will likely result in, at best, moderate increases in retirement income. However, even these increases could bolster the financial prospects of many future retirees. These options do, of course, pose important trade-offs for individuals, employers, and the government that will need to be carefully weighed. Individuals, especially those in lower-income households, will still have to make difficult choices between spending now and saving for later. In addition, the government would forego tax revenue in the near-term because contributions to automatic IRAs would be tax-deferred. Moreover, the expansion of the Saver’s Credit would result in both a loss of revenue and increased federal spending. Such costs will have to be considered along with the proposals’ potential effects on labor force participation and dependence on other government programs, such as Social Security, in retirement. We provided a draft of this report to the Department of Labor and the Department of the Treasury for review and comment. While neither agency provided official comments, each provided technical comments, which we incorporated as appropriate. As agreed with your office, unless you publicly announce its contents earlier, we plan no further distribution until 30 days after the date of this letter. At that time, we will send copies of this report to the Secretary of Labor, the Secretary of the Treasury, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-7215 or jeszeckc@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made contributions to this report are listed in Appendix III. To analyze the extent to which workers with lower earnings can benefit from tax incentives for retirement savings and automatic IRAs, we examined (1) the earnings and tax rates of households that do not have DC plans or IRAs, (2) the effects of the Saver’s Credit on retirement income, and (3) how automatic IRAs could affect retirement income, especially for low- and middle-income workers. This appendix and appendix II provide a detailed account of the information and methods we used to answer these objectives. Section 1 describes the key information sources we used. Section 2 describes the empirical methods we used to answer objective 1 and presents information on standard errors and confidence intervals for our estimates. To answer our objectives, we obtained information from a variety of sources including the Survey of Consumer Finances (SCF); the Policy Simulation Group’s (PSG) microsimulation models; relevant literature; interviews with a range of experts in the area of retirement security; presidential and legislative proposals to modify the Saver’s Credit and create automatic IRAs; and relevant federal laws and regulations. To answer the first objective, we used data from the 2010 SCF to analyze incomes and tax rates of households that did not take advantage of the existing tax incentives for retirement savings. The SCF is a triennial, nationally representative survey from the Board of Governors of the Federal Reserve. The 2010 SCF surveyed 6,482 households about their pensions, incomes, labor force participation, asset holdings and debts, use of financial services, and demographic information. The SCF is conducted using a dual-frame sample design. One part of the design is a standard, multistage area-probability design, while the second part is a special over-sample of relatively wealthy households. This is done in order to accurately capture financial information about the population at large as well as characteristics specific to the relatively wealthy. The two parts of the sample are adjusted for sample nonresponse and combined using weights to make estimates from the survey data representative of households overall. In addition, the SCF excludes people included in the Forbes Magazine list of the 400 wealthiest people in the United States. Furthermore, the 2010 SCF dropped 10 observations from the public data set that had net worth at least equal to the minimum level needed to qualify for the Forbes list. For the purposes of this report, a household refers to the primary economic unit within a household, which the SCF refers to as a family. To estimate the age, marital status, net worth, tax filing status, and whether the household had a member with a DC or DB plan, we relied on variable definitions used for Federal Reserve publications using the SCF. To estimate AGI and tax rates, we used TAXSIM, an application provided by the National Bureau of Economic Research that estimates tax information for households using survey data. To prepare the data for TAXSIM, we relied on a program provided by the Federal Reserve. We followed SCF documentation and estimated the standard errors that incorporate both implicates and replicate weighting. The estimated populations we used for our analysis were derived with the first implicate. The SCF and other surveys that are based on self-reported data are subject to several other sources of