Statement of the
Investment Company Institute

On the President’s Proposals for Fiscal Year 2006 

Submitted to the
Committee on Ways and Means
U.S. House of Representatives

February 22, 2005 

Chairman Thomas, Members of the Ways and Means Committee, I am Paul Stevens, President of the Investment Company Institute, the national association of mutual funds. On behalf of our many members who manage more than eight trillion dollars on behalf of nearly 90 million individual investors, I thank you for the opportunity to address the important tax, savings, and retirement policy proposals the President has put forward for the coming year.

Table of Contents

I. The Mutual Fund Industry’s Role in Expanding Americans’ Access to Ownership

II. The Mutual Fund Industry’s Role in Preparing for Retirement

III. Social Security

IV. EGTRRA Permanence

V. JGTRRA Permanence

VI. Simplifying & Strengthening Private Savings Opportunities

VII. Clarifying Section 529 Qualified Tuition Programs

VIII. Deferring Taxation of Reinvested Mutual Fund Capital Gains Distributions

IX. Conclusion

I. The Mutual Fund Industry’s Role in Expanding Americans’ Access to Ownership
Nearly half of all U.S. households -- and nearly two-thirds of middle-income households -- invest in mutual funds. Individuals from every walk of life choose to invest in mutual funds for the diversification, professional management and varying investment objectives that funds provide. Americans may invest in mutual funds through taxable accounts, retirement accounts, or qualified tuition programs (more commonly known as “529 Plans”).

The powerful impact that mutual fund popularity has had on the economy, on jobs, and on access to the markets for workers and small business is equally significant. Several years ago, The Economist reported that mutual funds had emerged as “the biggest source of capital for American companies . . . giving small and medium-sized businesses unprecedented access to capital markets and thereby financing nearly all of America’s employment growth.”1

In its 2002 study of the mutual fund industry, Congress’ Joint Economic Committee found that mutual funds provide increased savings opportunities for Americans and ready and stable sources of capital for America’s financial markets:2

The size and flexibility of mutual fund complexes, and of some individual funds, enable them to choose among a much wider range of investments than individual investors can. Mutual funds make markets in those investments more efficient by allocating capital so its marginal product tends to be substantially the same for different users. Mutual funds are just one of a few institutions that can, at the margin, bring supply and demand together for different types of financial instruments to maximize the aggregate real return on capital in society.3

In short, mutual funds are both an essential vehicle for enabling middle-income Americans to reach their long-term savings goals and an important source of capital and growth for the American economy.

II. The Mutual Fund Industry’s Role in Preparing for Retirement
Mutual funds play a particularly important role in helping millions of Americans prepare for a financially secure retirement. Funds are an important investment medium for employer-sponsored retirement programs (e.g., section 401(k) plans) as well as for individual savings vehicles (e.g., individual retirement accounts (“IRAs”)). Of the $2.9 trillion in 401(k) plan and other defined contribution assets accumulating for American workers as of December 31, 2003, $1.4 trillion – almost half – was invested in mutual funds. Similarly, of the $3 trillion in IRAs, $1.3 trillion was invested in mutual funds. In addition to their role as important savings and investment vehicles, mutual fund companies also provide a broad range of services to defined contribution plans, such as 401(k) plans, and individual account plans, such as IRAs. These services include recordkeeping, tax compliance and reporting and participant education services.

Intertwined as we are with Americans’ retirement savings, the mutual fund industry believes it can offer a helpful perspective on the urgent retirement security issues now central to so many challenges – challenges facing Washington lawmakers, regulators, businesses and working families.

The President has launched a historic debate on both Social Security reform and retirement security proposals needed to strengthen the other legs of the retirement income stool – private pensions and individual savings. The President’s budget sets forth a number of specific provisions that we believe hold great promise for encouraging the growth and retention of individual savings, strengthening the economy, promoting the adoption and continuation of employer-sponsor pension plans to supplement savings and Social Security, and much more. We welcome the opportunity to assist policymakers in addressing these issues. With the growth of defined contribution pension plans, retirement planning increasingly involves individual decisions and individual education about alternatives that can seem quite complex and overwhelming. In fact, an ICI household survey found that about a third of those offered but not participating in a 401(k) plan did not participate because of confusion about plan features. We want to work with you to break through the complexity and to expand savings opportunities as the President has challenged us all to do together.

III. Social Security
To set our comments on specific tax initiatives in context, let me begin by addressing Social Security. The Institute believes it is imperative to ensure the permanent solvency and sustainability of the Social Security system. To this end, ICI commends the Bush Administration’s effort to develop and propose appropriate reforms of the system. And the Institute commends the Chairman’s leadership in encouraging all parties to be broad and creative in analyzing this challenge and seeking constructive solutions.

The Institute strongly supports maintaining Social Security as a universal system, and one that provides a floor benefit to those many Americans who rely principally on Social Security for retirement income. Preserving the fiscal soundness and fairness of the Social Security system will help ensure Americans’ continued faith in and support of the program.

