[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
RETIREMENT SECURITY AND DEFINED CONTRIBUTION PLANS
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 26, 2002
__________
Serial No. 107-66
__________
Printed for the use of the Committee on Ways and Means
80-332 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Allison Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
.................................................................
C O N T E N T S
__________
Page
Advisory of February 11, 2002, announcing the hearing............ 2
WITNESSES
U.S. Department of the Treasury, Hon. Mark Weinberger, Assistant
Secretary for Tax Policy....................................... 9
U.S. Department of Labor, Hon. Ann L. Combs, Assistant Secretary,
Pension and Welfare Benefits................................... 17
______
Jefferson, Regina T., Catholic University of America, Columbus
School of Law.................................................. 77
Schieber, Sylvester J., Watson Wyatt Worldwide................... 69
Vanderhei, Jack L., Employee Benefit Research Institute, and
Temple University, Fox School of Business...................... 59
SUBMISSIONS FOR THE RECORD
American Prepaid Legal Services Institute, Chicago, IL, Wayne
Moore, statement............................................... 97
Industry Council for Tangible Assets, Inc., Annapolis, MD,
statement...................................................... 99
International Mass Retail Association, Arlington, VA, statement.. 102
Investment Company Institute, statement.......................... 104
Pension Reform Action Committee, statement....................... 111
RETIREMENT SECURITY AND DEFINED CONTRIBUTION PLANS
----------
TUESDAY, FEBRUARY 26, 2002
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 2:11 p.m., in
room 1100 Longworth House Office Building, Hon. Bill Thomas
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
February 11, 2002
No. FC-15
Thomas Announces a Hearing on Retirement
Security and Defined Contribution Plans
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
retirement security and defined contribution plans. The hearing will
take place on Tuesday, February 26, 2002, in the main Committee hearing
room, 1100 Longworth House Office Building, beginning at 2:00 p.m.
Oral testimony will be heard from invited witnesses only. Any
individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee or for
inclusion in the printed record of the hearing.
BACKGROUND:
Private pension plans are an important component of retirement
savings. In 1997 (the most recent year for which the U.S. Department of
Labor data is available), 71 million workers actively participated in
more than 720,000 pension plans. Assets held by private pension plans
totaled $3.6 trillion in 1997. In general, private pension plans fall
under two broad categories: defined benefit (DB) plans and defined
contribution (DC) plans.
The DB plans provide participants with a guaranteed retirement
benefit that is typically tied to the employee's earnings and/or length
of service. Generally, employers are responsible for making
contributions to the plan that are actuarially sufficient to fund
promised benefits. The employer (or a chosen fiduciary) is responsible
for directing plan investments and bears the risk of such investments.
To ensure a certain level of solvency within DB plans, the Internal
Revenue Code (IRC) sets forth certain minimum funding requirements that
must be met on an ongoing basis. Most private-sector DB plans must pay
premiums to the Pension Benefit Guaranty Corporation (PBGC) to insure
the risk of plan termination without sufficient assets to pay benefits
under the plan. The PBGC is required to pay a minimum guaranteed
benefit to each plan participant in the case of such termination.
Under a DC plan, individual accounts are established for each
participating employee. Accounts are funded with employer
contributions, employee contributions, or both. A DC plan may be
designed to allow participants to direct the investment of their
account balances. Alternatively, the plan design may require that
employer contributions be invested in employer assets or securities.
Yet another design will require the plan sponsor (or an appointed
investment manager) to direct the investment of all the plan assets.
Retirement benefits under a DC plan are based on the individual's total
account balance at retirement. In general, the minimum funding rules
set forth in the IRC are not applicable to DC plans because DC plans
are, by definition, fully funded through employer and/or employee
contributions. Similarly, DC plans are not insured by the PBGC because
there is no risk of termination with insufficient assets.
The past 20 years has seen a significant growth in DC plans. In
1977, 15 million individuals participated in 281,000 DC plans with $91
billion of total assets. By 1997, 55 million individuals participated
in 661,000 plans with $1.8 trillion in assets. In 1997, about 54
percent of covered employees were covered only by a DC plan, 14 percent
were covered only by a DB plan, and 32 percent were covered by both a
DC and a DB plan.
The shift from DB plans to DC plans has provided many advantages
for both employees and employers. However, the trend has also shifted
some measure of the responsibility for financing retirement benefits
from the employer to the employee. As a result, it is necessary that we
examine the rules and regulations that currently govern DC plans as
well as the existing protections for workers who participate in these
plans.
In announcing the hearing, Chairman Thomas stated: ``401(k) plans
and other defined contribution pension plans have provided workers with
important advantages, including the opportunity for increased
retirement income and more portability--a feature that is particularly
important for today's mobile workforce. However, defined contribution
plans also shift more risk and responsibility to the employee. As
defined contribution plans become more and more popular, we need to
evaluate the laws that govern them to ensure we are maximizing
retirement security while minimizing undue regulatory burdens that may
discourage employers from offering these plans.''
FOCUS OF THE HEARING:
The hearing will examine the rules and regulations that currently
govern private DC pension plans. Specific issues to be discussed
include rules regarding diversification of plan assets, restrictions
placed on plan assets under the terms of the plan, standards for
investment education and advice, and notice and reporting requirements.
The hearing will also examine existing protections for plan
participants, including fiduciary rules and applicable penalties for
fraud and/or breach of the fiduciary rules. Witnesses will also discuss
regulatory burdens associated with sponsoring certain retirement plans
as well as the other challenges faced by employers who offer (or seek
to offer) pension plans.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or
organization wishing to submit a written statement for the printed
record of the hearing should send it electronically to
``[email protected]'', along with a fax copy to
202/225-2610 by the close of business, Tuesday, March 12, 2002. Those
filing written statements who wish to have their statements distributed
to the press and interested public at the hearing should deliver their
300 copies to the full Committee in room 1102 Longworth House Office
Building, in an open and searchable package 48 hours before the
hearing. The U.S. Capitol Police will refuse unopened and unsearchable
deliveries to all House Office Buildings.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. Due to the change in House mail policy, all statements and any
accom- panying exhibits for printing must be submitted electronically
to ``[email protected]'', along with a fax copy
to 202/225-2610, in Word Perfect or MS Word format and MUST NOT exceed
a total of 10 pages including attachments. Witnesses are advised that
the Committee will rely on electronic submissions for printing the
official hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. Any statements must include a list of all clients, persons, or
organizations on whose behalf the witness appears. A supplemental sheet
must accompany each statement listing the name, company, address,
telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov/.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman THOMAS. If our guests could find seats, please?
Thank you and good afternoon.
Today's examination of defined contribution pension plans
is the first in a series of hearings that will allow the
Committee on Ways and Means to look at significant aspects of
retirement security for America's workers.
Private pension plans are an important component of
retirement savings for millions of Americans. Historically,
most American workers were covered by defined benefit (DB)
plans that provided a guaranteed benefit at retirement after a
number of years' commitment almost always at one company or
corporation.
However, over the last two decades, we have seen an
expansion in defined contribution pension plans. In a defined
contribution plan, individual accounts are established for each
worker and funded with either employer contributions, employee
contributions, or a mix of both. These contributions are
usually invested at the worker's discretion, and retirement
income depends on the worker's account balance at retirement.
Today, more than 55 million American workers hold nearly
$2.5 trillion in assets in more than 660,000 defined
contribution plans.
We have witnessed a huge growth in defined contribution
plans because they create significant benefits for both
employers and employees. For employers, they are less
burdensome and cheaper to administer. For employees, they
provide more control and the opportunity for higher retirement
income. Moreover, they are more portable so that employees with
today's mobility in the work force can take assets with them
when they change jobs.
Overall, defined contribution plans have been extremely
successful, allowing millions of Americans to retire more
comfortably than they otherwise could have. However, defined
contribution plans do contain the risk that the contribution
will not be invested to maximize return while minimizing risk.
As a result, it is important to examine whether the law has
successfully kept pace with the shift to defined contribution
plans or whether adjustments to these plans are required.
An important issue has emerged in the context of these
recent experiences, and that is the need for greater commitment
to financial education. Indeed, when we look at the decisions
that employees or workers as consumers need to make now, not
only in the retirement area but in the health care field as
well, educating workers about their options that allow them to
make the right choices for their own specific circumstances is
more important than ever before. Financial literacy will allow
employees to make more sophisticated judgments about where and
how to place their investments.
It is not the intention of this Committee to legislate
based on isolated cases where the system has not worked but,
rather, to look at whether and how the broad underlying
fundamentals need correction. Therefore, this Committee will
look at the current legal framework for defined contribution
plans and examine reforms that help workers successfully save
and invest for their retirement. That doesn't mean that the
Committee on Ways and Means will not listen to and examine any
current specific situations. The Subcommittee will be holding a
series of hearings, both Oversight and other subcommittees,
focusing on specific examples and allowing the Committee to
look at the broader framework.
I look forward to learning more about the President's
recommendations for retirement security and hearing from our
panel of pension experts. Ultimately, we will hold a series of
hearings, as I said, on retirement security to examine defined
benefit pensions as well as defined contributions and Social
Security and its solvency in the 21st century.
Prior to calling on the witnesses, I would recognize my
colleague, the Ranking Member, the gentleman from New York, Mr.
Rangel, for any opening statement he might have.
[The opening statement of Chairman Thomas follows:]
Opening Statement of the Hon. Bill Thomas, a Representative in Congress
from the State of California, and Chairman, Committee on Ways and Means
Good afternoon. Today's examination of defined contribution pension
plans is the first in a series of hearings that will allow the Ways and
Means Committee to look at significant aspects of retirement security
for America's workers.
Private pension plans are an important component of retirement
savings for millions of Americans. Historically, most American workers
were covered by ``defined benefit'' plans that provided a guaranteed
benefit at retirement after a number of years of commitment, almost
always at one company or corporation. However, over the last two
decades we have seen an expansion in defined contribution pension
plans. In a defined contribution plan, individual accounts are
established for each worker and funded with either employer
contributions, or employee contributions, or a mix of both. These
contributions are usually invested at the worker's discretion, and
retirement income depends on the worker's account balance at
retirement. Today more than 55 million American workers hold nearly
$2.5 trillion in assets in more than 660,000 defined contribution
plans.
We have witnessed a huge growth in defined contribution plans
because they create significant benefits for both employers and
employees. For employers, they are less burdensome and cheaper to
administer. For employees, they provide more control and the
opportunity for higher retirement income. Moreover, they are more
portable so that employees with today's mobility in the workforce can
take assets with them when they change jobs.
Overall, defined contribution plans have been extremely successful,
allowing millions of Americans to retire more comfortably than they
otherwise could have. However, defined contribution plans do contain
the risk that the contribution will not be invested to maximize return
while minimizing risk. As a result, it is important to examine whether
the law has successfully kept pace with the shift to defined
contribution plans, or whether adjustments to the plan are required.
An important issue has emerged in the context of these recent
experiences, and that is the need for a greater commitment to financial
education. Indeed when we look at the decisions that employees or
workers as consumers need to make now, not only in the retirement area
but in the healthcare field as well, educating workers about their
options that allow them to make the right choices for their own
specific circumstances is more important than ever before. Financial
literacy will allow employees to make more sophisticated judgments
about where and how to place their investments.
It is not the intention of this Committee to legislate based on
isolated cases where the system has not worked, but rather to look at
whether and how the broad underlying fundamentals need correction.
Therefore, this committee will look at the current legal framework
for defined contribution plans and examine reforms that help workers
successfully save and invest for their retirement.
That doesn't mean that the Ways and Means Committee will not listen
to and examine any current specific situation. Subcommittees will be
holding a series of hearings, both Oversight and other subcommittees,
focusing on specific examples and allowing the Committee to look at the
broader framework.
I look forward to learning more about the President's
recommendations for retirement security and hearing from our panel of
pension experts. Ultimately we will hold a series of hearings, as I
said, on retirement security to examine defined benefit pensions as
well as defined contributions and Social Security and its solvency in
the 21st century.
Mr. RANGEL. Thank you, Mr. Chairman.
I had initially thought, when it was suggested that this
hearing was going to be on 401(k)s, that we would be dealing
with the specific--I might as well say the word--the Enron
situation, not because I think that this Committee should try
to make a political statement out of this catastrophe, but
because we have jurisdiction over pensions, oversight over
401(k)s, and I think it is safe to say that investors'
confidence in this system has been eroded. The market has been
negatively impacted. And it just seems to me that we have a
responsibility to let the world know, at least let Americans
know, that what has happened at Enron is not happening with
every 401(k), not happening with every company, and that we are
prepared to provide the oversight, and where we see a need for
change, that this Committee is committed to do it and let the
chips fall where they may.
But I guess this is just an overall review, and the more
specifics will be handled by an Oversight Committee, and I
think it is important enough, whenever the Chair decides to
look at this thing specifically, that the whole Committee be
involved.
I hope that the silence of this Committee is not mimicked
by the Administration because a lot of people were hurt by the
actions of probably a handful of people. And it just seems to
me that the quicker we talk about it and the quicker the
Administration emphasizes that we should correct what needs to
be corrected, leave alone what is working, the quicker we can
work as a team--not as Democrats and Republicans, but as people
who are concerned about the 40 million workers that participate
in these 401(k)s. And I don't think by just talking about non-
specific and specific that we are fulfilling our obligation
under the defined benefit or the defined contribution plan
system.
As a matter of fact, there was a lot of talk about
privatization of the Social Security system. It would seem to
me that at some hearing or at some time we should find out what
happens if the market is not working and do we provide some
type of guarantee for those people that are involved with
privatization of the Social Security system, or do we provide
some security for those people with the 401(k)s.
This is so serious that I think that just by avoiding it,
not talking about it, it is beginning to frighten me. I hope
that the Administration has come prepared to talk about it and
not to have us to believe that we can't even mention Enron.
And, Mr. Chairman, I think the quicker we just try to work
an agenda together, the less political the agenda would be. But
when I see this subject just being avoided by the Committee of
jurisdiction, it just concerns me as to whether there is a
deliberate effort to avoid this, especially since it just so
happens that retirement benefits appears on our hearing
schedule.
It seems to be inconsistent, but you haven't had time to
discuss it with me, and I know that there is an explanation
that would make a lot of sense when we get around to it. But I
just want to thank you for this opportunity, and I will just
wait to see which way the testimony comes from the
Administration, and maybe they will be dealing with this more
directly than you have.
Thank you.
[The opening statements of Mr. Crane and Mr. Camp follow:]
Opening Statement of the Hon. Phillip M. Crane, a Representative in
Congress from the State of Illinois
Mr. Chairman, I appreciate the opportunity to submit my comments on
this important issue. The Ways and Means Committee has taken bold steps
in the last six months to modernize and improve the private pension
system. In particular, the passage of the so-called Portman-Cardin bill
provides increased opportunities for individuals to save for their
retirement years. Likewise, a bill passed out of the Education and the
Workforce Committee will give workers the opportunity to seek advice
from outside financial experts so that they can adequately plan for
their retirement. These two bills provide a powerful one-two punch in
our continued efforts to make retirement plans more available, portable
and stable.
On that note, I strongly encourage my colleagues to proceed with
caution, as we look at new legislation that might impose increased
regulatory burdens on employers. Time and time again throughout my
service in Congress, I have seen us decimate various industries through
over-regulation. We must be sensitive to the limited resources of
employers or else, I'm afraid, that many will stop offering pension
plans, 401(k)'s and employee stock-option plans altogether.
I look forward to working with my colleagues on the Committee as we
continue to engage this important issue.
Opening Statement of the Hon. Dave Camp, a Representative in Congress
from the State of Michigan
Today we are discussing protections for working Americans
participating in Defined Contribution plans, especially the problems
that arise where the employer controls the investment vehicle for the
contribution. I want to make my colleagues aware of another growing
trend, which threatens the retirement savings of American workers, both
in 401(k) rollovers and IRA's.
There are some brokers who see the availability of 401(k) rollover
and IRA money as an opportunity to enrich themselves. They prey on
employees who have access to their defined contribution plans, either
through job changes or retirement. These brokers advise investment of
these sometimes sizable 401(k) and IRA roll-over accounts in risky
schemes.
As we discuss protections for workers in defined contribution
plans, we must look also look at what happens to that money once the
employee leaves that company or retires. A major part of any retirement
security solution must include security for these roll-over funds.
There is something simple we can do to help.
I have introduced a bill in the House, H.R. 1434, which reinstates
the beneficial tax treatment of employer provided group legal services
benefits to employees.
This simple mechanism can provide the necessary legal advice about
investment vehicles. These independent attorneys can review documents
and solicitations and explain to employees what they mean, before they
invest.
If the employee needs a legal document such as a will or trust, to
implement a retirement plan, the attorneys provide that. Of course
group legal services allow employees access to justice for many other
legal life events.
The area of retirement security and investment protection are prime
examples of how readily available legal assistance serves an important
need when an employee's financial well-being may be in jeopardy. I hope
you will all join me in supporting this important piece of the
retirement security puzzle.
I look forward to the testimony today about retirement security and
defined contribution plans. Thank you.
Chairman THOMAS. Apparently the gentleman from New York did
not fully appreciate the Chairman's statement when he said it
was not the intention of this Committee to legislate based on
isolated cases. That is, this hearing should not, in the
Chair's opinion--and I hope in most Members' opinion--focus on
Enron exclusively. There are 10 other committees in Congress
focusing on that specifically.
To say that you can't mention something is rather ironic
coming from that statement that we shouldn't focus on isolated
cases, that we want to make sure in a broader sense the
problems are introduced, not just one particular company's
example of that. But if the gentleman wishes to make a case
that we are somehow trying to avoid that, he completely
misunderstands the Chairman's intention of not legislating
based on isolated cases; rather, we should look at the broad
success and occasional failure in an attempt to write
legislation. That is the entire import of the Chairman's
direction. If the gentleman wants to dwell on any one company,
he certainly has the right to do so as a Member of the
Committee. I indicated that we are going to have a follow-up
where we can have small business, large business, employers,
employees go in-depth into that issue so that those who are
going to have to move legislatively from a Subcommittee have a
greater opportunity to hear particulars.
The full Committee is not going to be able to investigate
each and every isolated case, and the Chair will repeat, there
are 10 other committees of Congress currently plowing that same
furrow. We will watch to see if they produce responsible
conclusions that will allow us in our job, as the gentleman
indicates quite clearly, in overseeing retirement plans, and we
hope that there will be some light generated by the other
committees in assisting this Committee in moving forward.
And, with that, the Chair is pleased to recognize the
Honorable Mark Weinberger, Assistant Secretary for Tax Policy,
U.S. Department of the Treasury, and Ann Combs, Assistant
Secretary, Pension and Welfare Benefits, of the U.S. Department
of Labor. You have submitted written testimony. It will be made
a part of the record. And you can address us any way you see
fit in the time you have available. The microphones have to be
turned on, and they are very unidirectional, until we change
the sound system in this wonderful but somewhat antiquated
hearing room.
STATEMENT OF THE HON. MARK WEINBERGER, ASSISTANT SECRETARY FOR
TAX POLICY, U.S. DEPARTMENT OF THE TREASURY
Mr. WEINBERGER. Thank you, Mr. Chairman, Congressman
Rangel, and distinguished Members of the Committee, again, for
inviting me to appear here before you.
As you are aware, certain recent tragic events--such as the
loss of substantial workers' retirement savings due to failures
of well-established businesses--have prompted a critical
examination of employer-provided retirement plans. This has
raised legitimate concerns that merit close attention and
thoughtful solutions. I applaud the Chairman for calling this
hearing.
The Members of this Committee have always been serious
proponents of the improvement of the retirement system for
American workers, retirees, and families. Mr. Portman and Mr.
Cardin have led the way in promoting retirement legislation.
Their efforts over the last few years resulted in retirement
legislation that had overwhelming bipartisan support in the
House of Representatives. Most of the provisions in the
retirement bill enacted last year as part of EGTRRA or Economic
Growth and Tax Relief Reconciliation Act of 2001 were also
included in earlier bills by Congressmen Portman and Cardin. We
thank you for your leadership.
But there are many more Members of this Committee who have
also led the way when it comes to expanding and protecting
retirement security. Mr. Johnson is one of those leaders both
by using his position on this Committee and as the Chairman of
the Employer-Employee Relations Subcommittee of the Education
and Workforce Committee. Mr. Neal has also shown great interest
in retirement savings over the years. Both Mr. Weller and Mr.
Matsui have been champions for greater disclosure to
participants when employers change plan formulas. Mr. Ramstad
has been a strong proponent of employee stock ownership plans
(ESOP). Ms. Dunn has been an advocate of retirement issues,
especially as they related to women. Mr. Pomeroy has a
longstanding interest in retirement policy, especially the
revitalization of the defined benefit plan. Mr. Rangel has
demonstrated interest in solving some of the problems that have
arisen in the defined contribution world. And finally, you, Mr.
Chairman, have been a long-time sponsor of legislation that
expands retirement savings through the use of IRAs or
individual retirement accounts. We at Treasury appreciate all
of your efforts.
Chairman THOMAS. Now, Mr. Weinberger, you have our
attention.
[Laughter.]
Mr. WEINBERGER. At the outset, we must recognize that the
issues relating to promoting and protecting retirement savings
can be difficult and the proper balance hard to strike. Under
our retirement system, no employer is obligated to provide a
retirement plan for employees; the private retirement plan
system is completely voluntary. There are clear benefits to
employers who provide retirement plans--not only tax benefits
but also the benefits of hiring and retaining qualified
employees who help businesses prosper. As we explore added
protections and new rules, we must be careful not to overburden
the system. If costs and complexities of sponsoring a plan
begin to outweigh advantages, employers will stop sponsoring
them. On the other hand, we must do what we can to ensure that
workers have adequate protections and information to make
informed decisions.
The general rules governing qualified plans were
established in the Employee Retirement Income Security Act 1974
(ERISA). The special tax treatment accorded deferred
compensation plans is intended to encourage employers to
establish retirement plans for their employees.
A sponsoring employer is allowed a current tax deduction
for plan contributions, subject to limits, and employees do not
include contributions or earnings in gross income until
distributed from the plan. Trust earnings accumulate tax-free.
Qualified plans are also subject to extensive rules protecting
participants and restricting the use of assets.
There are two broad categories of tax-qualified retirement
plans: defined benefit plans and defined contribution plans.
While many of the rules are similar, there are important
differences.
A defined benefit plan provides a participant with a
defined benefit that is set out in the plan. The employee has
no risk that his or her entire pension benefit will be lost. If
the funds of the plan are insufficient to pay the benefits
promised and the company goes bankrupt, the Pension Benefit
Guaranty Corporation (PBGC) provides a guarantee of benefits up
to a statutory maximum.
In a defined contribution plan, the employer makes a
contribution that is allocated to participants' accounts under
an allocation formula specified by the plan. Earnings increase
the participant's ultimate retirement benefit; losses decrease
the ultimate benefit. Under a defined contribution plan, the
plan sponsor may, but is not required to, give participants the
ability to allocate assets in their accounts among a variety of
investments. If a participant has the ability to direct plan
investments, his or her investment decisions will determine the
ultimate retirement benefit.
Employees and employers both appreciate many of the
advantages of defined contribution plans. Employees have become
more mobile and defined contribution benefits are often more
valuable than defined benefits for employees who change
employers during their working life.
A popular feature in defined contribution plans is the cash
or deferred arrangement, referred to as the 401(k). Section
401(k) of the Tax Code permits a participant to elect to
contribute, on a pre-tax basis, to a defined contribution plan
instead of receiving cash compensation. Employer-matching
contributions are often used to give an incentive to lower-paid
employees to contribute to the plan.
The combined web of retirement vehicles, despite their
complexities, has proven very successful. In 1998, qualified
retirement plans for private employers covered 41 million
defined benefit participants and 58 million defined
contribution participants. These plans hold $4 trillion in
assets. Currently it is estimated that 42 million workers
participate in 401(k) savings plans and hold $2 trillion in
assets.
As the 42 million 401(k) participants carry more and more
responsibility for their retirement security, full confidence
in the security of their pension plan is essential. Too many of
these workers lack adequate access to investment advice and
useful information on the status of their investment in
retirement savings. Moreover, better advice and information
serve little purpose unless workers are free to act on them, at
least to the same extent as the executives for whom they work.
With this in mind, the President has put forth a balanced,
four-step proposal based on the recommendations of the
Retirement Security Task Force. The President believes that
Federal retirement policy should expand not limit employee
ability to invest plan contributions as they see fit.
First, the President's proposal will increase workers'
ability to diversify their retirement savings. While many
companies already allow rapid diversification, others impose
holding periods that can last for decades. The President's
proposal provides that workers can sell company stock and
diversify into other investment options after they have
participated in the 401(k) plan for 3 years.
Second, the President's proposal addresses the concerns
regarding ``blackout periods''--periods where plan participants
are restricted from selling shares. The President has proposed
policies that create equity between senior executives and rank-
and-file workers by preventing executives from selling company
stock during times when workers are unable to trade in their
401(k) plans. As a matter of principle, the interest of
executive officers and rank-and-file employees in a company
should be aligned.
The proposal also clarifies that employers have a fiduciary
responsibility for workers' investments during a blackout
period.
Third, the President proposes to increase worker
notification of blackout periods and provide workers with
quarterly benefits statements about their individual pension
accounts. The President's proposal requires that plan
participants be given a 30-day notice before any blackout
period begins.
Finally, in order for employees to get the investment
advice that they need, the President advocates the enactment of
the Retirement Security Advice Act--which passed the House with
overwhelming support. The legislation encourages employers to
make investment advice more widely available to workers and
only allows qualified financial advisers to offer advice if
they agree to act solely in the interests of employees.
The Administration looks forward to working with Members of
this Committee and all of Congress to ensure greater
protections for the retirement benefits of all workers and
their families.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Weinberger follows:]
Statement of the Hon. Mark Weinberger, Assistant Secretary for Tax
Policy, U.S. Department of the Treasury
Mr. Chairman, Congressman Rangel and distinguished Members of the
Committee, I thank you for the opportunity to testify before the Ways
and Means Committee on the important issue of retirement security--
specifically, employer sponsored tax-qualified retirement savings
plans, such as 401(k) plans.
My testimony this afternoon will address the President's Retirement
Security Plan. As background, I will also address the current structure
of the employer-provided retirement system as it is reflected in the
Internal Revenue Code (the Code), especially plans that invest in
company stock, and the expansions brought about by last year's Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
The members of this Committee have always been serious proponents
of the expansion of the retirement system for American workers,
retirees, and their families. Mr. Portman and Mr. Cardin have lead the
way in promoting retirement legislation. Their efforts over the last
few years resulted in retirement legislation that had overwhelming
bipartisan support in the House of Representatives. Most of the
provisions in their retirement bill were enacted last year as part of
EGTRRA and we, at Treasury and the IRS, are working hard to make sure
that these provisions have been implemented. Thank you for your
leadership.
There are many more members of this Committee who also lead the way
when it comes to expanding and protecting American retirement security.
Mr. Johnson is one of those leaders both by using his position on this
Committee and as the Chairman of the Employer-Employee Relations
Subcommittee of the Education and the Workforce Committee. Mr. Neal has
always shown great interest in retirement savings over the years. Both
Mr. Weller and Mr. Matsui have been champions for greater disclosure to
participants when employers change plan formulas. Mr. Ramstad has been
a great friend of employee stock ownership plans, especially when used
by small business. Ms. Dunn has always been an advocate of retirement
issues, especially as they relate to women. She was a passionate
proponent of the catch-up contribution, which is now available to those
over age 50. Mr. Pomeroy, although new to this Committee, has a
longstanding interest in retirement policy, especially the
revitalization of the defined benefit plan. Mr. Rangel has demonstrated
interest solving some of the problems that have arisen in the defined
contribution world. And finally, you, Mr. Chairman, have been a long-
time sponsor of legislation that expands retirement savings through the
expansion of IRAs. We at Treasury appreciate all of your efforts in
this area.
The issues relating to promoting and protecting retirement savings
can be difficult and the proper balances hard to strike. The
substantial experience of this Committee will be a valuable asset.
In talking about retirement security and the defined contribution
system, let us follow the path of bipartisanship that the House of
Representatives has been following when dealing with retirement issues.
When looking at how to further improve the system, both sides having
common goals. They include the promotion of the use of the voluntary,
employer-based retirement system to provide retirement benefits to
Americans and to protect participants' savings and retirement income.
These laudable goals are reflected in all the various legislative
proposals that have been introduced. Let us remember that we have the
same goals when commencing this debate.
While the universal goal of the system is to provide for retirement
security, each individual's personal goals for retirement savings
differ. All agree that we must equip participants with tools to
accomplish individual goals in a rational manner. Artificial
restrictions may not be appropriate for all employees who are making
personal decisions on how much to contribute to a plan and how to
invest their contributions. Employees who determine their own
investment goals do not want a government to restrict the amount of
their investment that can be invested in specific funds.
Last month, President Bush formed a task force on retirement
security. He asked Treasury Secretary O'Neill, Labor Secretary Chao and
Commerce Secretary Evans to analyze our current pension rules and
regulations and make recommendations to create new safeguards that
protect the pensions of millions of American workers. In his State of
the Union speech, the President reiterated this commitment when he
said:
``A good job should lead to security in retirement. I ask
Congress to enact new safeguards for 401(k) and pension plans.
Employees who have worked hard and saved all their lives should
not have to risk losing everything if their company fails.''
The President's Retirement Security Plan, announced on February 1,
2002, would strengthen workers' ability to manage their retirement
funds by giving them freedom to diversify their investments and better
information for making savings and investment decisions, including
access to professional investment advice. It would ensure that senior
executives are subject to the same restrictions as American workers
during temporary blackout periods and that employers assume full
fiduciary responsibility during such times. I will talk more about the
specifics of his proposal later in my testimony.
Under our retirement system, no employer is obligated to provide a
retirement plan for employees; the private retirement plan system is
completely voluntary. There are clear benefits to employers who provide
retirement plans--not only tax benefits but also the benefits of hiring
and retaining qualified employees who help the business prosper.
Because of these benefits, we must be careful not to overburden the
system. If costs and complexities of sponsoring a plan begin to
outweigh advantages, employers will stop sponsoring plans. What benefit
does an elaborate protection mechanism provide for retirement savings
if the employer ceases sponsoring a plan? We should join together in a
bipartisan fashion to ensure that the legislative proposals we advance
will not result in a reduction in the number of employers' sponsoring
plans.
An important point I would like to make is that the retirement
system is thriving. Some statistics illustrate the strengths of the
system.
In 1998 (the most recent data available from the
Department of Labor), qualified retirement plans for private employers
covered a total of 41 million defined benefit plan participants and 58
million defined contribution plan participants. These plans held assets
of $4 trillion. Contributions of $202 billion were made and benefits of
$273 billion were paid.
Currently, it is estimated that 42 million workers
participate in 401(k) plans, which hold $2 trillion in assets (of which
19 percent are invested in employer securities). Employees contribute
about $100 billion per year to 401(k) plans, and employers contribute
another $50 billion per year. About half of 401(k) participants are
also covered by another pension plan.
These statistics underscore the breadth of coverage of employer-
sponsored plans and the strength and vitality of the 401(k) plan
system. Other statistics, however, point out the lack of coverage in
small business--something that EGTRRA was designed to remedy.\1\ In
1998, 86 percent of the employers with 500 or more employees sponsored
a retirement plan. Fewer than 14 percent of the smallest employers
sponsored a plan.
---------------------------------------------------------------------------
\1\ For example, EGTRRA provided a small business tax credit for
qualified plan contributions and new plan expenses for small
businesses.
---------------------------------------------------------------------------
Tax Principles Regarding Retirement Plans and Company Stock
The importance of the retirement system under the tax code is long-
standing. In the Revenue Act of 1921, Congress provided that
contributions by an employer to a stock bonus or profit sharing plan
\2\ are deductible by the employer and not taxable until the amounts
contributed are distributed or made available to the employee. Five
years later, in the Revenue Act of 1926, the Congress extended this tax
treatment to pension plans. The concepts of profit-sharing and stock
bonus plans date back to the 1920's, and some of the oldest defined
contribution plans now maintained by well-known and well-run companies
began as stock bonus plans. Many companies that contribute stock to
their retirement plans have employees who end up with very comfortable
retirements. For example, the average rate of return from 1990 to 1997
for employee stock ownership plans was 13.3 percent, while for 401(k)
plans it was 11.9 percent.
---------------------------------------------------------------------------
\2\ A ``profit sharing'' plan is a tax qualified plan under which
employer's contributions on behalf of covered employees are allocated
according to a definite predetermined formula and distributed after a
fixed number of years, the attainment of a stated age, or upon the
occurrence of some event such as layoff, illness, disability,
retirement, death, or severance of employment. An employer does not
have to have profits to make contributions to a profit sharing plan. A
``stock bonus'' plan is similar to a profit sharing plan, except that
the contributions by the employer are distributable in stock of the
employer.
---------------------------------------------------------------------------
Some assert that having company stock in a retirement plan is a
gamble that employees should not take. We believe that company stock,
as part of one's overall retirement nest egg, has generally proven to
be a favorable for employees. We all know examples of employees who did
not fare well. While appropriate steps should be taken to enable
employees to better protect themselves, we should not abandon the long-
standing and successful employer-provided plan retirement system.
Rather we should give employees more flexibility and more information
so that they can better manage their retirement nest egg.
Tax qualified plans are accorded favorable tax treatment. A
sponsoring employer is allowed a current tax deduction for plan
contributions, subject to limits, and employees do not include
contributions or earnings in gross income until distributed from the
plan. Trust earnings accumulate tax-free.
Qualified plans are also subject to rules protecting participants
and restricting the use of plan assets, including the following:
Plan funds must be used only for the exclusive benefit of
employees or their beneficiaries.
To ensure that employers provide benefits under these
plans to moderate and lower-paid employees, qualified plans are subject
to rules that prohibit discrimination in favor of highly compensated
employees (the nondiscrimination rules).
To encourage participants to keep amounts in plans to
satisfy retirement needs, sanctions are imposed if funds are withdrawn
from a qualified retirement plan prior to retirement.
To ensure that plan assets are accumulated for retirement
purposes and not accumulated as a death benefit, sanctions are imposed
for not taking distributions during a participant's retirement years.
Since 1974, many of the tax qualification rules have also been
addressed in provisions of the Employee Retirement Income Security Act
of 1974 (ERISA).\3\
---------------------------------------------------------------------------
\3\ For example, most of parts 2 and 3 of Title I of ERISA (the
vesting, participation, and funding rules) are virtually identical to
tax qualification rules in the Internal Revenue Code. The Internal
Revenue Service makes determinations as to the qualified status of the
form of a plan and audits whether plans operate in accordance with
their terms. Generally, an employee cannot bring an action to enforce
tax qualification requirements, which are enforced by the Internal
Revenue Service. If a tax qualification requirement is also contained
in ERISA, however, it can also be enforced by a plan participant or by
the Department of Labor. The Reorganization Plan No. 4 of 1978 provides
that, in general, the Secretary of the Treasury has the regulatory
authority for those provisions that are contained in both the Internal
Revenue Code and ERISA.
---------------------------------------------------------------------------
Types of Retirement Plans
There are two broad categories of tax qualified retirement plans:
defined benefit plans and defined contribution plans. While many of the
tax rules regarding these types of plans are similar, there are
important differences.
A defined benefit plan provides a participant with a benefit
defined by the plan. The employer makes plan contributions that are
actuarially determined to fund the benefit over the working life of the
employee. The employee has no risk that his or her entire pension
benefit will be lost. If the funds of the plan are insufficient to pay
the benefits promised and the company is bankrupt, the Pension Benefit
Guaranty Corporation provides a guarantee of benefits up to a statutory
maximum, which in most cases exceeds the promised benefits. Conversely,
if the investment experience of the underlying fund outpaces the
promised benefits, the employer benefits through a lower contribution
obligation. While excess funds are held for employees, they are not
required to be used to increase pension benefits.
In a defined contribution plan, the employer makes a contribution
that is allocated to participants' accounts under an allocation formula
specified by the plan. Investment gains or losses increase or decrease
the participant's account, without obligating the employer to make
further contributions. Earnings increase the participant's ultimate
retirement benefit; losses will decrease that ultimate benefit. Under a
defined contribution plan the plan sponsor may, but is not required to,
give participants the ability to allocate assets in their accounts
among a number of investment alternatives. If a participant has the
ability to direct plan investments, his or her investment decisions
will determine the ultimate retirement benefit.
Due to a number of factors, there is a recent trend among employers
to shift toward defined contribution plans. One of these factors has
been the increasing mobility of the American workforce and demands by
employees for a portable benefit. It is difficult for an employee who
changes jobs frequently to vest in a significant defined benefit. From
1985 to 1998, the number of defined benefit plans fell by 67 percent
and the number of active defined benefit participants fell by 21
percent. Over the same period, the number of defined contribution plans
rose by 46 percent and the number of active defined contribution plan
participants rose by 52 percent. In particular, the growth in the
number of defined contribution plans and participants is due to an
explosion in the number of 401(k) plans and participants.
Employees and employers both appreciate many of the advantages of
defined contribution plans. Employees have become more mobile and
defined contribution benefits are more valuable than defined benefits
for employees who change employers during their working life. Employees
also appreciate the ability to control the allocation of the assets in
their accounts. Employers appreciate the more predictable funding
obligations of defined contribution plans.
401(k) Plans
A very popular feature in defined contribution plans is the cash or
deferred arrangement, codified under section 401(k) of the Code (hence,
the term ``401(k) plan''). Section 401(k) of the Code permits a
participant to elect to contribute, on a pre-tax basis, to a defined
contribution plan instead of receiving cash compensation.
There are restrictions on these elective contributions, including a
requirement that the average amount of elective contributions made by
highly compensated employees (as a percentage of compensation) may not
be greater than a certain percentage of the average amount of
contributions made by non-highly compensated employees. This test is
referred to as the Actual Deferral Percentage (ADP) test and must be
satisfied annually. One result of the ADP test is that employers
encourage participation by lower-paid employees. Employer matching
contributions give an incentive to lower-paid employees to contribute
to the plan. A new EGTRRA provision requires that matching
contributions be 100 percent vested after three years of service or
vested ratably over six years. Another important provision of EGTRRA,
the Saver's Credit, provides a tax credit equal to 50 percent of the
retirement savings (up to $2,000) of many lower paid employees. The
more lower-paid employees save for retirement the more higher-paid
employees can save.
Matching contributions are subject to a nondiscrimination test
similar to the ADP test. This test, the Actual Contribution Percentage
(ACP) test, is used to make sure that matching contributions do not
disproportionately favor the highly compensated (as a percentage of
compensation) relative to non-highly compensated employees. Prior to
EGTRRA, an additional nondiscrimination test--called the Multiple Use
Test--had to be passed. EGTRRA eliminated this third nondiscrimination
test because it unnecessarily complicated 401(k) plan testing. Congress
and the Administration agreed that the ADP and ACP tests are adequate
to prevent discrimination in favor of highly compensated employees.
The ADP and ACP tests can be avoided through the use of one of two
statutory safe harbors. Under one of the safe harbors, the employer
matches 100 percent of an employee's contributions, up to 3 percent of
compensation, and 50 percent of the employee's contributions between 3
percent and 5 percent of compensation. The other safe harbor requires
the employer to make a contribution on behalf of all eligible employees
(regardless of whether the employee actually makes a 401(k)
contribution) equal to 3 percent of compensation.
Employee Stock Ownership Plans
A stock bonus plan may be designated in whole or in part as an
employee stock ownership plan, or ESOP. An ESOP is a plan that is
designed to invest primarily in company stock. Currently, it is
estimated that there are about 11,500 ESOPs, covering about 8.5 million
workers. Only about nine percent of ESOPs are in publicly traded
companies. However, these tend to be large companies and hence account
for about half of ESOP-covered workers. In 1999, ESOPs held about $500
billion in assets and received $20 billion in contributions.
If a plan or a portion of a plan is an ESOP, the ESOP generally
must pass voting rights on publicly traded stock held in participants'
accounts to participants. An ESOP must give participants the right to
request the distribution in stock, and, if the distribution is made in
stock, the right to ``put'' (i.e., sell) the stock back to the company
or the plan. In addition, participants who are age 55 and have at least
10 years of participation in the plan must be given the opportunity to
diversify a portion of the stock held in their ESOP account.
Employers establish ESOPs for many reasons. In addition to
providing retirement benefits to employees, an ESOP transfers employer
stock to employees, thereby encouraging employee ownership and aligning
employees' interests with the success of the company. An ESOP can be
used to transfer ownership from a company founder to employees by
having the ESOP borrow funds to purchase company stock as the owner
retires or to provide additional capital for employer expansion. Tax-
deductible ESOP contributions can be used by the ESOP to repay a loan.
As the loan is repaid, the stock purchased with loan proceeds is
allocated to participants. About three-quarters of ESOPs have used
borrowed funds to acquire employer securities.
Another advantage to establishing an ESOP is the ability of the
employer to deduct dividends paid on employer stock held in the plan.
EGTRRA made this feature even more attractive by extending this
deductibility feature to all ESOP dividends provided that participants
are given the opportunity to elect to receive the dividend in cash.
Because of the value of this expanded deduction for ESOP dividends, we
understand that most publicly traded companies that have a non-ESOP
employer stock fund will convert that stock fund to an ESOP and offer
participants the opportunity to take a distribution of the dividend in
cash.