nonsampling error, including the inability to get information about all sample cases; difficulties of definition; differences in the interpretation of questions; respondents’ inability or unwillingness to provide correct information; and errors made in collecting, recording, coding, and processing data. These nonsampling errors can influence the accuracy of information presented in the report, although the magnitude of their effect is not known. To answer objectives 2 and 3, we used PSG’s SSASIM, GEMINI, and PENSIM simulation models. GEMINI simulates Social Security benefits and taxes for large representative samples of people born in the same year. GEMINI simulates all types of Social Security benefits including retired workers’, spouses’, survivors’, and disability benefits. It can be used to model a variety of changes to Social Security. GEMINI uses inputs from SSASIM, which has been used in numerous prior GAO reports, and PENSIM, which was developed for the Department of Labor. GEMINI relies on SSASIM for economic and demographic projections and relies on PENSIM for simulated life histories of large representative Life samples of people born in the same year and their spouses.histories include educational attainment, labor force participation, earnings, job mobility, marriage, disability, childbirth, retirement, and death. Life histories are validated against data from the Survey of Income and Program Participation, the Current Population Survey, Modeling Income in the Near Term (MINT), and the Panel Study of Income Dynamics. Additionally, any projected statistics (such as life expectancy, employment patterns, and marital status at age 60) are, where possible, consistent with intermediate cost projections from the Social Security Administration’s Office of the Chief Actuary (OCACT). At their best, such models can provide only very rough estimates of future incomes. However, these estimates may be useful for comparing future incomes across alternative policy scenarios and over time. GEMINI can be operated as a free-standing model or it can operate as a SSASIM add-on. When operating as an add-on, GEMINI is started automatically by SSASIM for one of two purposes. GEMINI can enable the SSASIM macro model to operate in the Overlapping Cohorts (OLC) mode or it can enable the SSASIM micro model to operate in the Representative Cohort Sample (RCS) mode. The SSASIM OLC mode requests GEMINI to produce samples for each cohort born after 1934 in order to build up aggregate payroll tax revenues and Old-Age, Survivors, and Disability Insurance (OASDI) benefit expenditures for each calendar year, which are used by SSASIM to calculate standard trust fund financial statistics. In either mode, GEMINI operates with the same logic, but typically with smaller cohort sample sizes in OLC mode than in the RCS or stand-alone-model mode. PENSIM simulates the timing for each life event by using data from various longitudinal data sets to estimate a waiting-time model (often called a hazard function model) using standard survival analysis methods. PENSIM incorporates many such estimated waiting-time models into a single dynamic simulation model. This model can be used to simulate a synthetic sample of complete life histories. PENSIM employs continuous- time, discrete-event simulation techniques, such that life events do not have to occur at discrete intervals, such as annually on a person’s birthday. PENSIM also uses macro-demographic and macroeconomic variables generated by SSASIM. PENSIM imputes pension characteristics using a model estimated with 1996—1998 establishment data from the Bureau of Labor Statistics Employee Benefits Survey (now known as the National Compensation Survey). Pension offerings are calibrated to historical trends in pension offerings from 1975 to 2005, including plan mix, types of plans, and employer matching. Further, PENSIM incorporates data from the 1996– 1998 Employee Benefits Survey to impute access to and participation rates in DC plans in which the employer makes no contribution, which the Bureau of Labor Statistics does not report as pension plans in the National Compensation Survey. The inclusion of these “zero-matching” plans enhances PENSIM’s ability to accurately reflect the universe of pension plans offered by employers. The baseline PENSIM assumption, which we adopted in our analysis, is that 2005 pension offerings, including the imputed zero-matching plans, are projected forward in time. PENSIM also simulates federal income taxes. PSG has conducted validation checks of PENSIM’s simulated life histories against both historical life history statistics and other projections. Different life history statistics have been validated against data from the Survey of Income and Program Participation, the Current Population Survey, MINT, the Panel Study of Income Dynamics, and the Social Security Administration’s Trustees Report. PSG reports that PENSIM life histories have produced