The Institute thus strongly supports the Administration’s close and timely attention to Social Security reform. All credible reform options should be considered carefully. Under one such proposal, younger workers would have the option to place a portion of their Social Security contributions into a personal account invested in a government-sponsored fund or funds similar to those available to federal employees under the Thrift Savings Plan (“TSP”). The Institute believes that any proposal for personal accounts should be judged by whether they will bolster the permanent solvency and sustainability of the Social Security system.

Personal accounts could provide other benefits in addition to retirement income. They would introduce many more Americans to basic principles of saving and investing. Encouraging American workers to focus more broadly on these basic principles could have very positive effects – including, for example, prompting them to make additional provisions for their retirement security through individual savings and employer-sponsored plans.

If reform of the Social Security system entails opportunities for younger workers to invest in personal accounts, then care must be taken to protect them as investors, through measures similar to those in the federal securities laws, and to educate them about investing. The Institute has substantial expertise concerning such issues. Several federal agencies have important and intersecting roles to play in these areas and are hard at work with them currently in various initiatives aimed at improving disclosure to investors, making more comparable the information pension plan managers must analyze, and strengthening the tracking systems that will restore and enhance investor confidence in complicated systems needed to implement individual decisions in today’s changing retirement plan landscape. We look forward to working with the Administration and Congress as they consider a range of proposals to enhance retirement security.

We welcome the ongoing efforts of Congress and the Administration to expand private retirement programs and savings opportunities and to simplify the rules governing them. As noted above, these private programs, such as IRAs and employer-sponsored plans, are also essential to Americans’ retirement security. The greater their success and the more widespread their use, the less pressure the Social Security system will be under in the future.

Millions of retirees today receive income above Social Security thanks to their employer-sponsored pensions and their savings. We know, too, that IRAs have been a tremendous success, particularly in the years in which decisions to save were not inhibited by the complexity of changing deduction and eligibility limits. However, we also know that much more is needed. Of the 151 million Americans working today, only 63.5 million, or less than half, are earning benefits under an employer’s retirement plan. We also know that savings opportunities through IRAs and other options have been constrained over time, often for revenue raising reasons, and in time those constraints may appear increasingly costly, so to speak. The President proposes several important initiatives promoting greater retirement security for the future and we welcome the opportunity to work with the Committee to bring them to fruition.

IV. EGTRRA Permanence
The Institute strongly supports the President’s proposal to make permanent the retirement and education savings provisions enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). Among the important improvements to our retirement system, EGTRRA:

  • Increased contribution limits to IRAs - limits that had not been increased (even for inflation) since 1981;
  • Increased the contribution limits to employer-sponsored retirement plans, such as 401(k) plans, 403(b) arrangements, and governmental 457 plans;
  • Provided for "catch-up" contributions to be made by individuals age 50 and over to employer-sponsored plans and IRAs;
  • Made retirement assets significantly more portable, especially among different types of retirement plans, such as 401(k) plans, 403(b) plans, 457 plans, and IRAs; and
  • Created additional long-term savings incentives for education savings vehicles such as section 529 Plans and Coverdell education savings accounts (formerly, education IRAs).

Unless EGTRRA’s retirement and education savings provisions are made permanent, the restrictive savings rules that applied in 2001 will once again be law in 2011. Making EGTRRA’s provisions permanent will promote economic growth and individual savings and financial security. For individuals to plan appropriately for their retirement years, they must be able to rely on predictable rules -- rules that apply now and throughout their career and retirement.4 The future termination of these provisions could affect the long-term savings strategies of working Americans, undermining the purpose of these reforms and jeopardizing saving and long-term growth.

V. JGTRRA Permanence
The Institute strongly supports the President’s proposal to make permanent the important savings and investment provisions enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”), including reduced tax rates on capital gains and qualifying dividends. JGTRRA reduced the tax rate on long-term capital gains. The 20 percent rate has been reduced to 15 percent; the 10 percent rate has been reduced to 5 percent through 2007 and will be reduced to zero in 2008. Unless the changes enacted by JGTRRA are made permanent, the higher rates will be reinstated for tax years beginning in 2009. JGTRRA also reduced the tax rate on qualified dividend income (as defined in the Act) to the 15 percent and 5 percent capital gains rates. These lower rates expire after December 31, 2008.

Just as employer plans and individual retirement savings habits are best served by consistent and predictable retirement laws, corporations and individuals are also best served by consistent and predictable expectations. Both individual investors and the financial markets need certainty in order to plan for the future. It is therefore imperative that the provisions of JGTRRA be made permanent.

VI. Simplifying & Strengthening Private Savings Opportunities
The Institute has long supported initiatives to enhance financial security by advocating efforts to encourage retirement savings through employer-sponsored plans and IRAs, to simplify the rules applicable to retirement savings vehicles, to enable individuals to better understand and manage their retirement assets, to encourage college savings, and to reduce the tax burden on other long-term investing through mutual funds.

The President’s budget includes several important savings incentives. One bold initiative is the proposed creation of Retirement Savings Accounts, Lifetime Savings Accounts and Employer Retirement Savings Accounts. These three new retirement and savings vehicles would both enhance the ability of Americans to save for their future and simplify the current rules governing retirement plans. The Institute strongly supports savings and simplification initiatives that would bring long-term savings and investment opportunities within the reach of every working American.