When talking about ESOPs, many people refer to K-SOPs and M-SOPS. A
K-SOP is an ESOP that uses an employee's 401(k) contributions to
purchase employer stock or repay a loan whose proceeds had been used to
purchase employer stock for the plan. Likewise, an M-SOP is an ESOP
that uses the employer's matching contributions to purchase employer
stock or repay an ESOP loan.
The President's Retirement Security Plan
The President's plan puts employees in better control of amounts
that they contribute to a 401(k) plan and improves employees' ability
to make good individual investment decisions and reach their retirement
goals. The President's plan focuses on the following four areas:
1. Giving Employees Investment Choice
The President believes that federal retirement policy should
expand, not limit employee ability to invest their contributions or
matching contributions as they see fit. Under the President's plan,
employers cannot require that accounts of employees who have three or
more years of participation in the plan be invested in employer stock.
However, the employee is not required to diversify these amounts; it is
the employee's choice. The three-year rule provides a balance between
the employer's desire to have employees invested in employer stock and
the employee's interests in diversification. The three-year period is
consistent with the shorter vesting rule for employer matching
contributions.
ESOPs are intended to be invested primarily in employer securities
and are an accepted method of transferring ownership of a company to
employees. Requiring diversification in all ESOPs would make it
virtually impossible to accomplish the well-accepted purposes of an
ESOP, including the encouragement of employee ownership and a source of
financing to the employer. Moreover, ESOPs are subject to special
diversification rules already in the Code. Therefore, the President's
plan provides that a stand-alone ESOP (i.e., an ESOP that holds no
401(k) contributions, matching contributions, or other contributions
used to satisfy the Code's nondiscrimination tests) will not be subject
to these diversification requirements. K-SOPs and M-SOPs will be
required to offer diversification rights to plan participants.
This new diversification requirement will be an addition to the
overall tax qualification requirements under the Code. Since the
diversification rule will be a tax qualification requirement, the plan
document must specifically provide for the diversification right. If
the diversification right is not contained in the plan, the IRS will
refuse to issue a favorable determination letter stating that the plan
meets the qualification requirements.\4\ The diversification
requirement would also be added to Title I of ERISA, thereby giving
participants and the Department of Labor the ability to enforce the
diversification right.
---------------------------------------------------------------------------
\4\ The IRS estimates that it will review approximately 120,000
plans during this year's filing season to determine whether they meet
the qualification rules of the Code.
---------------------------------------------------------------------------
2. Clarifying Employers' Responsibilities During Blackout Periods and
LCreating Parity Between Senior Corporate Executive and
LRank-and-File Workers
The President's plan provides fairness by eliminating double
standards with respect to the ability to sell employer stock during the
time plan recordkeepers or plan investments change--the so-called
blackout period. This is accomplished by placing restrictions on
corporate executives trading employer stock outside of a plan that
parallel restrictions on employer stock transactions inside the plan
during a blackout period. In addition to being fair to employees, this
rule would create a strong incentive for corporate management to
shorten the blackout period to the minimum time required to make
changes.
Section 404(c) of ERISA provides employers with a defense against
lawsuits when employers give workers control of their individual
account investments. The President's plan would clarify ERISA to
disallow employers from utilizing this 404(c) defense for fiduciary
breaches that occur during a blackout period. Because the 404(c)
defense is based on the premise that employers have given investment
control to their workers, the defense logically is inappropriate during
blackout periods when employers have suspended investment control from
their workers.
3. Giving Employees Better Information about Their Pensions
To make sure that employees have maximum control over the
investment of their retirement savings, the President's plan requires
that notice be given to employees 30 days before the blackout period
begins. With this notice, employees will be able to adjust investment
selections in anticipation of the blackout period. Failure to provide
this notice will result in a penalty on the plan sponsor of $100 per
day per employee for every day that an employee did not get the notice.
The President also wants to make sure that employees get up-to-date
information on plan investments and reminders of sound investment
principles. The President's plan expands the current reporting
requirements for 401(k)-type plans so that quarterly statements are
required. In addition, the quarterly statement should address
appropriate investment diversification. We believe that the more
employees hear about diversification, the more they can decide for
themselves whether their overall retirement savings are secure.
4. Expanding Workers' Access to Investment Advice
In order for employees to get the investment advice they need, the
President advocates the enactment of the Retirement Security Advice
Act--which passed the House with overwhelming bipartisan support.
Currently, ERISA impedes employers from obtaining investment advice for
their employees from the financial institutions that often are in the
best position to provide advice. The Retirement Security Advice Act
would address this by providing employees with access to advice from
fiduciary advisers that are regulated by Federal or State authorities.
As fiduciaries, these advisers would be held to the standard of conduct
currently required by ERISA. This legislation encourages employers to
make investment advice more widely available to workers and only allows
qualified financial advisors to offer advice if they agree to act
solely in the interests of employees. The Retirement Security Advice
Act would also add important protections by requiring information about
fees, relationships that may raise potential conflicts of interest, and
limitations on the scope of advice to be provided. The legislation also
would place advisers who have affiliations with investment products on
a more equal footing with non-affiliated advisers, foster competition
among firms, and promote lower costs to participants.
I reiterate the Administration's desire to achieve consensus on
both the problems and solutions surrounding the retirement security of
all Americans. I hope that we can work together to improve the
employer-based retirement system and provide more retirement security
for all Americans by providing more investment choice, plan
information, and investment education to employees.
I appreciate the opportunity to discuss these important issues with
the Members of this Committee, and would be pleased to explore these
issues further.
Mr. Chairman, this concludes my formal statement. I will be pleased
to answer any questions you or other Members may wish to ask.
Chairman THOMAS. Thank you, Mr. Weinberger. Secretary
Combs?
STATEMENT OF THE HON. ANN L. COMBS, ASSISTANT SECRETARY,
PENSION AND WELFARE BENEFITS ADMINISTRATION, U.S. DEPARTMENT OF
LABOR
Ms. COMBS. Good morning, Chairman Thomas, Ranking Member
Rangel, and Members of the Committee. At the beginning I would
like to associate myself with Mr. Weinberger's gracious
comments to the Committee on your hard work in this area.
I appreciate the invitation to appear before you today to
discuss developments in the private pension system and the
President's plan to enhance workers' retirement security. The
Administration looks forward to working with this Committee,
especially those Members who have already introduced
legislation to address these serious issues, such as Mr.
Portman, Mr. Cardin, Mr. Johnson, Mr. Rangel, and Mr. English.
Today's hearing is especially timely because it is being
held on the eve of the 2002 National Summit on Retirement
Savings mandated by the Savings Are Vital to Everyone Act of
1997 or SAVER Act. This important event will develop
recommendations to encourage Americans to increase their
retirement savings and to improve financial literacy. I am
grateful for the participation of several Members of this
Committee in the summit, including Representatives Portman,
Johnson, Cardin, and Pomeroy.
Our private pension system is a great success story. Today,
more than 46 million American workers are earning retirement
benefits with more than $4 trillion invested in the private
pension system. The improvements championed by Representatives
Portman and Cardin passed in the President's tax package last
June will bring even more retirement savings opportunities to
America's workers.
Recent events, however, have called the strength of our
system into question. It is essential that we work together to
restore Americans' confidence in our retirement system. We must
be mindful of its voluntary nature and strike an appropriate
balance that will improve retirement security while encouraging
employers to offer plans and to make generous matching
contributions.
The emergence of 401(k) plans over the past 20 years can be
described as a virtual revolution in retirement savings. We now
face the challenges of this revolution as we scrutinize the
strengths and the weaknesses of defined contribution plans.
401(k) plans have--in a single generation--made America a
nation of investors, but workers also bear the risks and the
rewards of our economy in a much more personal way.
Participants in the vast majority of 401(k) plans today
enjoy the freedom to make their own choices about how to invest
their savings and plan for their own retirement. They also bear
much of the responsibility for those choices. The
Administration strongly believes that workers should be given
more choice--not less--along with more control over and more
confidence in their choices. More freedom, along with the tools
necessary to make wise choices, is the best approach to
equipping workers to plan for a secure retirement.
Let me turn now to a brief discussion of the President's
plan to enhance retirement security by strengthening the rights
of workers in defined contribution plans. On January 10th,
President Bush formed a Task Force on Pension Security,
appointing Secretaries Chao, O'Neill, and Evans to study this
important issue. The Task Force tackled this project with the
speed and the seriousness dictated by the importance of its
mission. It was able to complete its work and issue
recommendations in a very timely fashion, and I am pleased that
we are here today to be able to discuss those with you.
On February 1st, the President announced his plan to give
workers more choice in how to invest their retirement savings,
the confidence in their investment decisions that comes from
getting quarterly account information and reliable professional
financial advice, and the same degree of control over their
investments that corporate officers and executives enjoy.
The President's plan would increase workers' ability to
diversify their retirement savings. We believe employers should
continue to have the option to use company stock to make
matching contributions. It is important to encourage employers
to make as generous a contribution to workers' 401(k) plans as
possible. However, workers also should have the freedom to
choose how they wish to invest their retirement savings. The
President's Retirement Security Plan will ensure that workers
can sell company stock and diversify into other investment
options after they have participated in the 401(k) plan for 3
years.
The President's plan would ensure that workers have
adequate notice of an upcoming blackout period by requiring
that employers give notice of the blackout at least 30 days
before it begins. Workers deserve to know when a blackout
period is expected and to have the opportunity to reallocate or
change their investments, to apply for a loan, or to take a
distribution in anticipation of the blackout if they believe
that is the appropriate course of action for them.
We also suggest imposing rules that will encourage
employers to make blackout periods as brief as possible. The
President's plan would clarify ERISA to prohibit an employer
from using section 404(c) of ERISA as a defense against a
challenge that it breached its fiduciary duty during a blackout
period, causing the participants to suffer losses as a result.
The 404(c) defense is based on the premise that plan
participants have been given ``control'' over their investments
in the plan. This shield from fiduciary responsibility should
not be available during blackout periods when employers have
suspended investment control from their workers.
But let me be clear. The President's plan would not hold
employers liable for the rise and fall of investment values
that occur during a blackout period because of market
fluctuations. To bring a lawsuit against an employer under
ERISA, a worker would still have to set and prove that a
fiduciary breach occurred and that the worker's loss was caused
by that breach.
Another element of the President's plan will further
encourage employers to make blackout periods as brief as
possible. Our proposal creates parity between senior executives
and rank-and-file workers by restricting senior executives'
ability to sell employer stock while workers are unable to
change their 401(k) investments during a blackout period. The
President believes it is simply unfair for workers to be denied
the ability to sell stock held in their 401(k) accounts while
senior executives do not face similar restrictions against
selling company stock held outside the 401(k) plan. What is
good for the shop floor is good for the top floor.
The President's plan also calls on the Senate to pass H.R.
2269, the Retirement Security Advice Act, which passed your
Committee and the House with a strong bipartisan majority. This
bill would encourage employers to make professional investment
advice available to workers and allow qualified financial
advisers to provide advice--if they agree to act solely in the
interest of the workers in the plan and disclose any fees or
relationships they have with the plan.
Finally, the Administration recognizes that workers deserve
timely and complete information about their 401(k) plan
investments. To enable them to make informed decisions, workers
should be given quarterly benefit statements that include
information about the value of their assets, the right to
diversify, and the importance of a diversified portfolio. The
President's proposal explicitly allows the Secretary of Labor
to tailor this requirement to meet the needs of small
businesses.
This combination of access to professional investment
advice, an increased ability to diversify, and quarterly
benefit statements will give workers the tools, we believe,
that they need to make sound investment decisions.
Taken together, the measures proposed by the President will
give workers the choice, confidence, and control they need to
protect their savings and plan for a secure retirement. Workers
deserve the chance to make unrestricted investment decisions,
the confidence that comes from good information and
professional investment advice, and a level playing field that
gives them control over their retirement earnings.
As the President said in his State of the Union address, a
good job should lead to security in retirement.
Thank you for giving me the opportunity to address this
important subject today. We look forward to working with the
Committee to ensure greater retirement security for all
Americans. Thank you.
[The prepared statement of Ms. Combs follows:]
Statement of the Hon. Ann L. Combs, Assistant Secretary, Pension and
Welfare Benefits Administration, U.S. Department of Labor
Introductory Remarks
Good morning Chairman Thomas, Representative Rangel, and Members of
the Committee. Thank you for inviting me here today to share
information about the Department's role in enforcement and regulation
under the Employee Retirement Income Security Act (ERISA). Over the
past 28 years, ERISA has fostered the growth of a voluntary, employer-
based benefits system that provides retirement security to millions of
Americans. I am proud to represent the Department, the Pension and
Welfare Benefits Administration (PWBA), and its employees, who work
diligently to protect the interests of plan participants and support
the growth of our private pension and health benefits system.
Recent events have heightened concern about our private pension
system, especially the defined contribution system. The Department has
been working diligently to evaluate current law and regulations, and
has consulted extensively with the President's domestic and economic
policy teams on how to improve and strengthen the pension system.
Although some reforms are necessary, we should not presume that the
private pension system is irreparably ``broken.'' In fact, the private
pension system is a great success story. Just two generations ago, a
``comfortable retirement'' was available to just a privileged few; for
many, old age was characterized by poverty and insecurity. Today,
thanks to the private pension system that has flourished under ERISA,
the majority of American workers and their families can look forward to
spending their retirement years in relative comfort. Today, more than
46 million Americans are earning pension benefits on the job. More than
$4 trillion is invested in the private pension system. This is, by any
measure, a remarkable achievement.
As employers move toward greater use of ``defined contribution''
retirement plans, such as 401(k) plans, we must nurture and protect
employee choice, confidence and control over their investments. I
welcome this opportunity to work with the Ways and Means Committee, and
recognize the leadership you provide in protecting workers' pension
assets, in raising necessary questions about the Enron situation and
similar cases, and formulating policy to strengthen this country's
retirement system.
My testimony will describe ERISA's background and regulatory
framework; the trend towards greater use of ``defined contribution''
retirement plans and what that means for employers and employees; the
Department's role in enforcing ERISA and providing assistance to
employees and their families; the Department's actions regarding the
Enron bankruptcy; and the President's Retirement Security Plan to
improve our current laws to ensure retirement security for all American
workers, retirees and their families.
ERISA
The fiduciary provisions of Title I of ERISA, which are
administered by the Labor Department, were enacted to address public
concern that funding, vesting and management of plan assets were
inadequate. ERISA's enactment was the culmination of a long line of
legislative proposals concerned with the labor and tax aspects of
employee benefit plans. Since its enactment in 1974, ERISA has been
strengthened and amended to meet the changing retirement and health
care needs of employees and their families. The Department's Pension
and Welfare Benefits Administration is charged with interpreting and
enforcing the statute. The Office of the Inspector General also has
some criminal enforcement responsibilities regarding certain ERISA
covered plans.
Under ERISA, the Department has enforcement and interpretative
authority over issues related to pension plan coverage, reporting,
disclosure and fiduciary responsibilities of those who handle plan
funds. Additionally, the Labor Department regularly works in
coordination with other state and federal enforcement agencies
including the Internal Revenue Service, Federal Bureau of
Investigation, and the Securities and Exchange Commission. Another
agency with responsibility for private pensions is the Pension Benefit
Guaranty Corporation, which insures defined-benefit pensions.
ERISA focuses on the conduct of persons (fiduciaries) who are
responsible for operating pension and welfare benefit plans. Such
persons must operate the plans solely in the interests of the
participants and beneficiaries. If a fiduciary's conduct fails to meet
ERISA's standard, the fiduciary is personally liable for plan losses
attributable to such failure.
Trends in Pension Coverage
There are two basic categories of pension plans--defined benefit
and defined contribution. Defined benefit plans promise to make
payments at retirement that are determined by a specific formula, often
based on average earnings, years of service, or other factors. In
contrast, defined contribution plans use individual accounts that may
be funded by employers, employees or both; the benefit level in
retirement depends on contribution levels and investment performance.
Over the past 20 years, the employment-based private pension system
has been shifting toward defined contribution plans. The number of
participants in these plans has grown from nearly 12 million in 1975 to
over 58 million in 1998. Over three-fourths of all pension-covered
workers are now enrolled in either a primary or supplemental defined
contribution plan. Assets held by these plans increased from $74
billion in 1975 to over $2 trillion today.
Most of the new pension coverage has been in defined contribution
plans. Nearly all new businesses establishing pension plans are
choosing to adopt defined contribution plans, specifically 401(k)
plans. In addition, many large employers with existing defined benefit
plans have adopted 401(k)s and other types of defined contribution
plans to provide supplemental benefits to their workers.
Most workers whose 401(k) plans are invested heavily in company
stock have at least one other pension plan sponsored by their employer.
Just 10 percent of all company stock held by large 401(k) plans (plans
with 100 or more participants) was held by stand-alone plans in 1996;
the other 90 percent was held by 401(k) plans that operate alongside
other pension plans, such as defined benefit plans covering the same
workers.
Although there has been a shift to defined contribution plans,
defined benefit plans remain a vital component of our retirement
system. Under defined benefit plans, workers are assured of a
predictable benefit upon retirement that does not vary with investment
results.
The trends in the pension system are a reflection of fundamental
changes in the economy as well as the current preferences of workers
and employers. The movement from a manufacturing-based to a service-
based economy, the growth in the number of families with two wage
earners, the increase in the number of part-time and temporary workers
in the economy, and the increased mobility of workers has led to the
growing popularity of defined contribution plans.
Employers' views have similarly changed. Increased competition and
economic volatility have made it much more difficult to undertake the
long-term financial commitment necessary for a defined benefit pension
plan. Many employers perceive defined contribution plans to be
advantageous while workers have also embraced the idea of having more
direct control over the amount of contributions to make and how to
invest their pension accounts.
Emerging trends in defined contribution plans and workers' job
mobility make it increasingly important that participants receive
timely and complete information about employment-based pension and
welfare benefit plans in order to make sound retirement and health
planning decisions.
Employer Securities Under ERISA
The investment of pension funds in the securities of a sponsoring
employer is specifically addressed by ERISA. ERISA generally requires
that pension plan assets be managed prudently and that portfolios be
diversified in order to limit the possibility of large losses. Indeed,
under ERISA, traditional ``defined benefit'' pension plans are
generally allowed to invest no more than 10 percent of their assets in
employer securities and real property. However, ERISA includes specific
provisions that permit individual account plans like 401(k) plans to
hold large investments in employer securities and real property, with
few limitations.
As a separate matter, employee stock ownership plans (ESOPs) are
eligible individual account plans that are designed to invest primarily
in qualifying employer securities. Congress also has provided a number
of tax advantages that encourage employers to establish ESOPs. By
statutory design, ESOPs are intended to promote worker ownership of
their employer with the goal of aligning worker and employer interests.
By statute, they must be designed to invest more than 50 percent of
their assets in employer stock. On average, ESOPs held approximately 60
percent in employer securities in 1996.
The legislative history of ERISA provides us with some of the
rationale behind these exceptions to the rules regarding
diversification. First, Congress viewed individual account plans as
having a different purpose from defined benefit plans. Also, Congress
noted that these plans had traditionally invested in employer
securities.
In 1997, Congress amended ERISA to limit the extent to which a
401(k) plan can require workers to invest their contributions in
employer stock. The rule generally limits the maximum that an employee
can be required to invest in employer securities to 10 percent. The
rule, however, does not limit the ability of workers to voluntarily
invest in employer stock. Furthermore, the rule does not apply to
employer matching contributions of employer stock or ESOPs.
Recent data indicate that 401(k) plans holding significant
percentages of assets in employer securities tend to be very large,
though few in number. Currently, almost 19 percent of all 401(k)
assets, or about $380 billion, is invested in company stock. The
distribution of holdings of employer securities is very uneven,
however, with most 401(k) plans holding very small amounts or no
employer stock. Fewer than 300 large plans (those with 100 or more
participants), or just 0.1 percent of all 401(k) plans, invested 50
percent or more in company stock in 1996.
Because the plans heavily invested in company stock tend to be very
large (with an average of 21,000 participants), the number of workers
affected and the amount of money involved are substantial. In 1996,
just 157 plans held $100 million or more in company stock. Together,
these plans covered 3.3 million participants, and held $61 billion in
company stock.
A great deal of the 401(k) money invested in company stock is under
the control of workers. When participants can choose how to invest
their entire account and company stock is an option, participants
invest 22 percent of assets overall in company stock. However, when
employers mandate 401(k) plan investments into employer stock, workers
choose to direct higher portions of the funds they control into
employer stock. In these plans, participants direct 33 percent of the
assets they control into company stock.
If a 401(k) plan provides workers with the right to direct their
account investments, and the plan is determined to have complied with
section 404(c) of ERISA, then plan fiduciaries are relieved of
liability regarding the consequences of participants' investment
choices. The Department's Section 404(c) regulations are designed to
ensure that workers have meaningful control of their investments. Among
other things, employees must be able to direct their investments among
a broad range of alternatives, with a reasonable frequency, and must
receive information concerning their investment alternatives.
PWBA Actions: Immediate Reponse to Enron
We are bringing to bear our full authority under the law to provide
assistance to workers affected by situations such as the recent Enron
bankruptcy.
The Department of Labor has made a concerted effort to respond
rapidly to situations such as Enron. In these circumstances, there are
two aspects to our efforts: to help the workers whose benefits may be
placed at risk and to conduct an investigation to determine whether
there has been any violation of the law.
On November 16, 2001, over two weeks before Enron declared
bankruptcy, the Department launched an investigation into the
activities of Enron's pension plans. Our investigation is fact
intensive with our investigators conducting document searches and
interviews. The investigation is examining the full range of relevant
issues to determine whether violations of ERISA occurred, including
Enron's treatment of their recent blackout period.
Blackout periods routinely occur when plans change service
providers or when companies merge. Such periods are intended to ensure
that account balances and participant information are transferred
accurately. Blackout periods will vary in length depending on the
condition of the records, the size of the plan, and number of
investment options. While there are no specific ERISA rules governing
blackout periods, plan fiduciaries are obliged to be prudent in
designing and implementing blackout periods affecting plan investments.
In early December, it became apparent that Enron would enter
bankruptcy. Because the health and pension benefits of workers were at
risk, we initiated our rapid response participant assistance program to
provide as much help as possible to individual workers.
On December 6 and 7, 2001, the Department, working directly with
the Texas Workforce Commission, met on-site in Houston with 1200 laid-
off employees from Enron to provide information about unemployment
insurance, job placement, retraining and employee benefits issues.
PWBA's staff was there to answer questions about health care
continuation coverage under COBRA, special enrollment rights under
HIPAA, pension plans, how to file claims for benefits, and other
questions posed by the employees. We also distributed 4500 booklets to
the workers and Enron personnel describing employee benefits rights
after job loss, and provided Enron employees with a direct line to our
benefit advisors and to nearby One-Stop reemployment centers. These
services were made available nationwide to other Enron locations.
PWBA regularly works throughout the country to assist employees
facing plant closings, job loss or a reduction in hours, and subsequent
loss of employee benefits. Our regional offices make it a top priority
to offer timely assistance, education and outreach to dislocated
workers.
I am pleased to announce that we have just activated a new Toll
Free Participant and Compliance Assistance Number, 1-866-275-7922 for
workers and employers to make inquiries regarding their retirement and
health plans and benefits. The Toll Free Number is equipped to
accommodate English, Spanish, and Mandarin speaking individuals.
Callers will be automatically linked to the PWBA Regional Office
servicing the geographic area from which they are calling. Benefits
Advisors will be available to respond to their questions, assist
workers in understanding their rights or obtaining a benefit, and
assist employers or plan sponsors in understanding their obligations
and obtaining the necessary information to meet their legal
responsibilities under the law. Callers may also access our
publications hotline through this number or they may access them on the
PWBA website. Some of the publications available are: Pension and
Health Care Coverage--Questions & Answers for Dislocated Workers,
Protect Your Pension, Health Benefits Under COBRA, and many more.
Workers and employers may also submit their questions or requests for
assistance electronically to PWBA through our website,
www.askpwba.dol.gov.
PWBA Benefits Advisors also provide onsite assistance in
conjunction with employers and state agencies to unemployed workers--
conducting outreach sessions, distributing publications, and answering
specific questions related to employee benefits from workers who are
facing job loss. In FY 2001, we participated in onsite outreach
sessions for workers affected by 140 plan closings. So far this year,
we have participated in 106 rapid response events reaching nearly
40,000 workers.
The Rapid ERISA Action Team (REACT) enforcement program is designed
to assist vulnerable workers who are potentially exposed to the
greatest risk of loss, such as when their employer has filed for
bankruptcy. The new REACT initiative enables PWBA to respond in an
expedited manner to protect the rights and benefits of plan
participants. Since introduction of the REACT program in 2000, we have
initiated over 500 REACT investigations and recovered over $10 million
dollars.
Under REACT, PWBA reviews the company's benefit plans, the rules
that govern them, and takes immediate action to ascertain whether the
plan's assets are accounted for. We also advise all those affected by
the bankruptcy filing, and provide rapid assistance in filing proofs of
claim to protect the plans, the participants, and the beneficiaries.
PWBA investigates the conduct of the responsible fiduciaries and
evaluates whether a lawsuit should be filed to recover plan losses and
secure benefits.
In certain cases, PWBA may seek the appointment of an independent
fiduciary to manage a retirement plan even before an investigation is
completed, particularly if the plan sponsor has filed for bankruptcy.
We initiated negotiations in January with Enron to secure the removal
of the Administrative Committees for Enron's pension plans. The
Administrative Committees are made up of Enron officials who serve as
plan fiduciaries with responsibility for operating and managing the
plans and protecting the rights of participants and beneficiaries. Our
objective is to replace them with an independent fiduciary, expert in
ERISA and experienced in protecting the interests of participants and
beneficiaries in complex pension plans like Enron's. On February 13,
Secretary Chao announced an agreement with Enron to appoint an
independent fiduciary to replace the Enron pension plans'
Administrative Committees, and for Enron to pay up to $1.5 million per
year for those services. We are working to name a qualified independent
fiduciary as soon as possible.
Our investigation of Enron was begun under REACT. Because I do not
want to jeopardize our ongoing Enron investigation, I cannot discuss
the details of the case. Without drawing any conclusions about Enron
activities, I will attempt to briefly describe what constitutes a
fiduciary duty under ERISA, how that duty impacts on investment in
employer securities, the duty to disclose, and the ability to impose
blackout periods.
Determining whether ERISA has been violated often requires a
finding of a breach of fiduciary responsibility. Fiduciaries include
the named fiduciary of a plan, as well as those individuals who
exercise discretionary authority in the management of employee benefit
plans, individuals who give investment advice for compensation, and
those who have discretionary responsibility for administration of the
pension plan.
ERISA holds fiduciaries to an extremely high standard of care,
under which the fiduciary must act in the sole interest of the plan,
its participants and beneficiaries, using the care, skill and diligence
of an expert--the ``prudent expert'' rule. The fiduciary also must
follow plan documents to the extent consistent with the law.
Fiduciaries may be held personally liable for damages and equitable
relief, such as disgorgement of profits, for breaching their duties
under ERISA.
While a participant or beneficiary can sue on their behalf of the
plan, the Secretary of Labor can also sue on behalf of the plan, and
pursue civil penalties. We have 683 enforcement and compliance
personnel and 65 attorneys who work on ERISA matters. In calendar year
2001, the Department closed approximately 4,800 civil cases and
recovered over $662 million. There were also 77 criminal indictments
during the year, as well as 42 convictions and 49 guilty pleas.
President Bush's Plan
In January, President Bush formed a task force on retirement
security and asked Labor Secretary Chao, Treasury Secretary O'Neill and
Commerce Secretary Evans to analyze our current pension rules and
regulations and make recommendations to ensure that people are not
exposed to losing their life savings as a result of a bankruptcy. In
his State of the Union speech, the President reiterated his commitment
to improving the retirement security of all Americans.
The President's Retirement Security Plan, announced on February 1,
would strengthen workers' ability to manage their retirement funds more
effectively by giving them freedom to diversify, better information,
and access to professional investment advice. It would ensure that
senior executives are held to the same restrictions as American workers
during temporary blackout periods and that employers assume full
fiduciary responsibility during such times.
Under current law, workers can be required to hold company stock in
their 401(k) plans for extended periods of time, often until they reach
a specified age. Workers lack the certainty of advance notice of
blackout periods when they cannot control their accounts, lack access
to investment advice and lack useful information on the status of their
retirement savings. The President' Retirement Security Plan will
provide workers with confidence, choice and control of their retirement
future.
The President's plan would increase workers' ability to diversify
their retirement savings. The Administration believes employers should
continue to have the option to use company stock to make matching
contributions, because it is important to encourage employers to make
generous contributions to workers' 401(k) plans. However, workers
should also have the freedom to choose how they wish to invest their
retirement savings. The President's Retirement Security Plan will
ensure that workers can sell company stock and diversify into other
investment options after they have participated in the 401(k) plan for
three years.
The President is also very concerned about blackout periods, and
the Retirement Security plan suggests changes to make blackout periods
fair, responsible and transparent. Our proposal creates equity between
senior executives and rank and file workers, by imposing similar
restrictions on senior executives' ability to sell employer stock while
workers are unable to make 401(k) investment changes. It is unfair for
workers to be denied the ability to sell company stock in their 401(k)
accounts during blackout periods while senior executives do not face
similar restrictions with regard to the sale of company stock not held
in 401(k) accounts. Because the oversight of stock transactions of
senior executives may go beyond the jurisdiction of the Department of
Labor's regulation of pension plans, I will work with the appropriate
agencies to develop equitable reform.
The President's Retirement Security Plan ensures that workers will
have ample opportunity to make investment changes before a blackout
period is imposed by requiring that they be given notice of the
blackout period 30 days before it begins. Although employers regularly
give advance notice of pending blackout periods, an explicit notice
provision will give workers assurance that they will know when a
blackout period is expected.
As my testimony stated, ERISA may limit the liability of employers
when workers are given control of their individual account investments.
The President's Retirement Security Plan would amend ERISA to ensure
that when a blackout period is imposed and participants are not in
control of their investments, fiduciaries will be held accountable for
treating their workers' assets as carefully as they treat their own. Of
course, employees would still have to prove that the employer breached
a fiduciary duty in order to seek damages.
The President's plan calls on the Senate to pass H. R. 2269--the
Retirement Security Advice Act--which passed the House with an
overwhelming bipartisan majority. We believe it is important to promote
providing professional advice for workers. The bill would encourage
employers to make investment advice available to workers and allow
qualified financial advisers to offer advice if they agree to act
solely in the interests of the workers they advise. Partnered with the
proposed increased ability for workers to diversify out of employer
stock, investment advice services will be more critical than ever.
Finally, the Administration recognizes that workers deserve timely
information about their 401(k) plan investments. To enable workers to
make informed decisions, the President's Retirement Security Plan will
require employers to give workers quarterly benefit statements that
include information about their individual accounts, including the
value of their assets, their rights to diversify, and the importance of
maintaining a diversified portfolio. The Secretary of Labor would be
given authority to tailor this requirement to the needs of small plans.
Again, in combination with investment advice and the ability to
diversify, quarterly, educational benefit statements will give workers
the tools they need to make sound investment decisions.
Conclusion
The private pension system is essential to the security of American
workers, retirees and their families. While the current scrutiny is
appropriate and welcome, we must strengthen the confidence of the
American workforce that their retirement savings are secure. The
challenge before us today is to strengthen the system in ways that
enhance its ability to deliver the retirement income American workers
depend on. We must accomplish this without unnecessarily limiting
employers' willingness to establish and maintain plans for their
workers or employees' freedom to direct their own savings. The
President's Retirement Security Plan strikes just such a balance.
We look forward to working with Members of this Committee in
continuing this discussion and in developing ways to achieve greater
retirement security for all Americans.
Chairman THOMAS. Thank you.
If we are going to be talking about defined contribution
pension plans, or the so-called Tax Code section 401(k), you
mentioned the term, workers ought to be able to ``diversify.''
It is pretty obvious that one of the things that employers or
employees could put into these retirement plans is cash. Right?
You put in dollar amounts. But if you can also put stocks, are
there any other things that employers or employees could put
into 401(k) plans: gold coins or rare paintings?
Mr. WEINBERGER. The answer is no, Mr. Chairman.
Chairman THOMAS. All right. Then why was it created to do
just money and stocks? And how many companies do just money or
how many companies do just stock, or a combination of either?
Ms. COMBS. I am sorry, Mr. Chairman. We were getting some
clarification. Apparently real property is also--qualifying
employer real property and real property generally is also a
permitted contribution to a 401(k)-type plan as well.
Chairman THOMAS. My assumption is that is not very often.
Ms. COMBS. I think that is a good assumption.
Mr. WEINBERGER. One of the apparent issues that was raised
early on was you want to put assets into plans that are
relatively easy to value. And so publicly traded stock,
certainly cash--I don't know how employer-provided property got
in there, but once you move down the line of things where you
are putting any kinds of assets in there, it becomes more
difficult.
Chairman THOMAS. So we are basically looking at a universe
of 401(k)s containing either dollar contributions, employer
stock, or the employee then diversifying, i.e., going into
other assets that could be easily determined, stock or other
items.
Do we know roughly how many companies use the stock option
versus companies that use dollars?
Ms. COMBS. The data is hard to come by, actually, on how
many actually make the matching contribution in employer stock.
On average, 401(k) plans hold about 19 percent of their assets
in employer stock, but it really is very heavily skewed toward
large plans. If you look at----
Chairman THOMAS. But an employee could purchase the
company's stock that they work for, so that really doesn't tell
you how many companies use stock.
Ms. COMBS. That is correct. That is what I was saying. The
data on how many make matches in employer stock is more
difficult to come by.
We, the Department of Labor, they don't report that to us.
They don't break it out that way on the annual report they
submit with us. We don't have that data.
Chairman THOMAS. The gentleman from Ohio?
Mr. PORTMAN. I think that is an excellent question, and we
will get some follow-up here. But my understanding is that it
is less than 1 percent of plans that offer corporate stock as a
match. Some companies, of course, offer non-elective stock,
which is not a match. Total assets in 401(k)s is roughly 10
percent in terms of the match because, as Ms. Combs said, it
tends to be larger companies; therefore, larger plans. But I
believe the number you are looking for would be less than 1
percent. In fact, I think it is less than one-half of 1
percent.
Chairman THOMAS. So, clearly, most corporations, when they
participate in a 401(k) plan with an employee, do it on a cash
contribution basis, and then the employee makes decisions as to
what the holdings are.
I want to try to get a feel for just how extensive the
stock as the employer's contribution is, and if the data is
correct, it is like 1 percent.
Both of you indicated that the President was talking about
making changes, and clearly, if there are so-called blackout
periods where decisions are removed from supposedly the owner
of the asset, the employee, there could be games played in
blackout periods. And recent examples indicate maybe the
decisions that didn't need to be made could have been made to
allow for a blackout period. I applaud you in terms of making
sure that you have no games. Transparency on a blackout period,
prior notification are all good ways to make sure games aren't
played.
The way you put it, what is good for the shop floor is good
for the top floor in terms of handling stock outside of a
401(k) is a good idea as well. I think most people are going to
focus on the controls the Administration advocates over
decisions made by both the company and the individuals in the
401(k).
You indicated that there was a timeframe that the President
is requesting of 3 years. Three years to do what? What are the
options that are restricted during the 3-year period, and what
can you do after the 3-year period in terms of diversification
of company stock?
Mr. WEINBERGER. In the President's proposal, the employer
would not be able to require the employee to hold employer
stock after a 3-year period of participation in the plan.
Obviously, the employer can allow the employee to, any time
before that, diversify. But the 3-year period, which about
marries up with the 3-year vesting rule, is the time period
that the President has chosen.
Chairman THOMAS. And do some companies require that
employees, if stock is part of the 401(k), hold for a longer
period than that?
Ms. COMBS. Yes. Under current law, it is really up to the
employer on how they design the plan. Many employers offer
employees the ability to diversify immediately. Others can
restrict the ability to sell out of employer stock.
The one rule is that if it is an ESOP, you have to allow
people to begin diversifying when they turn age 55 and they
have 10 years of participation in the plan.
Chairman THOMAS. Do some employers offer stock to employees
at less than market prices, i.e., at a discount?
Ms. COMBS. Generally not in a qualified plan. They could
offer stock purchase plans, but those are really a form of
executive compensation that is not generally covered under
ERISA. But in a qualified plan, the contributions are made at
the market value.
Chairman THOMAS. But under a 401(k), then why should there
be any restriction if, in fact, it is like an arm's-length
business arrangement? If there is no discount to the stock, why
shouldn't an employee be able to make a decision at any time
that they receive it?
Ms. COMBS. Well, we were trying to strike a balance between
encouraging employers to make generous matching contributions,
and there are reasons through the Tax Code--I will defer to
Mark on that--and reasons of trying to retain employee loyalty
and align the interests of the workers and the firm, that
people want to have their workers invested in employer stock.
Our fear was if we had immediate diversification, you might
see a dropoff in the level of matching contributions. We
thought 3 years struck a reasonable balance because, as Mark
said, that is generally the vesting period for plans, the point
at which someone has demonstrated a real commitment to the
firm.
Chairman THOMAS. Then, finally, I did not hear about the
President's plan--and there has been a discussion and, in fact,
legislation introduced--that beyond the holding period
requirements, perhaps some percentage of company stock
limitation within the 401(k) might be appropriate. I did not
hear that as part of the President's plan. Is that correct?
Mr. WEINBERGER. That is correct, Mr. Chairman.
Chairman THOMAS. And why is it not there?
Mr. WEINBERGER. Well, as we outlined, the President's plan
is designed to give the maximum level of choice to individuals,
and so we thought that it was appropriate to provide that
choice not to have the Federal government look in and have a
one-size-fits-all--whatever the percentage might be--limitation
or cap in the amount of employer-provided stock that could be
in a plan. There are several reasons for that, not the least of
which is that very often defined contribution plans are just
part of an overall retirement benefit plan, and so there are
lots of other assets within the retirement plan in a company or
outside the company.
Moreover, depending upon how the cap is structured, it
could create some anomalous results, such as that as the stock
price goes up and you reach a certain percentage of the value
of the amount in various plans, you can be forced to sell the
stock, and as the stock goes down, buy it back. It is not
necessarily the type of activity you would want to encourage.
So there are definitely issues associated with that.
Chairman THOMAS. I think you are going to find that there
are going to be a lot of questions surrounding both of those
issues. And if there is some ability to create question-and-
answer pages on both the holding period and on the rationale
for not dealing with the percentage, that that will save a lot
of time and energy. If the group did look at those questions,
did decide the way they did, and looked at options and didn't
carry them out, a Q&A might be very useful for us as we move
forward on paper to allow us to quickly understand the decision
matrix that wound up with the President's plan the way it is.
Does the gentleman from New York wish to inquire?
Mr. RANGEL. Thank you, Mr. Chairman.
I hope the record would indicate that Secretary Combs did
not mention nearly as many Members favorably as did Secretary
Weinberger.
[Laughter.]
Mr. WEINBERGER. Congressman Rangel, this is my 20th time
here before the Committee. I wanted to make sure I was listened
to this time, so I thought it might be helpful.
Mr. RANGEL. You are all right.
Secretary Combs, what I would like to see is where the
employer has the maximum opportunity to invest in the private
sector and maximize their returns, and at the same time have
the security of knowing that they have a protected pension
fund. Is that possible?
Ms. COMBS. I think that is the right goal. We, too, agree
that people need the maximum amount of flexibility and choice.
Mr. RANGEL. Where is the insurance? Without mentioning that
firm that the Chairman mentioned----
Chairman THOMAS. What firm was that?
Mr. RANGEL. The E word. But, listen, I respect your
decision, and I know that the Administration cannot comment
because it is under investigation. That is all right, too. But
if a similarly situated firm had someone investing up to what
appeared what he thought was a million dollars for retirement,
and then ended up with $5,000, they had all the flexibility in
the world but somehow ended up with nothing.
I want to know--I don't want to have a goal. I want to know
whether the Administration can say that what they want to do is
to make certain that at the end of the retirement period that
there is a pension fund that is going to be available for the
faithful employee. Can you give any ideas where that thought
could be guaranteed rather than having this as a goal and
objective?
Ms. COMBS. I think one of the issues we have to grapple
with is the balance between defined benefit and defined
contribution plans.
Mr. RANGEL. I am okay with the defined benefit. There is a
cap on what you are going to get, and, of course, there is a
cap on the risk that is involved. The other is the American
way. You take the risk, and I don't want to pay for--I don't
want the worker to pay for choices that they made that were not
appropriate choices.
Am I being too restrictive and dampening the American
dream? I want to make certain that they get out there and do
what they have to do, but at the end of the day, that they
don't come back to the Federal government and ask for a
handout. I want to make certain that they have a defined
benefit, they have something there to take home. Or is this the
type of thing that you take the risk and if at the end of the
day you made bad choices, you have no pension?
Ms. COMBS. Well, I think, again, we both agree that defined
benefit plans provide that guaranteed benefit and----
Mr. RANGEL. I want to get away from that because it is not
popular with some of my colleagues. I want to go the route of
privatization, go to the stock market, and do well, and not
have a cap on the amount of money. I want a good economy. I
want the employee to benefit from the good economy and not have
a cap on the benefits. But I want to make certain that there is
an insurance that they don't end up broke.