similar annual population, taxable earnings, and disability benefits for the years 2000 to 2080 as those produced by the Congressional Budget Office’s long-term Social Security model and as shown in the Social Security Administration’s 2004 Trustees Report. According to PSG, PENSIM generates simulated DC plan participation rates and account balances that are similar to those observed in a variety of data sets. For example, measures of central tendency in the simulated distribution of DC account balances among employed individuals are similar to those produced by an analysis of the Employee Benefit Research Institute-Investment Company Institute 401(k) database and of the 2004 SCF. We performed no independent validation checks of PENSIM’s life histories or pension characteristics. In 2006, the Employee Benefits Security Administration (EBSA) submitted PENSIM to a peer review by three economists. The economists’ overall reviews ranged from highly favorable to highly critical. While the economist who gave PENSIM a favorable review expressed a “high degree of confidence” in the model, the one who criticized it focused on PENSIM’s reduced form modeling. This means that the model is grounded in previously observed statistical relationships among individuals’ characteristics, circumstances, and behaviors, rather than on any underlying theory of the determinants of behaviors, such as the common economic theory that individuals make rational choices as their preferences dictate and thereby maximize their own welfare. The reduced form modeling approach is used in pension microsimulation models and the feasibility of using a nonreduced form approach to build such a model may be questionable given the current state of economic research. The third economist raised questions about specific modeling assumptions and possible overlooked indirect effects. We conducted a data reliability assessment of the PSG models and selected variables from the SCF by conducting electronic data tests for completeness and accuracy, reviewing documentation on the data set, and interviewing knowledgeable officials about how the data are collected and maintained and their appropriate uses. When we learned that particular fields were not sufficiently reliable, we did not use them in our analysis. For the purposes of our analysis, we found the variables that we ultimately reported on to be sufficiently reliable. We conducted an extensive literature review and interviewed a range of experts. To identify existing studies, we conducted searches of various databases, such as ECO, ArticleFirst, WorldCat, Social SciSearch, Harvard Business Review, EconLit, ProQuest, PolicyFile and CQ.com. From these sources, we reviewed article abstracts, when available, to determine which articles contained information germane to our report and reviewed those articles. In addition, we collected articles posted on the websites of organizations such as Brookings, the Heritage Foundation, and AARP. We performed these searches and identified articles from June 2012 through October 2012. We also interviewed experts. To ensure we obtained a balanced perspective, we interviewed experts with a range of perspectives and from different types of organizations including government, research organizations, advocacy groups, and the private sector. We also conducted interviews with several experts in government and the private sector on technical issues related to our analysis. Specifically, we interviewed agency officials at the departments of the Treasury and Labor; researchers from the Urban Institute, the Heritage Foundation, and the Economic Policy Institute; experts and advocates from the Pension Rights Center, Demos, Aspen Institute, American Society of Pension Professionals and Actuaries, and AARP; and private sector professionals from PAi, Prudential Financial, Inc., and Putnam Investments. We consulted with officials at the Social Security Administration (SSA) and an expert from the PSG on technical issues. To analyze the earnings and tax rates of households that do not take advantage of the tax incentives for retirement saving, we used the 2010 SCF. We limited our sample to households where the household head was under age 65 and either the respondent or spouse worked in the private sector. Our estimates for households only include retirement benefits and savings of the survey respondent and a spouse or partner and do not include retirement benefits or savings held by additional family members. As a result, our estimates may understate retirement assets held by a household. We estimated whether the household had a DB plan, and AGI and marginal tax rates for households with and without DC plans or IRAs. We also estimated net worth using variable definitions outlined by the Federal Reserve. We estimated AGI and marginal tax rates by inputting the SCF data into the National Bureau of Economic Research’s (NBER) TAXSIM Model, a microsimulation model of U.S. TAXSIM