Comprehensive reform like the President’s proposals will significantly reduce the overwhelming complexity of our current savings system. Today’s rules governing retirement and education saving are simply too difficult to understand and too unwieldy and costly to administer. Simple universal savings vehicles, without age and income limits and other burdensome restrictions, will give Americans of all income levels and in all workplaces greater opportunities to achieve retirement security.

There are other important retirement savings proposals that can enhance the effectiveness of those discussed above. They include proposals to automatically enroll employees in 401(k) plans, to offer new ways of efficiently managing small accounts for missing accountholders, to expand access to the investment advice that defined contribution plan participants need as their choices expand in number and complexity, and more. On many of these initiatives, the Administration has already taken the lead and we welcome the opportunity to work with the Congress as the entire retirement security discussion moves forward.

VII. Clarifying Section 529 Qualified Tuition Programs
Helping American families save for the ever-increasing cost of college is a longstanding and important policy goal. Congress furthered this goal by enacting Code section 529 as part of the Small Business Job Protection Act of 1996 and granting certain federal tax benefits to these state-sponsored “529 Plans.” In 2001, EGTRRA significantly enhanced 529 Plans by allowing tax-free treatment of distributions used to pay for qualified higher education expenses.

Congress’ efforts, particularly the EGTRRA enhancements, increased investor awareness and participation dramatically. Assets in 529 Plans more than doubled since 2002, increasing from $26.8 billion at year-end 2002 to $57 billion by September 2004. During the same period, the number of 529 Plan accounts rose to more than 7 million, and the average account balance was approximately $8,000.5 Although these statistics are encouraging, many Americans who want to save for college still do not save enough.6 Legislation making permanent the tax-free treatment of qualified deferrals from section 529 plans will remove uncertainty, encourage long-term savings for education, and enhance economic growth and productivity. The Institute supports prompt enactment of legislation making permanent this important savings program.

The President’s budget includes proposals to clarify the gift and estate tax consequences of contributions to 529 Plans. Among other things, the Administration’s proposal would impose an excise tax of as much as 50% on certain distributions above $50,000 (computed on a cumulative, lifetime basis for each designated beneficiary). While the proposed clarifications are intended to eliminate transactions designed to avoid gift and estate tax consequences, they have the unintended effect of making 529 Plans significantly less attractive for American families saving for college. We look forward to continuing our dialogue with the Treasury Department to address its concerns without significantly compromising this important college savings tool.

VIII. Deferring Taxation of Reinvested Mutual Fund Capital Gains Distributions
The Institute strongly supports legislation that would permit the deferral of the payment of tax on capital gains realized by a fund until the fund shareholder receives the gain in cash, such as by redeeming fund shares. This proposal would remedy the result, misunderstood by many fund shareholders, that capital gains realized by the fund are taxed currently to the fund’s long-term shareholders -- who continue to hold, rather than sell, their shares.

If this type of legislation were enacted, the millions of fund shareholders investing in taxable accounts would benefit. These investors are mainly middle-income investors who are providing capital necessary for continued economic growth – their own and the country’s. At a time when the retirement community is struggling to prevent leakage of retirement savings, to encourage portability among retirement investments, and to address tax provisions that present obstacles to the retention of sufficient retirement savings to last through the much longer retirement many Americans now experience, it’s right that this idea, too, should be put forward in the tax and retirement debate.

By reducing current tax bills and allowing earnings to grow tax-deferred, this change would boost long-term savings. The proposal would not result in these gains being excluded from tax. Instead, the gains would merely be deferred, albeit, in some cases, outside the relevant budget-scoring period. The proposal’s boost to long-term savings would have little, if any, long-term cost and would provide benefits to the economy in both the short run and the long run. It would eliminate an event that threatens to prematurely interrupt long-term savings, as would proposals to delay the minimum required distribution “start-date” that forces savings out of IRAs.

IX. Conclusion
The Investment Company Institute thanks you, Mr. Chairman, for this opportunity to be heard. We also thank you for your interest in related policy issues – for example, health care reform and additional savings opportunities for health care expenditures – that will be important complements to other savings initiatives and will help make retirement security an achievable goal. The Institute is proud of its research capacity, its expertise in economic analysis, and its educational efforts to reach special populations with savings and investing tools, and we welcome the opportunity to work with you on the challenges ahead. Thank you for the opportunity to present our views.


1 “The Seismic Shift in American Finance: Mutual Funds,” The Economist, October 21, 1995.

2 The Mutual Fund Industry: An Overview and Analysis, Joint Economic Committee, United States Congress, February 2002.

3 Ibid, page 22.

4 Americans will be better positioned to build adequate retirement plans if they know now whether, for example, they will be able to contribute $2,000 or $5,000 to an IRA in 2011 and whether they will be able to make catch-up contributions.

5 ICI Memorandum 18530.

6 See Profiles of American Households Saving For College, ICI Research Series, Fall 2003.