Ms. COMBS. Well, I think in a defined contribution plan,
the promise is the contribution, and there is risk involved,
depending on how you invest your portfolio. What we have tried
to do, what the Administration's proposal would do, is to make
sure that people aren't restricted in their ability, for
instance, to diversify their accounts. Under the current law,
you can end up in a situation where a significant portion of
your retirement assets are tied up in a single----
Mr. RANGEL. Secretary Combs, I think some of the leaders in
the Congress really want to get the government out of--out of a
lot of things, out of health, out of education, out of Social
Security. And the best way to do it is to tell them, Go out
there and take the government out of it, let people do what
they want. The less government, the better.
So here is an amount of money. Here are some options.
Diversify, invest. And if you don't make it at the end of the
day, then there are charities and there are other things. But,
for God's sake, don't come back to the Federal Government. That
is not our job to make--it is not like the ERISA things where
there were goals and objectives for equity and fairness. The
name of the game is you take the risk, you pay the price.
Ms. COMBS. But there are also rules of the game, and we do
have fiduciary standards under ERISA which are a way to make
sure that the rules are fair, that employers are responsible
for the investment options that they offer, that they monitor
those investment options.
Mr. RANGEL. But under the laws that we just passed, the
person can have a conflict of interest, be an investor in the
company and at the same time be accepted as the adviser to the
employee. So, in a sense, for most workers--strike ``most.''
For a lot of workers, the cards are really stacked against them
as to what they really know. You need professionals who know.
And I don't see where you have to go as far as Enron in
violating a fiduciary responsibility. You just never know what
is going to happen in the market.
I am just saying, could you devise some plan or think that
it is possible or is it the right thing to say that there is
going to be a guaranteed pension? True, there may be some
restrictions. You can't just roll the dice and put everything
on one roll. But can you give some guarantee at the end of the
day that the pension fund is going to be there? Can you avoid
the Enron problem that we face today for employees?
Mr. WEINBERGER. Mr. Rangel, could I just add----
Mr. RANGEL. Yes.
Mr. WEINBERGER. Thank you. Obviously there are lots of--an
overused phrase--legs to the stool of savings. In this
situation, insurance is diversification. That is basically what
an insurance vehicle is. We want to provide the tools to
individuals, coupled with defined benefit plans and Social
Security, which is the leg to help people who don't have enough
savings to be able to survive, and also to give them a benefit
for when they retire and reach retirement age.
The defined contribution plan is a very important asset-
building, wealth-generating tool. The average percentage return
has been about 12 percent between 1990 and 1998 on assets in
defined contribution plans going right to employees. That is a
very good return, and it helps a lot of people who otherwise
wouldn't have the wherewithal to move up the ladder in the
income to get those assets.
So the defined contribution plan is a wealth-generating,
asset-building type of plan.
Mr. RANGEL. Mr. Secretary, I embrace all of the advantages
of the plan. I want my cake and eat it, too. I want them to be
able to do all of these things. But at the end of the day, I
don't want this person coming to the Federal Government and
saying, ``I lost.'' I don't want this Las Vegas approach to a
pension plan, no matter how much latitude you give to the
investor-employee. I want at the end of the day to know that
there is something to take home and take care of their family.
Is that possible? All you have to do is say no, you can't do
both, and I will have to accept that is the Administration's
position and try to work out something legislatively.
Is that a fact that you can't give the employee all of
these opportunities and expect at the end of the day that you
are going to give them a guarantee, too?
Mr. WEINBERGER. I think that if you were to go ahead and
provide a specific guarantee----
Mr. RANGEL. Yes.
Mr. WEINBERGER. Some sort of guaranteed return----
Mr. RANGEL. Insurance plan.
Mr. WEINBERGER. You would see the most probably aggressive
investments possible so that people would not worry about any
downside risk, and it would not be--the market would not
function appropriately.
Mr. RANGEL. So what I am saying is unrealistic? You don't
have to defend me. I mean, it is unrealistic to believe that
you can play this game of defined contribution and still expect
that you are going to get a defined benefit, no matter----
Mr. WEINBERGER. Let me give you this answer, Mr. Rangel.
You can invest in private market insurance vehicles with
guaranteed return, like Guaranteed Investment Contracts (GIC).
So there is that ability right now to invest in government
bonds or GICs and get a guaranteed return. GICs are the
insurance company, GIC.
Ms. COMBS. You can invest in treasuries, you can buy an
annuity. I do think it is a very difficult goal to achieve,
because as Mr. Weinberger pointed out, you would create a moral
hazard if you provide a government guarantee of investment
return. People will have an incentive to make very aggressive
investments knowing that if they don't pan out, there is a
floor beneath them. It is more akin to kind of the S&L, savings
and loans, situation, if you will, in an insurance program, if
you design it wrong, than it is to the insurance program for
defined benefit plans.
In that program, you are insuring against corporate
failure. It is an insurable event that you can identify. There
are funding rules in place that the players have to meet on an
ongoing basis, and so it is a more discrete insurable event.
Insuring against market risk in defined contribution plans
really, I believe, would create a moral hazard, and it would be
very difficult to do. And, you know, we want to work with the
Committee to minimize risks people face in their retirement
savings, but we need to do it with our eyes wide open and aware
of the kind of incentives that you can create.
Chairman THOMAS. The gentleman's time has expired. Does the
gentleman from Illinois wish to inquire?
Mr. CRANE. Yes, thank you, Mr. Chairman.
Mr Weinberger, there is some confusion regarding the
diversification requirements in the Administration plan for
ESOPs, ESOP with 401(k) feature (K-SOPs), and 401(k) plans. As
you can imagine, I have a serious concern regarding Federal
requirements on any private pension plan that forces an
employer who voluntarily establishes a plan and makes voluntary
contributions to diversify under a Federal law.
Could you please clarify the Administration's position on
this matter?
Mr. WEINBERGER. Certainly, Mr. Crane. What the
Administration proposes is that employers cannot restrict
individuals from diversifying after 3 years of participation in
any defined contribution, 401(k) plan. So obviously the
employer has the ability to be able to require more rapid
diversification, but the objective here is to balance between
creating a situation where employers will still provide the
benefit and giving the ability to individuals to have choice.
What we have done is separated out employee stock ownership
plans that have no relation to 401(k)-type plans. ESOPs, which
have been used in many cases traditionally as a vehicle for
leveraged buyouts, retirements, things along those lines, where
there no employer match, it is not tied to a 401(k) plan, are
not subject to the diversification rules because they have a
different purpose.
Chairman THOMAS. Does the gentleman from California, Mr.
Matsui, wish to inquire?
Mr. MATSUI. Thank you very much, Mr. Chairman.
I want to thank you, Mr. Weinberger, and you, Ms. Combs,
for being here today.
Obviously the issue of the 401(k)s, the whole issue of
diversification, whether you go for a defined contribution
approach rather than a defined benefit approach, and obviously
the lockout issue, all three of those are very critical, and
legislation has been introduced to deal with that. Obviously
you have your own bill.
I wanted to move over from that for a minute because I
think there is a more fundamental issue than how you make these
changes on the 401(k) plan. I think the Enron example is one
that probably was shared by a lot of the dotcoms as well, where
you had ISOs, incentive stock options, that were given to
employees that were not on the books. You had derivatives both
for the dotcoms, particularly with companies like Enron. You
had contracts that Enron had through partnerships that were not
reflected appropriately on the balance sheets of the
prospectus.
The real issue here, I think, is one of transparency, the
fact that the Securities and Exchange Commission (SEC) and
others really did not know the real financial status of Enron,
nor did they know, many investors, the real financial status of
many of those dotcoms that failed over the last 5 years.
What is the Administration thinking in that area? There has
to be something you need to do in this area? I mean, we can
fool around with a cap on the amount of investments. We can,
you know, talk about diversification. We can talk about the
lockout. We have to do all those things, obviously, because we
find there are some problems there.
But what about the fundamental issue? What is the
Administration going to do about these other areas to make sure
that financial statements are accurate from now until whenever?
Because I think that is really going to be the major issue for
many investors, many of those employees that have these
401(k)s. And I think we are moving in that direction. I think
this issue is very timely because we are moving away from
defined benefits to defined contributions, and there are a lot
of young people in their 20s, 30s, and 40s that might find
themselves in trouble.
You mentioned, Mark, that, you know, over the last year the
equity markets have gone up 12 percent through the defined
contribution, but it depends upon when you retire, not over the
10-year period. And if you retire at the wrong time--when, for
example, the Nasdaq went from 4,500 to 1,700--you got a problem
on your hands.
So how do we deal with this fundamental issue of making
sure financial statements are adequate? Because I think under
the current situation you can manipulate the system in a way
that literally billions of dollars could be hidden in terms of
your losses.
Mr. WEINBERGER. Well, Mr. Matsui, it is obviously an
excellent question, and today's issue is not meant to resolve
all the issues surrounding Enron or other failures that have
occurred. The President has set up another working group that
is looking at these very issues which go to corporate
disclosure. You might have seen the Secretary has been pretty
outspoken with regard to responsibilities of directors and
Chief Executive Officers (CEO).
That Task Force is made up of a number of people, including
Members of the SEC, Mr. Pitt; my boss, the Secretary; Don Evans
is on it, and others. And they are working to come up with a
report to the President as well, and that will discuss a lot of
the issues you are talking about.
Of course, we don't know--it is always hard to legislate
good or bad doings, so to the extent----
Mr. MATSUI. If I may just interrupt, Mark, I am not
suggesting we legislate on morality. I am just suggesting that
some of these things that we have kept off the books--and we
are as guilty as anyone else, because a lot of Members of
Congress--I could name a few--and Senators who actually pushed
the Administration, then the Clinton Administration, not to
pursue some of these things that we are talking about.
Mr. WEINBERGER. There is a thorough review going on within
the Administration of that Task Force. I am sure the SEC, as
you all know, is also looking at it. And you are absolutely
right. Sunshine is important for accountability, and we have
seen some of the markets reacting to the uncertainty about what
else may be out there. And the more we can do to get adequate
disclosure and responsibility, I think we will all be better
off.
Mr. MATSUI. When do you think this report or this Task
Force is going to come up with its recommendations?
Mr. WEINBERGER. Mr. Matsui, I don't know. I know they are
working with all due speed because of the importance of the
issue, and I do expect that it won't be terribly long. But
there is a whole host of interlocking issues, and you have lots
of agencies involved in that type of situation. So they are
working quickly to try and come up with recommendations.
Mr. MATSUI. When you say quickly, I mean, are we talking
about the next month or two, or 2004? And I don't mean to--
obviously you have no answer at this time, but--see, I don't
want us to be diverted on the wrong issue. I think we can--it
is going to be really easy to deal with the 401(k)s, I think.
There are some problems, obviously, but we could probably deal
with them. The big issue is whether we are going to be able to
take on some of the big interests and deal with these other
issues.
I would like to kind of get a sense--you know, maybe you
could do this. Maybe you could get back to us on when you think
the working group will come up with its recommendation on these
other areas outside in terms of perfecting a balance sheet and
providing transparency. Could you do that?
Mr. WEINBERGER. I will certainly check with the Secretary
and try and get an answer for you.
Mr. MATSUI. If I may just--and I know my time has expired.
Are you part of this working group, or are you, Ms. Combs?
Mr. WEINBERGER. No, I am not.
Mr. MATSUI. Who would be in the Administration working on
this?
Mr. WEINBERGER. Well, Secretary O'Neill is on it, Secretary
Evans, Mr. Pitt from the SEC.
Mr. MATSUI. Who is the Assistant Secretary that is actually
managing this on a day-to-day or week-to-week basis? Do we
happen to know?
Mr. WEINBERGER. Peter Fisher, who is the Under Secretary of
Finance, will be working for it at Treasury.
Mr. MATSUI. Okay. And I know this isn't within our
jurisdiction, but it is important.
Chairman THOMAS. No, the gentleman's point is very well
taken. This Committee has moved forward and provided leadership
in this difficult area.
What the Chairman hopes is that the Administration doesn't
bog down in turf wars between departments or agencies in
producing the document he is talking about. And I think that
was implicit in the points that he was making.
We need as much sound advice as we can get. That is why I
asked you for the Q&A sheets previously. The report would be
very helpful to us, but if you are not going to be able to come
to reasonable agreements within the administrative
jurisdictional difficulties, you can imagine how hard it is
going to be for the committees of Congress that have shared
jurisdiction in this area.
This Committee has--and I am proud to say--under previous
chairmen and under this one, we will lead where it is necessary
to legislate. So I think the gentleman from California is
telling you, if you have got something to provide to the
legislative product, get it to us as quickly as you can. We
will move forward. We would appreciate the benefit of your
suggestions.
Mr. WEINBERGER. I will be happy to bring that back. I sense
no--it is not a disagreement issue. It is just grappling with
the difficult issues.
I forgot a very important Member of the Task Force;
Chairman Greenspan from the Federal Reserve is also on that
Task Force.
Chairman THOMAS. And we would like the recommendations in
understandable English.
Mr. WEINBERGER. No comment.
Chairman THOMAS. Does the gentleman from Florida, Mr. Shaw,
wish to inquire?
Mr. SHAW. Thank you, Mr. Chairman. Just one minute to
further pursue Mr. Matsui's line of questioning, which I think
was a very good line.
We as investors as well as government through the SEC are
very dependent upon the certified public accountants of this
country in certifying and giving their opinion with regard to
financial statements that they audit, an important component in
looking at the failure of a huge corporation which came as a
complete surprise, and when we saw some of the things going on
which shouldn't have been going on, and actually some financial
dealings that were actually covering up tremendous losses and
liabilities.
The big question you have to ask is: What did Arthur
Andersen know and when did they know it? And I think this is
something that all of this is going to have to come down to.
As a former certified public accountant myself, I can well
understand exactly the problems. The American Institute of
Certified Public Accountants is probably one of the most
respected--and for good reason--organizations in the entire
world. We depend upon them for so much, and I think it is a
question of going to them and talking to them about what they
can do to be sure that we don't get in this trouble, in this
bind again.
Also, in both 401(k)s as well as IRAs, I think the big
question is diversification. Even when your employer is giving
you a good deal on the stock, you should certainly know that
you are putting all your eggs in that basket.
Mr. Rangel brought up the point about who is going to
guarantee the benefits. Well, I don't think these pension plans
are set up so that we are the guarantor. However, I would
invite my very good friend Charlie to take a look at my Social
Security reform package which does contain these guarantees,
keeps the existing Social Security system totally in place
without in any way interfering with any of the benefits or in
any way invading the Social Security trust fund, but at the
same time allows for individual retirement accounts with
contributions directly from the U.S. Treasury into these in
order to save Social Security for all time.
I would hope that we will recognize the power of investment
in the private sector. This Committee, I think we only had one
person to vote against taking the railroad funds out of
treasury bills and putting them into these type of investments,
and I think the only one that voted against it on this
Committee was on the Republican side, not on the Democrat side.
So I think all of us do recognize that you can get a much
better return in the private sector.
We have to be careful not to get stampeded into destroying
a system that is working very well just because we have some
significant failures, when you see that the economy and this
type of investment you have to view over a long period of time,
people in these type of investments have to plan for their
retirement and a few years out start thinking about going more
into bonds and treasury bills than corporate stocks in order to
be able to project with some certainty exactly what their
retirement is going to be.
There are going to be ups and downs in the market. There is
no question about that, and I think we all have to be very much
aware of that. But when you look over the last 75 years, which
goes through a depression and world war and several other wars,
you see that you have done a lot better investing in corporate
America than investing in U.S. Treasury bills, as the present
Social Security system is required to do.
So we need to add something onto Social Security in order
to make it grow, because we do know we are going to be running
out of money in Social Security. Social Security will not have
the funds through the Federal Insurance Contributions Act
(FICA) taxes to pay the benefits commencing in 2016. It is that
simple. And we are going to have to start cashing in those
Treasury bills, which we have already been told by Greenspan
and others who have come before this Committee, including the
former Administrator of Social Security, that Treasury bills
held by the government and issued by the government are not
real economic assets. We have to fact that, and we have to also
come to the realization that 2016 is the date that we have to
be concerned about. Whereas we do have responsibilities for our
private pension funds and we must continue our work, and I am
pleased that we are having this hearing and some of the comment
that we are having, but we do not have nearly the
responsibility toward them that we do have to save America's
largest pension system that does affect every American worker
who pays FICA tax, which is just about everybody. That is our
responsibility in this Congress. We need to move forward to
save Social Security for all time.
Thank you, Mr. Chairman.
Chairman THOMAS. I thank the gentleman. Does the gentleman
from Washington, Mr. McDermott, wish to inquire?
Mr. McDERMOTT. Thank you, Mr. Chairman.
As you look at this Committee and answer our questions, you
have to remember that there are two committees up here. There
are the people from Matsui to Shaw; those are the defined
benefit people. And then the rest of us are living in the
hybrid world, a little bit of defined benefit and a whole lot
of stuff in this defined contribution.
So we have different viewpoints on exactly how this thing
works, and I was trying to think, as I listened to you two
talk, do you equate asset accumulation with a secure
retirement?
Mr. WEINBERGER. I certainly think that asset accumulation
should be a component of a secure retirement.
Mr. McDERMOTT. So the man from Enron, Mr. Presswood, or
whatever his name was, who went from a million and a half
dollars when he retired to $5,000 when the stock disappeared,
you would call that a secure retirement because he had a
million and a half when he retired?
Mr. WEINBERGER. I don't know what other assets this
gentleman had. I don't know the factual circumstances
surrounding this gentleman. I am sorry.
Mr. McDERMOTT. But certainly if we were just talking about
his asset accumulation, he hadn't done a very good job. I mean,
he is in deep trouble.
Mr. WEINBERGER. Again, I don't know. You are only talking
about one of his investments. I don't know if he had other
assets or not.
Mr. McDERMOTT. Do you think that there should be any
guarantee for him when he retired with a million and a half? Or
should he still have to keep making decisions--I mean, both of
you seem to think that if we give people more choice and more
information, they can go out there and this guy will do just
fine. But he went from a million and a half to five thousand
bucks in a few months. So you don't think the government should
guarantee anybody anything? Is that the Administration's
position?
Mr. WEINBERGER. I think the government has. I mean, the
Social Security system is there to provide a guarantee to all
Americans as the safety net. In addition, some employers are
certainly able to provide defined benefit plans, which are
guarantees. And defined contribution plans or investments that
you and I make, you can't--we can't, the government can't
outlaw the risk/reward relationship. It is there, and some
people are going to be more aggressive and some aren't.
Diversification, which is very important to asset accumulation,
is something we would like to get the message out more about
and try and give people the tools so they can accumulate
wealth.
Mr. McDERMOTT. Okay. Let me get to the tools, because I
heard you are going to to have a savings summit. I presume
there will be some paper that you hand out there.
Would there be anything that you would hand out that would
tell people how to read an annual report and spot crooks when
they are putting one together and handing it around? Do you
have such a paper that would help me--because I am not an
economist, and I know a lot of people in my district don't know
how to read an annual report. So are you going to give a manual
so we can figure these things out?
Ms. COMBS. No, we won't be handing out manuals. There was a
SAVER Summit 4 years ago. These are summits that were mandated
by Congress in statute, and the first one really focused on
trying to educate people about the need to save for retirement.
And I think a lot has been accomplished in the last 4 years.
This year's summit is going to focus on people's need to
save and how to become better asset managers so that they know
what to do in terms of diversification and what messages really
target different groups of people. What we are trying to do is
break the population down into different generations and to
develop the messages and the tools that people need when they
are starting out their working career, when they first have an
opportunity to decide to sign up for a 401(k) plan, what are
the tools and the messages that appeal to people who are mid-
career, those who are preparing for retirement, and those who
are already retired, so that we can take this effort to the
next step and really try to refine how we can educate people
about these very important decisions that they have to make and
improve financial literacy.
It is a day-and-a-half summit. It is extremely important,
and I think it will do a great deal to get the word out. It is
only part of our ongoing efforts to improve financial literacy
and understanding, but I don't presume to think we can educate
people about how to read financial statements in this type of
an environment. I don't think that is----
Mr. McDERMOTT. But we put together a law some years ago
called ERISA. That was to guarantee that people would have a
defined benefit contribution--or they would have a defined
benefit pension when they got there. If things went to pieces,
the government would give them some guaranteed benefit. I am
not sure exactly what the maximum under that was. Can you tell
me?
Ms. COMBS. It has been indexed over time. It is now about
$43,000 a year.
Mr. McDERMOTT. On top of your Social Security?
Ms. COMBS. Yes, if you have a defined benefit plan. ERISA
didn't require you to have a defined benefit plan. It
established the rules that they operate under, but it is a
voluntary system, and many employers do offer defined benefit
plans, particularly larger employers, but there has been real
stagnation for a number of reasons, and they are not growing.
And to the extent there is growth in the pension system, it is
on the defined contribution side.
So those people who are lucky enough to have a defined
benefit plan, yes, if they are eligible for the maximum amount
that it guarantees, it could be upwards of $43,000, $45,000 a
year.
Mr. McDERMOTT. So they could have $43,000 plus $18,000 of
Social Security guaranteed, about $60,000 guaranteed.
Ms. COMBS. Yes.
Mr. McDERMOTT. And anybody who has a defined contribution
program has their Social Security guaranteed, whatever that is,
$18,000, and then they are on their own. That is the situation.
And it is the Administration's position that we should not do
anything about those people, even though they were moving in
the direction?
Mr. WEINBERGER. No. It is the Administration's position
that we need to do all we can to help to educate those people
so they could take part in the capital markets like everyone
else.
Ms. COMBS. And defined contribution plans are not
unregulated. They, too, are subject to ERISA. There is no
insurance program for defined contribution plans. Again, in a
defined benefit plan, the employer is promising to pay you a
certain benefit when you retire, and there are rules that
require them to fund that benefit over time.
The PBGC, the insurance system for defined benefit plans,
insures against the company failing. When a company goes into
bankruptcy, they turn over their assets to the Pension Benefit
Guaranty Corporation as well as their liabilities. So a lot of
that guarantee is paid out of money that has been accumulated
by the employer and is transferred over to the Pension Benefit
Guaranty Corporation.
Defined contribution is a very different animal. There the
employer is only saying what he or she is going to contribute
each year, and the ultimate retirement income does depend on
investment gains and losses that you experience. We are trying
to help people make good choices, to diversify their accounts,
to get advice, and to be prudent with respect to their
management. So we are trying to reduce the risk in defined
contribution plans without an insurance system.
Chairman THOMAS. The gentleman's time has expired. I would
tell the gentleman we will go into the defined benefits at a
hearing, and one of the questions we will want to pursue is why
the defined benefit declined so rapidly, which provided for the
defined contribution to build up. I think you might find one of
the reasons was we put so many burdens on the defined benefit
to make it ``fairer and safer,'' that employers shifted and
employees shifted to the defined contribution. We may be
successful in ruining that one as well.
Does the gentleman from Texas, Mr. Johnson, wish to
inquire?
Mr. JOHNSON OF TEXAS. Thank you, Mr. Chairman.
Secretary Combs, you made a statement during your opening
remarks about the responsibility, the fiduciary responsibility
of an employer during a blackout period. That wasn't part of
your written statement. Can you elaborate on that?
Ms. COMBS. Yes. Under ERISA, employers have a fiduciary
responsibility to manage the plans prudently and solely in the
interest of the workers in those plans.
Now, there is an exception for individual account plans
like a 401(k) plan where the control over the investment
decisions is transferred to the individual worker.
The Department of Labor issued regulations in 1992 defining
what ``control'' was. If you don't shift control, the employer
is responsible for the investments in the plan. If you are
under what is called section 404(c) and you shift control to
the worker, the employer is no longer responsible for the
results of the investment decisions that worker makes. And that
is what 404(c) does. It shields them from the results of the
participant's investment decisions.
What we are proposing is that during a blackout period, by
definition, employees don't have control over their accounts;
and, therefore, the employer, if they breach their fiduciary
duty, would be responsible for losses that workers suffered
that result from that breach. So it----
Mr. JOHNSON OF TEXAS. They can't control the market.
Ms. COMBS. Lawsuit, essentially--I am sorry?
Mr. JOHNSON OF TEXAS. They can't control the market. How
can they be responsible for a loss?
Ms. COMBS. We are not saying that they are responsible for
any losses attributable to market changes. If the loss can be--
if the plaintiff can prove in a lawsuit that they suffered a
loss because of the fiduciary breach that the employer engaged
in, then in that limited circumstance the employer would have
to make that person whole. So they have to prove the breach,
and they have to prove that the loss was due to the breach.
Mr. JOHNSON OF TEXAS. So that is the remedy under current
fiduciary law, and do you think the participants have adequate
access to remedies of the fiduciary irresponsibility?
Ms. COMBS. I think the remedies under ERISA for pension
plans are very vigorous. The plan sponsor, the fiduciary, is
personally liable for losses to the plan, to make the plan
whole plus interest. There are criminal provisions under ERISA
for things such as embezzlement, money laundering, fraud.
We have an active enforcement program, and I think you will
find that the remedies and the fiduciary protections for the
pension side of the equation are quite----
Mr. JOHNSON OF TEXAS. I know you are in an investigation
into Enron. Can you generally explain a typical time line for
prosecution of fiduciary breaches? Are we talking about years
or months or what?
Ms. COMBS. It really does depend on the complexity of the
situation. We can bring some cases that are very cut-and-dried
and can proceed rather quickly.
We have an active program, for instance, in making sure
that 401(k) contributions that are withheld from people's
salary are contributed to the plan in a timely fashion. Those
are pretty cut-and-dried, quick cases.
Mr. JOHNSON OF TEXAS. But in this particular instance,
where are we?
Ms. COMBS. This is a very complicated case, and we are
working on it as quickly as we can. We are devoting all the
resources that we need to it. But I wouldn't--I can't presume
to tell you when it will be finished, but I think it will be
rather lengthy. It is obviously a very complicated situation.
Mr. JOHNSON OF TEXAS. When you say that, are you talking
about a year?
Ms. COMBS. You know, I hesitate to put a timeframe on it. I
don't want to--we will do it as quickly as we can.
Mr. JOHNSON OF TEXAS. Okay. Pension plans are audited
annually, are they not?
Ms. COMBS. Yes, they are.
Mr. JOHNSON OF TEXAS. Those audits get filed in a 5500 with
you, I believe. Do you think that the fiduciaries and the
Department of Labor officials who receive that form ought to
look at those audits and follow up on recommendations made in
them?
Ms. COMBS. We do review the auditor's report. There is an
exception for small plans with fewer than 100 participants to
file an audited employee benefit plan. But we have an Office of
the Chief Accountant within the Department of Labor, within my
agency, that does review the accountant's work product to make
sure that we have clean opinions, and audits those audits, if
you will.
Mr. JOHNSON OF TEXAS. Okay. Secretary Weinberger, the
Treasury has announced it won't issue 30-year bonds anymore and
eliminating that rate is going to cause some of the companies
to face tens of millions of dollars of pension contributions
because of the funding formula.
The House passed a temporary solution back in November, and
we have written letters, along with Portman, Cardin, and
Pomeroy, to Secretary O'Neill and haven't had a response.
Do you think that you are going to support the House-passed
version, or do you support some other approach?
Mr. WEINBERGER. Well, first of all, we did support, as you
know, Congressman, the provision in the simplification bill
which would have dealt with it on a short-term basis. And, yes,
we do support revisiting that and working with you to try to
determine what the appropriate rate should be.
Mr. JOHNSON OF TEXAS. Okay. Thank you very much, Mr.
Chairman.
Chairman THOMAS. Does the gentlewoman from Washington wish
to inquire?
Ms. DUNN. Thank you very much, Mr. Chairman.
Welcome to both of you. I think, Secretary Combs, knowing
what a huge percentage of the Labor Department your office, the
office that you manage, controls, I think it is wonderful to
have you here talking to us about what we are dealing with.
A couple of questions. Let me move back to the employer
liability issue that Mr. Johnson approached. I have seen a
number of bills that treat this issue constructively, but I
think we have to be very careful about going too far here,
particularly, for example, during a blackout. And my concern is
that that sort of thing could make companies, in essence,
legally liable for fluctuations in the market. So I am
interested in hearing more from you about that. Do we believe
that litigation is the best way to handle the retirement system
to provide regulation to it? And my further concern is: Would
this be a disincentive to employers to offer 401(k) programs?
Ms. COMBS. We don't believe that this will be a
disincentive for employers to offer 401(k) plans. Let me be
clear. We view this as a clarification of current law. Several
of the lawsuits that are pending by private litigants in
situations, Enron and other situations, are based on this
theory, that the control--that the individual workers did not
have control and, therefore, fiduciaries may be liable for
losses if they breached their fiduciary duty and that caused
the loss. So it is important to understand that we view this as
a clarification. In that way, I think we can help by making it
very certain that what we are not saying is that you are a
guarantor of investment downturns in the markets during a
blackout period.
But what we are trying to do is get the incentives right.
Several of the proposals in the President's plan, both this
proposal on liability and the parity proposal, with freezing
executives' ability to sell stock, are designed to make sure
that those blackout periods are administered fairly, that they
are as brief as possible, and that they are done because they
are in the interests of the workers in the plan.
It is a fiduciary responsibility under current law. The
decision to impose a blackout period and how you administer it
is a fiduciary decision under current law. We want to make sure
that people understand that and take that seriously. I think
that would prevent a lot of the anxiety that people have
suffered in recent circumstances.
Ms. DUNN. Great. Thanks.
One other question. I think you would have to agree that
participation by normal people in 401(k)s has been a huge
addition to the responsible planning of one's retirement, and I
don't know what the numbers are. You might have already stated
them. I know they are something over 50 percent, close to 50
percent of folks who are invested, for example, in the stock
market. Every time we talk about reducing capital gains taxes,
we talk about this huge number of people who already take part
in managing their own retirement.
This whole movement has created amazing wealth and savings
opportunities for ordinary Americans like those of us who are
sitting in this room. On the other hand, there is a great deal
of misunderstanding about the responsibilities that come with
this sort of investment risk and how important diversification
is.
Do you think there is a role for the government in
providing education to people about the risks?
Ms. COMBS. One of the proposals in the President's plan is
to require employers to provide quarterly benefit statements in
401(k) plans and to include in those statements a description
of the advantages of a diversified portfolio and basic
investment principles to try to improve financial literacy and
people's understanding of the risks and rewards here.
So, yes, I think we can encourage employers to make this
information available. I think, again, many employers do want
to have an educated work force in this area. It is in their
interest in having, you know, a content and stable workforce to
make sure that they understand how to invest their 401(k)
plans. So I am optimistic that we are going to get more
information out there.
Ms. DUNN. Good. Thank so much. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you. Does the gentleman from
Georgia, Mr. Lewis, wish to inquire?
Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
Mr. Chairman, before I ask my question, I am sort of
curious about what my colleague from Washington meant when she
said something about normal people who participate in 401(k)s.
I didn't quite understand that. Something about abnormal people
who participate? I just didn't understand it. I wish she
would----
Ms. DUNN. I think we are talking about a group that is not
necessarily the management of a company, for one thing.
Mr. LEWIS OF GEORGIA. Well, thank you for informing me. I
appreciate that very much.
Secretary Combs, you said a great deal in your statement,
but I really want to know what can we do, what can this
Administration do to reassure the workers, the employees that
their pension, their 401(k), their nest egg will be safe,
secured, and protected?
Ms. COMBS. Well, I think there is a two-pronged approach. I
think the President has come forward very quickly in response
to legitimate concerns that have been raised by the public with
a very vigorous package that will strengthen the protections of
workers in 401(k) plans.
At the same time, we are in the midst of conducting an
investigation into the Enron situation. I can't talk about the
details. I appreciate your understanding in that. But, also, we
have a tough enforcement program, which I think will
demonstrate to the public that we take our responsibilities in
that area seriously. There are serious sanctions if we find
that there have been violations. And we are prepared to move on
that.
So I think the combination of tough enforcement and a
responsible, vigorous legislative package will do a great deal
to restore people's confidence.
Mr. LEWIS OF GEORGIA. Thank you.
Secretary Weinberger, do you believe that the Federal
Government, that our government should bail out employees who
lose their pension, their nest egg? Do you think that is a role
for the Federal Government to play? I think this is really a
follow-up to what Mr. Rangel was asking.
In the past--you know, we have a rich history in this
country of bailing out things: the S&Ls, railroads, the
automobile industry, a few months ago the airlines. What about
the people who lose their pensions?
Mr. WEINBERGER. Mr. Lewis, as my colleague, Ms. Combs, was
talking about earlier, for defined benefit plans the Pension
Benefit Guaranty Corporation is there as a company goes
bankrupt to be a reinsurer of those plan assets. So that is
something we already do do. Of course, we also provide Social
Security benefits, so there are several things we do.
With regard to the defined contribution plans, the best
thing that the government can do there is to try and aid
individuals to better understand their opportunities for
diversification, the opportunities to create wealth, and to put
appropriate protections in so that they are not taken advantage
of. And that is all part of the President's plan.
Mr. LEWIS OF GEORGIA. Do you or anyone in the
Administration, do you have any plans to come to the rescue of
the Enron employees?
Mr. WEINBERGER. I am not involved in any way in the Enron
investigation or know anything about the details of that case.
Ms. COMBS. We do have an ongoing investigation into the
Enron situation. We normally don't talk about our
investigations. This was a situation that was quite
extraordinary, so we did----
Mr. LEWIS OF GEORGIA. Let me come from another angle. Do
you think, do you believe that the Federal Government should
play a role, whatever comes out of the investigation, in
helping secure what these people lost?
Ms. COMBS. We are going to pursue--if we find that there
was wrongdoing in the Enron situation, we will pursue that, and
we will bring to bear the full panoply of sanctions that are
available to us under the law.
Mr. LEWIS OF GEORGIA. Thank you, Madam Secretary. Thank
you, Mr. Chairman.
Chairman THOMAS. I thank the gentleman. Does the gentleman
from Georgia, Mr. Collins, wish to inquire?
Mr. COLLINS. Thank you, Mr. Chairman. And I won't attempt
to address ``normal'' or ``abnormal.''
You know, I am amazed as I listen to Members talk about
guarantees. You know, there are only two things I know that we
are guaranteed as individuals is death and taxes. This
Committee has a lot to do with taxes, but only the Good Lord
has to do with death.
We have a tendency to try to immediately come up with a lot
of solutions and a lot of answers when something like the Enron
situation pops up at us, and it is a major, major situation for
a lot of people who had their monies invested in their stock
and in their plans.
But if we just step back and look and observe people, we
will find that people are a lot smarter than we give them
credit for. I think with the Enron situation a lot of people
have become more involved, more interested, and are looking and
learning and watching closely as to what is happening with
their investments. They are concerned about the Dow average,
the Nasdaq average. They get excited when they see it going
back up because they know their retirement funds are being
restored somewhat.
We have a tendency here to hold hearings going out our
ears. Today we are on the defined contribution. Later we will
do the defined benefit. But I think the most important hearings
or investigations that are going on in this town are by the
Justice Department and other agencies. And as I hear people in
the 3rd District of Georgia refer to this subject, they
immediately say if there have been any violations of law, then
those people should be prosecuted and punished accordingly.
In fact, some even say we have a nice little building down
there on the boulevard in Atlanta called the U.S. Penitentiary
that could house them rather than some golf-course resort in
some other areas of the country.
But those types of corrective measures, once the evidence
shows and the prosecution goes through and people are paying
the debt for wrongdoing, those types of corrective measures
will have a resounding effect on others who would commit the
same type of fraud and deceit.
I hope that the President's Task Force takes time to fully
review everything about this situation and possible others. I
have said before to this Committee, my daddy was the smartest
man I ever knew, even though he had less than a third-grade
education. But he used to tell me, he would say, ``Son, haste
makes waste.''
Don't get in a hurry. Take your time. Thoroughly review
everything that has gone on with the people who have committed
these acts of, I think, deceit and fraud against good people.
Don't take a knee-jerk reaction. And I believe the people of
this country will come out a lot better than we sitting up here
holding political hearings instead of doing really good work.
And the recommendations that I see that you put forth here for
this defined contribution that the President has put forth I
think make good sense. They are not a knee jerk. They are not
going beyond the realm of what should be happening. And so,
therefore, I appreciate each of you being here.
Chairman THOMAS. Does the gentleman from Pennsylvania, Mr.
English, wish to inquire?
Mr. ENGLISH. Thank you, Mr. Chairman.
I would like to thank the witnesses for coming before us
today and offering on behalf of the Administration a set of
proposals that I think build on the extraordinary success of
the 401(k) provision over the years, which I believe, whatever
the recent problems with any particular company, we certainly
want to preserve.
I also want to congratulate the Administration for laying
before us a set of positive proposals that are clearly pro-
employee and are clearly populist in their thrust. What you
have done is lay out a set of proposals that would make it
easier for employees to control and protect their own pensions.
And I also am glad, Ms. Combs, for your testimony
clarifying the fiduciary responsibility under this proposal of
employers.
I am wondering, normally with pension funds--and I think I
know the answer to this, having been the trustee of a municipal
pension system. Normally, do fiduciary standards require
diversification?
Ms. COMBS. Diversification is one of the fiduciary
standards. There are exceptions in ERISA for individual account
plans such as 401(k) plans.
Mr. ENGLISH. Okay. Normally, are private fiduciaries
required to maintain diversified plans or portfolios on behalf
of those they are acting for?
Ms. COMBS. Outside of the employee benefit plan context?
Mr. ENGLISH. Yes.
Ms. COMBS. I am not sure I know the answer to that. Under
common law of trust, yes.
Mr. ENGLISH. Okay. Your proposal, as I understand it,
allows employees the ability to diversify their portfolios at
will, much more quickly than the current law does, and does not
require that diversification. Is that a fair assessment of your
proposal?
Ms. COMBS. That is correct. It just gives the people the
right to choose to divest if they want to, if they so choose.
Mr. ENGLISH. As you may know--and, Mr. Weinberger, I know
this didn't make your testimony's seemingly exhaustive list of
contributions by Members of the Committee, but I have
introduced a bill, the Safeguarding America's Retirement Act
(SARA) House bill 3677, that speaks to some of these concerns
and I think differs with the Administration's proposal in one
particular that I would like to focus on for a second, and that
is, I would require, as some other proposals do, that no more
than 20 percent generally of a portfolio under a 401(k) be
invested in a single asset.
I think you have already addressed this, Mr. Weinberger, in
your exchange with the Chairman, but I would like to draw you
out. As I understand it, your position is that this is
unnecessary and potentially arbitrary to be setting a specific
limit.
Ms. COMBS. Well, there are a number of reasons that we did
not go down this road. We have, as you correctly identified,
Mr. English, emphasized choice, investor choice, and giving
them the opportunity for diversification as opposed to
government coming in with a specific mandate.
There are other issues that it raises, particularly with
regard to how it would be administered, such as we talked
about, for example, as assets accumulate, how would the cap
apply? There is potential--and I can explore this further with
you, but there is potential complexity because you have to go
to look at each individual account to see whether each
individual account had more than a specific percentage in it,
and then let that individual diversify, as opposed to a defined
benefit-type approach where it is a universal and single plan.
So there are lots of issues that are associated with it.
Mr. ENGLISH. I would like to get your analysis of that
administrative complexity problem, because it is an issue that
we are aware of. I think it is a soluable problem. But I think
you have raised a legitimate issue.
You also said that 401(k)s are designed to be only one
component of an individual's retirement, and that on that basis
I understand you would not think that a--you would not argue
that a 20 percent standard be enshrined in law. Is that fair?
Mr. WEINBERGER. Mr. English, what I was saying was that a
20 percent standard may be appropriate for some but not for
others. If it is their only asset, who would know what it would
be? It is hard to say, to come up with a bright-line, arbitrary
test to apply to all plans and all individuals.
Mr. ENGLISH. And that is what we have tried to do in my
bill, and what I would like to do, knowing, Mr. Chairman, that
our time is limited here, I would like for an opportunity to
explore in greater detail with the Administration some of their
concerns on this particular issue and perhaps see if we can
find a way to resolve them. And I thank you very much.
Mr. WEINBERGER. We are happy to do it, and I will amend my
testimony, Mr. English, to include your----
Mr. ENGLISH. Not necessary.
Chairman THOMAS. I thank the gentleman from Pennsylvania,
Mr. English, capital E-N-G . . .
[Laughter.]
Chairman THOMAS. Does the gentleman from California, Mr.
Becerra, wish to inquire?
Mr. BECERRA. Thank you, Mr. Chairman.
Thank you both for taking the time to come, especially on a
Monday. Let me first ask Mr. Weinberger a question. You
mentioned--and, actually, Secretary Combs, you as well also
mentioned it--the issue of education. And as best I can
understand from what you said and the proposal that we have
seen so far from the President, it is to provide additional
information about what has gone on, the activity that has
occurred with regard to various investment options that an
employee can receive through the employer.
Other than these quarterly contribution statements, is
there anything else that you mean or refer to when it comes to
the issue of educating employees when it comes to some of these
risky investments?
Mr. WEINBERGER. In the President's proposal, in the
quarterly statements there would be a requirement that there be
discussions of the benefits of diversification. So there would
be a part there.
In addition, I am not, I must admit, involved in it, but in
Treasury there is a separate program ongoing, which is a
financial literacy program that is run out of the Department,
the Domestic Finance Division, that has a goal to try and
increase financial literacy for everyone, employer and those
unrelated to work.
Ms. COMBS. The President's proposal also incorporates
legislation that was passed by the House last year, the
Retirement Security Advice Act, to give people access to
individualized investment advice with respect to their plans as
well.
Mr. BECERRA. With regard to Enron employees, what level of
advice would have made their investments secure through Enron?