calculates estimated federal and state income tax systems.liabilities under U.S. federal and state income tax laws from actual tax returns that have been prepared for public use by the Statistics of Income Division of the IRS. The SCF is a probability sample based on random selection, so the 2010 SCF sample is only one of a large number of samples that might have been drawn. Since each sample could have provided different estimates, we express our confidence in the precision of our particular sample’s results as a 95 percent confidence interval (e.g., plus or minus 4 percentage points). This is the interval that would contain the actual population value for 95 percent of the samples we could have drawn. As a result, we are 95 percent confident that each of the confidence intervals in this report will include the true values in the study population. Tables 2 through 6 show the confidence intervals for our estimates of AGI, marginal tax rates, and retirement plan ownership. This appendix describes the modeling scenarios and assumptions for objectives 2 and 3. It also presents the results from our sensitivity analyses and describes cohort summary statistics resulting from our simulations. To analyze the effects of the Saver’s Credit and automatic IRAs on retirement income, we used the PSG models. We started with a 2 percent sample of a 1995 cohort, totaling 118,142 people at birth. We projected income in retirement when the cohort is age 67. Our simulations included some of the following key assumptions and features: Individuals who died before they retire, died before age 67, retire after age 67, immigrated into the cohort at an age older than 25, emigrated before age 67, or became permanently disabled before age 62 were omitted from the sample. We did not include individuals who became permanently disabled before age 62 because we could not account for missed career growth and opportunities to participate in employer- sponsored pension plans. Retirement occurred as early as age 62. Anyone who became disabled at age 62 or older was considered retired. Workers could be covered by DB plans. We relied on PENSIM’s defaults to determine DB plan coverage and benefit amounts. Rates of return were fixed. The annual nonstochastic nominal rate of return was 9.2 percent for stocks and 5.7 percent for government bonds. Using different rates of return would result in different effects on DC and automatic IRA account balances at retirement and, as a result, the size of the household’s retirement annuity. Also, because our projections did not stochastically model stock returns, assuming a rate of return on assets equal to the historical return on stocks did not capture the risks associated with stock returns. Further, the nominal rate of return for stocks is based in part on a long-term equity risk premium calculated in 2000. PENSIM assigned each individual one of four “lifetime asset allocation styles.” DC assets were invested according to the individual’s asset allocation style. These styles included (1) all assets are invested in a diversified-equity fund, (2) all assets are invested in a government bond fund, (3) 15 percent of assets are invested in a collection of individuals stocks and the remaining 85 percent are invested in an age-specific mixture of a diversified-equity fund and a government- bond fund, and (4) 15 percent of assets are invested in a collection of individual stocks and the remaining 85 percent are invested in a target-date fund. Account fees for investment funds were 75 basis points for target-date funds; 100 basis points for diversified-equity funds; 45 basis points for money-market funds, equity-index, and government bond funds; and 0 basis points for stable-value and guaranteed-return funds. We considered these account fees to be our “standard fees” scenario. When workers change jobs, they either roll over their DC account balances or cash them out. Whether workers roll over their DC account balances or cash them out depends on the relative size of their account balances. We relied on PENSIM’s defaults to determine whether workers rolled over their account balances. PENSIM does not allow for hardship withdrawals. Workers accumulated DC and IRA savings from past jobs in one rollover account, which continued to receive investment returns. At retirement, benefits were consolidated into one account. Workers used their entire DC account balance at retirement to purchase a single-life annuity at retirement that was not adjusted for inflation. DB benefits were also provided in the form of an annuity. DB and DC annuities were combined into one retirement annuity. Annuity prices were based on projected mortality rates for the 1995 birth cohort and on loading factors that ensured that the cost of providing annuities in PENSIM equaled the revenue generated by selling them at those prices. We assume that the annuity provider had no administrative or marketing costs, no costs in acquiring the capital it needs to hold in reserve, and earns no profits. Eligible individuals received Social Security benefits in retirement. According to 2012 projections of the Social Security Trustees for the next 75 years (2012-2087), revenues will not be adequate to pay full benefits as defined by the current benefit formula. Therefore, estimating future Social Security benefits should reflect that actuarial deficit and account for the fact that some combination of benefit reductions and revenue increases will be necessary to restore long- term solvency. Our tax-increase-only benchmark simulated “promised benefits,” or those benefits promised by the current benefit formula. We also developed an alternative benefit-reduction-only benchmark which simulated “funded benefits,” or those benefits for which currently scheduled revenues are projected to be sufficient (see Sensitivity Analysis below). Our tax-increase-only benchmark raised payroll taxes once and immediately by the amount of Social Security’s actuarial deficit as a percentage of payroll. It resulted in the smallest ultimate tax rate of those we considered and spread the tax burden most evenly across generations; this was the primary basis for our selection. The later that taxes are increased, the higher the ultimate tax rate needed to achieve solvency, and, in turn, the higher the tax burden on later taxpayers and lower on earlier taxpayers. Still, any policy scenario that achieves 75-year solvency only by increasing revenues would have the same effect on the adequacy of future benefits in that promised benefits would not be reduced. Nevertheless, alternative approaches to increasing revenues could have very different effects on individual equity. All estimates related to this benchmark were simulated using the SSASIM OLC mode. Starting in 2013, we increased the tax rate by 2.61 percent in order to achieve 75-year solvency. As reported in the Social Security Administration’s 2012 Trustees Report, immediately raising taxes by 2.61 percent would achieve solvency. In our policy scenarios, we varied other assumptions to see how these variations affect retirement income at age 67. We did not account for any behavioral responses that changes in policy may have created. In reality, some individuals may choose to contribute more to their pension plans or may choose to start saving in a pension plan or IRA in response to policy changes. Policy scenarios we analyzed include: No Saver’s Credit. In addition to the assumptions described above, this scenario assumed no Saver’s Credit’s was available. This scenario served as the baseline against which we compared the results for the existing and refundable Saver’s Credit scenarios. Existing Saver’s Credit. This scenario was drawn from the existing design of the Saver’s Credit as established by the Economic Growth and Tax Relief Reconciliation Act of 2001. Under the credit’s current design, taxpayers may receive a non-refundable credit of up to $1,000 ($2,000 if married filing jointly) for contributing to a pension plan or IRA. The credit amount is equal to the credit rate multiplied by the amount of qualified contribution (of up to $2,000 per individual). Taxpayers receive a credit rate of 50, 20, or 10 percent depending on AGI and filing status. Certain students, individuals under age 18, and those who are claimed as a dependent on another taxpayer’s return are not eligible to receive the credit. If a worker receives a pre- retirement distribution from a pension plan, any credit received in that year and the subsequent two years will be reduced by the amount of the distribution. We used information from the Internal Revenue Service to determine current AGI limits. 2013 AGI limits are: $59,000 for individuals with a filing status of married filing jointly, $44,250 for individuals with a filing status of head of household, and $29,500 for individuals with a filing status of single, married filing separately, or widow(er). Limits in subsequent years were indexed to inflation. PENSIM assumed the credit was deposited directly into the taxpayer’s DC account. This is not a requirement under law, and in reality the credit would be part of the household’s tax refund. We assumed a 100 percent utilization rate, meaning that all eligible taxpayers received the credit, to show the maximum potential accumulation for retirement income from the Saver’s Credit. This utilization rate also reflects PENSIM’s default values for 2012 and beyond. We did not assess behavioral responses related to the utilization of the Saver’s Credit. Refundable Saver’s Credit. This scenario had the same eligibility requirements and 2013 AGI limits as the existing Saver’s Credit scenario. Starting in 2014, the following changes were implemented, drawn from our understanding of modifications included in the President’s budget proposal of fiscal year 2011: (1) the credit became fully refundable, (2) all taxpayers received a 50 percent credit