Mr. WEINBERGER. Well, certainly, you know, obviously--
again, I don't know the facts of Enron, but the more
individuals hear about the benefits of diversification,
understand risks, understand rewards, we would hope to have a
more educated consumer, and that would be helpful. Individuals
could make different choices.
Mr. BECERRA. But if you are referring to their quarterly
contribution statements and the information they could have
received with regard to investments, those statements would
have reflected what Arthur Andersen and other companies,
investment companies were saying about Enron that in some cases
it might have still been a good purchase even when we knew that
it was close to collapse. So I am not sure if just providing
education, as the President proposes, is going to do much to
help a lot of employees, as we saw with Enron.
But with regard to that advice legislation that this House
passed out, that I understand the President supported, and my
understanding is you have adopted in the President's plan, the
President himself adopts, again, in now his plan to provide
some reform of our pension system, we have the whole issue of
conflict of interest, of a pension fund manager providing
advice.
Let me make sure about something. Enron had an interest in
seeing its employees invest in its stock. Enron had an interest
in seeing its employees be encouraged to invest in its stock.
And certainly when most Enron executives had an idea that the
company was nearing collapse, those Enron executives and Enron
as a company had an interest in seeing those employees maintain
their funds, their pension funds, in that Enron stock. In fact,
there is evidence that they were encouraging, these executives
were encouraging Enron employees to continue to invest in Enron
when they themselves were pulling their moneys out of their
401(k)s with Enron and were, in fact, aware that the company
was nearing collapse.
If those are the interests of Enron and Enron was giving
this type of advice, imparting this advice to its employees,
does the Administration still wish to take the posture that it
would want to encourage fund managers, very much like what
Enron executives were doing, to give advice to its employees on
how to invest their money, despite the fact that we know there
is a self-interest or a conflict of interest that could easily
be involved?
Ms. COMBS. What the President's proposal on the bill that
was adopted by the House would do is make it easier for all
employers to hire someone else to give the advice. And what the
bill does is allow them to hire an investment manager----
Mr. BECERRA. But it could also hire people----
Ms. COMBS. For instance--I am sorry?
Mr. BECERRA. It could also--Enron under this proposed law
that the President supports could also hire a fund manager that
it is paying to give advice on with whom to invest, which could
include Enron itself.
Ms. COMBS. Which could--no. It has to be a regulated
financial institution. You have to hire----
Mr. BECERRA. But that institution, if Enron has contracted
with that financial institution to do accounting and,
therefore, has an interest that that firm, that accounting
firm, do well and that accounting firm has an interest in
seeing Enron do well since it has a contract with it to do
accounting work and other investment work, wouldn't there be a
conflict in allowing that accounting or investment company to
then turn around and tell employees that it should invest in
Enron stock, without having to necessarily give full disclosure
about its relationship completely with Enron?
Ms. COMBS. There are protections in the bill, and what it
would do, you would have to be either a regulated bank, broker-
dealer, insurance company--I am forgetting the--mutual fund
complex----
Mr. BECERRA. But how does that stop an employee----
Ms. COMBS. You have to be someone who is a professional
investment adviser.
Mr. BECERRA. But how does that stop an employee from
ultimately receiving advice which is conflicted or has a self-
interest, which is permitted by the legislation----
Ms. COMBS. The adviser is a fiduciary. They have personal
responsibility for the advice they give. They must disclose the
conflict. They must disclose their fees. They must disclose the
relationship.
Mr. BECERRA. But, Secretary Combs, is it not a fact that
the advice ultimately could be conflicting advice and it could
be self-interested advice?
Ms. COMBS. That would be illegal under the bill. If they
did that, they would be violating their fiduciary
responsibility, and it would be illegal.
Mr. WEINBERGER. You have to run it solely for the benefit
of the employees, which is a fiduciary standard, and it will
require a legal analysis.
Mr. BECERRA. Okay. Well, I thank the Chairman for the time,
and I would like to explore that later on.
Chairman THOMAS. They could go ahead and do it, but they
would be responsible.
Mr. BECERRA. So they could do it----
Chairman THOMAS. For their behavior, i.e., they would be--
--
Mr. BECERRA. As we saw the executives in the Enron case.
Chairman THOMAS. Breaking the law.
Mr. BECERRA. We saw a lot of folks breaking the law and a
lot of folks----
Chairman THOMAS. I understand that, and there is an
investigation to look at that.
The other points, perhaps the gentleman was not here when
the other Administration points were presented in terms of
changing the blackout rules, and probably one of the better
ideas I have heard is, as it was articulated, what is good for
the top floor is good for the shop floor. If the management,
notwithstanding the fact they are not in a 401(k) plan and they
have stock and they make decisions about the stock, that has to
be disclosed so that the shop floor can follow the top floor on
flight away from the company's stock, as may have been the case
in Enron.
Again, the fundamental rule here of transparency I think
goes a long way toward resolving some of the particular
problems, but we have a panel following this one that might
want to either support or augment some of the President's
proposals, and we look forward to hearing from them sometime
today. If not, we will hear from them Tuesday.
Does the gentleman from Louisiana wish to inquire?
Mr. McCrery. Mr. Chairman, just briefly.
I am sorry I was not here for your testimony. I was with
the President announcing his welfare reform proposal, which is
very good. But I did have a chance to read some excerpts from
your testimony, your prepared testimony, and I want to
compliment you on the tone of your testimony and the kind of
thorough, go-slow approach that I believe we should take in
this matter.
Frankly, the way I see it, most of the fine-tuning that
needs to be done with respect to pensions and 401(k)s, defined
contribution, defined benefit plans, like outside the
jurisdiction of this Committee. And there are other committees,
Financial Institutions, Commerce, looking at doing some things
with respect to stock manipulation, stock value manipulation,
those kinds of things that were going on with Enron, or least
appeared to be going on with Enron, that need to be corrected.
And those ought to be done.
But as you pointed out in your testimony, the pension
system, the defined contribution system, has worked extremely
well in this country, providing much more financial security
for many, many more people in this country than ever before,
and we ought to be very, very careful before we tamper with
something that has worked so well.
So that is really all I wanted to say, Mr. Chairman. I
appreciate the tone of their testimony and look forward to
working with the Administration to fine-tune, perhaps, our
system but be very careful not to do anything that would harm
it more than it would do it any good. Thank you.
Chairman THOMAS. I thank the gentleman. Does the gentleman
from Oklahoma, Mr. Watkins, wish to inquire?
Mr. WATKINS. Thank you, Mr. Chairman.
Let me say, I think you have got some good points to be
made in the legislation. I think it is a step in the right
direction, trying to root out some of the things that can bring
around some fraud and criminal action. I think we have got to
try to address that. If there have been some wrongdoings, then
we need to find out. But you cannot get the entire--we have
free enterprise, capitalism and all. We are not going to be
able to take all risk out of everything. We are going to have
freedom in investment and freedom doing business. We are going
to have to have the opportunity to have the responsibility of
succeeding and failing. But we need to make sure we try to root
out all the--but that is going to be tough to always do. They
always find different ways, you know.
Let me just ask for a reflection, Mr. Chairman, if I might.
Who is the person that today is looked at as probably the
greatest responsible person about the economy? Most people
would say probably Greenspan. That is probably true in most
people's minds.
But if you look around at some of the people that have lost
by far more money, it has been in CDs or certificates of
deposits at banks, lost more money in the interest rates, the
CDs. You ask any elderly person who has been trying to live on
interest rates, back when they had--not too many months ago
down the road they had 6, 7, 8 percent from some CDs or the
treasury securities. There has been a greater percentage of
loss from the CDs at the banks and the treasuries than the
stock market overall. Now, there are isolated companies that
have had a higher percentage, but overall. So when you look at
that, I would say we have got to be careful on what we propose
and what we require, when we take away a lot of the freedom of
investors across this country.
I can assure you there is an outcry of a lot of the elderly
about the interest rates, but were those decisions made in the
best interests of the country, of trying to make sure we
stimulate the economy, I am quite sure, and most of our elderly
people say do whatever is necessary to move this country
forward. And I think that is what we have got to look at as we
try to protect investors as much as we can, give them the
guidelines, give them the education, root out those who
criminalized the system, and I think we can solve some of the
problems.
So I want to thank you for bringing this. I will be looking
at it very carefully as we go through here, but I think we have
too many people who want to throw everything out with the--the
baby with the bath water, so to speak.
Thank you, Mr. Chairman. I just wanted to make that point.
Chairman THOMAS. I thank the gentleman. Does the
gentlewoman from Florida, Mrs. Thurman, wish to inquire?
Mrs. THURMAN. Thank you, Mr. Chairman.
I will be like everybody else. Thanks for being here,
although I was a little concerned that I wasn't mentioned in
your testimony, Mr. Weinberger. So I will ask you what Mr.
Ramstad would be asking you if he were here today, which is
about ESOPs. We worked on this just for your next testimony
before the Committee so you can----
[Laughter.]
Mrs. THURMAN. I actually had the opportunity, oh, I would
say a couple weeks ago, to go down to actually talk to a group
of ESOP owners in the Southeastern part of the United States.
It was a small group. And I have to tell you, they are very,
very concerned about what is going on up here and certainly
what kind of an effect this will have on their ESOPs.
This was not the owners. In fact, these were the employees
of the ESOPs that are asking us, and Mr. Collins' Southern way
of saying, slow down, you know, don't throw everything out.
And I notice that you did in your testimony spend some time
on ESOPs, and I guess maybe we can do this at some other time,
but we do know already in the ESOPs that they already have
diversification that they have to meet. And it is pretty well
spelled out. I mean, I am not sure in other areas in pension
plans that they have been as--they are as good as what can
happen in these other--in ESOPs.
And you did say stand-alone ones would be okay. I guess you
are not going to worry about them.
So who are those other companies that you see out there
that are not stand-alones that might be affected by this, that
are going to have some concerns because they may be small, you
know, 20, 30, 40 employees that may end up having to meet some
of those diversification requirements that are not going to be
able to? I mean, are we going to open up a can of worms here
for some of these other ESOPs, and how can we work through
this?
Mr. WEINBERGER. Congresswoman Thurman, it is a really good
question, and we do embrace the spirit behind ESOPs, which is
to provide ownership and certainly to transfer to employees
ownership, which is a positive thing, an alignment of employees
and owners. That is why we did carve out stand-alone ESOPs.
That is really how you leverage a company, with the stock in
the ESOP, and you go ahead and you basically are able to
transfer that ownership, and that is a positive thing.
What we have seen, what has happened is ESOPs, because
there are special tax advantages unique to ESOPs, have become
part and parcel in many cases of 401(k)s, and there are
matching contributions for ESOPs. If we were not able to treat
those ESOPs where you have matching contributions or where they
are part of 401(k) with the same 3-year diversification
requirement as we do for 401(k)s, it would be a way to get
around the entire diversification rule because everyone could
then elect to be an ESOP.
Mrs. THURMAN. Knowing that we just got this testimony, and
certainly with the issue that you have laid out fairly well in
your testimony before us, let's not close the door yet. I need
to have some--we need to sit down and really kind of talk about
this and see what these special cases are, because I think they
are one area that, in fact, did do some diversification before,
you know, they were asked or were told to do something and
pretty explicit in what they can do.
If the issue is on tax law, then we will talk about the tax
law, but I don't know that it necessarily has to do with the
diversification part of it. So I just leave this open-ended and
hope that we will have some more conversations about this
issue.
Mr. WEINBERGER. Happy to do it.
Mrs. THURMAN. Thank you.
Chairman THOMAS. I thank the gentlewoman. Does the
gentleman from Illinois, Mr. Weller, wish to inquire?
Mr. WELLER. Thank you, Mr. Chairman.
Mr. Weinberger, Ms. Combs, thank you for spending a lengthy
afternoon with us on an important issue. Of course, we are
talking about retirement security today, something that is
important for all of us. Forty-three million Americans today
have 401(k)s, and in the almost generation-long experiment of
401(k)s, they have been pretty successful in giving people an
opportunity to have an opportunity to save for their
retirement, particularly for small employers now with the
changes that we have made in the last few years.
I find that employees and workers tell me they like the
choices, they like the control, they like the fact that a
401(k) is portable if they change jobs or positions.
But, of course, what has occurred in the last few months
has drawn a lot of attention to how these plans are potentially
managed and some of the questions that occur. So I think this
is a very helpful hearing, I know certainly for me.
I would just like to get a clarification on a couple
questions. This past fall, of course, we passed the Retirement
Security Advice Act, legislation that you have addressed in
your legislation that the President has now put forward. And we
passed it last fall, and like most legislation the House
passes, the Senate hasn't done anything on this issue. And
hopefully they will one of these days, but the bill that we
passed last fall, you said you used a base bill. Is your
proposal identical to what we passed out of the House last
fall, or are there some changes or differences in what is in
the President's bill?
Ms. COMBS. It is the bill that was passed out of the House.
Mr. WELLER. And have you added anything to it, any
additions? So it is identical to the proposal?
Ms. COMBS. No. We thought that it would make sense, since
this was something that had broad bipartisan support in the
House and that we had endorsed previously, that we would just
incorporate it by reference into our plan.
Mr. WELLER. Could you give an example of how an average
worker would--you know, if the Retirement Security Advice Act
was signed into law as the President has endorsed, how would a
worker, an average worker in the south suburbs of Chicago,
Illinois, be able to take advantage of this? What would it mean
for them, the choices they would have to make and be able to
make an informed choice?
Ms. COMBS. There are two components to the bill. The first
would clarify that employers who wanted to make investment
advice available to their workers would not be responsible for
the actual advice given. That fiduciary responsibility would
shift to the adviser. So that we think would create a real
incentive for employers to make this service available. That
has been a chill in the market, if you will.
The second piece is to say that financial institutions,
regulated financial institutions who have a relationship to the
retirement plan would be allowed to give individualized advice
to workers in the plan, provided that they acknowledged that
they were a fiduciary when they were doing that so that they
had to act solely in the interest of the worker, not in their
own corporate interest, that they assumed fiduciary liability,
and that they disclosed their relationships, they disclosed
their fees, any limitations on their advice, that there was
very full and fair disclosure.
Say a small- or medium-size employer that offered a 401(k)
plan, they want to go to one service provider. They call it
bundled services. They want to contract with Fidelity or
Vanguard or Merrill Lynch or an insurance company as the
principal. They want them to provide all the services. They
would be able--the Fidelitys, the Vanguards would be able to
sit down one on one with workers and talk to them about their
investment choices that they were making in their 401(k), and
then the worker would choose whether or not to follow that
advice.
Mr. WELLER. And would there be any additional cost to the
worker to obtain this investment advice from these service
providers?
Ms. COMBS. The way the bill is structured, the employer
could choose. They could choose to pay for the advice. They
could pass the cost on to workers who elected to receive it.
They could spread it out over the plan as a whole. There would
be flexibility there.
Again, we think it would be a lower cost if it were
provided by the service provider who otherwise had the
relationship to the plan because they would tend to have
economies of scale. They already know the plan. They know the
plan design. They could offer it for a lower price.
Mr. WELLER. Now, there has been a bipartisan effort in this
Committee over the last several years, led by Chairman Thomas
and our colleagues Mr. Portman and Mr. Cardin, to simplify our
opportunities for retirement savings and security, and we, of
course, passed a major portion of those changes this past year
in legislation that the President signed last June, something
that was commonly known as Portman-Cardin, and gave an
opportunity for greater retirement savings.
With the President's proposal, what kind of changes would
the President recommend that we make to the legislation that
was passed earlier this year? Does he see any need to modify
that legislation based upon the recommendations he has made?
Mr. WEINBERGER. Congressman Weller, no. We at Treasury and
the Internal Revenue Service (IRS) are trying to do everything
we can to write regulations to implement the good things that
were in that legislation, to expand the ability of individuals
to participate. This plan is aimed at just adding further
protections to the individuals through the diversification and
the investment advice and other issues we talked about.
Mr. WELLER. Thank you, Mr. Chairman. I see my time has
expired.
Chairman THOMAS. Mr. Doggett.
Mr. DOGGETT. Thank you, Mr. Chairman.
Mr. Weinberger, yesterday's Wall Street Journal reported
that your firm lobbied for the Swap Funds Coalition. The
article identified the coalition as, I quote, ``a group of
financial firms that ran exchange or swap funds and opposed
changes in how the funds are regulated.''
Who were the specific members of the coalition?
Mr. WEINBERGER. I have no recollection. That had to be 5
years ago. It was on my disclosure form. It had to be at
least--I haven't lobbied on issues for many years, but it had
to be since 1999 or 2000, or 1998. So I don't know the answer
to that.
Mr. DOGGETT. The same article said that your spokeswoman
said that your firm was paid in 1999 for that fund. You don't
know who any of the members of that coalition were?
Mr. WEINBERGER. I don't recall, Mr. Doggett.
Mr. DOGGETT. Is that information that you can get for me?
Mr. WEINBERGER. I don't know. You can certainly call the
old firm and ask them.
Mr. DOGGETT. Well, in the July 2, 1999, Washington Post,
you were quoted as a lobbyist representing another coalition, a
coalition of businesses, which you said found attempts by the
Treasury to establish strict standards to define tax shelters
as ``an anathema.'' Do you recall whether Enron or any of its
subsidiaries, partnerships, or joint ventures were a member of
that coalition or any of the other coalitions for which you or
your law firm lobbied?
Mr. WEINBERGER. I don't recall, but I don't believe they
were.
Mr. DOGGETT. But you do not have accessible to you a list
of the members of the coalitions for which you lobbied on any
matter within the jurisdiction of the Treasury Department
during 1999 or 2000, just before coming to this job?
Mr. WEINBERGER. I am not aware--no, I do not have any list
of individual member companies or was not required to produce
one. it is not part of any ethical requirements, and I have not
done so.
Mr. DOGGETT. Would you be willing to provide such a list?
Mr. WEINBERGER. I don't have--I don't have such a list.
Mr. DOGGETT. And you don't have a recollection as to who
any of the individual companies were that were members of those
coalitions?
Mr. WEINBERGER. Again, you can check with the company that
I worked for, but I don't know the relevance to the issue we
have today before us in the 401(k) area or any other issues
that I am working on with the Treasury Department.
Mr. DOGGETT. Regarding the testimony from Ms. Combs on the
Retirement Security Task Force appointed by President Bush on
January 10th, composed of the Secretaries of Treasury, Labor,
and Commerce, or their designees, to consider pension concerns
arising from the Enron debacle, is that a Task Force in which
both of you have participated?
Mr. WEINBERGER. On the Retirement Security Task Force?
Mr. DOGGETT. Yes.
Mr. WEINBERGER. Yes.
Mr. DOGGETT. And you also, Ms. Combs?
Ms. COMBS. Yes, I helped staff Secretary Chao.
Mr. DOGGETT. Can you identify all of the individuals,
organizations, and corporations that to your knowledge had met
with Members of the Task Force on a matter within the scope of
its review?
Ms. COMBS. The Task Force itself during its deliberations
from January 10th until today has not met with outside
organizations. It really has been a matter of internal
deliberations among the agencies.
Mr. DOGGETT. Has it received to your knowledge any
communications, electronic or written, from any nongovernmental
source?
Ms. COMBS. Not to my knowledge as a task force. I am sure
the Members of the Task Force have received information and
feedback from many people who would be affected by these
proposals, but not the Task Force itself.
Mr. WEINBERGER. Well, I think the Employee Benefits
Research Institute (EBRI)--I do recall getting some information
from them with regard to what type of plans are out there.
EBRI.
Ms. COMBS. That is correct.
Mr. DOGGETT. I know that the Secretaries with whom you work
have many responsibilities. Is the most immediate day-to-day
work of that Task Force done by you as designees from your
respective Secretaries?
Mr. WEINBERGER. No. The most immediate day-to-day work is
done by the people behind me, and also the Domestic Finance as
well, which is Assistant Secretary for Financial Institutions,
Sheila Bair.
Mr. DOGGETT. But the Members of the Task Force were not
given the responsibility of seeking opinion from any
nongovernmental source for any of their work?
Mr. WEINBERGER. That is correct.
Mr. DOGGETT. There has been a recommendation that following
the announcement by Cindy Olson, an Enron Vice President, at a
1999 meeting with Enron, that its employees should keep 100
percent of their 401(k) in Enron stock, that within about 3
months she sold a million dollars of Enron stock. I am
wondering if you support individually a requirement that
company executives that engage in such inside stock sales
promptly notify the pension plan administrator that they have
done so.
Ms. COMBS. I would certainly take it under advisement. I
would want to think about it. But it strikes me as something we
could consider.
Mr. DOGGETT. You don't have an opinion on it?
Mr. WEINBERGER. No.
Mr. DOGGETT. Okay. And, similarly, both the Wall Street
Journal and the New York Times have reported that an obscure
provision in legislation that this Committee approved last year
actually provided an incentive to encourage--a tax incentive or
tax subsidy to encourage corporations to contribute company
stock to 401(k)s through K-SOPs. Given the large percentage of
company stock in plans for Procter & Gamble, Enron, a number of
other corporations, do you support continuing a tax subsidy to
encourage the placement of company stock in 401(k)s?
Mr. WEINBERGER. I just had this dialog with your colleague,
Mrs. Thurman, about the Administration is supportive of ESOPs.
We do not have any reason to believe that any tax provisions
that are currently in law created any Enron problem or
anything. So we do support the legislation. We supported it
last year as part of the President's past tax bill.
Mr. DOGGETT. And support the provision that specifically
encouraged some corporations--I believe the Wall Street Journal
reported on Abbott potentially saving over $20 million and
Pfizer saving over $20 million by merging their retirement plan
into a K-SOP.
Mr. WEINBERGER. I have no knowledge of those facts. I can't
even opine on that.
Mr. DOGGETT. Thank you very much. Thank you, Mr. Chairman.
Chairman THOMAS. Does the gentleman from Ohio, Mr. Portman,
wish to inquire?
Mr. PORTMAN. Mr. Chairman, thank you. I will be brief. I
was here at the outset, then had to go to a meeting, and I am
back for the next panel, but have just a couple of questions
for our panelists, first to thank them for the testimony
today--and I read their statements--and for working with us to
try to improve our pension system in the wake of what happened
at Enron.
But I want to know a couple of things about where we have
been in the last 20 years. How many 401(k)s were there in 1979?
Ms. COMBS. Since 401(k)s, the aggregate--today there are
about 350,000 401(k) plans, so the growth has been----
Mr. PORTMAN. My point is that in the last 20 years we have
gone from zero to over 300,000. How many million people, almost
43 million, are now in 401(k)s?
Mr. WEINBERGER. Correct. I could tell you there is a
tenfold rise in the number of 401(k) plans, from 30,000 in 1985
to 301,000 in 1998.
Mr. PORTMAN. That is in a short period of time. My point is
this has been a tremendous success for this Congress and for
this country, and it has empowered employees because they have
been able to take control of their own retirement. We still
have half the workforce without a pension, and the last thing
we should do is to put more rules and regulations on 401(k)s
just at a time we are trying to expand them and other options,
including defined benefit plans. And I would hope that in this
hearing we can come up with ways to improve the retirement
security of all employees by providing some common-sense
changes to the law.
For instance, now with a 401(k) you can tie somebody down.
In an earlier question from the Chairman, Ms. Combs mentioned
that some plans do that. They all could do that. ESOP plans, of
course, are limited to age 55 and 10 years of participation.
But this is something that we believe ought to be addressed.
There are different proposals as to how to do it. We want to
work with you on that to not enable employers to tie people
into corporate stock, instead to provide more information and
education and disclosure and give people the option to get out
of that corporate stock should they choose to do so.
I would also say that there are going to be a lot of
different jurisdictional issues here. The Committee on Ways and
Means is committed to working with the other committees to put
together a good product. The Chairman has already talked about
that. We think this is something that ought to be addressed
this year. We want to be aggressive about it and continue the
efforts we have made over the last 6 or 7 years in this
Committee really to be a leader on expanding retirement
security for all employees. Thank you for being here.
Chairman THOMAS. Does the gentleman from North Dakota,
notwithstanding the fact he was prominently mentioned by the
Assistant Secretary in his opening remarks, wish to inquire?
Mr. POMEROY. Yes, Mr. Chairman, briefly.
First of all, I would commend you for your statement,
particularly as regards to me.
[Laughter.]
Mr. POMEROY. Further, I am certainly looking forward to the
SAVER Summit coming up later this week. I was an original
cosponsor, along with former colleague Harris Fawell, in
passing the legislation initially. And I believed then and
events have certainly shown that it is important not just to
have one summit. This isn't a deal that you have a big event
and it is all over. The challenge of getting Americans to
adequately save and manage their assets for retirement is an
ongoing challenge. It is one of the greatest priorities of this
country, and it is going to become even more important. So
pulling that together, especially in light of what a chaotic
and eventful year our Nation has had, has been terribly
difficult. I commend you, Secretary Combs, for doing that.
I want to tell you that I think that the reforms you have
advanced, the Administration has advanced are balanced and
constructive. I think that they are substantive and meaningful.
There are a couple of fairly minor issues I would take with
them. The 3-year diversification requirement, did you give any
consideration to altering that based upon age of an employee? I
mean, certainly someone at 50, a 3-year timeframe on
diversification is more significant than someone at the age of
25. Any thought about age, linking that, making it shorter for
someone older?
Ms. COMBS. We did look at age requirements. For instance,
in the ESOP rules there is an age requirement of 55. So we
looked at that and decided that with the mobility in defined
contribution plans that may not make sense, that the motives
really were employers wanted a demonstration that you were
attached to their workforce and were going to accumulate a
significant retirement benefit from that employer. And so our
thought was to use 3 years as opposed to age-specific, but we
did consider it, and we are open to discussing other
approaches.
Mr. WEINBERGER. And again, Mr. Pomeroy, as I said earlier,
obviously employers can do it sooner, but the 3 years was a
close tie to the 3-year vesting requirements. We figured why
let people diversify before they actually vest, and so that was
part of the reason for the 3 years.
Mr. POMEROY. I do share your concerns that a percentage
limit may have the unintended effect of actually reducing
employer match, and the employer match is the greatest retiree
savings incentive out there, bar none. And I do think we have
really got to consider that as we look at percentage match
limitations. I think your approach is simply more effective.
On the investment advice component of your plan, I would
point you to a colloquy between Chairman Boehner and myself
regarding some tweaking of the legislation passed by the House
that would add some additional safeguards for participating
employees, specifically more advanced and frequent fee
disclosure, as well as a requirement that salespersons
operating within this very restrictive fiduciary responsibility
all have some type of administrative oversight. And so that
would be licensure for securities and insurance, and after
coming to more fully understand banking trust powers, you don't
require licensure of bank trust employees. They have a very
full array of administrative remedies sitting on them that
could put them out of business if they violate their
responsibilities.
But if you don't have it limited to trust department
employees, you really don't have that type of administrative
reach on bank personnel. So I would suggest that change as
well. A fairly minor tweaking, but I think important to
consumer protection.
Ms. COMBS. We are aware of the colloquy, and we do support
the changes that you and Mr. Boehner agreed to.
Mr. POMEROY. Thank you.
Finally, there was a very interesting article in the Wall
Street Journal yesterday, not the one mentioning you, Secretary
Weinberger, but the one that talked about the company that
voted to discount the earnings on its pension plan for purposes
of corporate earnings to be considered in determining bonuses
for company executives. The performance of the pension plan,
which was fabulous during the stock market run-up, artificially
bolstered corporate earnings in the balance statements for
years. And it was a windfall to company personnel whose
reimbursement was in part based upon performance measurements
based on earnings because it was simply driven by the stock
market on the pension program. This action by this company I
thought was progressive and constructive.
Do you have any evaluation of this company's actions and
whether it ought to be held up as a laudable example to others
to consider?
Mr. WEINBERGER. I don't, but I will have a look at the
article.
Ms. COMBS. I wasn't familiar with it either, but----
Mr. POMEROY. It is an interesting concept, isn't it? That
as you determine compensation to be paid under some kind of
bonus award, the earnings on the pension plan, having nothing
to do with the company performance, aren't going to be
considered. I like that idea. I thought it was appropriate.
Thank you very much.
Chairman THOMAS. I thank the gentleman. Does the gentleman
from Texas, Mr. Brady, wish to inquire?
Mr. BRADY. Thank you, Mr. Chairman.
With 42 million workers in 401(k) plans, there is a lot at
stake in this discussion. It is important that as we look at
reforms that we consider them very carefully, that any changes
be thoughtful so that we do this right, we not pass legislation
in haste.
Although this hearing is not about Enron, it is hard to
avoid it, and we have a number of ex-Enron employees in my
congressional district. In meetings with them, and again last
night, a townhall meeting with about 300 of the former workers
gathered, we talked again and asked for their advice on reforms
for pension issues.
And, again, repeatedly they said, look, don't limit our
ability to invest in our company or any other company in our
plans. What we want to know is if the auditors tell us the
numbers are good on a company, we want to be able to rely on
those numbers.
And I think the points you made earlier that the
Administration is looking at reforms to make sure that audits
truly are independent, that the numbers are closer to accurate,
that they are something that people can rely upon, they can
make informed decisions to build that nest egg that they want
to build. And while there is interest in parity in blackout
periods, more disclosure, more advice, issues like that, there
seems to be a growing interest on their part, at least, to
really see reforms on the accounting side of this to prevent it
in the future.
But in dealing with them, one of the questions that comes
forward often deals with current law protections if you are in
these types of plans. From your information, what specific
provisions exist under current law to protect workers in
defined contribution plans? If an employer or a plan sponsor
violates the law, what remedies are available to workers who
participate in them? Are they all in the courts, or are there
other laws as well?
Ms. COMBS. The defined contribution plans are subject to
ERISA and its fiduciary standards, so that the plan sponsor and
fiduciaries of the plan have a responsibility to act prudently,
to act solely in the interest of the workers. There are
prohibited transaction rules which prevent self-dealing. And
there are remedies, both civil and criminal. On the civil side,
fiduciaries are personally liable for losses that occur to the
plan that are attributable to the breach that may have occurred
to make the plan whole, plus interest so that it is truly made
whole. And there are criminal penalties for behavior such as,
as I mentioned, embezzlement, fraud, money laundering, wire
fraud. So there is quite a broad--we have very broad subpoena
power. We have a good investigative capability, and the
protections are----
Mr. BRADY. How often, in addition to criminal penalties,
how often--because we are asked this question often. What is
the likelihood that when there is a fiduciary breach or fraud
that occurs that it really results in some type of financial
remedy for those who have been harmed?
Ms. COMBS. The Department of Labor, we opened approximately
4,000 investigations. It depends year by year, but it ranges
between 4,000 and 5,000 investigations which are opened and
completed each year. We recovered, for instance, in 2001 $662
million on behalf of participants.
Now, another important feature of ERISA which I neglected
to mention is participants themselves have a right to bring a
suit under ERISA. There is a private right of action. And I
don't have--the statistics are not reported to us, but it is
manyfold times the number of cases that we can bring, that the
private bar is out there or private individuals are enforcing
their rights under ERISA. So there is not only a deterrent
effect, but there are some very serious consequences to
breaching a fiduciary duty.
Mr. WEINBERGER. There is one more. Of course, the IRS could
come in and disqualify a plan as well, which has major
ramifications, if there are violations of the rules.
Mr. BRADY. From your perspective, are there any--what you
basically said is we have got some strong protections. You
aggressively enforce them. You go through a process to do that.
As you look at that process, are there any reforms or changes
that can be made to further strengthen that? Obviously, the
more you have at stake in your fiduciary responsibility and the
need to avoid fraud, hopefully the less likely that will occur.
Ms. COMBS. We think we have a good set of tools now, but we
would be happy to work with the Committee to see if there are
ways to provide additional strength.
Mr. BRADY. Thank you, Mr. Chairman.
Chairman THOMAS. I thank the gentleman, and we have to be
cognizant of the fact that there is a significant shared
jurisdictional responsibility in this area.
I want to thank the panel. We will be seeing you again, and
I would be willing to augment any name list, Mr. Weinberger,
that you wish to present. I have some folks that I probably
would like to have mentioned, and possibly some others not. I
will work with you on your next presentation.
Thank you very much. The information that you provide to us
will be essential in not only reviewing but obviously as we
move forward legislatively. I want to underscore the gentleman
from California's--Mr. Matsui's concern about the timeliness of
providing us with this information.
I would ask the next panel--first of all, I want to thank
the upcoming panel for their patience. The information that you
are to provide us is extremely valuable.
The second panel consists of Mr. Vanderhei from Temple
University; Mr. Schieber, Vice President, Research and
Information, Watson Wyatt Worldwide; and Regina Jefferson, a
Professor of Law at Catholic University.
We have your written statements, and we will make them a
part of the record, without objection. And if you will address
us in the time you have available in any way you desire to
inform us, we will listen to you and then we will follow with
some questions.
Why don't we start with Mr. Vanderhei and then simply move
across the panel.
STATEMENT OF JACK L. VANDERHEI, PH.D., FACULTY MEMBER, RISK
INSURANCE AND HEALTH CARE MANAGEMENT, FOX SCHOOL OF BUSINESS
AND MANAGEMENT, TEMPLE UNIVERSITY, PHILADELPHIA, PENNSYLVANIA,
AND RESEARCH DIRECTOR, FELLOWS PROGRAM, EMPLOYEE BENEFIT
RESEARCH INSTITUTE
Mr. VANDERHEI. Thank you. Chairman Thomas, Ranking Member
Rangel, Members of the Committee, I am Jack VanDerhei, a
Faculty Member in the Fox School of Business and Management at
Temple University. I am also the Research Director of the
Employee Benefit Research Institute Fellows Program.
My testimony today will focus on retirement security and
defined contribution plans with emphasis on the role of company
stock in 401(k) plans. I wish to note that the views expressed
in this statement are mine alone and should not be attributed
to my co-authors, Temple University, the Employee Benefit
Research Institute, or their officers, trustees, sponsors, or
other staff.
I would like to highlight six points in my testimony today.
First, most 401(k) plans do not include company stock as an
investment option or a mandate. The Employee Benefit Research
Institute/Investment Co. Institute (EBRI/ICI) 401(k) database--
a 5-year collection of individual specific data of more than 11
million participants from over 30,000 plans--shows that only
2.9 percent of the plans included company stock. However, as
noted earlier, the plans that do have----
Chairman THOMAS. Mr. VanDerhei, if you would suspend just
briefly.
If people want to carry on conversations, I would
appreciate it if they would remove themselves from the
Committee room so the Committee could hear the testimony.
Mr. VANDERHEI. However, as noted earlier, the plans that do
have company stock are generally quite large and represented 42
percent of the participants. In terms of account balances,
plans with company stock account for 59 percent of the
universe. The fact that plans with company stock had higher
average account balances was no doubt partially due to the bull
market preceding this time period but may also be a function of
the plan's generosity parameters and the average tenure of the
employees.
Second, the overall percentage of 401(k) account balances
in company stock has remained consistently in the 18 to 19
percent range from 1996 to 2000. However, when the analysis is
limited only to those plans that include company stock, the
average allocation increases to approximately 30 percent.
Third, several proposals have called for an absolute upper
limit on the percentage of company stock that an employee will
be allowed to hold in his or her 401(k) account. Analysis of
the EBRI/ICI data shows that a total of 48 percent of the
401(k) participants under age 40 in these plans have more than
20 percent of their account balances invested in company stock.
That percentage decreases to 41 percent for participants in
their sixties.
Fourth, some employers require that the employer
contribution be invested in company stock rather than as
directed by the participant. Participants in these plans tend
to invest a higher percentage of their self-directed balances
in company stock than participants in plans without an
employer-directed contribution. Company stock represents 33
percent of the participant-directed account balances in plans
with employer-directed contributions compared with 22 percent
of account balances in plans offering company stock as an
investment option but not requiring that employer contributions
be invested in company stock.
Fifth, what would happen if a minimum rate of return were
guaranteed for 401(k) participants? Proposals have been
suggested recently that would attempt to transfer part or all
of the investment risk inherent in defined contribution plans
from the employee to another entity. Although the party
initially exposed to said risk varies among the proposals, the
likely targets would be the employer, a government agency--
perhaps the PBGC--and/or a private insurance company. While the
cost of the guarantees and/or the financial uncertainty
inherent in such an arrangement may be borne by the employer at
least initially, it is unlikely that in the long term such a
shift in risk-bearing would not somehow alter the provisions of
the existing defined contribution plans.
It is obviously impossible to model the financial
consequences of such proposals until additional detail is
provided; however, a highly stylized example of one method of
achieving this objective can be readily simulated. Assume, if
you will, a proposal that would require the employer to insure
that participants receive an account balance no less than what
would have been obtained under a minimum rate of return. While
some employers may choose to voluntarily assume the additional
cost of this arrangement, others may wish to re-think the
investment options provided to the employees and provide little
or no participant direction. In fact, an easy way of mitigating
that new risk imposed by the minimum guarantee would be to
force all contributions--whether contributed by the employee or
by the employer--into a relatively risk-free investment. While
this is unlikely to be popular with young employees and other
participants desiring high long-term expected returns, it would
minimize the new risks shifted to the employer.
Figure 2 in my written testimony shows the expected results
of running one such proposal through a simulation model I
created for this testimony. Instead of allowing employees to
direct their own contributions and perhaps those of the
employer, assume employers are forced to guarantee a minimum
rate of return of 5 percent nominal and they are able to find a
GIC, or its synthetic equivalent, that will provide that return
in perpetuity. If all existing balances and future 401(k)
contributions were required to be invested in this single
investment option, the average expected reduction in 401(k)
account balances at retirement would decrease between 25 and 35
percent for participants born after 1956.
While the results in Figure 2 are specific to the
assumptions mentioned above, similar results are obtained,
albeit with different percentage losses, under various
combinations of minimum guarantees and assumed asset
allocations and rates of return.
Finally, number six, what happens if company stock were
removed from 401(k) plans? I simulated the overall gain or loss
from prospective retention of company stock in 401(k) plans, as
opposed to company stock being entirely eliminated immediately,
for birth cohorts between 1936 and 1970, and the results
indicate the estimated gain of retaining company stock is
either 4.0 percent or 7.8 percent of 401(k) balances depending
on the assumptions used.
There would, however, be a wide distribution of winners and
losers from retaining company stock. For example, at least 25
percent of the sample is expected to gain 5.1 percent or more
if they were allowed to have company stock going forward, while
at least 25 percent of the sample is expected to lose 10.8
percent or more if company stock continues to be permitted.
That concludes my oral testimony. I would like to thank the
Committee for the opportunity to appear today, and I would be
happy to respond to any questions you may have.
[The prepared statement of Mr. VanDerhei follows:]
Statement of Jack L. VanDerhei,* Ph.D., Faculty Member, Risk Insurance
and Health Care Management, Fox School of Business and Management,
Temple University, Philadelphia, Pennsylvania, and Research Director,
Fellows Program, Employee Benefit Research Institute
---------------------------------------------------------------------------
* The views expressed in this statement are solely those of Jack
VanDerhei and should not be attributed to Temple University or the
Employee Benefit Research Institute, its officers, trustees, sponsors,
or other staff.
---------------------------------------------------------------------------
1 Introduction
Chairman Thomas, Ranking Member Rangel, members of the committee. I
am Jack VanDerhei, a faculty member in the risk insurance and health
care management at the Fox School of Business, Temple University, and
research director of the Employee Benefit Research Institute Fellows
Program.
1.1 Objectives of the Testimony \1\
My testimony today will focus on retirement security and defined
contribution pension plans with special emphasis on 401(k) plans with
company stock. This draws on the extensive research conducted by the
Employee Benefit Research Institute and on the EBRI/ICI 401(k)
database. Portions of this testimony borrow heavily from a recent
publication I co-authored with Sarah Holden of the Investment Company
Institute, ``401(k) Plan Asset Allocation, Account Balances, and Loan
Activity in 2000,'' EBRI Issue Brief, November 2001.
---------------------------------------------------------------------------
\1\ Portions of this testimony borrow heavily from Sarah Holden and
Jack VanDerhei, ``401(k) Plan Asset Allocation, Account Balances, and
Loan Activity in 2000,'' EBRI Issue Brief n. 239, November 2001.
---------------------------------------------------------------------------
2 Defined Benefit/Defined Contribution Trends
More than a quarter-century ago, Congress enacted the landmark law
that still governs employment-based retirement plans in the United
States. The Employee Retirement Income Security Act of 1974 (ERISA),
after more than two decades of amendments and regulatory
embellishments, remains the basis of the Federal Government's approach
to retirement plan regulation. Widely praised for achieving its goal of
greater retirement security for those American workers who have
pensions, it is simultaneously criticized for contributing to the
demise of the traditional defined benefit corporate pensions that it
was created to secure and encourage. The number of these traditional
pension plans has sharply declined, while new forms of defined benefit
plans have increased their position of dominance.\2\ These new plans
include cash balance plans,\3\ which are technically defined benefit
plans but are often more readily understood by employees as a result of
their use of ``individual accounts'' and ``lump-sum distributions,''
and defined contribution plans, which are typified by the 401(k).
---------------------------------------------------------------------------
\2\ ``The Future of Private Retirement Plans,'' Dallas Salisbury,
ed. EBRI Education and Research Fund (Employee Benefit Research
Institute, 2000)
\3\ See Jack VanDerhei, ``The Controversy of Traditional vs. Cash
Balance Plans.'' ACA Journal, Vol. 8, no. 4 (Fourth Quarter 1999): 7-
16.
---------------------------------------------------------------------------
The decline in traditional defined benefit plans has been well-
documented and is continuing.\4\ Several reasons for the decline of
defined benefit plans have been suggested: the change in the industrial
patterns of employment in America favoring the small service industry;
administrative costs of operating defined benefit plans, which have
been especially burdensome for small and medium-size plans; competition
from 401(k) salary deferral plans, which are easier for employees to
understand and which came along just as the cost and complexity of
defined benefit plans began to skyrocket; and tax policy that has
restricted funding of defined benefit plans.
---------------------------------------------------------------------------
\4\ For a detailed analysis of these trends from 1985 to 1993, see
Kelly Olsen and Jack VanDerhei, ``Defined Contribution Plan Dominance
Grows Across Sectors and Employer Sizes, While Mega Defined Benefit
Plans Remain Strong: Where We Are and Where We Are Going,'' EBRI
Special Report SR-33 and EBRI Issue Brief no. 190 (Employee Benefit
Research Institute, October 1997).
---------------------------------------------------------------------------
2.1 The Relative growth of Defined Contribution Plans From 1978 to
1997 \5\
In 1978, the first year detailed data were collected after ERISA,
there was a total of 442,998 private pension plans, 29 percent of which
were of the defined benefit variety. By 1997, the most recent year for
which detailed data are available, the number of plans had increased to
720,041 but the relative share of defined benefit plans had decreased
to 8 percent. Even though defined benefit plans have always been in the
minority, they tend to be sponsored by large employers and accounted
for 65 percent of the 44.7 million active participants in 1978. The
number of active participants increased to 70.7 million in 1997, but
the relative share of defined benefit plans fell to 32 percent.
---------------------------------------------------------------------------
\5\ U.S. Department of Labor, Pension and Welfare Benefits
Administration. ``Abstract of 1997 Form 5500 Annual Reports,'' Private
Pension Plan Bulletin No. 10 (Winter 2001).
---------------------------------------------------------------------------
A total of $377 billion of private pension assets existed in 1978.
This number grew to $3.55 billion in the following 20 years. Although
defined benefit plans represented 72 percent of the total in 1978, it
fell to only 49 percent in 1997. If the latest numbers are any
indication, it would appear that this financial trend will not reverse
any time soon. In 1978, net contributions (the difference between
contributions and benefits disbursed) amounted to $29.4 billion for all
private plans, and 68 percent of this was from defined benefit plans.
By 1997, net contributions had fallen to a negative $54.5 billion.
Although defined contribution plans contributed a positive $12.8
billion, defined benefit plans had a negative net contribution of $67.4
billion.\6\
---------------------------------------------------------------------------
\6\ The rate of return generated by these plans also needs to be
considered for a complete analysis of the relative financial cash flow.
---------------------------------------------------------------------------
2.2 The Increasing Importance Of Defined Contribution Plans For
Family Retirement Security
Although the preceding section documented the increasing importance
of defined contribution plans with respect to plan aggregate data, for
purposes of this testimony it may be even more important to consider
how the relative value of these plans has changed from the standpoint
of the family's retirement security. Craig Copeland and I \7\ analyzed
data from the Federal Reserve Board's triennial Survey of Consumer
Finances (SCF), which provides the most comprehensive data available on
the wealth of American households. We tracked information from the
1992, 1995, and 1998 (the most recent data currently available) surveys
and found the following:
---------------------------------------------------------------------------
\7\ Craig Copeland and Jack VanDerhei, ``Personal Account
Retirement Plans: An Analysis of the Survey of Consumer Finances,''
EBRI Issue Brief no. 223 (Employee Benefit Research Institute, July
2000).
The percentage of families with a pension plan who have
defined benefit coverage has decreased from 62.5 percent in 1992 to
43.1 percent in 1998, and the significance of 401(k)-type plans for
those families participating in a pension plan more than doubled, from
31.6 percent in 1992 to 64.3 percent in 1998.
The percentage of family heads eligible to participate in
a defined contribution plan who did so increased from 73.8 percent in
1995 to 77.3 percent in 1998. Of those families choosing not to
participate in a defined contribution plan, 40.3 percent were already
participating in a defined benefit plan.
Overall, ``personal account plans'' represented nearly
one-half (49.5 percent) of all the financial assets for those families
with a defined contribution plan account, IRA, or Keogh, in 1998. This
was a significant increase from 43.6 percent in 1992. The average total
account balance in personal account plans for families with a plan in
1998 was $78,417, an increase of 54 percent in real terms over the 1992
balance of $50,914 (expressed in 1998 dollars).
2.3 Size And Importance Of 401(K) Plans
Profit-sharing plans with cash or deferred arrangements (more
commonly referred to as 401(k) plans) grew in number from virtually no
plans in 1983 \8\ to 265,251 by 1997 (the most recent year for which
government data are currently available), accounting for 37% of
qualified private retirement plans, 48% of active employees, and 65% of
new contributions.\9\
---------------------------------------------------------------------------
\8\ Although cash or deferred arrangements have existed since the
1950's, the Revenue Act of 1978 enacted permanent provisions governing
them by adding Sec. 401(k) to the Internal Revenue Code. While this was
effective for plan years beginning after 1979, the proposed regulations
were not released until November 1981. See Jack VanDerhei and Kelly
Olsen, ``Section 401(k) Plans (Cash or Deferred Arrangements) and
Thrift Plans,'' Handbook of Employee Benefits, 5th Ed., Jerry S.
Rosenbloom, ed. (Homewood, IL: Dow Jones-Irwin, 2001).
\9\ U.S. Department of Labor, Pension and Welfare Benefits
Administration. ``Abstract of 1997 Form 5500 Annual Reports,'' Private
Pension Plan Bulletin No. 10 (Winter 2001). For a review of the
academic literature analyzing these trends, see William Gale, Leslie
Papke, and Jack VanDerhei, ``Understanding the Shift Toward Defined
Contribution Plans,'' in A Framework For Evaluating Pension Reform
(Brookings Institution/TIAA-CREF/Stanford University), forthcoming.
(www.brook.edu/es/erisa/99papers/erisa2.pdf)
---------------------------------------------------------------------------
As of 1997, the most recent year for which published government
data are currently available, there were 265,251 401(k)-type plans with
34 million active participants holding $1.26 trillion in assets.
Contributions for that year amounted to $115 billion, and $93 billion
in benefits were distributed.\10\ By year-end 2000, it was estimated
that approximately 42 million American workers held 401(k) plan
accounts, with a total of $1.8 trillion in assets.\11\
---------------------------------------------------------------------------
\10\ U.S. Department of Labor, Pension and Welfare Benefits
Administration, ``Abstract of 1997 Form 5500 Annual Reports,'' Private
Pension Plan Bulletin No. 10 (Winter 2001).
\11\ Holden and VanDerhei (November, 2001), p. 3.
---------------------------------------------------------------------------
2.4 What Will The Future Hold?
While it is impossible to predict with certainty how future
developments for legislative and regulatory constraints and
opportunities as well as plan sponsor and participant decisions will
translate into future defined benefit/defined contribution trends,
Craig Copeland of EBRI and I modeled the likely financial consequences
of continuing the status quo. Our preliminary findings \12\ from the
EBRI/ERF Retirement Income Projection Model were presented at the
National Academy of Social Insurance 13th Annual Conference on The
Future of Social Insurance: Incremental Action or Fundamental Reform?
---------------------------------------------------------------------------
\12\ The results were generated prior to the contribution
modifications enacted as part of ``The Economic Growth and Tax Relief
Reconciliation Act of 2001'' (EGTRRA). The model is currently being
modified to allow for the new EGTRRA provisions.
---------------------------------------------------------------------------
Results of the model are compared by gender for cohorts born
between 1936 and 1964 in order to estimate the percentage of retirees'
retirement wealth that will be derived from DB plans versus DC plans
and IRAs over the next three decades. Under the model's baseline
assumptions, both males and females are found to have an appreciable
drop in the percentage of private retirement income that is
attributable to defined benefit plans (other than cash balance plans).
In addition, results show a clear increase in the income retirees will
receive that will have to be managed by the retiree. This makes the
risk of longevity more central to retirees' expenditure decisions.
3 Background on Company Stock
Although the topic of company stock investment in 401(k) plans has
recently been the focus of considerable interest, the concept of
preferred status for employee ownership has been part of the U.S. tax
code for more than 80 years.\13\ When the ERISA was passed in 1974, it
required fiduciaries to diversify plan investments for defined benefit
plans and some types of defined contribution plans. However, ERISA
includes an exception for ``eligible individual account plans'' that
invest in ``qualifying employer securities.'' \14\ An Employee Stock
Ownership Plan (ESOP) normally qualifies for this exception, as do
profit-sharing plans.\15\
---------------------------------------------------------------------------
\13\ The first stock bonus plans were granted tax-exempt status
under the Revenue Act of 1921. See Robert W. Smiley, Jr. and Gregory K.
Brown, ``Employee Stock Ownership Plans (ESOPs),'' Handbook of Employee
Benefits. 5th Ed., Jerry S. Rosenbloom, ed. (Homewood, IL: Dow Jones-
Irwin, 2001).
\14\ ERISA Sec. 407(b)(1).
\15\ This is important because an ESOP is to be ``primarily
invested'' in qualifying employer securities. See ``Employee Stock
Ownership Plans (Part II),'' Journal of Pension Planning and Compliance
(Winter 2000); John L. Utz; pages 1-34.
---------------------------------------------------------------------------
The concept of legislating diversification for qualified retirement
plan investments in company stock was first applied to ESOPs via a
provision enacted as part of the Tax Reform Act of 1986.\16\ Employees
who are at least age 55 and who have completed at least 10 years of
participation must be given the opportunity to diversify their
investments by transferring from the employer stock fund to one or more
of three other investment funds.\17\ The right to diversify need be
granted only for a 90-day window period following the close of the plan
year in which the employee first becomes eligible to diversify and
following the close of each of the next five plan years. This right is
limited to shares acquired after 1986 \18\ and is further limited to
25% of such shares until the last window period, when up to 50% of such
shares may be eligible for diversification.
---------------------------------------------------------------------------
\16\ It should be noted that less than 5% of all ESOPs are in
public companies. For an explanation of the challenges that stricter
diversification rules may present to private company ESOPs, see Corey
Rosen, ``Should ESOPs Be Subject to Stricter Diversification Rules?''
(www.nceo.org/library/boxer--corzine--bill.html)
\17\ Alternatively, amounts subject to the right of diversification
may be distributed from the plan. See Everett T. Allen, Jr., Joseph J.
Melone, Jerry S. Rosenbloom and Jack L. VanDerhei, Pension Planning:
Pensions, Profit Sharing, and Other Deferred Compensation Plans (8th
Ed.) (Homewood, IL: Richard D. Irwin, Inc., 1997).
\18\ As a result, the impact of this change was de minimis during
the significant market decline in the fall of 1997. See Jack VanDerhei,
``The Impact of the October 1987 Stock Market Decline on Pension
Plans,'' written testimony for U.S. House of Representatives, Committee
on Ways and Means, Subcommittee on Oversight, July 1988.
---------------------------------------------------------------------------
The Taxpayer Relief Act of 1997 applied a limit on mandatory
investment of 401(k) contributions in employer stock. This was a more
modest version of a proposal by Sen. Barbara Boxer (D-CA) to impose a
separate limitation of 10% of plan assets on the mandatory investment
of 401(k) contributions in qualifying employer stock and real
property.\19\
---------------------------------------------------------------------------
\19\ The final version exempts from the 10% limits: (1) de minimis
(i.e., as much as 1% of pay) mandatory investment provisions, (2) plan
designs under which the Sec. 401(k) deferrals (regardless of amount)
are part of an ESOP, and (3) plans in which the total assets of all
defined contribution plans of the employer are not more than 10% of the
total defined benefit and defined contribution plan assets of the
employer. The limit applies prospectively with respect to acquisitions
of employer stock. The investment of matching or other employer
contributions continues to be exempt from any limits. See Louis T.
Mazawey, ``1997 Tax Law Changes Affecting Retirement Plans,'' Journal
of Pension Planning and Compliance (Winter 1998): 72-86. For more
detail on the original proposal, see Ann L. Combs, ``Taking Stock of
the Boxer Bill,'' Financial Executive (Jan./Feb. 1997): 18-20.
---------------------------------------------------------------------------
The Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA) expanded the dividend deduction for ESOPs to include dividends
paid on qualifying employer securities held by an ESOP that, at the
election of participants or beneficiaries, are: (1) payable directly in
cash; (2) paid to the plan and distributed in cash no later than 90
days after the close of the plan year in which the dividends are paid
to the plan; or (3) paid to the plan and reinvested in qualifying
employer securities.\20\ A 401(k) plan with a company stock fund that
regularly pays dividends may consider designating a portion of the plan
that includes the company stock fund to be an ESOP in order to take
advantage of this deduction.\21\
---------------------------------------------------------------------------
\20\ Hewitt, Special Report to Clients, July 2001, ``Impact of
EGTRRA on Employer Plans.'' (www.hewitt.com/hewitt/resource/wsr/2001/
egtrra.pdf)
\21\ Watson Wyatt Worldwide, ``Retirement Plan Provisions: What,
When and How Much?'' (Washington, DC: Watson Wyatt Worldwide, 2001).
---------------------------------------------------------------------------
At Enron, 57.73% of 401(k) plan assets were invested in company
stock, which fell in value by 98.8% during 2001.\22\ The decrease in
share price and eventual bankruptcy filing of Enron resulted in huge
financial losses for many of its 401(k) participants. This has prompted
several lawsuits as well as congressional and agency investigations
into the relative benefits and limitations of the current practice. In
addition, the practice of imposing ``blackout'' periods when the 401(k)
sponsor changes administrators has recently been called into question
in light of the Enron situation.\23\
---------------------------------------------------------------------------
\22\ ``Enron Debacle Will Force Clean Up of Company Stock Use in DC
Plans,'' IOMA's DC Plan Investing, Dec. 11, 2001, p. 1.
\23\ Currently, there is no statutory or regulatory limit on the
length of time during which participants can be blocked from
reallocating assets or conducting other transactions in a 401(k) plan.
See Patrick J. Purcell, ``The Enron Bankruptcy and Employer Stock in
Retirement Plans,'' CRS Report for Congress (Jan. 22, 2002): 5.
---------------------------------------------------------------------------
Certainly, the Enron situation has caused the retirement income
policy community to focus increased attention to the desirability of
current law and practices regarding company stock in 401(k) plans,
resulting in much debate. Presumably, any recommendations to modify
current pension law would attempt to strike a balance between
protecting employees and not deterring employers from offering employer
matches to 401(k) plans. Some have argued that if Congress were to
regulate 401(k) plans too heavily, plan sponsors might choose to
decrease employer contributions or not offer them at all. Previous
research \24\ has shown that the availability and level of a company
match is a primary impetus for at least some employees to make
contributions to their 401(k) account. Others have argued that
individuals should have the right to invest their money as they see
fit.
---------------------------------------------------------------------------
\24\ Jack VanDerhei and Craig Copeland, ``A Behavioral Model for
Predicting Employee Contributions to 401(k) Plans,'' North American
Actuarial Journal (First Quarter, 2001).
---------------------------------------------------------------------------
4 The Concentration of Company Stock In 401(k) Plans
4.1 Percentage of 401(K) Plans and Participants With Company Stock
In Figure 1 of my February 13, 2002, hearing testimony before the
House Education and Workforce Committee's Subcommittee on Employer-
Employee Relations,\25\ I show that for the 1996 version \26\ of the
EBRI/ICI database, only 2.9% of the 401(k) plans included company stock
(1.4% of the plans had company stock but no guaranteed investment
contracts (GICs) \27\ while 1.5% of the plans had both company stock
and GICs). However, the plans that do have company stock are generally
quite large and represented 42% of the 401(k) participants in the
database that year (17% of the participants had company stock but no
GICS, while 25% had both options).\28\ In terms of account balances,
plans with company stock account for 59% of the universe (23% of the
assets were held in plans that had company stock but no GICS, while 36%
of the assets were held in plans that had both options).\29\ The fact
that plans with company stock had higher average account balances was
no doubt partially due to the bull market preceding this time period,
but may also be a function of the plan's generosity parameters and
average tenure of the employees.
---------------------------------------------------------------------------
\25\ See Jack L. VanDerhei, ``The Role of Company Stock in 401(k)
Plans,'' hearing testimony before the House Education and Workforce
Committee Subcommittee on Employer-Employee Relations, ``Enron and
Beyond: Enhancing Worker Retirement Security,'' Feb. 13, 2002.
\26\ Readers should be cautioned that while the EBRI/ICI database
appears to be very representative of the estimated universe of 401(k)
plans, there has currently been no attempt to develop extrapolation
weights to match up these plans with those reported on the Form 5500.
See Holden and VanDerhei (November 2001), p. 6 for more detail.
\27\ Guaranteed investment contracts (GICs) are insurance company
products that guarantee a specific rate of return on the invested
capital over the life of the contract.
\28\ See figure 2 of VanDerhei, ``The Role of Company Stock in
401(k) Plans.''
\29\ Ibid. See Figure 3.
---------------------------------------------------------------------------
4.2 Company Stock as a Percentage of Total 401(K) Balances
The overall percentage of 401(k) account balances in company stock
has remained consistently in the 18-19% range from 1996 to 2000.\30\
The age distribution for year-end 2000 is somewhat of an inverted ``U''
shape, with younger and older participants holding slightly less than
participants in their 40s (where the value peaks at 19.7%).\31\
---------------------------------------------------------------------------
\30\ Ibid. See Figure 4.
\31\ Ibid. See Figure 5.
---------------------------------------------------------------------------
Although often quoted, this figure is somewhat misleading given
that a sizeable percentage of the 401(k) participants are in small
plans that do not generally include company stock in the investment
menu. The average asset allocation in company stock is: \32\
---------------------------------------------------------------------------
\32\ Ibid. See Figure 6.
ess than 1% for plans with fewer than 500 participants,
3.8% for plans with 501-1,000 participants,
8.7% for plans with 1,001-5000 participants, and
25.6% for plans with more than 5,000 participants.
When only plans that include company stock are analyzed, plans that
offer company stock but not GICs have an average of 31.8% of the
account balances invested in company stock, while the figure decreases
to 27.7% for plans that also include GICs. Once the influence of the
investment menu is controlled for, the impact of plan size is less
significant.\33\
---------------------------------------------------------------------------
\33\ Ibid. See the bottom two panels in Figure 6.
---------------------------------------------------------------------------
I also illustrate the impact of salary on company stock allocation
for the subset of the EBRI/ICI database for which we have the requisite
information.\34\ For plans both with and without GICs, there appears to
be an inverse relationship between the level of salary and the
percentage of 401(k) balance invested in GICs, although the
relationship is much less significant in the former case. The extent to
which this is due to non-participant-directed matching contributions
making up a larger percentage of annual contributions for lower-paid
individuals awaits further investigation.\35\
---------------------------------------------------------------------------
\34\ Ibid. See the bottom two panels in Figure 7.
\35\ For recent EBRI/ICI research on the contribution activity of
401(k) plan participants, see Sarah Holden and Jack VanDerhei,
``Contribution Behavior of 401(k) Plan Participants,'' EBRI Issue Brief
n. 238, October 2001.
---------------------------------------------------------------------------
4.3 Distribution of Company Stock Allocations
Several legislative proposals have called for an absolute upper
limit on the percentage of company stock that an employee will be
allowed to hold in his or her 401(k) account. Figure 8 of my February
13th testimony provides the year-end 2000 company stock allocation for
the EBRI/ICI universe of plans offering company stock. A total of 48%
of the 401(k) participants under age 40 in these plans have more than
20% of their account balances invested in company stock. The percentage
decreases to 47% for participants in their 40s, 45% for those in their
50s and drops to 41% for participants in their 60s.
5 Employee Reaction When Employers Mandate That Matching Contributions
Be Invested in Company Stock
Typically, in a 401(k) plan, an employee contributes a portion of
his or her salary to a plan account and determines how the assets in
the account are invested, choosing among investment options made
available by the plan sponsor (employer). In many plans, the employer
also makes a contribution to the participant's account, generally
matching a portion of the employee's contribution. Some employers
require that the employer contribution be invested in company stock
rather than as directed by the participant.\36\ Participants in these
plans tend to invest a higher percentage of their self-directed
balances in company stock than participants in plans without an
employer-directed contribution. Company stock represents 33% of the
participant-directed account balances in plans with employer-directed
contributions,\37\ compared with 22% of account balances in plans
offering company stock as an investment option but not requiring that
employer contributions be invested in company stock.\38\
---------------------------------------------------------------------------
\36\ Source of contribution (employer versus employee) can be
matched to fund information for a subset of the data providers in our
sample. Of those plans in the 2000 EBRI/ICI database for which the
appropriate data are available, less than 0.5% require employer
contributions to be invested in company stock. However, most of the
plans with this feature are large, covering 6% of participants and 10%
of plan assets in the subset.
\37\ For this group, the participant-directed portion of the
account balances represents 65% of the total account balances.
\38\ See figure 9 of VanDerhei, ``The Role of Company Stock in
401(k) Plans.''
---------------------------------------------------------------------------
When total account balances are considered, the overall exposure to
equity securities through company stock and pooled investments is
significantly higher for participants in plans with employer-directed
contributions. For example, investments in company stock, equity funds,
and the equity portion of balanced funds represent 82% of the total
account balances for participants in plans with employer-directed
contributions, compared with 74% of the total account balances for
participants in plans without employer-directed contributions. This
higher allocation to equity securities holds across all age groups.
6 What Would Happen to Employees If Company Stock Were Not Permitted
in 401(K) Plans?
Well before the plight of Enron 401(k) participants had made the
headlines, personal finance and investment advisors had long touted the
benefits of diversification.\39\ While the trade-off of a diversified
portfolio of equities for an individual stock may be of limited
advantage for employees, what many of the commentators in this field
have disregarded is the potentially beneficial attendant shift in asset
allocation resulting from the inclusion and/or mandate of company
stock, especially for young employees, who otherwise exhibit extremely
risk-averse behavior in the determination of equity concentration for
their 401(k) portfolio.
---------------------------------------------------------------------------
\39\ See Scott Burns, ``Examining Your Gift Horse,'' Dallas Morning
News, April 17, 2001, for an excellent example of the tradeoff of risk
between the S&P 500 Index and an individual stock.
---------------------------------------------------------------------------
What I will attempt to demonstrate in the following section is that
although forcing the employer match into company stock obviously
increases the standard deviation of expected results relative to a
diversified equity portfolio, for each of the last five years the EBRI/
ICI data base has demonstrated that, left to their own choices, the
employee's asset allocation would have lower concentrations in equity
(defined as diversified equity plus company stock plus 60% in balanced
funds) and therefore have a lower expected rate of return.
In my February 13th testimony, I start with some stylized examples
of how the inclusion of company stock may work to the benefit of
employees in general and expand the analysis by simulating the expected
change in 401(k) account balances if company stock were prospectively
eliminated from 401(k) plans for birth cohorts from 1936-1970. These
results may be useful in analyzing previous charges that company stock
should not be used in tax-subsidized accounts. In an attempt to assess
the first-order impact of eliminating company stock in 401(k) plans, I
programmed a new subroutine to the EBRI/ERF Retirement Income
Projection Model to simulate the financial impact on 401(k) account
balance.\40\
---------------------------------------------------------------------------
\40\ See VanDerhei, ``The Role of Company Stock in 401(k) Plans''
for details of the simulation.
---------------------------------------------------------------------------
6.1 Simulation Results
The simulation was performed for birth cohorts between 1936 and
1970, and the results indicate the overall gain or loss from
(prospective) retention of company stock in 401(k) plans (as opposed to
company stock being entirely eliminated immediately). The estimated
gain of retaining company stock is 4.0% of 401(k) balances, assuming
complete independence with respect to the probability of company stock
in a subsequent plan and 7.8% assuming perfect correlation.
Figure 1 (below) provides the results of the simulation by gender
and preretirement income, assuming complete independence.\41\
Preretirement income was categorized as either high or low by
simulating the income in the year prior to retirement and comparing it
with the median income for participants in the same birth cohort. Males
would gain more than females from retention of company stock for both
levels of relative salary. Participants in the lower relative salary
levels would stand to gain more than their higher paid counterparts for
both genders.
---------------------------------------------------------------------------
\41\ Ibid. The distributional results for this population are shown
in Figure 14.
Figure 1
Average Gain From Retention of Company Stock as a Percentage of 401(k) Balance, By Gender and Relative Pre-
retirement Salary (Assuming Complete Independence)
----------------------------------------------------------------------------------------------------------------
Gender
Preretirement salary relative to median for age -------------------------------------------------------------
cohort Male Female
----------------------------------------------------------------------------------------------------------------
Low 5.2% 3.5%
High 5.0% 1.6%
----------------------------------------------------------------------------------------------------------------
Source: Simulations using the EBRI/ERF Retirement Income Projection Model with modifications as described in
author's February 13, 2002, written testimony to the House Education and Workforce Committee's Subcommittee on
Employer-Employee Relations.
7 What Would Happen If a Minimum Rate of Return Were Guaranteed for
401(k) Participants?
Proposals have been suggested recently that would attempt to
transfer part or all of the investment risk inherent in defined
contribution plans from the employee to another entity. Although the
party initially exposed to said risk varies among the proposals, the
likely targets would be the employer, a government agency (perhaps the
Pension Benefit Guaranty Corporation) and/or a private insurance
company. While the cost of the guarantees and/or financial uncertainty
inherent in such an arrangement may be borne by the employer at least
initially, it is unlikely that, in the long-term, such a shift in risk-
bearing would not somehow alter the provisions of the existing defined
contribution plans.
It is obviously impossible to model the financial consequences of
such proposals until additional detail is provided; however, a highly
stylized example of one method of achieving this objective can be
readily simulated. Assume a proposal that would require the employer to
ensure that participants receive an account balance no less than what
would have been obtained under a minimum rate of return. While some
employers may choose to voluntarily assume the additional cost of this
arrangement, others may wish to re-think the investment options
provided to the employees and provide little or no participant
direction. In fact, an easy way of mitigating the new risk imposed by
the minimum guarantee would be to force all contributions (whether
contributed by the employee or the employer) into a relatively risk-
free investment. While this is unlikely to be popular with young
employees and other participants desiring high long-term expected
returns, it would minimize the new risks shifted to the employer.
Figure 2 shows the expected results of running one such proposal
through the EBRI/ERF Retirement Income Projection Model. Instead of
allowing employees to direct their own contributions and perhaps those
of the employer, assume employers are forced to guarantee a minimum
rate of return of five percent nominal and they are able to find a GIC
(or its synthetic equivalent) that will provide that return in
perpetuity.\42\ If all existing balances and future 401(k)
contributions were required to be invested in this single investment
option, the average expected reduction in 401(k) account balances at
retirement would decrease between 25 and 35 percent for participants
born between 1956 and 1970.\43\
---------------------------------------------------------------------------
\42\ The computations assume a long-term average return of 11% for
both a diversified portfolio and an individual stock but a standard
deviation of 19.6% for the former compared to 65% for the latter. I
have arbitrarily assumed all nonequity investments earn an annual rate
of return of 6%.
\43\ This portion of the model does not currently provide
simulations for cohorts born after 1970.
---------------------------------------------------------------------------
While the results in Figure 2 are specific to the assumptions
mentioned above, similar results are obtained (albeit with different
percentage losses) under various combinations of minimum guarantees and
assumed asset allocations and rates of return.
[GRAPHIC] [TIFF OMITTED] T0332B.002
Source: Simulations using the EBRI/ERF Retirement Income Projection
Model with modifications as described in author's February 13, 2002
written testimony to the House Education and Workforce Committee's
Subcommittee on Employer-Employee Relations.
Chairman THOMAS. Thank you, Doctor.
Mr. Schieber.
STATEMENT OF SYLVESTER J. SCHIEBER, VICE PRESIDENT, RESEARCH
AND INFORMATION, WATSON WYATT WORLDWIDE
Mr. SCHIEBER Mr. Chairman, Members of the----
Chairman THOMAS. You need to turn your microphone on, and
then it is very unidirectional.
Mr. SCHIEBER Sorry. Mr. Chairman, Members of the Committee,
thank you----
Chairman THOMAS. You need to pull the mike down and speak
directly into it. It is very unidirectional.
Mr. SCHIEBER Thank you very much for the opportunity to
testify here today. The comments I am giving are my own. Recent
developments have raised concerns about the operation of
employer-sponsored defined contribution plans suggesting the
need for additional regulation. I begin my testimony with a
caution against doing anything that jeopardizes the extremely
robust and resilient element of our retirement system.
I believe that ERISA has done much to improve the
retirement prospects of millions of workers in this country.
But I also believe that the over-regulation of pensions during
the 1980s and the early 1990s led to fewer pensions and drastic
changes in the sorts of plans that were offered. In my prepared
testimony, I cite research that supports this conclusion. On
balance, regulation is important, but over-regulation is
potentially counterproductive.
Public accounts of Enron employees losing their retirement
savings as their employer plunged into bankruptcy last year
have raised concerns about 401(k) plans generally. Remarkably
less has been said about what happened to the defined benefit
savings of workers in this same case.
One of the concerns arising from recent developments is
that employers are forcing employees to hold employer stock in
their 401(k) accounts, subjecting them to excessive risk. There
are two issues here. First is the extent to which workers are
forced to hold company stock. Second is the extent to which
workers' retirement security is at risk because of insufficient
diversification.
Most of the company stock that Enron employees held in
their 401(k) plan was there at employee discretion. Ignoring
for the moment the trading blackout period, these workers were
not precluded from selling most of their employer stock. There
may be three potential explanations for why Enron employees did
hold so much of their 401(k) balance in the company stock. One
is that they here misled about the potential performance of the
stock. Second is that they did not understand the risks
associated with investing in a single company's stock. Third is
that they knew there were downside risks from holding so much
in Enron stock, but perceived the upside potential outweighed
the cost of taking the risk.
To the extent that workers are duped into buying a
particular company's stock by the senior management of a
company, there are already SEC rules on what corporate managers
can tell any potential investors in their stock. If these rules
are being violated or were violated in this case, the senior
managers who violate them should be prosecuted to the maximum
extent possible.
If the problem with 401(k) plans is that employees do not
appreciate the risks that they take on in investing heavily in
their employer's stock, it can be addressed in one of two ways.
One is more education. The other is imposing limits on the
employer stock that workers can hold in their 401(k) accounts.
While the latter approach might be more effective from the
perspective of an enlightened regulator, I would caution that
what seems enlightened here in Washington sometimes seems less
so outside the Beltway.
This leaves a question of whether we should restrict
employees who understand their employer's financial prospects
and understand the risks associated with investing in a single
stock from investing most or all of their 401(k) balances in
their employer's equities. Keep in mind that workers feel
strongly that the assets in their retirement accounts are
theirs. Next to the basic freedoms we enjoy in this country,
property rights are something we guard with tremendous fervor.
For ever business failure where employees have lost most of
their funds from investing in their employer's stock, there are
many other examples of employees in other companies who have
done well voluntarily investing in this way. Prohibiting
workers from investing their retirement money in the assets
they wish to invest in will likely create a public outcry that
policymakers ought to seriously consider before they adopt
restrictive regulations in this area.
As we move toward legislative change, I urge caution. I
applaud the prior efforts of Representatives Portman and
Cardin, Earl Pomeroy, and others on this Committee who have
been very mindful about trying to adopt rules or modify rules
to expand the system.
Given the track record of plan growth, worker
participation, and overall saving in 401(k) plans, we should
attempt to solve existing problems without creating new ones.
As a matter of public policy, I believe that the absolute
restrictions on the amount of employer stock a worker can hold
in his or her retirement savings account will cause a strong
adverse reaction on the part of plan sponsors and participants
and is not warranted.
I am sympathetic to the argument that workers' vested
benefits in their retirement plan are an economic asset
intended to secure their retirement needs. As such, the ability
for anyone to dictate that such assets be invested in a
particular way should be limited.
Given the growing dependence of American workers on the
401(k) plans, any effort to provide more information about
appropriate investment behavior should be favorably considered.
Keep in mind, however, that many plans are offered by small
employers or in highly competitive environments where budgets
are limited. We do not want to relearn the lessons of the 1980s
that too much regulation leads to fewer plans rather than more
security in the plans that already exist.
Finally, any provisions that seek to provide guaranteed
returns in these plans should be viewed with a wary eye. I
cannot think of any single policy change that would have the
potential to so radically alter the landscape of our retirement
system in an adverse way. If this guarantee is going to be
foisted on employers, policymakers should expect to see a
significant exodus of sponsors from offering plans. If the
Federal Government is going to establish and run such a
program, policymakers should have a full understanding of the
costs involved in it and who is going to be assessed these
costs. And I warn you, if it is the workers who are going to be
assessed these costs, you are going to have a public outcry
over these plans that you haven't seen since discussions about
tax reform back in the mid-1980s. Thank you very much.
[The prepared statement of Mr. Schieber follows:]
Statement of Sylvester J. Schieber *, Vice President, Research and
Information, Watson Wyatt Worldwide
---------------------------------------------------------------------------
* The opinions and conclusions stated here are the author's and
should not be construed to be those of Watson Wyatt Worldwide or any of
its other associates.
---------------------------------------------------------------------------
Mr. Chairman and members of the Committee on Ways and Means, I am
Sylvester J. Schieber, Vice President of Research and Information at
Watson Wyatt Worldwide. I am testifying today on issues regarding
Retirement Security and Defined Contribution Plans. My comments are my
own and do not reflect those of Watson Wyatt Worldwide, or any of its
other associates.
I have spent more than 30 years studying the retirement systems in
the United States and elsewhere around the world. I understand why
there are concerns today about the retirement security system in this
country and specifically about the operation of employer-sponsored
defined contribution plans given recent developments. But I would like
to begin by cautioning the members of this Committee and other members
of Congress against doing anything that jeopardizes an extremely robust
and resilient element of our retirement system.
I firmly believe in the importance of public policy in regulation
of employer sponsored retirement plans. I believe that the Employee
Retirement Income Security Act (ERISA) has done a great deal to improve
the retirement prospects of millions of workers in this country. But I
also believe there is strong evidence that the over regulation of
pensions during the 1980s and early 1990s led to the reduction in the
availability of pensions and to drastic changes in the sorts of plans
that have been offered to workers. In other words, I believe regulation
is important but that over regulation is potentially counterproductive.
Today, many people are concerned about the risks associated with
defined contribution plans and would saddle these plans with new sets
of requirements, restrictions, and expenses in order to ameliorate such
risks. A significant problem, however, is that the reduction of current
risks in these plans has the potential to create another set of risks
for them and their participants. In highlighting the recent concerns
about defined contribution plans, much has been said about these plans
and others that is very misleading and has the potential to result in
the development of bad public policies. I am concerned that such
policies might lead to the curtailment of plans in the short term with
a long-term result that few would consider appropriate or desirable.
Prior Evidence on the Importance of Regulation
Nearly 10 years ago, Professor John Shoven of Stanford University
and I presented a paper at a policy conference here in Washington, DC,
that analyzed the implications of pension funding restrictions that had
been imposed on private sector employers during the 1980s and 1990s.\1\
Our analysis concluded that these policies had significantly delayed
the funding of pension obligations for the baby boom generation of
workers and would ultimately result in much higher costs to employers
than if prior rules had been left in place. We suggested the
implications of these policies were likely to be adverse to the pension
prospects of baby boomers. At the conference when we first presented
our paper, a policy analyst from the Department of Labor suggested the
implication of our analysis was simply that employers would have to
contribute more to their pension plans late in the baby boomers'
careers than under prior funding regulations. We observed that there
was an alternative prospect that employers might simply curtail their
defined benefit plans as the delayed liabilities came due. I believe
that there is strong evidence over the past decade that our concerns
about the potential curtailment of private defined benefit plans were
well founded. I am convinced that public policy has played a major role
in what has transpired.
---------------------------------------------------------------------------
\1\ This paper was first presented at a conference during September
1993 and was subsequently published in Sylvester J. Schieber and John
B. Shoven, ``The Consequences of Population Aging on Private Pension
Fund Saving and Asset Markets,'' in Sylvester J. Schieber and John B.
Shoven. eds., Public Policy Toward Pensions (Cambridge, MA: The MIT
Press, 1997), pp. 279-246.
---------------------------------------------------------------------------
In a subsequent policy paper that Professor Robert Clark of North
Carolina State University, a colleague of mine at Watson Wyatt
Worldwide, Janemarie Mulvey, and I wrote, we analyzed the effects of
pension nondiscrimination rules on private sector pension
participation.\2\ In an effort to prevent plan sponsors from targeting
tax benefits accorded pensions to high-wage employees, Congress
established nondiscrimination standards that require employers to
include a wide range of workers in pension plans in order for these
plans to achieve tax-qualified status. In addition, regulations have
been introduced to limit maximum benefits to high-income workers and to
restrict the integration of pension benefits with Social Security. The
objective of these nondiscrimination rules has been to increase the
participation rate of low-wage workers while limiting the loss in tax
revenues associated with benefits to highly paid employees.
---------------------------------------------------------------------------
\2\ Robert L. Clark, Janemarie Mulvey, and Sylvester J. Schieber,
``The Effects of Pension Nondiscrimination Rules on Private Sector
Pension Participation,'' in William Gale, John Shoven, and Mark
Warshawshky, eds., Public Policies and Private Pensions (Washington,
DC: The Brookings Institution, 2002 forthcoming). Until released in its
published form this paper may be found at: http://www.watsonwyatt.com/
progress__files/whitepapers/wp-05.pdf.
---------------------------------------------------------------------------
In our analysis, we examined changes in pension coverage rates
between 1979 and 1998 to determine if the absolute and relative
participation of low-wage workers increased following the
implementation of new, more restrictive nondiscrimination standards
adopted during the 1980s. In our analyses, we found no support for the
hypothesis that more restrictive discrimination rules forced or enticed
employers to provide pensions to low-paid workers. Participation rates
for low earners simply did not rise in absolute terms or relative to
the participation rates of high-wage workers following the
implementation of new standards.
These new nondiscrimination standards along with other pension
regulations have increased the cost of providing pensions. We showed in
our analysis that in many cases, the administrative costs associated
with government regulation of employer-sponsored plans can exceed the
tax advantage of pension saving for workers at lower pay levels
especially in smaller plans. As a result, it is not surprising that
many small employers terminated defined benefit plans over the past two
decades. This indirect effect of these regulations is one of the
reasons that participation rates of low-income workers have remained
relatively low.
Administrative costs are a disincentive for employers to provide
pension coverage to low-income workers. Yet, most of the legislative
efforts aimed at increasing participation have actually increased the
regulatory burden to employers and thus their overall administrative
costs. In reality, these regulations have done little to increase
participation among low-wage workers over the past twenty years.
Workers at low and middle earnings levels actually experienced small
declines in pension participation following the adoption of these
regulations. If Congress wants to expand participation for low-income
workers it should look for ways to reduce, rather than increase, the
regulatory burdens on employers.
Recent Developments and the Need for New Regulation
A renewed awareness of the fragility of our retirement system has
arisen from a number of public accounts of Enron employees losing their
retirement savings as their employer plunged into bankruptcy late last
year. Remarkably less has been said about what happened to their
defined benefit savings. A widely published problem in this case was
that many Enron employees had invested most, if not all, of their
401(k) assets in Enron stock. To further complicate a bad situation, it
appears that the most senior managers in Enron encouraged workers to
buy Enron stock even after they became aware of the likelihood that the
company was in financial peril. This combination of problems was
further exacerbated by the fact that the participants in the Enron
401(k) plan had gone through a blackout period when they could not sell
the Enron stock in their plan during a period when the value of the
stock was plunging. This latter situation arose because of a shift from
one plan administrator to another. And finally, to add insult to
injury, the senior managers in Enron are reported to have been selling
substantial blocks of Enron stock at exactly the same time the rank-
and-file employees were trapped in the blackout on selling the Enron
stock in their 401(k) accounts.
Out of this situation several proposals have evolved that would
limit the exposure that employers could impose on workers to employer
stock in their 401(k) plans. Other proposals would require certain
communication with workers. There have even been proposals that we
adopt some sort of benefit insurance covering defined contribution
plans that would be similar to the insurance protection provided to
participants in defined benefit plans through the Pension Benefit
Guaranty Corporation (PBGC). Before turning to an assessment of the
policy proposals, it is important to put some facts on the table
regarding the demise of the Enron 401(k) plan and the general situation
of 401(k) plans.
One of the concerns arising out of Enron is that employers are
forcing their employees to hold their stock in their 401(k) accounts
and thus putting them at excessive risk in terms of their retirement
security. The risk to retirement security comes partially from over
concentration in a single stock but is exacerbated by the correlation
with employment risks associated with employers that go bankrupt. In
other words, the employees at Enron faced double jeopardy as the
company went bankrupt--they not only lost much of their retirement
security they also lost the security of their existing jobs. There are
two issues here that are important. The first of these is the extent to
which workers are forced to hold company stock. The second is the
extent to which their retirement security is at risk because their
retirement portfolio is not sufficiently diversified in the assets
securing it.
While there may be a misperception about the case, the fact is that
most of the company stock that Enron employees held in their 401(k)
plan was there at the employees' discretion. Ignoring for the moment,
the blackout period, Enron workers in the plan were not precluded from
selling most of their employer's stock and buying some other financial
security. There may be three potential explanations for why the workers
in this case held so much Enron stock in their 401(k) portfolios. One
is that they had been misled about the potential performance of the
stock in the future relative to alternative investment options. Second
is that they did not appreciate the risks associated with investing in
a single company's stock. Third is that they knew there were downside
risks but perceived the upside potential outweighed the cost of taking
the risk of investing heavily in Enron.