rate (there is no phase-out), and (3) AGI limits were increased. The 2014 AGI limits were: $85,000 for individuals with a filing status of married filing jointly, $63,750 for individuals with a filing status of head of household, and $42,500 for individuals with a filing status of single, married filing separately, or widow(er). Limits in subsequent years were indexed to inflation. Individuals could receive a refundable credit of up to $1,000 if filing singly or $2,000 if filing jointly. PENSIM assumed that the credit is deposited directly into the taxpayer’s DC account. This change was not proposed in the President’s budget. We assumed a 100 percent utilization rate, meaning that all eligible taxpayers claimed the credit, to show the maximum potential accumulation for retirement income from the Saver’s Credit. We did not assess behavioral responses related to the utilization of the Saver’s Credit. Automatic IRAs. This scenario is drawn from our understanding of H.R. 4049 The Automatic IRA Act of 2012. For our scenario, we assumed that private sector employers began offering automatic IRAs in 2014. Employers who employed more than 10 employees and did not offer a DB or DC plan were required to offer automatic IRAs to employee ages 18 and over after they have been employed for 90 days. Contributions were made to traditional IRAs. If the employee did not select a contribution rate or investment fund, 3 percent of the employee’s salary was contributed to a target-date fund. The aggregate participation rate is centered around a target participation rate of 69 percent in the year 2035, when the cohort was age 40 and in the midst of its prime working years. We selected this rate by estimating a hypothetical average participation rate using parameters from economic literature and SCF data on households that did not currently participate in a DC or IRA plan. Our model considered the effects of automatic enrollment in 401(k) plans, the effects of an employer match (or a lack there-of), income, and age. Individuals may choose to terminate their participation in the automatic IRA after being enrolled in the plan. The Saver’s Credit provisions matched the Existing Saver’s Credit scenario described above. We assumed that the utilization rate for the credit was 100 percent to model the full savings potential of the credit. Automatic IRAs and a refundable Saver’s Credit. In addition to modeling automatic IRAs as described above, we modeled the Saver’s Credit with the same provisions as in the Refundable Saver’s Credit scenario, also described above. The refundable Saver’s Credit was fully refundable, there was no credit rate phase-out, and AGI limits were extended starting in 2014. Individuals could receive a refundable credit of up to $1,000 if filing singly or $2,000 if filing jointly. We assumed that the utilization rate for the refundable Saver’s Credit was 100 percent. Figures 10 through 13 show the results of our modeling scenarios presenting means instead of medians. In general, for dollar changes, the means were higher than the medians. In addition, we modeled alternative scenarios to examine how sensitive our results were to our assumptions. Specifically, we ran the PSG models using the following alternative assumptions: Alternative assumptions for investment account fees. Should investment account fees be higher than those in our standard fees assumption, we established a “high fees” assumption. Account fees for target-date funds were 200 basis points; account fees for diversified-equity funds were 225 basis points; account fees for money-market funds, equity-index, and government bond funds remained at 45 basis points; and account fees for stable-value and guaranteed-return funds remained at 0 basis points. Alternative assumptions for Social Security benefits. Our benefit- reduction-only benchmark simulated “funded benefits,” or those benefits for which currently scheduled revenues are projected to be sufficient. Under this scenario, the benefit reduction did not begin until 2018 to give workers and Social Security beneficiaries time to prepare for the reduction. In 2018, benefits were reduced by 18.2 percent for new and existing beneficiaries. SSA actuaries scored this benchmark and determined it would achieve 75-year solvency. Alternative assumptions for Saver’s Credit utilization rate. Research on Saver’s Credit utilization rate for the first couple of years it was available indicates that between 60-67 percent of eligible taxpayers claimed the credit. We modeled a utilization rate of 60 percent to reflect the lower bound of this range. This scenario demonstrates the effects of the Saver’s Credit if utilization is as low as the initial rate at which taxpayers claimed the credit. Alternative assumptions for automatic IRA participation rate. We modeled an aggregate automatic IRA participation rate of 48 percent to demonstrate the effects of automatic IRAs should overall participation be lower