To the extent that workers were duped into buying Enron stock
because senior management in the company was misleading them about the
prospects of the company's performance, there are already Securities
and Exchange Commission rules on what senior managers of publicly
traded corporations can tell any potential investors in their stock. If
these rules were violated, the senior managers who violated them should
be prosecuted to the maximum extent possible. If a thief on the street
who broke into Enron employees' or executives' homes is subject to
prosecution, mandatory sentences including three-strike rules, and
lengthy jail time, any thieves stealing from retirement plans should be
just as subject to the same potential punishment. While the SEC might
need to beef up accounting and disclosure rules, the best deterrent to
protect 401(k) plan participants from corporate managers who mislead
them about the prospects of their companies might be vigorous
enforcement of existing laws.
There is some likelihood that Enron employees and many other
employees around the country do not appreciate the risks they take on
in investing heavily in their employer's stock, especially in doing so
in their retirement plans. This problem can either be addressed by
providing more education for workers or by imposing limits on them in
terms of the extent to which they can buy their employers' stock
through their 401(k) plans. While the latter approach might be the more
effective one from the perspective of an enlightened regulator, I would
caution policymakers from rushing headlong into this approach. What
seems enlightened from the perspective of Washington, sometimes seems
less so outside the beltway.
This leaves us with a question of whether we should restrict
employees who are not misled about their employer's financial prospects
and who understand the risks associated with investing in a single
company's stock from investing most or all of their 401(k) assets in
that stock. I believe that one of the strongest aspects of the 401(k)
system in the United States is the sense of ownership that workers have
in the programs. Workers are adamant that the assets in their
retirement accounts are theirs. Next to the basic freedoms we enjoy in
this country, property rights are something that we guard with
tremendous fervor.
For every Enron where employees have lost most of their funds from
investing in their employer's stock, there are many other examples of
employees in other companies who have done very well over extended
periods of time by voluntarily investing in their employers' stock.
Prohibiting workers from investing their retirement money in the assets
they wish to invest in has the potential to create an adverse public
outcry that policymakers ought to seriously consider before they adopt
restrictive regulations in this area. You might recall that during the
debates over tax reform during the mid-1980s that both the Reagan
Administration and the Chairman of the Ways and Means Committee
entertained proposals to restrict 401(k) plans that were quickly
abandoned when workers voiced their displeasure en masse.
One of the problems that we face in devising limits that protect
401(k) participants is the highly variable set of circumstances under
which these plans are offered. In some cases, employers offer their
401(k) plan as a supplement to a relatively generous defined benefit
plan. In others, it is the only retirement saving vehicle the company
offers. If an employer has a defined benefit plan that in combination
with Social Security provides career workers with pension annuities
that allow them to maintain preretirement standards of living, what
risks to their retirement security do workers pose when they invest
their 401(k) assets in employer stock? Even in cases where workers are
predominantly dependent on their 401(k) savings for retirement, there
are tremendous differences in the risks associated with investing in
company stock at ages 25, 35, 45, or 55. How do you control for those
in setting rules limiting where workers can invest their retirement
assets?
Insuring Against Risk in Defined Contribution Plans
Going beyond simply limiting where employees can invest their
401(k) retirement funds, some policy analysts are now advocating that
we actually insure the investment performance in these plans. The
argument here is that the insurance guarantee provided to defined
benefit participants is the equivalent of a minimum investment return
guarantee. If the government is going to be the insurer of one sort of
plan, then why not the other. Indeed, cash balance plans are insured
under the PBGC and basically insures the implied rates of return on
these plans.\3\ There are several problems with this logic and the
proposals that flow out of it.
---------------------------------------------------------------------------
\3\ Regina T. Jefferson, ``Rethinking the Risk of Defined
Contribution Plans,'' Florida Tax Review (2000), vol. 4, no. 9.
---------------------------------------------------------------------------
First of all, the argument that insuring investment performance in
a defined contribution plan with participant-directed investment and
insuring benefits in a defined benefit plan are equivalent is far
fetched. The PBGC insures benefits only in cases of bankruptcy
resulting in the inability of a pension sponsor to pay promised
benefits under the plan. In cases where the insurance comes into play,
the PBGC has a claim against any residual assets in the sponsoring
company. This insurance is provided in conjunction with a stringent set
of funding requirements and variable premiums that seek to entice if
not force plan sponsors to keep asset levels in the plan at roughly the
level of liabilities that exist within them. Adverse experience in the
investment of the assets in these plans does not trigger an insurance
payment by the PBGC, it triggers added contributions on the part of
plan sponsors. Even in cash balance plans, the plan sponsor's failure
to realize rates of return on plan assets that are as high as the
credited rate of return on the notional accounts has to be made up with
added sponsor contributions.
In a defined contribution world, the provision of similar insurance
to that provided in the defined benefit world would conceivably put the
employer in the position of being the insurer of first resort. Most of
the employers who were motivated to shift from offering defined benefit
plans to offering defined contribution plans because of their
unwillingness to accept investment risks in retirement plan sponsorship
would likely quit offering plans. Those that continued to offer them
would likely move back toward a highly restricted set of investment
options in their plans. In the early days of 401(k) plans much of the
investment was in guaranteed investment contracts (GICs) or similar
instruments that paid relatively low fixed rates of return over the
long term. In part, the move to self-directed investment in these plans
was the result of workers wanting the higher returns from more
aggressive investment that plan sponsors were not willing to pursue
directly with their employees' vested account balances.
The problem here cannot be diversified away. Figure 1 shows the
variability in annual nominal returns payable to investors in broad
stock or bond indexes in the United States between 1942 and 2000. Over
the period shown, the average return on the S&P 500 index fund was 14.6
percent per year compared to 5.8 percent per year for the bond fund.
But the volatility in the stock fund, as measured by the standard
deviation of the historical returns, was also higher at 16.5 percent
compared to 9 percent for the bond fund. Workers want the higher
returns over time they seemingly get from investing in stocks, but
employers are unwilling to take on the added risks associated with
investing in stock to provide these higher returns.
Figure 1: Annual Returns from the Standard and Poors 500 Stock Index
Including Dividends and from an Index of U.S. Ten-Year Treasury Bonds
[GRAPHIC] [TIFF OMITTED] T0332A.001
Source: Derived by Olivia Mitchell and Marie-Eve Lachance, Wharton
School, University of Pennsylvania.
The advocates of providing some sort of return guarantee in defined
contribution plans argue that by setting up cash balance plans,
employers have demonstrated they are willing to provide such
guarantees. But these advocates ignore that employers have imposed a
relatively heavy price on participants when they provide return
guarantees in these plans. In data we have gathered on approximately
120 cash balance plans, two-thirds of them provided interest credits at
the equivalent to either the consumer price index rate or some federal
bond rate. A number of others had fixed credit rates that were even
lower than federal bond rates. It is highly unlikely that the majority
of 401(k) participants would be willing to accept a guaranteed rate of
return at such a steep price.
If the Federal Government is going to provide this insurance
instead of attempting to force employers to do it, it would almost
certainly mean the creation of some sort of pooled account with
centralized administration. Even if we were willing to create such an
entity, it is not clear that policymakers would be willing to impose
the price of return guarantees on participants. In fact, President
Bush's recent Social Security Commission considered some sort of return
guarantees for the individual accounts created in the Social Security
reform options they devised. But the Commission did not include a
guarantee in any of its reform options. In large part, the Commission
members thought the cost would be too high to guarantee returns in this
sort of program.
If we can figure out the mechanism for providing investment
insurance, it would still mean a radical reorientation of the
investment of assets in these plans. If we allowed the current method
of investment to persist along with an investment return insurance
program, we would create a tremendous moral hazard situation. If I know
that I have a large up-side potential from pursuing a risky investment
strategy but realize that I have little downside exposure because of
the insurance program, then why would I do anything but pursue the
risky strategy? I would accrue all the benefits of such an approach and
the insurer would sustain all the risks.
Making Defined Contribution Benefits More Secure
In his State of the Union Address this year, President Bush noted
the public concern about 401(k) plans that has arisen out of the Enron
bankruptcy situation. He has formed a task force including the
Secretaries of Treasury, Labor, and Commerce to develop new safeguards
for these plans. The President has recommended that workers be given
greater freedom to diversify and manage their retirement funds; that
corporate managers be restricted in their ability to trade company
stock during 401(k) trading blackout periods; that workers be given
quarterly information on their asset balances; and that they be given
more access to investment advice. While the Bush Administration has not
put forward specific legislation, a bill that has been introduced by
Representatives Rob Portman (R-OH) and Benjamin Cardin (D-MD) would
substantially cover the principles that have been laid out by the
President.
In some regards, it is regrettable that any new restrictions have
to be put on these plans as the track record they have achieved is
remarkable. Where plans are offered, 70 to 80 percent of eligible
workers participate in them. Total contributions going into these plans
equal 8 to 9 percent of pay.\4\ Jim Poterba, Steven Venti, and David
Wise estimate that by 2030 the 401(k) system in the United States will
be generating retirement benefits that are larger than Social
Security.\5\ In other words, this totally voluntary system has the
potential to completely outstrip Social Security in terms of aggregate
benefit delivery by 2030, a only half century after the first plan was
put in place. On a totally voluntary basis it will outstrip the
government program that requires more in tax revenue to support it than
any other government program. The 401(k) system is so admired or envied
by policymakers elsewhere in the world that other countries are moving
to implement similar programs. Germany and Japan recently adopted
systems that seek to mimic ours to a considerable extent. We should be
very careful about doing anything that jeopardizes this system.
---------------------------------------------------------------------------
\4\ Robert L. Clark, Gordon P. Goodfellow, Sylvester J. Schieber,
and Drew Warwick, ``Making the Most of 401(k) Plans: Who's Choosing
What and Why,'' in Olivia S. Mitchell, P. Brett Hammond, and Anna M.
Rappaport, eds., Forecasting Retirement Needs and Retirement Wealth
(Philadelphia: University of Pennsylvania Press, 2000, p. 104.
\5\ James M. Poterba, Steven F. Venti, and David A. Wise, ``401(k)
Plans and Future Retirement Patterns,'' American Economic Review (May,
1998), p. 183.
---------------------------------------------------------------------------
As a matter of public policy, I believe that absolute restrictions
on the amount of employer stock a worker can hold in his or her
retirement savings account will cause a strong adverse reaction on the
part of plan sponsors and participants and is not warranted. Employers
use their benefit programs for a variety of purposes and they use them
in combination to attract, retain, and motivate workers. Providing
matching contributions in the form of employer stock is one tool that
employers have in achieving their goals. Employees in successful
companies, often seek to participate in some of the benefits of that
success beyond simply taking home a paycheck. Our research suggests
that companies with higher levels of employee ownership of stock
generally out perform those where employees do not have such a
financial interest.\6\ The success of our economy, the labor markets,
and the growth of retirement saving over the period since 401(k) plans
have come into operation highlight the reason we should be wary of
adopting any massive overhaul of the 401(k) system.
---------------------------------------------------------------------------
\6\ Watson Wyatt Worldwide, Human Capital Index (Washington, DC,
2001), p. 5.
---------------------------------------------------------------------------
While I oppose restrictions that would preclude workers from freely
investing in their employers' stocks, I am sympathetic to the argument
that a workers' vested benefits in their retirement plan are an
economic asset intended to secure their retirement needs. As such, the
ability for anyone to dictate that such assets be invested in a
particular way should be limited. Some employers may be unhappy that
such restrictions might limit their ability to give workers a vested
interest in the success of their organizations. If the new restrictions
do not include absolute limits, however, good companies will still be
desirable places for workers to invest. Like many other aspects of the
organization of our economy, this requirement will place an added
premium on good management, but it is good management of our private
sector businesses that has made our economy such a dominant force in
the world.
Given the growing dependence of American workers on the
accumulating balances in their retirement savings plans, any effort to
provide them with more information about the appropriate investment
behavior should be favorably considered. As with many things in life,
however, retirement savings plans are often offered by small employers
or in highly competitive environments where lavish budgets to provide
extensive communication and investment advice are limited. We do not
want to relearn the lessons of the 1980s that too much regulation leads
to fewer plans rather than more security in the ones that already
exist.
Finally, any provisions that seek to provide guaranteed returns in
these plans should be viewed with an extremely wary eye. I cannot think
of any single policy change that would have the potential to so
radically alter the landscape of our retirement system in an adverse
way. If this guarantee is going to be foisted on employers,
policymakers should expect to see a significant exodus of sponsors from
offering plans. If the Federal Government is going to establish and run
such a program, policymakers should have a full understanding of the
costs involved in it and who is going to be assessed those costs.
Chairman THOMAS. Thank you very much, Mr. Schieber.
Professor Jefferson?
STATEMENT OF REGINA T. JEFFERSON, PROFESSOR OF LAW, COLUMBUS
SCHOOL OF LAW, CATHOLIC UNIVERSITY OF AMERICA
Ms. JEFFERSON. Good afternoon, Chairman Thomas, Congressman
Rangel, and Members of the Committee. I am Regina Jefferson, a
Professor of Law at the Catholic University of America. Thank
you for inviting me here today to testify on retirement
security and defined contribution plans.
The collapse of Enron has drawn attention to the need for
diversification in 401(k) plans. However, the use of defined
contribution plans as primary retirement saving vehicles
presents an array of concerns that extend beyond this limited
issue.
In my testimony, I identify some of the problems defined
contribution plan participants face under current law that have
not been addressed in the Enron discussions. In connection with
these weaknesses, I make recommendations for regulatory
changes.
Specifically, I focus on the need for residual fiduciary
liability for employers who sponsor participant-directed plans,
a minimum education standard, and the establishment of defined
contribution plan insurance. The ideas presented in my
testimony are explained in greater detail in an article I wrote
entitled ``Rethinking the Risks of Defined Contribution
Plans.''
Notwithstanding the significant ramifications of investment
decisions and the fact that most participants lack training to
allocate their assets, ERISA imposes no additional education or
notification requirements on employers who sponsor participant-
directed plans. Generally, employers are not responsible for
the investment decisions made by participants if the plan
provides a broad range of investment choices. Consequently, in
participant-directed plans, the employer's liability as an
ERISA fiduciary for poor investment performance is
substantially reduced, rendering many of ERISA's fiduciary
rules irrelevant.
The self-help characteristic of participant-directed plans
is inconsistent with ERISA's goal of increasing retirement
security. Furthermore, the economic benefits enjoyed by
employers who establish retirement plans presumably are
unwarranted if participants are no better off covered by the
plan than they would be saving on their own. Therefore, to
justify the retirement system's costs, as well as to increase
retirement security, residual fiduciary liability should be
imposed on employers who sponsor participant-directed plans.
To avoid residual liability for plan losses, employers
would be required to provide investment education and
notification to participants who use less than optimum
investment strategies.
Because the success or failure of the participant-directed
plan depends upon the participant's ability to properly
allocate assets, employers should be required to provide a
minimum level of investment education that will enable most
participants to make decisions consistent with recommended
guidelines, as well as to appreciate the future value of their
expected retirement benefits. Additionally, a minimum standard
would provide consistent education throughout the private
retirement system. The education requirement should mandate a
variety of educational mediums. There is substantial evidence
showing that printed communications generally are ineffective
in aiding the investment education of plan participants because
employees either do not understand them or disregard them.
Therefore, the education provided by employers should be non-
generic and should include a complement of written materials,
seminars, and financial planning software.
There also should be insurance for defined contribution
plans comparable in amount and objective to that provided
defined benefit plans. Although defined benefit plans are
insured by the Pension Benefit Guaranty Corporation, there is
no insurance for defined contribution plans because the
benefits are determined by contributions and investment
performance.
Interestingly, the effects of poor investment performance
in defined contribution and defined benefit plans are very
similar. Consequently, reluctance to insure investment
performance in defined contribution plans is based more on
perception than reality.
The similarity of the impact of poor investment performance
in the two types of plans can be illustrated best if one
considers a defined benefit plan in which all actuarial
assumptions used in the funding process are correct, except for
the interest assumption. Therefore, if the plan terminates with
insufficient assets, benefit losses would be solely
attributable to unfavorable investment performance. Thus, to
the extent that the PBGC guarantees payment of the benefits in
such a plan, it effectively insures an average investment
return over the plan's life.
In the article I wrote, I proposed a risk-based, voluntary
insurance program for defined contribution plans that would
protect participants against similar risks of shortfalls. Under
this proposal, annual guaranteed rates of return would be
determined by a prescribed diversification formula, which would
define an acceptable range of complementary allocations with
respect to investment category and risk classification. The
proposed insurance would protect participants against severe
market contractions to the extent that their accounts were in
compliance with the formula.
Accordingly, if the market took a sudden downturn
immediately preceding a participant's retirement, the insured
participant would be guaranteed at least an average return on
her aggregate contributions payable at normal retirement,
notwithstanding her actual account balance.
This concludes my testimony, and I thank you for the
opportunity to express these important concerns.
[The prepared statement of Ms. Jefferson follows:]
Statement of Regina T. Jefferson, Professor of Law, Columbia School of
Law, Catholic University of America
Mr. Chairman, and Members of the Committee, I am Regina Jefferson,
a professor of law at The Catholic University of America, Columbus
School of Law located in Washington D.C. I thank you for the
opportunity to share my views about the adequacy of existing
protections for defined contribution plans under current law. At The
Catholic University of America, I teach federal income taxation of
individuals and partnerships, and pension and employee benefits law. My
research and scholarship address issues of taxation, pensions, and
related topics.
Since the passage of ERISA, the composition of the private pension
system has changed dramatically. In recent years, there has been
discernable movement towards using defined contribution plans instead
of traditional defined benefit plans as primary retirement savings
vehicles. This trend has serious implications for the private pension
system because it shifts the risk of accumulating insufficient
retirement assets from the plan sponsor to the plan participant. As a
result of this development, many of the protective measures introduced
by ERISA are ineffective or inadequate. The collapse of Enron
highlights the diversification problem; however, problems with defined
contribution plans extend far beyond this issue. Unless the pension law
is amended in other areas as it applies to defined contribution plans
in general, and participant directed defined contribution plans in
particular, many more participants may suffer plan losses of the same
magnitude that Enron employees experienced.
In my testimony, I will identify some of the problems that a
defined contribution plan participant faces in accumulating targeted
amounts for retirement, that have not been discussed in the wake of
Enron. I will also make recommendations for regulatory changes that
would correct these deficiencies. Specifically, I will focus on the
need for: (1) residual fiduciary liability for employers who sponsor
participant directed defined contribution plans; (2) a minimum
education standard for employers who sponsor participant directed
plans; and (3) the establishment of a defined contribution plan
insurance program comparable in amount and objective to the existing
defined benefit plan insurance program. The ideas presented in my
testimony are explained in greater detail in an article I wrote
entitled Rethinking the Risks of Defined Contribution Plans.\1\
---------------------------------------------------------------------------
\1\ Regina T. Jefferson, Rethinking the Risks of Defined
Contribution Plans, 4 Florida Tax Review 607 (2000).
---------------------------------------------------------------------------
I. Residual Fiduciary Liability in Participant Directed Plans
To provide the level of retirement income security envisioned by ERISA
as originally drafted, there should be residual fiduciary liability
imposed on employers who sponsor participant directed plans.
Although employers who sponsor defined contribution plans are not
required to allow participants to make individual participation and
investment decisions, many employers recognize that giving flexibility
enables employees to customize their retirement programs to accommodate
their specific savings objectives and risk tolerances. Thus, the growth
in the defined contribution plan area has been driven largely by the
establishment of participant directed plans, also known as 401(k)
plans. In these plans, employees are required to decide not only
whether to participate, the level of contribution to be made on their
behalves by the employer, but also the manner in which their accounts
are to be invested.
Notwithstanding the complexity of making investment decisions,
ERISA imposes no additional education or notification requirements on
employers who sponsor participant directed plans. Only the general
fiduciary standards of ERISA govern these plans. ERISA defines a
``fiduciary'' as a person with discretionary authority or control over
the plan assets, or a person who manages the plan assets. Thus, because
employees make the investment decisions in participant directed plans,
the employer's liability as a plan fiduciary for poor investment
performance is substantially reduced. This reduction of liability
renders many of ERISA's general fiduciary rules regarding asset
investment and management irrelevant.
To further minimize liability for poor investment performance, many
employers establish section 404(c) ``safe harbor'' plans. In safe
harbor plans, an employer's exposure to fiduciary liability is even
further reduced, if the plan satisfies applicable rules and
regulations. These rules require the employer to give a broad range of
investment options, and reasonable instructions regarding the
significance of the options. Unlike, traditional participant directed
plans in which plan fiduciaries retain a limited obligation to make
sure that the plan assets are protected against losses, section 404(c)
safe harbor plans essentially shield the employer and other plan
fiduciaries from such liability. Consequently, in these plans
fiduciaries generally are not liable for losses that result from poor
investment returns, regardless of the manner in which plan participants
allocate their assets.
Therefore, participant directed plans raise serious questions about
the adequacy of ERISA's fiduciary rules. In a tax subsidized retirement
system, is it appropriate to allow employers to shift the
responsibility of making critical investment decisions to plan
participants who typically lack professional financial training?
Section 404(c) safe harbor plans raise even more concerns regarding the
adequacy of ERISA's fiduciary rules, because in these plans the
employer and other plan fiduciaries are almost entirely insulated from
fiduciary liability for poor investment decisions made by plan
participants.
Employers are encouraged to establish qualified retirement plans
with substantial tax benefits. The preferential tax treatment of
retirement plans reduces the employees current taxable income, and
therefore makes it possible for employers to deliver to their employees
a dollar of retirement income at a lower cost than a dollar of current
wages. One of the rationales for the employment based characteristic of
the private pension system is that it is believed that comparative
advantages result from saving in employer sponsored plans, as opposed
to personal savings arrangements. For example, participants should
receive greater returns inside a plan than outside a plan because their
accounts are professionally managed. Also, because the employer can
benefit from economies of scale, administrative costs and other fees
should be lower inside than outside a plan.
Although the sponsors of participant directed and employer directed
plans enjoy the same tax benefits, participants in participant directed
plans are not accorded the same non-tax advantages. In participant
directed plans, participants, not the employer, make the investment
decisions; consequently, they do not benefit from the expertise of
financial professionals. Also, any advantages derived from economies of
scale would diminish, if participants fail to make prudent investment
decisions.
The self-help approach utilized by participant directed plans is
inconsistent with ERISA's goal of increasing the retirement income
security of plan participants. Presumably, the economic benefits
enjoyed by employers are justifiable only if participants are, in fact,
better off being covered by an employer sponsored arrangement than they
otherwise would be. Therefore, in order to justify the cost of the
private retirement system, and to achieve its objective of increased
returns inside the plan, there should be residual fiduciary liability
imposed on employers who sponsor participant directed plans.
To avoid residual liability for plan losses, employers who sponsor
participant directed plans should be required to provide investment
education sufficient to enable employees to make prudent investment
decisions. In addition, in order to ensure that participants appreciate
the significance of the risk of shortages when they fail to use less
than optimum investment strategy, employers should be required to
notify participants when their accounts are inadequately diversified,
or otherwise exposed to greater than average risks of loss.
Employers who fail to comply with the education and notification
requirement would be liable as ERISA fiduciaries for plan losses.
Although determining actual loss in a defined contribution plan is not
a straightforward calculation, the loss could be measured by either
comparing the actual rate of return on the account to the average rate
of return for Treasury bills, or to an average rate of return for a
specified portfolio mix. After determining the loss, an excise tax
should be imposed on the employer. The excise tax could be a flat rate
tax designed to recoup an account holder's lost investment build-up.
Alternatively, like the section 4971 tax for underfunding, the flat
rate excise tax could be imposed at a rate high enough to both recoup
asset losses, and discourage noncompliance. Another option is for the
excise tax to be calculated on a case-by-case basis, using particular
facts and circumstances to measure the exact loss. Regardless of how
the tax is computed, however, under no circumstances should employers
who completely insulate themselves from liability for the imprudent
investment decisions made by plan participants enjoy the same level of
tax benefits as sponsors who retain liability for the investment of
plan assets.
II. A Minimum Education Standard
Sponsors of participant directed plans should be required to provide a
minimum level of investment education and training because the success,
or failure, of participant directed plans ultimately depends on the
participant's ability to make prudent investment decisions.
In employer directed plans, a plan administrator, or an investment
professional, typically controls the plan investments. These
individuals are required to allocate investments in a manner that
protects the accounts against inflation, sudden fluctuations, and
unfavorable market conditions. In participant directed plans the same
investment strategy should be used, but often is not, because employees
generally do not have sufficient investment training to achieve this
objective. Inexperienced participants generally fail to adequately
diversify their retirement accounts, investing disproportionately in
stable value funds.
The modern portfolio theory of investment explains that an
adequately diversified portfolio should include an appropriate balance
of stocks, bonds, and stable-valued funds. Furthermore, the
professional guidelines for investment mangers prohibit them from
investing more than 10% of a retirement plan's funds in a single asset.
Recommendations and restrictions such as these exist because a balanced
investment portfolio provides an appropriate relationship between risk
and return. For example, a high concentration of stable-value, low-
yield, instruments will generally produce insufficient income over a
participant's working life to provide financial security at retirement.
Therefore, an individual who disproportionately invests in low-yield
instruments would have to save significantly greater amounts to be in
the same position at retirement as participants who sufficiently
diversify their investment portfolios. Similarly, an individual who
overinvests in a single asset is excessively vulnerable to fluctuations
in a particular market, and exposes her retirement savings to a greater
risk of loss.
Inexperienced investors are not only less likely to adequately
diversify their portfolios, but are also less likely to recognize the
financial indicators on which trained professionals rely when deciding
to transfer funds from one investment to another. Therefore, an
untrained investor may fail to make changes when they are warranted, or
in other situations may react too quickly. For example, in sudden
market down-turns these individuals may sell high-risk, high-return
investments too hastily, although professional investors generally
believe that such investments perform best over the long-run. Thus, the
success or failure of participant directed plans ultimately depends on
the individual participant's ability to properly allocate plan assets.
Consequently, there should be a minimum education requirement imposed
on the plan sponsor.
Some employers voluntarily provide education for their employees to
enable them to make prudent investment decisions; however, many
employers choose not to provide such programs because they are costly.
Moreover, under current law the provision of investment education could
expose the employer to fiduciary liability for plan losses if the
information is considered investment advice, and later proves to be
incorrect.
If employers who sponsor defined contribution plans were required
to provide a minimum level of investment education it would be more
likely that participants would be able to make investment decisions
consistent with professional guidelines. An education requirement would
also enable participants to appreciate the future value of their
expected retirement so that they could determine if they needed to
supplement their expected retirement benefits with increased personal
savings. Furthermore, an education requirement would also provide
consistent standards for the type of investment information
participants would receive from one employer to another.
A properly implemented minimum education requirement should mandate
a variety of educational mediums. There is substantial evidence showing
that printed communication generally is ineffective in aiding the
investment education of plan participants, because employees either do
not understand the written materials, or disregard them. Therefore, the
requirement should specifically include a complement of written
materials, seminars, and financial planning software, on retirement
asset management. The education provided in connection with the minimum
standard should not be generic. The education provided should be
responsive to the investment needs of different groups within the
workforce. For example, there should be age specific information that
reflects the different investment strategies recommended for those
nearing retirement, versus those who are not.
III. Insurance Protection for Defined Contribution Plans
Insurance protection comparable in amount and objective to the defined
benefit plan insurance program should be available to defined
contribution plan participants.
Another reason defined contribution plan participants are more
likely to experience shortfalls in their retirement benefits is because
the insurance program for retirement plans has a gap in its coverage.
Defined benefit plans are insured by the Pension Benefit Guaranty
Corporation, the (PBGC), against losses owing to plan failure. The PBGC
insures a limited accrued retirement benefit in defined benefit plans
which is phased in over a period of five years. The maximum insurable
benefit is approximately $35,000 per year for an individual who retires
at page 65. However, defined contribution plan participants receive no
such protection.
Section 3(34) of ERISA specifically provides that PBGC protection
is unavailable to individual account plans. This section defines
individual account plans as plans in which the level of benefit for
each employee fluctuates depending on the experience of the account.
Because the retirement benefits in defined contribution plans are
determined by the contributions and the investment performance of each
separate account, defined contribution plans are excluded from
coverage.
Although policymakers have been reluctant to insure investment
experience as opposed to definite retirement benefits, the effects of
poor investment performance in defined contribution plans and defined
benefit plans, in reality, are very similar. Thus, the distinction
between insuring investment performance in defined contribution plans,
and insuring definitely determinable benefits in defined benefit plans
is primarily based on perception. Moreover, because of the use of
advanced funding methods in defined benefit plans, insuring a minimum
investment return in retirement savings plans actually occurs under the
existing defined benefit plan insurance program.
The funding of ongoing defined benefit plans is determined by the
use of actuarial cost methods. Actuarial cost methods estimate plan
costs and assign the costs to appropriate years. The present value of
pension benefits and liabilities depends on the actuarial assumptions
selected for interest, early retirement, turnover, and salary
increases. Regardless of how carefully the actuarial assumptions are
selected, advanced funding methods can only produce cost estimates, not
actual costs. Therefore, typically a plan will either have a funding
surplus or a funding deficiency, because any deviation in the
assumptions when compared with actual plan experience will produce a
shortfall, or a windfall.
When a defined benefit plan terminates with insufficient assets,
the PBGC pays the plan's vested accrued benefits at the time of
termination. In other words, the PBGC insures plan participants against
shortfalls that arise from differences in the estimated funding cost
and the actual cost of a defined benefit plan. Whether plan losses are
due to an erroneous turnover assumption or an erroneous interest rate
assumption, the PBGC is liable for the unfunded vested accrued
benefits. Because the interest rate assumption typically reflects the
long-term nature of the pension obligations, a change in the interest
rate assumption affects the valuation results more than a change in any
other actuarial assumption. Consequently, the accuracy of the interest
rate assumption is especially critical in preventing shortfalls.
Even if all other assumptions are correct, when a plan experiences
losses due to erroneous interest rate assumptions, a significant
funding deficiency could result. In such cases, if the plan terminated,
and the employer were unable to make an additional contribution, the
PBGC would pay the unfunded vested accrued benefits up to the
applicable limits. Effectively, when the PBGC pays any portion of the
retirement benefits in plans in which all actuarial assumptions other
than the interest rate assumption are correct, the PBGC insures a
minimum investment return. Therefore, under existing pension law,
participants in defined benefit plans are, in fact, insured against
poor investment performance.
By comparison, there presently is no protection against less than
average investment performance for participants in defined contribution
plans. When shortfalls occur because of unfavorable market conditions,
the participant alone bears the loss. The prevalence of defined
contribution plans in today's market makes the failure to provide
insurance protection to defined contribution plan participants a
serious threat to retirement income security. Millions of plan
participants now rely upon defined contribution plans as their primary
retirement savings vehicles. Although providing insurance protection
against unfavorable investment performance for defined contribution
plans is a controversial subject, designing a defined contribution plan
insurance program comparable in amount and objective to the existing
defined benefit plan insurance program is a feasible concept.
In the article I wrote entitled Rethinking the Risk of Defined
Contribution Plans, I proposed a risk-based, voluntary insurance
program to insure defined contribution plan participants against the
risk of earning less than average investment returns, over their
working lives. Under the proposal, annual guaranteed rates of return
would be determined by the performance of a hypothetical account,
assumed to be invested according to a prescribed diversification
formula. This insurance model is designed to protect the participant
against the negative effects of severe market contractions over the
participant's working life. Consequently, if the market took a sudden
downturn immediately preceding a participant's retirement, the
participant would be guaranteed at least an average return on her
aggregate contributions over her working life, notwithstanding the
actual account balance at retirement.
The proposed insurance model hinges on a diversification formula,
which defines an acceptable range of complementary allocations with
respect to both investment category, and risk classification. The
diversification formula would be designed to approximate an average
rate of return for an account invested in average risk investment
instruments, over a participant's working life. For example, the safe
harbor diversification allocation could be selected consistently with
the recommendations of financial planning experts who advise
individuals for a moderate return to place 60% of their investment
assets in the stock of companies with moderate volatility, 25% in
investment grade bonds, and 15% in stable value instruments.
Additionally, the diversification formula would also limit the extent
to which an insured account could be invested in a single asset.
The level of insurance protection and the cost of the insurance
premium would depend on the degree to which the participant's
allocation complied with the diversification formula. Using an
established indexing system, a risk factor would be assigned to all
allocations in order to compare their risk exposure to that of the
prescribed diversification standard. In order for an account to be
fully insurable at the regular premium rate, the participant's account
could not be exposed to an investment risk greater than that of the
prescribed diversification formula. Accounts having a risk factor
greater than that of the prescribed diversification formula would not
be in compliance with the diversification standard, and accordingly
would not be insurable at the regular premium rate. Unlike the existing
mandatory insurance program for defined benefit plans, the proposed
insurance program would be voluntary. The voluntary characteristic of
the proposal strikes a balance between individual choice and retirement
income security. However, because the proposed insurance model is not
mandatory, it would be unlikely that all defined contribution plan
accounts would ever be protected.
Skeptics of defined contribution plan insurance will argue that
extending insurance to defined contribution plans will intensify the
financial troubles of the PBGC. This concern is valid, however, only if
the defined contribution plan insurance program replicated, or expanded
the existing insurance program for defined benefit plans. The proposed
insurance model does neither. The proposed program is a completely new
program, with a completely new structure. Furthermore, the proposed
program makes adjustments for recent awareness of the design
deficiencies in the defined benefit plan insurance program. For
example, the premiums for the PBGC insurance program are not fully risk
based, or economically derived. These characteristics have contributed
to much of the financial difficulty that the PBGC has experienced. By
comparison, the premiums for the proposed defined contribution plan
insurance program are both risk based, and economically derived.
Therefore, the insuring institution, economically, should be no better
or worse off for establishing the program.
Others opponents will register concern that a defined contribution
plan insurance program would increase federal exposure, possibly
leading to a bailout similar to the one that resulted from the 1980's
savings and loan crisis. This result is unlikely, however, because the
1980 bailout developed out of circumstances unique to the savings and
loan industry. For example, because funds placed in savings and loan
institutions are available to depositors upon demand, when news that
the savings and loans were experiencing financial difficulties reached
the public, many depositors immediately withdrew their funds. This
reaction severely worsened the financial position of these
institutions. In contrast, in qualified retirement savings arrangements
early distributions generally are disallowed, unless specific events
occur, such as early retirement, disability, or death. Thus, it would
be unlikely that a single event would ever increase the volume of
insured claims in a retirement insurance program as it did in the
savings and loan crisis.
Finally, another argument that is likely to be made by those who
oppose the concept of defined contribution plan insurance, is that it
would cause employers, or individual participants, to expose their
accounts to unreasonable investment risks. This concern expresses the
moral hazard problem: those who are insured against certain risks have
no incentive to use optimal care to avoid the risk.
Prior to the passage of ERISA, there were similar concerns that the
adoption of defined benefit plan insurance would encourage employers to
engage in risky investment practices. As a result, the pre-ERISA
Committee determined that it was necessary to adopt safeguards to
prevent this behavior. Accordingly, the committee imposed restrictions
on the employer's ability to recover from the PBGC. These restrictions
remain in effect today. In connection with defined contribution plan
insurance it would be necessary to adopt similar safeguards.
Furthermore, the defined contribution plan insurance proposal that I
have described in my testimony solves this problem by using the
diversification formula to limit the risk exposure of insured accounts.
Insuring defined contribution plans does in fact present difficult
tradeoffs. However, many of the concerns regarding such a program are
reactionary rather than substantive. As for the relatively few
substantive concerns, the overwhelming need to amend ERISA to respond
to the current pension climate would appear to offset any difficulties
that these concerns present. Therefore, notwithstanding the complexity
of implementing a defined contribution plan insurance program, serious
consideration should be given to the concept of establishing an
insurance program for defined contribution plans. Whether consideration
is given to the model of insurance that I have described in my
testimony, or another model, it is important that some attempt be made
to establish an insurance program for defined contribution plan
participants in order to meet the needs of future retirees.
Chairman THOMAS. Thank you, and I appreciate the testimony
of all three of you.
Mr. Vanderhei, we heard earlier that actually the number of
companies that participate is not that great, utilizing stock,
but apparently those that do have quite a bit of involvement
and the dollar amounts are quite significant. So it is the
usual situation of probably very large companies.
Is there any data that gives you kind of a profile of
companies that might participate, Mr. Schieber or Professor
Jefferson, or does it really run the gamut of different types
of companies, structure of companies, what they do?
Mr. VANDERHEI. When you say participate, do you mean offer
company stock in the investment----
Chairman THOMAS. Offer company stock. Does there tend to be
a pattern for the company that would do this?
Mr. VANDERHEI. We only have it broken down currently by
plan size, which is in my written testimony. We have no ability
to identify industry code or anything else in our database. I
am sorry.
Chairman THOMAS. No, that is okay.
Mr. SCHIEBER One thing you should keep in mind, to the
extent that this does tend to be concentrated among larger
employers, many of these employers do have defined benefit
plans. So when you are looking at the amount of company stock
that a particular worker might have in his or her 401(k)
portfolio, that may be a relatively small part of their total
retirement portfolio.
One of the problems here is that not every employee holding
company stock is necessarily exposed to the same kind of risk.
Chairman THOMAS. And it is not either/or, correct. And that
is one of the problems we have got to get to, and that is, is
there no average or profile? And, therefore, in passing
legislation we have to be very sensitive to it.
One of the things that struck me, Mr. Vanderhei, on your
Figure 2 was the actuarial difference between the male and
female on the payout and the drops and the rest. Does that hold
true, is that just the usual actuarial difference age-wise and
payout-wise? You said you had additional figures that would be
similar with different profiles in terms of losses and gains.
Mr. VANDERHEI. Right.
Chairman THOMAS. Does the differential of male-female
maintain?
Mr. VANDERHEI. Much of that is due to not only a difference
in age-specific and gender-specific participation rates in the
401(k) system, but also their contribution rates and when they
make the contributions during their working careers.
When I said I could run under different assumptions, I was
basically referring to different investment rates of return.
Chairman THOMAS. Right, but you still get that actuarial
difference.
Mr. VANDERHEI. Yes, that is correct.
Chairman THOMAS. It will stick with every profile.
Mr. VANDERHEI. Yes.
Chairman THOMAS. Mr. Jefferson, you said that there is no
real difference between the defined contribution savings or
someone doing it on their own. But do you really believe that
there would be 55 million Americans with $2.5 trillion in
savings if they didn't have this structure? Isn't one of the
problems that Americans just don't save on their own?
Ms. JEFFERSON. Well, first, to clarify, I indicated that
insuring a guaranteed amount in defined contribution plans is
effectively no different, and no more difficult than insuring,
as we do now, a guaranteed return in defined benefit plans.
Chairman THOMAS. Well, that is a question I want to ask
each of the other individuals. Do you believe there really
would be no differences between insuring a defined benefit and
a defined contribution plan?
Mr. SCHIEBER There is tremendous----
Ms. JEFFERSON. In----
Chairman THOMAS. Well, I know your position. I want to see
if they agree with you or disagree.
Mr. SCHIEBER Well, I strongly disagree. In the case of the
insurance that is provided through the PBGC, those plans are
insured in the case where an employer goes bankrupt and can no
longer sustain the plan.
Now, because of the financial interest that the PBGC has in
providing that kind of--the government has in providing that
kind of insurance, there are multiple regulations that require
that these plans be funded, that they be valued on a regular
basis. There is a tremendous difference between these plans, no
matter how you look at it.
Mr. VANDERHEI. I would just add to what Syl mentioned, that
you also with the PBGC defined benefit insurance system have a
buffer from an ongoing employer. Just because you have adverse
investment experience with a defined benefit does not
necessarily present a claim to the government agency until such
time as there is a bankruptcy on the part of the sponsor. So to
compare those two is to look at completely different
probabilities.
Mr. SCHIEBER. And, in fact, if the employer realizes
adverse returns on the account, they have to actually
accelerate their contributions to get themselves back up to the
funding levels, or else they have to pay higher insurance
premiums.
Chairman THOMAS. And, conversely, if they have been paying
more in, there is now a way in which they can back off of the
percentage that they are paying.
Mr. SCHIEBER. Correct.
Ms. JEFFERSON. I would like to follow up.
Chairman THOMAS. You should.
Ms. JEFFERSON. The comparison I made was for the limited
purpose of contrasting the guarantee of the interest rate.
Certainly the plans are fundamentally different, and I would
not take the position that the plans were not different in
other respects.
In the article I wrote, I describe in greater detail, the
structure of the proposed insurance program. I explain that in
order to preserve the integrity of the program it would be
necessary to put restrictions on the payment of defined
contribution plan insurance, just as there are restrictions now
placed on defined benefit plan insurance.
Chairman THOMAS. I guess part of my problem is that I
understand the ability to create an insurance structure, even a
government-underwritten one, on a bankruptcy of a company and
its promised pension plan versus guaranteeing some return on
individual investments or what is the appropriate plan, unless
someone went belly up, like a bankruptcy on an individual basis
or a zero gain over a period of time. That gets me back then to
the ``you can't fail'' scenario in which why wouldn't you be
aggressive and roll the dice.
So I do think that that is something we are going to have
to look at. I appreciate--and I have not seen your article yet,
but I read your material, and we are going to have to examine
your options a little more closely.
Ms. JEFFERSON. I would like to respond to the point that
you raise about moral hazard: meaning those who are insured
against certain risks have no incentive to use optimum care to
avoid the insured risk. This same concern was present in 1974
when the insurance program was established for defined benefit
plans. People feared that insurance would encourage abusive
practices regarding risk exposure by allowing employers to
promise excessively large insurance benefits, and this is why
there are restrictions on the amount and the conditions under
which the employer can recover from the PBGC.
The proposed insurance program for defined contribution
plans addresses the moral hazard problem by using a
diversification formula which would require an insured
participant to invest according to a prescribed standard.
Chairman THOMAS. Except, again, you are dictating a profile
to address one issue while someone may want to invest to
address a different issue, and that is an enhancement of their
retirement at some risk.
Ms. JEFFERSON. Well, actually not. The proposal I make is a
voluntary program. Therefore, if a participant did not want to
participate, they would not be required to do so. That is one
of the distinctions between the existing defined benefit
insurance model and the one that I propose for defined
contribution plans.
Chairman THOMAS. And I will tell you, Professor, if you
have someone who chooses to be covered and someone who chooses
not to be, folks will be back here very quickly to make sure
that those who took that voluntary risk are covered, anyway. In
fact, we have Members of the Committee who are already
advocating that.
Let me ask you finally in terms of the President's plans.
Obviously, Professor Jefferson, you have some other concerns,
but you underscored education, and I think that is one thing we
are all in agreement, that we can't get too much education to
consumers, whether it is health care or retirement. But with
the exception, for example, of the colloquy between Mr. Pomeroy
and the Administration in which they agreed that some of the
points that Mr. Pomeroy made in another Committee were valid
points, on the whole does the President's plan seem to be
pretty much useful in responding to current concerns? Or are
there some particular holes in it from your perspective that
need to be addressed? Maybe we would just start with Mr.
Vanderhei and move across the panel. Pretty much okay or are
there particulars that you would like to see beefed up?
Mr. VANDERHEI. I would certainly say it depends on what
your objective is. If your objective is to try to continue a
relatively successful system, it seems to not only respond to
the concerns about the lack of diversification after a certain
period of time, but also--and this is very important--keeps
incentives there for the employers to make matching
contributions.
In many studies that both Syl and I have done independently
in the past, the primary motivating feature for employees to
make contributions is the employer match. You take that away,
you are not just taking away the employer money going into the
401(k) accounts; you are also probably taking away a large
share of the employee money that follows it.
Chairman THOMAS. Mr. Schieber.
Mr. SCHIEBER You know, it leaves considerable flexibility
in these plans. To the extent that you have employers who are
doing a good job with their operations and with their workers,
giving the workers some flexibility to continue to invest where
they want to invest, without restricting them to the extent
that maybe some have been restricted in the past, calls for
additional education, which I believe is valuable. It addresses
the blackout rule. There might be other ways to address it, but
at least it addresses it--it gives a common interest, as I
think someone here characterized earlier, the top floor and the
shop floor.
So I think it goes a long way in terms of correcting
problems that are perceived coming out of the recent
experience.
Chairman THOMAS. Professor Jefferson?
Ms. JEFFERSON. One of the concerns I have is that it does
not guarantee a minimum retirement benefit. I believe it is
important to have a minimum guaranteed benefit simply because
without it, as we see with the Enron employees, people who have
been saving in a tax-subsidized retirement arrangement, may end
up having nothing. So, that would be my primary concern with
the proposal.
Chairman THOMAS. Again, I want to thank you for the work
you have done in this area, and as more and more people become
aware of the downside--everyone was aware of the upside. Our
job is to protect on the downside without taking away the
opportunity on the upside. So thank you.
Does the gentleman from New York wish to inquire?
Mr. RANGEL. Yes, thank you.
Professor Jefferson, Mr. Schieber had indicated, as it
relates to this concept of guarantee a part of the employee's
pension, that he cannot think of any single policy change that
would have the potential to so radically alter the landscape of
our retirement system in an adverse way. So I think he has made
up his mind about providing guaranteed returns in defined
contributions.
How would you address this statement that strongly worded?
Ms. JEFFERSON. It is my position that it does not radically
change the playingfield; that indeed that was the purpose of
making the comparison between the defined benefit plan and the
defined contribution plan.
In fact, in some situations under the existing insurance
program, we effectively do insure an investment return. As I
explained earlier, if all actuarial assumptions are correct in
a defined benefit plan funding schedule, except for the
interest rate assumption, then to the extent that the PBGC at
any point provides payment for the plan's benefits, there would
be a guarantee of an investment return at some level.
So it is my position that insuring a minimum return in
defined contribution plans is not as radically different as one
might think. It is really a problem of perception rather than
reality.
Mr. RANGEL. Thank you.
Mr. Schieber, in the Enron type of situation where an
employee gets wiped out because of misinformation, do you
believe that the Federal Government has any responsibility at
all to make the employee whole, protected in whole or in part?
Mr. SCHIEBER. I think the government has responsibility
here, but I believe it has responsibility before the horse gets
out of the barn. And----
Mr. RANGEL. Let me try to rephrase the question, because
that horse is out of the barn and the person now is left
without a pension fund. As one of the Members has stated, many
corporations' horses get out of the barn, and we in Congress
are called upon to give some assistance after the horse is out
of the barn.
Now, this employee's pension is out of the account, and I
am just asking: Do you think we have any responsibility to
provide any relief at all to this type of employee?
Mr. SCHIEBER. These employees were investing their money
largely at their own direction. We do not insure investors
generally in this society----
Mr. RANGEL. Why is it so difficult to say you play the
game, you take your risk, you lose, you lose. That is what--I
think that is where you have got to end up.
Mr. SCHIEBER. And that happens every day in our economy. It
happens with jobs. It happens with----
Mr. RANGEL. I am not arguing with you, and so I am not
saying that you have an indefensible position. It is just I
want to take a clearer look as to how you look at pensions and
your government's role in protecting the investor. That is all.
Mr. SCHIEBER. I think the government has a very important
role in protecting investors. We learned that coming out of the
Great Depression with the establishment of the SEC and many of
the rules. I think that there have been breakdowns in
disclosure, in accounting----
Mr. RANGEL. What about the Social Security system? Do you
think we should move toward privatization of the----
Mr. SCHIEBER. I have sat in front of this Committee and
suggested that we should have some individual account reform on
more than one occasion in the past. Yes, I do.
Mr. RANGEL. So you really believe that investors should
have more freedom in making his or her determination as to
where they want to place their money, and if it is high risk,
that should be their choice, and if they make mistakes, then
the government should not be there for them.
Mr. SCHIEBER. What I have advocated in terms of Social
Security would be more restrictive than what I think should
operate with supplemental plans. I have not advocated the same
sorts of investment freedom with Social Security accounts that
I think employees should enjoy with their 401(k) money. Their
401(k) money has gone into those accounts because they made a
decision of their own to put their money, to defer consumption,
into these accounts.
If you want to go back, you can go back to the period
during the early 1980s when these plans first evolved. And at
that juncture, most of the money was invested by the employer
on a pooled basis. Most employees didn't like that kind of
investment of their retirement assets because employers were
investing that money along the lines being advocated here, in a
relatively risk-free form of investment vehicle. And the
employees wanted to have greater opportunities to realize
returns from the financial markets. They demanded it, and that
was largely why employers went in the direction they went in
restructuring their plans.
Maybe you can stand in front of the tide and stop it, but
there were massive numbers of workers who want this system to
work largely the way that it does.
Mr. McCRERY. [Presiding.] Thank you. I will just point out
before I call on Mr. Portman that I think you were on the right
track for a second, Mr. Schieber, pointing out that the
government does a number of things to protect investors. We do
regulate the stock market, individual stocks. We also regulate
the accounting profession. We do a number of things to try to
protect investors.
But the government can't protect investors from criminal
activity, from wrongdoing, just as, say, a wealthy lawyer gets
taken by somebody with a bogus investment deal, the government
doesn't insure that. We don't go to that lawyer and say here is
your money back, or a doctor who invests his money----
Mr. RANGEL. If the Chairman would yield?
Mr. McCRERY. I would be glad to.
Mr. RANGEL. What we are doing, we are partners in providing
incentives for the employee to participate in these plans and
providing incentives for the employer to do it, and so this
Committee through the tax laws, we are partners in this. This
is not just some lawyer out there. We are encouraging, it is
public policy, and I would believe----
Mr. McCRERY. I would hope everyone would agree that it is
good public policy.
Mr. RANGEL. And I would like to believe if my government
was encouraging me to make this type of investment, that my
government would give me some protection as well from the free
market, allowing the free market to work its will. But I know
that I disagree with you and Mr. Schieber, and it wouldn't
surprise me if ultimately you would like to see us get out of
the Social Security business altogether, you know, which is----
Mr. McCRERY. Is it Schieber----
Mr. SCHIEBER. That is not anything I have ever advocated.
Mr. RANGEL. Some of my colleagues in the Congress thought
it was a bad idea when it started, it is a worse idea now. And
so----
Mr. SCHIEBER. Social Security?
Mr. RANGEL. Yes.
Mr. SCHIEBER. Congress thinks it is a bad idea?
Mr. RANGEL. I am not saying that Mr. Armey is the Congress,
but he certainly has spoken that way many times, you know.
Listen, he is leaving, but a lot of people thought it was
socialistic, and that the best government is no government. I
think even our Chairman----
Mr. SCHIEBER. I would be happy to come back and talk at
length about Social Security.
Mr. McCRERY. I think we have gotten off the track. So to
get us back on track, I am going to call on Mr. Portman.
Mr. PORTMAN. Thank you, Mr. Chairman, and I thank the
witnesses for their testimony today. This area, as you know, on
the defined contribution side is full of regulations and rules,
and this Committee has spent a lot of time looking at those and
tried to make sense of them. The top-heavy rules would be one;
the non-discrimination testing would be another, all kinds of
fiduciary responsibilities. So we are partners, and there is an
active role by the Federal Government. It is a tremendous
subsidy. In fact, I count it to be probably the largest single
subsidy in the Tax Code now, retirement generally.
But the question is how do we build on the success of the
defined contribution wave. I would say it is a wave, not a
tide.
Mr. Rangel is a pretty powerful guy. I don't know if he can
stop the wave, and there is a good reason for it.
I really appreciate EBRI's work. We have worked with them
closely, and they always provide good, objective counsel. This
one figure, if we told everybody they had to limit investments
at 5 percent, they couldn't be below that for people born my
age or after, there would be a 25- to 30-percent reduction in
what they would get. And that is EBRI. And EBRI is not
partisan, and EBRI is very careful about the statistics that
they rely on. That is the wave. That is the tide. I mean, there
is a reason people feel this way. And all those people are now
watching CNBC and those 42 million-plus investors in 401(k)s
and others in 403(b)s and 457s and so on. A lot of them know
what they are doing. And I talk to a lot of them, and it is
true, diversification makes sense for retirement. On the other
hand, if you are 25 years old and you want to take a little
risk and you are watching the market, should we say to that
person you can't invest more than 20 percent in a particular
stock?
I represent Cincinnati. We have the Procter & Gamble
company there, and most of the stock in that plant is so-called
non-elective. It is not even a match. They just provide it.
They provided it to my dad when he worked there in the 1950s. I
have still got some. They are very happy with that, and they
know what they are doing. And they have done quite well.
There are lots of other examples like that, but another
statistic that frightens me is that 48 percent of 401(k)
participants have more than 20 percent of their plans in
company stock. So you are going to tell half of the people in
401(k)s you can't do what you want to do.
Now, I am all for retirement education, and I think that is
the next big challenge. I think the bill last year was a good
bill. I agree with Mr. Schieber. We worked long and hard on it.
But I think we frankly have more to do in education. And I
think Professor Jefferson makes a good point there. The big
challenge, as I see it, is being sure that people have access
to investment advice. Companies are very loath to provide it,
as you know, because they worry about liability. And it is
tough to provide it without weighing some very subjective
factors. But we have to break through that, and that is why
some of us are willing to take a risk on the investment advice
bill. I agree with the colloquy that Mr. Pomeroy had with Mr.
Boehner as well, and maybe there are some other things that we
can do.
Let me ask about one piece of our bill that Ben Cardin and
I have introduced this year in response to the Enron situation
and trying to get at this diversification and education. We
have a pre-tax investment advice piece. I don't know if you
have seen it, but it would be like a cafeteria plan. You could
use pre-tax dollars. You could take a payroll deduction in
order to get advice yourself. The employer wouldn't be telling
you who to use. It wouldn't be somebody coming in that had
anything to do with your plan. It would be you getting 300 or
400 bucks to go out and get advice.
I don't know how many people would want to set aside money
for that, but I think there would be some. What do you think
about that idea? Any of you.
Ms. JEFFERSON. I believe that is an excellent idea, and I
would support it. I think that self-help should be available
and encouraged. However, I don't believe that this approach is
sufficient, for individuals who may not recognize that they
need financial training or who may not be able to afford it.
Therefore, I would be in favor such a program, but not as a
substitute for a mandatory education requirment.
Mr. PORTMAN. Any other thoughts on that?
Mr. SCHIEBER. I would support it also. You may also want to
consider letting plan sponsors use employee assets during the
blackout periods to minimize the blackout periods. We were
listening earlier that when the sponsors are fiduciaries here,
they are supposed to have the participants' interests as their
primary concern. If you look at how the plan sponsors manage
their own money, they wouldn't shut down their accounts
receivable systems for 2 weeks or a month.
But having a transition accounting or administration system
that runs in parallel over a time and allows instantaneous
shift over costs money. And some employers simply can't afford
it, but they could if they could tap some of the plan assets--
and it should not take very much money. It is a small marginal
cost relative to the plan, but it would allow people to protect
themselves.
Mr. PORTMAN. To tap their assets during a blackout period.
Mr. SCHIEBER. I am sorry?
Mr. PORTMAN. The employees would be able to access their
assets during the blackout period.
Mr. SCHIEBER. So plan money could actually be used to run
systems for 2 weeks in parallel, or some period, and then have
an instantaneous switch-over rather than having this blackout
period that runs for a couple of weeks.
Businesspeople themselves don't shut down their financial
operations for 2 weeks because they are changing their
accounting systems.
Mr. PORTMAN. As you know, one of the proposals in the
President's plan is to encourage shorter blackouts by saying
during a blackout you can't trade in company stock, even
outside of a qualified plan, which is an interesting concept,
and one that we don't have time to get into because the red
light is on. Mr. Rangel has a proposal on that as well. His
proposal maintains the jurisdiction of the Ways and Means
Committee, which we all like, provides for an excise tax during
that period, should there be trades. But both of those would be
incentives to reduce that time. I think that makes sense.
Professor Jefferson--I appreciate the Chairman's
indulgence--just quickly, on your idea of a voluntary
insurance. I listened to you, and I am just not sure how it
would work. And I guess when I think through what you would
like to do, wouldn't it be simpler just to say to an employer
you have got to invest in GICs or you have to invest in
treasuries, rather than setting up an elaborate insurance
system. You simply say, as some would say for Social Security
private accounts, you can't go into your brother-in-law's real
estate or even some would say even into equities, you have to
stay in much safer investments, lower risk, lower yield.
Wouldn't that be a simpler way to go about what you are
trying to do?
Ms. JEFFERSON. It may be simpler, but I think that what
happens with the voluntary aspect of my proposal is that it
balances. On the one hand, it does allow the participant to
make a choice about what they want to invest in. But, on the
other hand, it provides some type of guarantee.
So I think that is does strike a balance differently than
requiring them to----
Mr. PORTMAN. Would this simply be a new Federal subsidized
plan, in other words, a new qualified plan that employers would
have the option to offer or not offer, much as 401(k)s are.
There is no requirement, as you know, to provide a defined
contribution or a defined benefit plan. You wouldn't change
that?
Ms. JEFFERSON. I am sorry. Would you repeat the question
please?
Mr. PORTMAN. You wouldn't require employers then to provide
this? It would be voluntary on the part of employers as well?
Ms. JEFFERSON. That is correct. It would be voluntary. And,
also, one of the distinctions between this model and what is
available for defined benefit plans is that the premiums would
be risk-based and economically derived. So what that means is
that the insuring institution should be economically no better
off or worse off for having established the program.
So, as I said, one of the major differences between the
PBGC insurance and what I am proposing is that it would not be
a situation where there would be a flat premium rate. As a
result, the premium rate would not be a flat rate but would be
based on the risk exposure of the account.
Mr. PORTMAN. So the market would decide what the rate is.
It is a different kind of insurance, obviously, because in a
sense PBGC doesn't insure the plan as much as the company.
Ms. JEFFERSON. That is exactly right.
Mr. PORTMAN. In other words, PBGC doesn't guarantee the
return. The company does.
Ms. JEFFERSON. But the end result would be the same, there
would be some guarantee for the participant. And I think that
is where there would is similarity. But you are correct the
insurance and the triggering events for payment would be
structured differently because the plans are different.
Mr. PORTMAN. I guess my time is up, and I won't take any
more time of the Committee. But, again, I really appreciate the
input, and particularly the facts. We just need to get more of
the facts here. And I think when you look at the 401(k)
experience over the last 20 years, it has been remarkably
successful. We have tinkered with it recently to try to make it
even more successful and, frankly, expand it to smaller
businesses, which is the big challenge. And I think the next
big challenge is to give people more security after Enron and
to provide more education and advice. I hope you will help us
do that. Thank you, Mr. Chairman.
Mr. McCRERY. Mr. Pomeroy.
Mr. POMEROY. Thank you, Mr. Chairman.
First of all, I want to begin by commending Professor
Jefferson. One of your former students, Alane Allman, is
staffing me on pension and Social Security issues for my Ways
and Means assignment, and she is doing an absolutely superb
job, so she must have been well trained somewhere. I give you
part of the credit. You were her tax professor.
Ms. JEFFERSON. Thank you.
Mr. POMEROY. You know what? I think as we talk about the
wonderful success of 401(k)s--and they certainly have played a
very important role in people preparing for retirement--it
would do well for us to look at what we have lost by way of
retirement security as we move from a defined benefit to a
defined contribution format. We ought to reflect on that a
little.
Now, that doesn't really get to Enron issues and the fix du
jour. It gets to more of the structure of U.S. retirement
programs and whether or not we ought to rethink or at least try
to revitalize pensions as a lower-risk, annuitized, lifetime
stream of income in retirement that had a lot going for it.
Mr. Vanderhei, I know that EBRI has done some research in
this area. Can you tell us the average balance in a 401(k) plan
for a worker in----
Mr. VANDERHEI. We don't have year-end 2001 data, but it is
just shy of $50,000. But I would like to make a very important
caveat on that. That is with the most recent employer. As you
know, many employees will go through their careers with several
different employers, and when they change jobs, they will
either leave that money with the previous employer, roll it
over to the new employer, perhaps cash it out, or as is being
done more and more often today, roll it over to an IRA.
In all the simulations we have done, the IRA rollover
market in the future swamps defined contribution plans. It
swamps defined benefit plans. So when you look at the $50,000,
I would just caution, don't look at that and say that is all
401(k)s are contributing to retirement security, because
401(k)s are generating those IRA rollovers that will be a very,
very large part of the future retirement income security for
those individuals.
Mr. POMEROY. I think it is important to have the full
context of whether or not these accounts show alarmingly
insufficient balances or somewhere near adequate balances. Do
you have any idea what kind of annuity payment you could buy
for 50 grand at the age of 65?
Mr. VANDERHEI. Well, if you want to look at age 65, then I
would say forget the $50,000 I just told you and take a look at
what we have for people in their 60s that have basically been
with an employer for their entire career. The only reason I am
doing that is it prevents the IRA leakages that I just referred
to.
I could check the exact figure for you, but I believe it is
approximately $200,000 that we came up with for year-end 2000.
Mr. POMEROY. I have the following concerns, and not just
about asset diversification, whether or not there is sufficient
savings occurring in the 401(k). And then one aspect that we
are really going to begin to wrestle with, but haven't yet is
that upon retirement are these assets matched to an average
life span? Are they being dissipated unduly quickly?
Syl, have you done any--Mr. Schieber, have you----
Mr. SCHIEBER. First of all, you and I would both like to go
back to the defined benefit world, and we would like to see
people reach retirement age with a 30-year career under their
belt at that last employer, and then convert their--get an
annuity and live happily ever after and go fishing as
frequently as they could and what have you.
The world isn't built that way, and it is a shame, but it
is just not. The problem is workers move around, and even the
ones that are participating in the defined benefit plans today,
when they get to the end of their career, many of them haven't
had 20 years or 30 years in that plan. It is a relatively short
period.
Many of them work their first 10 or 15 years under one of
those plans and go somewhere else, and the benefit they get out
of them isn't all that generous.
There have been some market forces that have pushed people
in this direction.
Mr. POMEROY. There was some horrific data about leakage at
the time of change. Is that getting any better? It was about--a
cashed-out plan, something like two-thirds of them weren't
being----
Mr. SCHIEBER. But it is the small accounts that are
leaking. The big accounts aren't. You know, young people turn
over a lot more than older people. You know, until you are 25
or 30, in many cases you don't settle down. There are a couple
of professors at Dartmouth who have looked at this issue,
Jonathan Skinner and Andrew Samwick. And they have simulated
workers' participating in defined benefit and defined
contribution plans over a whole career, and they have taken
account of job change. They have taken account of the pattern
of leakage that goes on. And their conclusion is that the
defined contribution plans are doing as good a job if not a
better job than the defined benefit plans because of the way
they work and because of mobility within the work force.
You know, it would be nice to get back to the good old
days, but I am afraid we are kind of caught with what we----
Mr. POMEROY. Actually, we can't turn the clock back, but I
am thinking that maybe looking at--instead of just recognizing
worker choice and freedom relative to retirement funds as the
ultimate objective of a worker's retirement account, I believe
retirement income security is the ultimate objective and
helping the worker manage risk, you know, asset accumulation
risk, investment risk, and asset drawdown risk----
Mr. SCHIEBER. Don't forget longevity.
Mr. POMEROY. Right.
Mr. SCHIEBER. You are right. One of the problems, though,
is this word ``retirement.'' We designed our system around what
we thought of the world back in the 1930s, and a lot of things
have happened since the 1930s, but we have hung on to this idea
of retirement set back then. And, if anything, we made
retirement a bit more generous since then. But the realities of
our demographics are changing on us in a way that demonstrates
a real reluctance on the part of people who have to pay for
these programs to continue to insure longevity. Longevity has
really stretched out since the mid-1930s, but we still think of
retiring at 65, or maybe even a little bit earlier. We have
really stretched out the retirement period. But we still want
to get the old benefit level.
Now, if you want to get that old benefit level for a longer
period of time, somebody needs to put a lot more money in the
pot. And we seem to be extremely reluctant to do that. We are
reluctant to do that in Social Security. We are reluctant to do
that in our employer pensions. And I think that is the nub, and
that is what is really pushing, I think in many cases, folks to
go to these defined contribution plans. They are putting the
longevity risk on the workers.
Mr. POMEROY. I am very interested in kind of hybrid
arrangements whereby we might be able to bring more risk
management for the worker into the defined contribution--or DB
proposal, some of these other things under discussion.
Professor, I want you to speak--and the Chairman has been
very lenient with my time. Each of you have contributed so much
to this topic. We could really go on at great length, and I
want to salute the professional achievements each of you have
made in this area. Professor?
Ms. JEFFERSON. I think that the points that you make are
very good ones. There are actually two distinct problems. There
is one problem with accumulating enough assets, and then there
is another problem with making sure the assets are used for
retirement.
Studies show that leakage is related not only to age but
also to income. Therefore, low-income individuals who receive
lump sum distributions before retirement age, are less likely
to roll them over into other retirement savings arrangements.
So the degree to which there is a leakage problem varies within
the population of plan participants relate to age and income.
Mr. POMEROY. I am also interested in ways we encourage more
annuitization of the lump sum at time of retirement, but there
are too many issues to get into. Mr. Chairman, thank you for
your indulgence.
Mr. McCRERY. You are quite welcome, Mr. Pomeroy, and thank
you all very much for your testimony and your patience today.
We appreciate it and look forward to seeing you again.
The hearing is adjourned.
[Whereupon, at 5:27 p.m., the hearing was adjourned.]
[Question submitted from Mr. McInnis to Mr. Weinberger, and
his response follows:]
Question: I would ask that the Treasury Department review and
comment on the attached proposal, designed to better enable people to
save for retirement. This proposed language would extend the current
tax-free exchange treatment under IRC section 1035 to situations where
a taxpayer consolidates one existing annuity into another existing
annuity, for two new annuities, or may even take two existing annuities
and exchange them for one new annuity--without triggering recognition
of income or tax. The policy behind IRC section 1035 is to allow
taxpayers the flexibility to shift their annuity savings to the best
vehicle, with better rates or terms. That policy is also served with my
proposal by allowing taxpayers the flexibility to consolidate two
existing annuities into one already existing annuity. My proposal would
deem such a consolidation of annuities to be an exchange, and includes
language to prevent abuse or ``leakage'' of funds.
Given today's hearing on retirement issues, I would ask the
Treasury Department's position regarding the attached proposal. My
proposed language is a very minor change to IRC section 1035. It is my
thought that the situation addressed by this proposal was simply not
foreseen when IRC section 1035 was drafted. There is ample evidence
that these annuities are used for retirement savings. A 1999 Gallop
survey found that 81% of all people who purchased non-qualified
annuities, and 94% of people under age 64, did so for retirement
income. Given the focus of today's hearing, I would ask the Treasury
Department to comment on this proposal to allow appropriate flexibility
for taxpayers who use these annuities for retirement income.
I look forward to your response and continuing this dialog on how
to encourage saving for retirement.
______
AMENDMENT OFFERED BY MR. MCINNIS
At the appropriate place in the bill insert the following new
section:
SEC. ______. REINVESTMENT OF SURRENDERED ANNUITY PROCEEDS INTO
CERTAIN EXISTING ANNUITY CONTRACTS TREATED AS AN EXCHANGE.
(a) IN GENERAL.--Section 1035 (relating to certain exchanges of
insurance policies) is amended by redesignating subsection (d) as
subsection (e) and by inserting after subsection (c) the following new
subsection:
``(d) REINVESTMENT OF SURRENDERED ANNUITY PROCEEDS INTO EXISTING
ANNUITY CONTRACT TREATED AS AN EXCHANGE.--A transaction shall not fail
to be treated as an exchange for purposes of subsection (a)(3) by
reason of the fact that the proceeds of the surrendered annuity
contract are invested in an existing annuity contract if----
``(1) the transaction would be treated as an exchange under this
section were the surrendered annuity contract and the existing annuity
contract surrendered in exchange for a new annuity contract having the
same obligee and insured as the existing annuity contract, and
``(2) such proceeds are received directly by the issuer of the
existing annuity contract from the issuer of the surrendered annuity
contract.''
(b) EFFECTIVE DATE.--The amendment made by this section shall apply
to contracts surrendered after the date of the enactment of this Act.
______
Answer: The Treasury Department believes that transactions
involving the consolidation of annuity contracts are tax-free under
current law section 1035. We are working with the IRS to issue guidance
in the near future that will clarify this position.
Statement of Wayne Moore, American Prepaid Legal Services Institute,
Chicago, Illinois
Mr. Chairman and Members of the Committee:
I am Wayne Moore, President of the American Prepaid Legal Services
Institute. The American Prepaid Legal Services Institute (API) is a
professional trade organization representing the legal services plan
industry. Headquartered in Chicago, API is affiliated with the American
Bar Association. Our membership includes the administrators, sponsors
and provider attorneys for the largest and most developed legal
services plans in the nation. The API is looked upon nationally as the
primary voice for the legal services plan industry.
The hearing today deals with protection of retirement benefits for
employees participating in defined contribution pension plans. Current
Department of Labor statistics put the number of Americans
participating in 401(k) plans at 42 million, with over $2 trillion in
assets invested. Although the pension issues in the Enron situation
have brought employer restrictions on 401(k) plans into the national
spotlight, there are other important pension security issues that
should and can be addressed by a simple system.
Our society, as Chairman Thomas noted in calling this hearing, is
highly mobile, and retirement plans have become increasingly more
portable to accommodate that mobility. When employees change jobs or
retire, funds must be rolled into another qualified plan. It is during
this rollover period that the employee and the funds are at the highest
risk. Unfortunately, there are unscrupulous brokers who take advantage
of employees' vulnerabilities and advise investment of these retirement
savings in risky, inappropriate or fraudulent schemes.
Achieving a balance between promoting and protecting retirement
savings will be difficult. However, a system already exists to help
employees deal with some of these retirement security issues without
costly over-regulation of pension funds. This mechanism is the
qualified group legal services plan under IRC Section 120.
When Congress first enacted Internal Revenue Code Section 120 in
1976, employers were provided with an incentive to provide their
workforce with group legal services benefits at modest cost. These
benefit programs enable employees to contact an attorney and get advice
and, if necessary, representation. Most plans cover the everyday legal
life events that we all expect to encounter, from house closings and
adoptions to traffic tickets and drafting wills. However, the provision
expired in 1992, eliminating this valuable benefit's favorable tax
status.
As part of the 2001 tax bill, President Bush signed an amendment to
Internal Revenue Code Section 132(a) adding qualified retirement
planning services to the list of statutory exclusions from gross
income. These services are defined as ``any retirement planning advice
or information provided to an employee and his spouse by an employer
maintaining a qualified employer plan.'' A logical extension of the
sound public policy behind the amendment to Section 132, is to
encourage access to the legal services that will surely arise out of
any comprehensive retirement planning, including wills and trust
documents. It is a consistent policy decision to encourage employers to
provide legal services, as well as retirement planning services.
In the area of pension benefits, access to a group legal plan can
increase the security of employees' retirement savings. President Bush,
in discussing his retirement security plan at the 2002 National Summit
on Retirement Savings stated, ``Americans can help secure their own
future by saving. Government must support policies that promote and
protect saving. But there's still more to do. Even when people are
saving enough, they need to feel more secure about the laws protecting
their savings.''
Qualified employer-paid plans have proven to be highly efficient.
These arrangements make substantial legal service benefits available to
participants at a fraction of what medical and other benefit plans
cost. For an average employer contribution of less than $100 annually,
employees are eligible to utilize a wide range of legal services often
worth hundreds and even thousands of dollars, which otherwise would be
well beyond their means.
In addition to the efficiency with which these plans can deliver
services, their ability to make preventive legal services available
results in additional savings in our economy. Group legal plans give
investors access to legal services, before they are induced to make
unwise investments. Having a lawyer available to review the investment
documents could mean the difference between a comfortable retirement
and lost life savings. Group legal plan attorneys add a layer of
security to the system.
Here are a few brief examples of how legal plan attorneys were able
to provide retirement security. Keep in mind that regardless of the
system, we all have the same goal: promotion of voluntary employer-
based retirement options and the protection of those retirement
savings.
In Kokomo and Marion, Indiana group legal plan attorneys are
working with 50 plan members who were among hundreds of individuals
taken in by a sophisticated investment scam. Between $22 and $30
million has disappeared. This represents the life savings of working
couples who put away money in IRAs and 401(k) accounts for 20 years.
When it came time to roll it into an account they could draw upon
during the retirement for which they had worked so hard, they put their
trust in the wrong person.
Joe Smith (not his real name) had lived in the Marion, Indiana area
for twenty years. He operated two investment businesses. Records show
that between 1997 and January 1999, Smith deposited over $3.3 million
into one account alone. He told investors that he was trading in
commodity futures although he is not registered with the Commodity
Futures Trading Commission (CFTC). He claimed it was a ``safe
investment'' and he could triple their money. Smith created false trade
logs purporting to show millions of dollars in trades. However, CFTC
records show no actual trades made by any accounts controlled by Mr.
Smith. Soon after his first meeting with the CFTC to discuss the
discrepancies, Mr. Smith disappeared. Investigators said that after
following a paper trail they were able to put a human face on the
tragedy at the courthouse where they talked with 40-50 of Smith's
customers. There they saw the emotional and financial toll Smith and
his scam had taken on these people. The FBI is still looking for Mr.
Smith in connection with securities and internet fraud.
If these unscrupulous brokers can get $22 million in Kokomo, how
much retirement money is being stolen across the country? The group
legal plan attorneys, working with local and federal prosecutors, have
already recovered $3 million. This particular group legal plan has 75
offices nationwide and covers almost one million Americans, all of whom
have retirement savings that could be at risk. Group legal plans can
give investors somewhere to turn for a second opinion on an investment
vehicle that sounds too good to be true and somewhere to go for help in
cases of fraud or misrepresentation.
Another office is helping a widow in Ohio recover money she
received from her husband's wrongful death case. When it came time to
invest the settlement funds, she wanted to set up an estate plan that
would provide money to educate family members and make charitable
contributions to her church and community. She turned to a trusted
neighbor who was a broker for assistance in managing this large sum of
money. Unfortunately, he suggested a loan to a business, and when the
money was not returned in accordance with the promissory note or the
broker's repeated promises, the widow called the legal plan office. The
plan attorney was able to get into court within two days and freeze
whatever assets were available. Access to a legal plan meant the
difference between a total loss of this widow's retirement fund and the
hope for a recovery of her money.
Legal plan members from Florida to Washington state were among the
thousands of investors taken in by unscrupulous individuals and
companies promising high returns from fraudulent investments in pay
telephone schemes. Securities regulators in 25 states are working to
identify the nearly 4500 people, most of them elderly, who lost an
estimated $76 million investing in ``coin-operated, customer-owned
telephones.'' Court documents reveal that in the typical pay telephone
scheme, a company sells phones to investors for between $5000 and
$7000. As part of the deal, the company agrees to lease back and
service the phones for a fee. The brokers used promises of 15 percent
annual returns to convince the mostly elderly investors to withdraw
money from their retirement accounts.
A group legal plan office in Canton, Michigan brought arbitration
proceedings against one of the brokers who sold these high-risk
investments. These plan members lost 50% of their retirement savings.
They needed the savings to support one of the spouses as her multiple
sclerosis progressed and medical costs mounted. The broker promised to
double their retirement savings in five years in an investment that was
as safe as a certificate of deposit. The investment was ``Secured'',
there was ``No Market Risk/Income Fluctuation'' and it was appropriate
for ``Use in Qualified Plans--IRA, SEP and Keogh Qualified Plans.'' Her
legal plan's fast action is another good example of how legal plans
provide retirement security. They give workers of moderate means the
access to counsel to combat fraudulent investment schemes by obtaining
injunctions and judgments.
Other plan attorneys have told me that they are able to tell when a
mailing for a new investment scheme goes out, by the increase in calls
to their offices. Legal plan attorneys are able to save the retirement
savings of plan members by reviewing the materials and advising members
on what to look for in investments, given their individual
circumstances. In some instances, plan attorneys have gone to their
state attorneys general with materials and stopped investment scams
before they rob thousands of taxpayers of their retirement savings.
Representative Dave Camp's bill, H.R. 1434, would make permanent
the beneficial tax status of employer-paid legal services benefits.
This bill's passage would stimulate employers to offer group legal
benefits and allow millions of working Americans access to legal advice
when they need it to protect their retirement savings.
As President Bush said in his State of the Union Address: ``A good
job should lead to security in retirement. I ask Congress to enact new
safeguards for 401(k) and pension plans. Employees who have worked hard
and saved all their lives should not have to risk losing everything . .
.''
We recommend the passage of H.R. 1434 as part of any retirement
security package to protect millions of working Americans' retirement
funds.
Statement of the Industry Council for Tangible Assets, Inc., Annapolis,
Maryland
S. 1405 ADDS NEEDED DIVERSITY & SECURITY TO RETIREMENT PLANS
History
While coin investing is certainly not unique to the United States,
the market for rare US coins is the most highly developed coin market
in the world. From 1795--1933 the US produced precious metals coinage
for use in commerce. Twice during the US' two-hundred-year history,
precious metals coins were recalled and melted by the government. These
meltdowns helped transform US coinage from common monetary units into
numismatic investments.
It is generally accepted that upwards of 95% of original mintages
were lost due to mishandling or melting. The small surviving population
of coins forms the backbone of the investment market for rare US coins.
Prior to 1981, all rare coins were qualified investments for
individually-directed retirement accounts. In fact, rare coins remain
as qualified investments today in certain corporate pension plans. The
Economic Recovery Tax Act of 1981 eliminated the eligibility of rare
coins for IRAs by adding Section 408(m) to the USC. Section 408(m)
created an arbitrary category of ``collectibles'' which suddenly were
no longer eligible investments. Regrettably, in 1981, the precious
metals/rare coin industry had no trade association to voice objections,
so this provision was enacted without opposition or benefit of comment.
The Industry Council for Tangible Assets, Inc. (ICTA) was formed in
1983 as a direct result of the 1981 legislation. Had ICTA existed in
1981, we believe that the organization could have easily demonstrated
how the inclusion of precious metals as collectibles was clearly a
mistake. For example, in his testimony before the Senate Finance
Subcommittee on Savings, Pensions and Investment Policy, the then
Assistant Secretary of the Treasury for Tax Policy, John E. Chapoton,
lumped gold and silver into a collectibles category of ``luxury items''
that also included jewelry. Clearly, for centuries the US Federal
Government has disagreed with this characterization insofar as it is
precisely those products that are stored in the government's Fort Knox
facility. Indeed finally, in the Taxpayer Relief Act of 1997, we did
prevail and were successful in having precious metals (gold, silver,
platinum, and palladium bars and coins) restored as qualified IRA
investments.
It is interesting to note that Mr. Chapoton concedes the investment
value of collectibles. However, once again, Mr. Chapoton applied
certain collectibles criteria to rare coins and precious metals that
were not appropriate. In fact, he often cited examples of the uses of
jewelry and silverware as though they applied to rare coins and
precious metals. (His arguments were similar to stating that, while
cotton may be an essential ingredient in the manufacture of clothing
fabric, disposable cotton balls, and currency banknotes, that does not
mean that banknotes are the same as cotton balls.) The testimony
relating to the consumption aspect (for example, a painting or antique
rug may be enjoyed for its original intended function in addition to
its investment potential) is especially irrelevant, since a coin's
original function is to be spent--clearly not something the owner of a
rare $20 gold coin now worth $500 would do. A bill pending in the US
Congress, S.1405, would correct this situation and restore certain
coins as qualified IRA investments
Expanded Safeguards
Beginning in 1986, the market in rare coins became even more viable
for investors with the creation of nationally-recognized, independent
certification/grading services. These companies do not buy or sell rare
coin products. They are independent third party service companies whose
sole function is to certify authenticity, determine grade, and then
encapsulate each rare coin item. Each coin is sonically sealed in a
hard plastic holder with the appropriate certification and bar coding
information sealed within, which creates a unique, trackable item. This
encapsulation serves also to preserve the coin in the same condition as
when it was certified.
These companies employ staffs of full-time professional graders
(numismatists) who examine each coin for authenticity and grade them
according to established standards. Certified coins (as the resulting
product is known) are backed by a strong guarantee from the service,
which provides for economic remuneration in the event of a value-
affecting error.
Unlike most other tangible assets, certified coins have high
liquidity that is provided via two independent electronic trading
networks--the Certified Coin Exchange (CCE) and Certified CoinNet.
These networks are independent of each other and have no financial
interest in the rare coin market beyond the service they provide. They
are solely trading/information services.
Encapsulated coins now enjoy a sight-unseen market via these
exchanges. These electronic trading networks function very much the
same as NASDAQ with a series of published ``bid'' and ``ask'' prices
and last trades. The two networks offer virtually immediate, on-line
access to the live coin exchanges. The buys and sells are enforceable
prices that must be honored as posted until updated. Submission to
binding arbitration, although rarely necessary, is a condition of
exchange membership. Just as investors in financial paper assets access
the marketplace via their stockbroker, investors in rare coins access
the on-line market via their member coin dealer(s). Trades are entered
on these electronic networks in the same manner as trades are entered
on NASDAQ, with confirmation provided by the trading exchange. These
transactions are binding upon the parties.
Why Rare Coins Provide Needed Diversity in Investment Portfolios
Most brokerage firms and investment advisors recommend that persons
saving for retirement diversify their investment portfolios to include
some percentage of tangible assets that are negatively correlated to
financial (paper) assets. Tangible assets tend to increase in value
when stocks, bonds and other financial assets are experiencing a
downward or uncertain trend. It is important that investors have both
tangible asset options--precious metals and rare coins, just as they
have the option of stocks and/or bonds.
The value of precious metals products fluctuates in direct
proportion to the changes in price for each metal (gold, silver,
platinum and palladium) on the commodity exchanges. The rare coin
market is often related to the precious metals markets; however, rare
coins have the added factor of scarcity, which adds to the stability of
the market. For instance, a US $20 gold coin contains .9675 troy ounces
of gold (almost a full ounce.) While the bullion-traded gold one-ounce
American Eagle coin's price will fluctuate daily in accordance with the
spot gold price, the US $20 will resist downward pricing since its
value is in both its precious metals (intrinsic) content and its
scarcity factor. To illustrate, today, with the gold spot price at
$292, a one-ounce gold American Eagle bullion coin ($50 face value)
retails for $303.50. The minimum investment grade US $20 face value
gold coin (.9675 ounces of gold) retails for $424. The American Eagle
gold coin has a higher face value and a slightly higher gold content,
yet the value of the US $20 rare coin is $120 greater. While even
``blue chip'' stocks can become worthless (Eastern Airlines, for
example), precious metals and rare coins can never be worth less than
the higher of their intrinsic or legal tender face values.