than expected. This alternative participation rate is similar to one study’s estimate for the participation rate for new employees in retirement plans where participation is voluntary. The results for all of our modeling scenarios, including those using our alternative assumptions, are presented in tables 7 through 11 below. Lifetime summary statistics of the simulated 1995 cohort’s workforce and demographic variables give some insight into the PSG model’s projections of income in retirement in our report (see tables 12 and 13). By restricting the sample to retirees who do not immigrate into the cohort after age 25, do not emigrate or die before age 67, and do not become permanently disabled before age 62, we reduce the full sample of 118,142 individuals to a sample of 60,813 individuals. In addition to the contact named above, Michael Collins, Assistant Director; Andrea Dawson, Jennifer Gregory, and Amrita Sen made key contributions. Also contributing to this report were Alicia Atkinson, Benjamin Bolitzer, Alicia Cackley, Colleen Candrl, David Chrisinger, Laura Henry, Sharon Hermes, Gene Kuehneman, Kathy Leslie, Thomas McCool, Mimi Nguyen, Marylynn Sergent, Kenneth Stockbridge, Nyree Ryder Tee, Roger Thomas, Frank Todisco, and Walter Vance.

Summary: Participants in DC plans and IRAs may receive tax incentives for their contributions and lower-earning households may qualify for the Saver's Credit, an additional tax incentive for their contributions. However, less than half of the workforce participates in an employer-sponsored plan and upper-income workers have been more likely to take advantage of associated tax incentives. In recent years, proposals have been put forth to modify the Saver's Credit and create automatic IRAs, under which employers who do not sponsor a plan would generally be required to offer their employees the opportunity to save in an IRA through payroll deduction. These proposals would have fiscal impacts for the federal government. GAO was asked to review tax incentives for contributions to DC plans and automatic IRAs. GAO examined (1) the earnings and tax rates of households that do not have DC plans or IRAs, (2) the effects of the Saver's Credit on retirement income, and (3) the effects of automatic IRAs on retirement income, especially for low- and middle-income workers. GAO examined the characteristics of households that do not take advantage of these tax incentives using data from the 2010 Survey of Consumer Finances, simulated the effects of the Saver's Credit and automatic IRAs, and reviewed related proposals. GAO is making no recommendations. GAO received technical comments on a draft of this report from the Department of Labor and the Department of the Treasury, and incorporated them as appropriate. Households without employer-sponsored defined contribution (DC) pension plans or individual retirement accounts (IRA) had lower incomes and tax rates than households with those plans, and are also likely to have limited additional resources to draw upon in retirement, according to GAO estimates. The median adjusted gross income for households without DC plans or IRAs was $32,000, compared to $75,000 for those that did have them. The median marginal tax rate for households without DC plans or IRAs was 15 percent, compared to 25 percent for households with those savings vehicles. A defined benefit (DB) pension plan could provide a monthly benefit during retirement years for those without a DC plan or IRA; however, in 2010 only 15 percent of married households and 11 percent of single households without a DC plan or IRA had a DB plan. The existing Saver's Credit tax incentive could result in small increases in a household's retirement annuity--that is, the household's annual retirement income received from DC or DB plans. GAO estimates that, on account of this credit, the median annuity increase for households in the lowest earnings quartile ($929-34,377) would be $155. If, however, the Saver's Credit was refundable (i.e., could generate a tax refund in excess of tax paid), it could result in larger increases in households' annuities across all earnings levels, and the median increase for households in the lowest earnings quartile would be $876 per year. Implementing automatic IRAs, unless waived by participants, could expand retirement coverage and modestly increase retirement annuities for households at all earnings levels. Specifically, 7 percent of all households could receive retirement annuities from automatic IRAs even though these households had no DB or DC plans, according to GAO's projections. Workers with DB or DC plans could also benefit from automatic IRAs at certain points in their lifetime if their jobs do not offer such plans. Moreover, low-income workers could see a sizable increase in their annuities under automatic IRAs and the existing Saver's Credit--the projected median dollar increase for these households' annual retirement annuity would be $479.