What's Wrong With the Current Law
An independent study * prepared for the Joint Committee on Taxation
found that the inclusion of rare coins and precious metals in a
diversified portfolio of stocks and bonds increased the portfolio's
overall return while reducing the overall risk of that portfolio. In
fact, rare coins remain a qualified investment product for corporate
pension plans. The average American investor should not be penalized
for not having that particular tax-advantaged program available to him/
her, and it would be only equitable to permit such investment options
for those individually-directed retirement accounts. Removing current
restrictions would allow small investors, whose total investment
program (or most of it) consists of their IRAs or other self-directed
accounts, to select from the same investment options currently
available to more affluent citizens.
---------------------------------------------------------------------------
* An Economic Analysis of Allowing Legal Tender Coinage and
Precious Metals as Qualified Investments in Individually-Directed
Retirement Accounts by Raymond E. Lombra, Professor Economics,
Pennsylvania State University, February, 1995; updated April, 2001.
Available from ICTA, PO Box 1365, Severna Park, MD 21146-8365;
telephone 410-626-7005; e-mail ictaonline.org
---------------------------------------------------------------------------
In addition, the current law creates the inequitable result that
occurs when an individual leaves one job and its related pension and
profit-sharing plan. When employees leave or are terminated, they are
usually excluded from the employer's pension and profit-sharing plan.
There is currently no provision for a conduit IRA that allows them to
transfer any rare coins that may be part of this plan. The result is
that the item must be liquidated--regardless of whether such
liquidation is to the employee's benefit or detriment at that time. The
only alternative--accepting the distribution in its rare coin form--
renders this a taxable event. This is obviously an inequitable and
unintended result.
Benefits of S. 1405
S. 1405 simply restores rare coins to the menu of options for
investors and allows them to diversify and stabilize their retirement
portfolios. It would also allow these products to be rolled over from
one plan to the employee's conduit IRA or new plan.
Important Provisions of S.1405
Investment coins purchased for individually-directed
retirement accounts must be in the possession of a qualified, third-
party trustee (as defined by the IRS), not the investor.
Coins eligible for inclusion in an individually-directed
retirement account must be certified by a recognized third-party
grading service, i.e., graded and encapsulated in a sealed plastic
case. Each coin, therefore, has a unique identification number, grade,
description, and bar code.
Only those coins that trade on recognized national
electronic exchanges or that are listed by a recognized wholesale
reporting service are eligible for inclusion.
Recent Action Taken by the US Congress and the States
The Taxpayer Relief Act of 1997 restored certain precious metals
bullion as qualified investments for IRAs. This was the first step in a
two-step process. The restoration of certain certified coins will
complete the restoration of these important products as acceptable for
individually-directed retirement accounts.
The Joint Committee on Taxation has concluded that the inclusion of
rare coins would have negligible economic impact on federal revenues.
There is broad, bipartisan support for the inclusion of rare coins
as qualified investments in individually-directed retirement accounts,
led by Senator John Breaux.
The independent study * done for the Joint Committee on Taxation
found that the inclusion of rare coins and bullion in a diversified
portfolio of stocks and bonds increased the portfolio's overall return
at the same time that it reduced risk. By purchasing rare coins in
their IRAs, investors are able to keep tangible assets in their
retirement plans over the long-term and, when they increase in value,
sell them for a profit and reinvest the proceeds without having to
immediately pay taxes on the gain.
Some of the conclusions of the study done for the Joint Committee
on Taxation appear to have relevance to current economic conditions.
The study reported that stocks and rare coins had the highest rates of
return over a 20-year period and the statistical analyses reveal that
rare coins are inversely related to stocks in a stock bear market
(e.g., the collapse in stocks in 1987 triggered a major bull market in
rare coins) but also, on occasion, are positively related to stocks
during stock bull markets (e.g., the recovery in stocks after the '87
crash did nothing to slow the bull market in rare coins). For the
majority of the period analyzed, the study showed that rare coins did
best when bear markets in stocks sent investors looking for alternative
investments.
Twenty-six states have exempted coins and precious metals from
sales tax because they recognize them to be investment products. In
seven additional states, such exemption legislation is under
consideration.
We believe that this legislation is consistent with Congress'
desire to encourage U.S. citizens to save/invest more and to take
personal responsibility for retirement. In addition, tangible assets
are real, not paper, investments that will never lose their intrinsic
value and which maintain an orderly, easily-transacted, and portable
marketplace. They provide today's investors with security for the
future just as they have for thousands of years.
Statement of the International Mass Retail Association, Arlington,
Virginia
The International Mass Retail Association (IMRA) is the world's
leading alliance of retailers and their product and service suppliers--
IMRA speaks for the trillion-dollar mass retail industry in Washington.
American consumers prefer mass retailers to all other shopping options
for the unmatched price, value and convenience they offer. Mass
retailers have revolutionized the way America shops, re-engineered the
global supply chain and redefined relationships between sellers and
suppliers. Today, mass retailers create markets for consumer products
here at home and around the world. Mass retailers are also some of the
largest employers in America, creating millions of good jobs for hard
working people of all skill levels. Many mass retailers provide
comprehensive retirement savings options and profit sharing
opportunities to most of their employees.
As Congress looks into the retirement savings losses suffered by
Enron employees as a result of the company's bankruptcy and reviews
whether reforms are needed to protect employees' savings, the member
companies of IMRA urge you to take a careful and measured approach to
any legislative changes. We applaud you for beginning that important
deliberative process by holding today's hearing.
The Importance Of Retirement Savings
American workers have come to realize that company-sponsored
pensions, 401(k) and other deferred compensation plans, and profit
sharing and stock ownership plans, are important supplements to Social
Security to help them maintain a comfortable standard of living during
their retirement years. The mass retail industry appreciates the
important role these additional retirement savings tools play and many
mass retail companies offer retirement savings plans and profit sharing
opportunities to most employees--including hourly, part-time employees.
Some Proposed Legislative Changes Could Hurt Retirement Savings
While it is certainly no one's intention to change pension and
retirement savings laws in a way that would deter companies from
offering these important benefits to their employees, IMRA is concerned
that some of the proposals could have that unintended effect. We urge
members of Congress to listen to the business community when we say
that certain proposals could cause employers to discontinue offering
these very successful, but wholly voluntary benefits to employees. Mass
retailers that provide retirement benefits understand that such savings
plans are a good arrangement for employees and that they help our
industry attract and retain high-quality employees. If these benefits
become too expensive, mass retailers--companies that operate on
extremely thin profit margins--might have no alternative but to scale
back or eliminate benefits.
Employee Stock Ownership Plans (ESOPs)
Some mass retailers have established ESOPs as a vehicle to hold
employer contributions of stock. ESOPs offered by mass retailers are
often available to most employees, including part-time, hourly
employees. The mass retail industry can suffer from a high turnover of
employees, yet mass retailers prefer to retain skilled employees, as
knowledge of the stores and the products they sell is important to
providing top-notch customer service. Mass retail companies that
provide profit sharing offer employees an incentive to remain with the
company and give employees an ownership stake in and pride in the
company. Employees with an ownership stake in their company have a
strong incentive to reduce waste and promote efficiency, which is so
important to the mission of mass retailers: providing high-quality
products at low prices with first-rate customer service. A study
available from the National Center for Employee Ownership shows
``unambiguous evidence that broad-based stock option companies had
statistically significantly higher productivity levels and annual
growth rates compared to non-broad-based stock option companies.'' \1\
---------------------------------------------------------------------------
\1\ Joseph Blasi, Douglas Kruse, James Sesil, Maya Kroumova, Public
Companies with Broad-Based Stock Options: Corporate Performance from
1992-1997, available electronically at http: //www.nceo.org/library/
optionreport.html.
---------------------------------------------------------------------------
Proposals that would require diversification of ESOP holdings
after as little as five years would change the fundamental nature of
ESOPs and would cause serious administrative problems. ESOPs were
designed to facilitate employee ownership of companies, but requiring
diversification frustrates that goal by mandating investment in
vehicles other than, or in addition to, company stock. Also, requiring
diversification after as little as five years (regardless of a
participant's age) would cause great administrative problems,
particularly for accounts of lower-wage or part-time employees that can
hold less than $5,000 even after five years in the program. Requiring
diversification of accounts holding such relatively small amounts would
create an administrative burden out of proportion to the account
balance, causing companies to rethink whether giving such profit
sharing opportunities to a broad group of employees is cost-effective.
401(k) Plans Combined with ESOPs (KSOPs)
Some mass retailers, like other companies, have combined their
401(k) plan with their ESOP. Companies that use these so-called
``KSOPs'' use ESOP contributions to match employees' contributions to
the 401(k) plan. Companies benefit from such an arrangement because the
employer contributions help avoid violating the anti-discrimination
rules (by attracting lower-wage employees into the plan) and because it
provides an attractive vehicle for giving employees company stock, and
thereby obtaining the benefits of ownership and pride in the company,
described above. Employees benefit because the employer match is,
essentially, free stock in their company, and because it provides a
tremendous incentive for employees to participate in their retirement
savings plan. Employer ESOP contributions to match 401(k) contributions
are tested as 401(k) matches, which makes them attractive to the
company; they are still tested, but do not have to go through the
additional ESOP allocation rules. Companies see a benefit in matching
employee contributions because it helps them attract employees, and it
helps employees save for their retirement. If Congress removes the KSOP
matching option, some companies may choose to match in cash, but many
others may not; and if they cannot satisfy the anti-discrimination
rules, they may not be able to offer a retirement savings vehicle to
their rank-and-file employees.
Holding Period Limitations
Like a lot of companies, many mass retailers match employee
contributions to retirement savings plans--such as 401(k) plans--with
either company stock or cash that the employee can invest in one of
several investment options. Similarly, many employers provide non-
elective contributions of employer stock. Employers may match in
employer stock to give employees an ownership stake in the company and
because it is less costly than matching in cash. Legislation that
eliminates an employer's ability to restrict the sale of company stock
given as a match or as a grant after an employee has a certain amount
of time with a company frustrates the employer's purpose of giving the
employee an ownership interest in the company. IMRA agrees that it is
reasonable to place limits on the length of time an employer may
restrict its stock given as a match, but we believe that employers must
be able to place some reasonable restriction on the sale of each block
of stock given to an employee. Without being able to require a
reasonable holding period, employers might be deterred from giving
company stock at all; and if they do not give company stock, they may
decide to reduce or eliminate their match.
Percentage Caps on Employer Stock
While most mass retail company retirement plans hold only a small
percentage overall of employer stock, some employees choose on their
own to hold a significant percentage of their retirement savings in
company stock. Plan participants that have had the benefits of
diversification explained to them should be able to direct their
investments as they choose. While the purported reason for such caps is
to protect employees' savings should their employer goes out of
business, in truth it is employees and their retirement savings that
would be harmed by the caps. Caps would force plan participants to sell
employer stock at a time when such a sale might be against their
interests. Furthermore, percentage caps would cause problems for
companies that match in employer stock, and could lead to fewer
companies providing matching contributions.
Notifications, Periodic Plan Statements
Several legislative proposals call for quarterly statements for
plan participants. While IMRA agrees that plan participants need
information about their retirement savings investments, we urge
Congress to consider that access to plan information can be made
available in many forms, including electronic access. Indeed, some
employer sponsored plans provide instant electronic access to
individual accounts at all times of day or night, so requiring mailed
quarterly statements, for example, is simply an unnecessary and costly
government mandate.
Conclusion
Mass retailers strive to be good employers by providing a wide
variety of retirement savings options for their employees. Millions of
mass retail employees are saving for their retirements because their
companies are able to offer them one or more retirement savings plans.
Many employees are able to save even more for their retirements because
their employers see a benefit in making non-matching contributions to
their employees or matching their employees' retirement savings
contributions, either in stock or in cash. Through these plans, many
countless employees have had corporate ownership opened up to them;
something that might not otherwise have been a possibility. As Congress
contemplates how to make employer sponsored retirement savings plans
operate better for employees, IMRA encourages you to make improvements
that will help employees make sound decisions about their investment,
but to avoid legislative changes that would only make it more costly
for companies to offer these important, successful and voluntary plans
for their employees.
Statement of the Investment Company Institute
The Investment Company Institute (the ``Institute'') \1\ is pleased
to submit this statement to the House Committee on Ways and Means with
regard to retirement security issues and the rules that govern defined
contribution plans. The U.S. mutual fund industry serves the retirement
savings and other long-term financial needs of millions of individuals.
By permitting individuals to pool their savings in a diversified fund
that is professionally managed, mutual funds play an important
financial management role for American households.
---------------------------------------------------------------------------
\1\ The Investment Company Institute is the national association of
the American investment company industry. Its membership includes 9,040
open-end investment companies (``mutual funds''), 487 closed-end
investment companies and 6 sponsors of unit investment trusts. Its
mutual fund members have assets of about $6.952 trillion, accounting
for approximately 95% of total industry assets, and over 88.6 million
individual shareholders.
---------------------------------------------------------------------------
Mutual funds also function as an important investment medium for
employer-sponsored retirement programs, including section 401(k) plans,
403(b) arrangements and the Savings Incentive Match Plan for Employees
(``SIMPLE'') used by small employers, as well as for individual savings
vehicles such as the traditional and Roth IRAs. As of December 31,
2000, about $2.4 trillion in retirement assets, including $1.2 trillion
in IRAs and $766 billion in 401(k) plans, were invested in mutual
funds. This represented about 46 percent of all IRA assets and 43
percent of all 401(k) plan assets.\2\ In addition, the mutual fund
industry provides a full range of administrative services to employer-
sponsored plans, including trust, recordkeeping, and participant
education services.
---------------------------------------------------------------------------
\2\ Mutual Funds and the Retirement Market in 2000, Fundamentals,
Vol. 10, No. 2, Investment Company Institute (June 2001).
---------------------------------------------------------------------------
Retirement security is of vital importance to our nation's future.
The Institute has long supported efforts to enhance retirement security
for Americans, including efforts to encourage retirement savings
through employer-sponsored plans and IRAs, simplify the rules
applicable to retirement savings vehicles, and enable individuals to
better understand and manage their retirement assets. Accordingly, in
light of the Committee's inquiry and hearing on these important
matters, we offer three recommendations.
First, we urge Congress to make permanent the crucial improvements
made to our pension laws in the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA). As the Committee is aware, unless
there is congressional action, the provisions of EGTRRA will expire on
December 31, 2010.
Second, the Institute recommends that Congress simplify the rules
governing retirement savings vehicles. In particular, we urge the
repeal of the complex income eligibility rules applicable to IRAs--
rules that effectively have deterred many eligible individuals from
using these vehicles to save for retirement. The rules on required
minimum distributions from retirement plans and the various rules that
govern different types of defined contribution plans also should be
simplified.
Finally, Congress should enhance participant access to professional
investment advice with regard to their pension plan investments. The
House has already acted decisively in passing H.R. 2269, the Retirement
Security Advice Act, to expand the availability of advisory services to
participants and beneficiaries. We urge swift enactment of this
important legislation, which will provide individuals with the tools
they need to appropriately invest their retirement assets.
I. A Shift in the Pension Landscape
The past few decades have witnessed a remarkable shift in the way
Americans save for retirement. When the Employee Retirement Income
Security Act (ERISA) was enacted in 1974, defined benefit plans were
the primary private sector retirement vehicle for employees. Since the
passage of that landmark legislation, defined contribution plans have
grown to become an equally important medium through which workers save
for retirement. From 1975 to 1998,\3\ the number of participants in
defined contribution plans nearly quintupled from 12 million to almost
58 million. The number of defined contribution plans tripled. In 1975,
$74 billion was held in defined contribution plans; today, assets in
defined contributions plans stand at about $2.3 trillion, of which $1.8
trillion is held in 401(k) plans.\4\ At the individual participant
level, 401(k) plan participants had an average account balance at their
current employer of nearly $50,000 as of year-end 2000. Individuals in
their 60s with at least 30 years tenure at their current employer had
average account balances in excess of $177,000.\5\
---------------------------------------------------------------------------
\3\ The most recent data available from the Department of Labor is
for 1998. Private Pension Plan Bulletin, Abstract of 1998 Form 5500
Annual Reports, U.S. Department of Labor, Pension and Welfare Benefits
Administration (Winter 2001-2002).
\4\ Private Pension Plan Bulletin, Abstract of 1998 Form 5500
Annual Reports, U.S. Department of Labor, Pension and Welfare Benefits
Administration (Winter 2001-2002); Mutual Funds and the Retirement
Market in 2000, Fundamentals, Vol. 10, No. 2, Investment Company
Institute (June 2001).
\5\ 401(k) Plan Asset Allocation, Account Balances, and Loan
Activity in 2000, Holden and VanDerhei, Perspective, Vol. 7, No. 5,
Investment Company Institute (November 2001).
---------------------------------------------------------------------------
Participant-directed defined contribution plans offer many features
that are attractive to employees. First, the portability offered under
defined contribution plans is well-suited to today's mobile
workforce.\6\ Participants in defined contribution plans are generally
able to take their retirement assets with them and maintain their value
as they move from job to job. The major tax legislation enacted last
year--EGTRRA--has enhanced the portability of retirement assets,
allowing rollovers between different types of retirement plans, such as
401(k) plans, 403(b) arrangements, government-sponsored 457 plans, and
IRAs. The ability to do so enables individuals to consolidate,
efficiently manage, and better preserve and enhance the value of their
retirement savings.
---------------------------------------------------------------------------
\6\ See Debunking the Retirement Myth: Lifetime Jobs Never Existed
for Most Workers, Issue Brief No. 197, Employee Benefit Research
Institute (May 1998).
---------------------------------------------------------------------------
Second, participants in self-directed defined contribution plans
have greater control of their retirement investments. For instance,
401(k) participants have the ability to select from among an average of
12 investment alternatives;\7\ the choice permitted in such plans
stands in contrast to the traditional defined benefit plan model, under
which plan sponsors or appointed investment managers exclusively manage
pension assets.\8\ Furthermore, for participants that wish to minimize
risk in their 401(k) accounts, most plans offer conservative investment
options, such as guaranteed investment products, money market funds and
fixed-income investment vehicles.
---------------------------------------------------------------------------
\7\ 44th Annual Survey of Profit Sharing and 401(k) Plans, Profit
Sharing/401(k) Council of America (2001).
\8\ The growth of the 401(k) and other self-directed retirement
plans has also enabled a greater number of Americans to own equity
investments. See Equity Ownership in America, Investment Company
Institute and the Securities Industry Association (Fall 1999). For
example, approximately 29 million households--representing 27.9 percent
of U.S. households--and 39.9 million individuals owned stock mutual
funds inside employer-sponsored retirement plans in 1999.
---------------------------------------------------------------------------
Third, individual account-based plans provide a visible,
understandable account value. Concepts applicable to defined
contribution plans such as salary deferral and employer matching
contributions are straightforward and easy to understand. In
particular, where mutual funds are offered as investment options in a
401(k) plan, investors are able to identify the accurate and current
value of their accounts, as mutual fund shares are valued on a daily
basis.
Despite the successes of participant-directed retirement plans,
however, policymakers must remain vigilant to assure that our pension
laws provide individuals with sufficient opportunities and incentives
to save, clear and understandable rules that govern long-term savings
vehicles, and the education and tools that enable them to make prudent
decisions with regard to their retirement savings. Consistent with
these objectives, the Institute offers the following recommendations.
II. Make Permanent the Retirement and Education Savings Provisions of
EGTRRA
Last year, Congress made sweeping, long-awaited enhancements to our
nation's pension laws by enacting EGTRRA. Among the numerous
improvements made to the private retirement system, the legislation:
increased the 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,
governmental 457 plans, and defined benefit plans;
provided for ``catch-up'' contributions to be made by
individuals 50 and over to their pension plans and IRAs; and
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.
The legislation also created additional long-term savings
incentives for education savings vehicles such as Code section 529
qualified tuition programs and Coverdell education savings accounts
(formerly education IRAs).\9\
---------------------------------------------------------------------------
\9\ EGTRRA provisions relating to 529 plans, among other things,
(1) exclude distributions used for qualified higher education expenses
from gross income, (2) replace the current state-imposed ``more than de
minimis penalty'' on nonqualified distributions with a federal 10
percent tax, (3) permit rollovers of amounts between 529 programs for
the same beneficiary, and (4) permit a change in designated beneficiary
to ``first cousins.'' With regard to Coverdell accounts, changes made
by EGTRRA included an increase in the annual contribution limit from
$500 per designated beneficiary to $2,000. These provisions generally
became effective on January 1, 2002.
---------------------------------------------------------------------------
A ``sunset'' provision, however, was included in EGTRRA for
procedural reasons. Thus, all of these (and other important) changes
made by EGTRRA will cease to apply after December 31, 2010. Clearly,
the consequences of inaction on this issue would be detrimental to our
retirement system. For individuals to plan appropriately for their
retirement, they must be able to rely on predictable rules--rules that
apply now and throughout one's career and retirement. The future
termination of these provisions could affect the long-term savings
strategies of working individuals, undermining the purpose of these
pension reforms.
Accordingly, we urge Congress to eliminate the uncertainty by
making permanent the retirement and education savings provisions of
EGTRRA.
III. The Need for Simplification
For savings incentives to be effective, the rules need to be
simple. Too often, however, frequent legislative changes and regulatory
interpretations have led to complicated tax rules that are extremely
difficult for taxpayers to understand. Furthermore, these complexities
make retirement plan administration more difficult and create
disincentives for plan formation. These considerations are also
important to financial institutions when they assess whether to make
long-term business commitments in the retirement savings market.
Such complexities are clearly evident in our nation's pension laws.
Since the passage of the ERISA, there have been over a dozen major
amendments to pension laws and the related tax code sections.\10\ Many
of these legislative changes--most recently, the retirement savings
provisions in EGTRRA which were strongly supported by the Institute--
have provided new savings opportunities by increasing contribution
limits to employer-sponsored retirement plans and IRAs and creating new
savings vehicles, including the Roth IRA, SIMPLE plans and 529
qualified tuition programs. Many amendments to our pension laws,
however, also have added unnecessary complexity and administrative
burdens that serve as disincentives to employers to sponsor retirement
plans and to individuals to save for retirement. Easing these burdens
will promote greater plan formation, coverage and overall retirement
savings.
---------------------------------------------------------------------------
\10\ Since 1994 alone, Congress has passed five substantial pieces
of pension-related tax legislation: the Uruguay Round Agreements Act of
1994, the Uniform Services Employment and Reemployment Rights Act of
1994, the Small Business Job Protection Act of 1996, the Taxpayer
Relief Act of 1997, and EGTRRA in 2001.
---------------------------------------------------------------------------
Last year, the Joint Committee on Taxation made a number of
significant recommendations on the overall state of the federal tax
system.\11\ That study included a number of proposals to simplify the
rules governing various retirement and education savings vehicles. The
Institute reiterates the recommendations made with regard to the Joint
Committee's report.\12\ Here, we specifically focus our recommendations
on the IRA eligibility rules, the required minimum distribution rules
that apply to employer-sponsored plans and IRAs, and the divergent
rules that govern different types of defined contribution plans.
---------------------------------------------------------------------------
\11\ See Study of the Overall State of the Federal Tax System and
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of
the Internal Revenue Code of 1986, JCS-3-01, Joint Committee on
Taxation (April 2001).
\12\ See Statement of the Investment Company Institute for the
Hearing on Tax Code Simplification submitted to the House Committee on
Ways and Means, Subcommittee on Oversight and Subcommittee on Select
Revenue Measures (July 31, 2001); Statement of the Investment Company
Institute submitted to the Senate Finance Committee on the Study of the
Overall State of the Federal Tax System and Recommendation for
Simplification Pursuant to Section 8022(3)(B) of the Internal Revenue
Code of 1986 (May 7, 2001).
---------------------------------------------------------------------------
A. IRA Eligibility Rules
As the Joint Committee recommended in its report last year, the
Institute requests that Congress simplify the rules governing IRAs by
eliminating the phase-out income eligibility restrictions for IRA
contributions and eliminating the income limits on the eligibility to
make deductible IRA contributions. Such simplification would address an
important need: the current IRA eligibility rules are so complicated
that even individuals eligible to make deductible IRA contributions are
often deterred from doing so.
When Congress imposed the current income-based eligibility criteria
in 1986, IRA participation declined dramatically--even among those who
remained eligible for the program. At the peak of IRA contributions in
1986, contributions totaled approximately $38 billion and about 29
percent of all families with a household under age 65 had IRA accounts.
Moreover, 75 percent of all IRA contributions were from families with
annual incomes of less than $50,000.\13\ However, when Congress
restricted the deductibility of IRA contributions in the Tax Reform Act
of 1986, the level of IRA contributions fell sharply and never
recovered--down to $14 billion in 1987 and $8.2 billion in 1998.\14\
Even among families retaining eligibility to fully deduct IRA
contributions, IRA participation declined on average by 40 percent
between 1986 and 1987, despite the fact that the change in law did not
affect them.\15\ The number of IRA contributors with income of less
than $25,000 dropped by 30 percent in that one year.\16\
---------------------------------------------------------------------------
\13\ Promoting Savings for Retirement Security, Stephen F. Venti,
Testimony prepared for the Senate Finance Subcommittee on Deficits,
Debt Management and Long-Term Growth (December 7, 1994).
\14\ Internal Revenue Service, Statistics of Income.
\15\ Promoting Savings for Retirement Security, Stephen F. Venti,
Testimony prepared for the Senate Finance Subcommittee on Deficits,
Debt Management and Long-Term Growth (December 7, 1994).
\16\ Internal Revenue Service, Statistics of Income.
---------------------------------------------------------------------------
Surveys by mutual fund companies also show that about fifteen years
later, many individuals continue to be confused by the IRA eligibility
rules. For example, in 1999, American Century Investments surveyed 753
self-described retirement savers about the rules governing IRAs. The
survey found that changes in eligibility, contribution levels, and tax
deductibility have left a majority of retirement investors
confused.\17\ This confusion is an important reason behind the decline
in contributions to IRAs from its peak in 1986. For these reasons, the
Institute strongly supports a repeal of the IRA's complex eligibility
rules, which serve to deter lower and moderate-income individuals from
participating in the program.\18\
---------------------------------------------------------------------------
\17\ American Century Investments, as part of its ``1999 IRA
Test,'' asked 753 self-described retirement ``savers'' ten general
questions regarding IRAs. Only 30% of the respondents correctly
answered six or more of the test's ten questions. Not a single test
participant was able to answer all ten questions correctly.
\18\ We note that the return of the universal IRA, coupled with the
availability of the Roth IRA, would eliminate the need for the
nondeductible IRA--thus, further simplifying the IRA rules. However,
should Congress retain the income eligibility limits for either the
traditional IRA or Roth IRA, the nondeductible IRA would continue to
serve a critical objective--enabling those individuals not eligible for
a deductible or Roth IRA to save for retirement. Thus, the
nondeductible IRA should be eliminated only if Congress repeals the
income limits for traditional and Roth IRAs.
---------------------------------------------------------------------------
B. Required Minimum Distribution Rules
The Institute also supports efforts to simplify the required
minimum distribution (RMD) rules applicable to retirement plans and
IRAs. Under these complex rules, plan participants and IRA owners are
generally required to take RMDs from their plans and IRAs after
reaching age 70\1/2\. While the Institute generally supports the
substantial steps toward simplification taken in the proposed
regulations issued by the IRS last year,\19\ we believe that additional
reforms could be made to further mitigate the complexity of the rules.
---------------------------------------------------------------------------
\19\ See 2001-11 I.R.B. 865 (March 12, 2001).
---------------------------------------------------------------------------
The Joint Committee on Taxation suggested various changes intended
to simplify the RMD rules. Specifically, the Joint Committee
recommended that: (1) no distribution should be required during the
life of a participant; (2) if distributions commence during the
participant's lifetime under an annuity form of distribution, the terms
of the annuity should govern distributions after the participant's
death; and (3) if distributions either do not commence during the
participant's lifetime or commence during the participant's lifetime
under a nonannuity form of distribution, the undistributed accrued
benefit must be distributed to the participant's beneficiary or
beneficiaries within five years of the participant's death.
While we have concerns about the unintended consequences of some of
these recommendations,\20\ the Institute supports the Joint Committee's
efforts to build upon the simplification achieved by the new IRS
proposed regulations. We would be pleased to work with members of the
Committee on Ways and Means and the Joint Committee to develop
legislative proposals that will make the RMD rules more understandable
and less burdensome to taxpayers.
---------------------------------------------------------------------------
\20\ For example, a rule requiring distribution of an entire
account balance subject to the RMD rules within five years of the
participant's death could result in harsh tax consequences for the
participant's beneficiaries.
---------------------------------------------------------------------------
C. Simplifying the Rules for Defined Contribution Plans
Employer-sponsored pension plans are a fundamental component of
America's retirement system. As is the case with IRAs, however, the
complexity of the rules applicable to employer-sponsored plans
frequently deters employers from establishing pension plans and workers
from taking advantage of them. By simplifying these rules, Congress
would undoubtedly encourage retirement savings.
A wide variety of retirement plans exists. Under the category of
defined contribution plans, there are a number of plan types, including
401(k) plans, 403(b) plans and 457 plans, each with its own set of
rules. As the divergent rules and plan types often confuse working
Americans and employers, the Institute urges Congress to reduce the
complexity associated with these retirement plans. The ability of
employees to understand the differences among plan types has become
even more important as a result of the enactment of the portability
provisions of EGTRRA.\21\ As noted above, these provisions enhance the
ability of American workers to take their retirement plan assets to
their new employer when they change jobs by facilitating the
portability of benefits among different types of arrangements, such as
401(k)s, 403(b)s, 457s and IRAs. The Institute strongly supports
efforts by Congress to simplify and conform rules that apply to
different plan types in order to increase employee understanding and
encourage plan formation and coverage.
---------------------------------------------------------------------------
\21\ See, e.g., sections 641 and 642 of EGTRRA.
---------------------------------------------------------------------------
IV. Enhance the Availability of Professional Investment Advice
Because participants in self-directed retirement plans like the
401(k) are responsible for directing their own investments, it is
critical that they have access to information, education and advice
that will enable them to prudently invest and diversify their
retirement savings. We, therefore, are pleased that the House has
passed H.R. 2269, the Retirement Security Advice Act, and hope that the
legislation will be enacted into law this year. This legislation, which
has also been incorporated into the President's pension reform package,
will help equip participants to appropriately invest their retirement
assets, while imposing stringent participant protections that would
require investment advisers to act solely in the interests of
participants and beneficiaries.\22\
---------------------------------------------------------------------------
\22\ See section 404 of ERISA, which sets forth the stringent
duties of ERISA fiduciaries.
---------------------------------------------------------------------------
A. Current Law Restricts the Delivery of Advisory Services
Many retirement plan participants who direct their own account
investments seek investment advice when selecting investments in their
plans. Today's pension laws, however, significantly and unnecessarily
limit the availability of investment advice. Indeed, ERISA severely
limits participants' access to advice from the very institutions with
the most relevant expertise and with whom participants are most
familiar. As a result, only about 16 percent of 401(k) participants
have an investment advisory service available to them through their
retirement plan.\23\ By contrast, more than half of ``retail'' mutual
fund shareholders outside of the retirement plan context have used a
professional adviser when making investment decisions.\24\ Clearly,
existing rules have stifled access to professional investment advice to
the detriment of plan participants.
---------------------------------------------------------------------------
\23\ 401(k) Participant Attitudes and Behavior--2000, Spectrem
Group (2001). With respect to internet-based advisory services--the
method by which most third-party advisers provide investment advice--a
Deloitte & Touche survey found that only 18% of mid-size to large
employers with 401(k) plans offered web-based advice to their
employees. 2000 Annual 401(k) Benchmarking Survey, Deloitte & Touche
(2000).
\24\ Understanding Shareholders' Use of Information and Advisers,
Investment Company Institute (Spring 1997).
---------------------------------------------------------------------------
The reason that many retirement plan participants do not have
access to investment advice is that ERISA's prohibited transaction
rules prohibit participants from receiving advice from the financial
institution managing their plan's investment options. This is often the
same institution that is already providing educational services to
participants.\25\
---------------------------------------------------------------------------
\25\ Current Department of Labor guidance permits plan service
providers to provide ``educational'' services, but not give actual
``investment advice'' without violating the per se prohibited
transaction rules of ERISA. See Interpretative Bulletin 96-1, in which
the Department of Labor specified activities that constitute the
provision of investment ``education'' rather than ``advice.''
---------------------------------------------------------------------------
Under ERISA, persons who provide investment advice cannot do so
with respect to investment options for which they or an affiliate
provide investment management services or from which they otherwise
receive compensation.\26\ The restriction applies even if the adviser
assumes the strict fiduciary obligations under ERISA--which, among
other things, require them to act ``solely in the interest of
participants and beneficiaries''--and even if an employer selects the
investment adviser and monitors the advisory services in accordance
with its own fiduciary obligations. Indeed, the per se prohibition
applies no matter how prudent and appropriate the advice, how objective
the investment methodology used, or how much disclosure is provided to
participants.\27\
---------------------------------------------------------------------------
\26\ See generally section 406 of ERISA for the prohibited
transaction rules.
\27\ Although the Department of Labor is authorized to provide
exemptive relief from these rules, the limited exemptions issued by the
Department to certain financial institutions have proven to be wholly
inadequate, as they have included conditions that act as de facto
prohibitions on the ability of these firms to provide advisory services
to plan participants. For example, under one approach adopted by the
Department, advice may be provided if the institution agrees to a
``leveling of fees'' it or an affiliate receives from each investment
option in the 401(k) plan. This makes little economic sense, however,
because advisory fees for various investment options may differ widely
from one fund to another, given that the underlying costs differ for
each, depending on the type of investments the fund is making.
---------------------------------------------------------------------------
Because of current legal constraints, the investment advisory
services available to plan participants have largely been limited to
``third-party'' advice providers. Notwithstanding the presence of these
third-party advice providers, however, relatively few 401(k) plan
participants have investment advisory services available to them
through their retirement plans. The Department's recent advisory
opinion issued to SunAmerica \28\ on the provision of advice did little
to rectify this problem. The ruling essentially reiterates preexisting
restrictions on the provision of investment advice to plan
participants--restrictions that limit participants to third-party
advice providers. Indeed, in a statement issued contemporaneously with
the advisory opinion, Assistant Secretary of Labor Ann Combs expressed
strong support for H.R. 2269. Clearly, the availability of advice from
third-party providers has not sufficiently addressed participants'
needs.
---------------------------------------------------------------------------
\28\ Department of Labor Advisory Opinion 2001-09A.
---------------------------------------------------------------------------
B. The Retirement Security Advice Act
Recognizing this important public policy concern, the House of
Representatives passed H.R. 2269, the Retirement Security Advice Act,
last November by a vote of 280 to 144. The Administration has also
incorporated H.R. 2269 in its broad pension reform proposal.\29\
---------------------------------------------------------------------------
\29\ See H.R. 3762, introduced by Representatives Boehner, Johnson
and Fletcher (February 14, 2002); S. 1921, introduced by Senators
Hutchison, Lott and Craig (February 7, 2002); S. 1969, introduced by
Senators Hutchinson, Gregg and Lott (February 28, 2002).
---------------------------------------------------------------------------
H.R. 2269 would expand and enhance the investment advisory services
available to participants. In particular, the legislation would allow
advice to be obtained from the institutions most likely to be looked to
for such services by participants and employers--the financial
institutions already providing investment options to their plans.
Participants, therefore, would be able to select their plans' providers
for advisory services, in addition to third-party advice providers.
Similarly, employers would be permitted to arrange for investment
advice through a provider with which they are familiar, thereby
eliminating the costs and burdens associated with selecting a separate
vendor.
H.R. 2269 would enable pension plan participants to access sound
investment advice from qualified financial institutions already known
to them, while maintaining strict requirements to assure that they are
protected from imprudent and self-interested actors. These requirements
include subjecting advice providers to strict fiduciary standards under
ERISA and extensive disclosures of any potential conflicts of interest
to participants.
First, only specifically identified, qualified entities already
largely regulated under federal or state laws would qualify as
``fiduciary advisers'' permitted to deliver advice to participants
under the bill.
Second, such advisers would have to assume fiduciary status under
the stringent standards for fiduciary conduct set forth in ERISA. This,
among other things, would require them to act solely in the interests
of plan participants and beneficiaries. These protections would shield
participants from imprudent or self-interested advice.
Third, employers, in their capacities as plan fiduciaries, would be
responsible for prudently selecting and periodically reviewing any
advice provider they choose to make available to their plan
participants. Thus, participants would be afforded an additional layer
of protection by virtue of the employer's responsibilities as a plan
fiduciary.
Fourth, the legislation would establish an extensive disclosure
regime. Specifically, the ``fiduciary adviser'' would have to provide
timely, clear and conspicuous disclosures to participants that identify
any potential conflicts of interest, including any compensation the
fiduciary adviser or any of its affiliates would receive in connection
with the provision of advice. Additionally, any disclosures required
under securities laws, which apply to similar advice provided outside
of the retirement plan context, also must be provided to participants.
It is important to note that these disclosure requirements would be in
addition to the safeguards discussed above. The bill does not rely on
disclosure alone to protect participants; rather, it includes
disclosure as part of a broad panoply of protections.
Fifth, any advice provided could be implemented only at the
direction of the advice recipient. Participants, therefore, would be
free to reject any advice for any reason.
Finally, plan participants would have legal recourse available if a
fiduciary adviser violates the standards set forth in the bill or
ERISA. For instance, under section 502 of ERISA, a plan or participant
could seek relief in federal district court to redress the adviser's
violation of its fiduciary duties. Similarly, the Department of Labor
has authority under ERISA section 502 to file suit against a fiduciary
adviser in violation of ERISA and take regulatory enforcement action,
including the assessment of civil penalties for any breach of fiduciary
duty.
The participant-protective safeguards and the overall approach of
H.R. 2269 stand in stark contrast to an alternative proposal introduced
by Senator Bingaman--S. 1677, the Independent Investment Advice Act of
2001. That bill would not expand the types of advisers that may provide
investment advice to participants; rather, it would only provide
fiduciary relief to employers when selecting and monitoring an
investment adviser to provide advice to participants. Under S. 1677,
participants largely would be limited to the advisory services of third
party advice providers already allowed under current law--which, as
noted above, effectively has restricted the availability of investment
advice to a small percentage of participants.
In short, there is little question that many plan participants seek
and are in need of professional advice. H.R. 2269 would greatly expand
the availability of these advisory services, while maintaining rigorous
protections against parties that fail to serve participants' interests.
We urge Congress to enact this important legislation.
V. Conclusion
Improving and maintaining savings incentives, simplifying the rules
governing retirement savings vehicles, and empowering individuals with
the education and professional advice they seek will promote greater
retirement savings and security for all Americans. The Institute,
therefore, urges Congress to advance these objectives by enacting the
foregoing recommendations.
Statement of the Pension Reform Action Committee
PRIVATE COMPANIES AND THEIR EMPLOYEES' RETIREMENT SAVINGS FACE UNIQUE
CONCERNS IN PENSION REFORM
Thousands of non-public companies across America are
employee-owned. These companies, the vast majority of which are small--
and medium-sized and/or family businesses, are a hallmark of American
entrepreneurship. Through their growth, they have helped fuel the
national economy by providing increasing numbers of jobs for millions
of workers in fields ranging from trucking to tourism, from
manufacturing to management consulting.
Private, employee-owned companies also have unique concerns
that must be considered in the context of the current debate over
proposed pension reforms. In particular, as described below, proposals
to change existing diversification rules for non-publicly traded stock
would harm, not enhance, the retirement savings of the employee-owners
of these companies.
Two particular features distinguish private from public
business: First, the stock of a private business cannot be sold on the
public market. Thus, when company stock is sold, the only purchaser of
the shares is the company itself. Any change to current law that
facilitates substantial sales of private company stock will place an
enormous strain on the capital of the company-buyer, potentially
forcing up leverage ratios and reducing the company's ability to fund
ongoing operations/growth.
The second, related distinction is that a private company's
stock value does not derive from the public markets, but rather from a
private valuation of the company's assets, liabilities and cash flow.
Any change to current law that facilitates the sale by employees of
large amounts of private company stock--regardless of whether the
employees choose to divest of these shares--creates a massive
contingent liability for the company-buyer. The automatic result of
this liability is that the company's stock value will fall, resulting
in a devaluation of the employees' stock accounts.
It is also important to understand that among private,
employee-owned companies there is a standard culture of
entrepreneurship and personal economic empowerment. Private employee-
owned companies are typically ``open book'' companies, where employees
are informed investors in the company. Furthermore, in the vast
majority of cases, these employees reap enormous benefits from their
piece of the rock in their company--setting aside more retirement
savings in their ESOP accounts, for example, than they could ever amass
in a 401k plan or other retirement program.
In summary, private companies are uniquely vulnerable to
proposals that would alter existing pension laws on mandatory
diversification, and any such changes would impair the retirement
savings of employee-owners of these businesses.
To date, only one pension reform bill that has been
introduced--the Portman/Cardin bill--to exempt private companies from
new mandatory diversification rules. It is critical to the viability of
these companies, and the health of the retirement savings of their
employees, that in any new pension reforms, this distinction survive.