[Senate Hearing 109-90]
[From the U.S. Government Publishing Office]
S. Hrg. 109-90
PRIVATE-SECTOR RETIREMENT SAVINGS PLANS: WHAT DOES THE FUTURE HOLD?
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JOINT HEARING
OF THE
COMMITTEE ON HEALTH, EDUCATION,
LABOR, AND PENSIONS
AND THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
EXAMINING A LONG-TERM PERSPECTIVE ON THE FUTURE OF OUR NATION'S
RETIREMENT PLANS IN THE PRIVATE SECTOR
__________
MARCH 15, 2005
__________
Printed for the use of the Committee on Health, Education, Labor, and
Pensions
______
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WASHINGTON : 2005
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COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS
MICHAEL B. ENZI, Wyoming, Chairman
JUDD GREGG, New Hampshire EDWARD M. KENNEDY, Massachusetts
BILL FRIST, Tennessee CHRISTOPHER J. DODD, Connecticut
LAMAR ALEXANDER, Tennessee TOM HARKIN, Iowa
RICHARD BURR, North Carolina BARBARA A. MIKULSKI, Maryland
JOHNNY ISAKSON, Georgia JAMES M. JEFFORDS (I), Vermont
MIKE DeWINE, Ohio JEFF BINGAMAN, New Mexico
JOHN ENSIGN, Nevada PATTY MURRAY, Washington
ORRIN G. HATCH, Utah JACK REED, Rhode Island
JEFF SESSIONS, Alabama HILLARY RODHAM CLINTON, New York
PAT ROBERTS, Kansas
Katherine Brunett McGuire, Staff Director
J. Michael Myers, Minority Staff Director and Chief Counsel
COMMITTEE ON FINANCE
CHARLES E. GRASSLEY, Iowa, Chairman
ORRIN G. HATCH, Utah MAX BAUCUS, Montana
TRENT LOTT, Mississippi JOHN D. ROCKEFELLER IV, West
OLYMPIA J. SNOWE, Maine Virginia
JON KYL, Arizona KENT CONRAD, North Dakota
CRAIG THOMAS, Wyoming JAMES M. JEFFORDS (I), Vermont
RICK SANTORUM, Pennsylvania JEFF BINGAMAN, New Mexico
BILL FRIST, Tennessee JOHN F. KERRY, Massachusetts
GORDON SMITH, Oregon BLANCHE L. LINCOLN, Arkansas
JIM BUNNING, Kentucky RON WYDEN, Oregon
MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York
Kolan Davis, Staff Director and Chief Counsel
Russell Sullivan, Democratic Staff Director
(ii)
C O N T E N T S
__________
STATEMENTS
TUESDAY, MARCH 15, 2005
Page
Enzi, Hon. Michael B., Chairman, Committee on Health, Education,
Labor, and Pensions, opening statement......................... 1
Grassley, Hon. Charles E., Chairman, Committee on Finance........ 2
Prepared statement........................................... 3
Baucus, Hon. Max, a U.S. Senator from the State of Montana,
prepared statement............................................. 2
Kennedy, Hon. Edward M., a U.S. Senator from the State of
Massachusetts, opening statement............................... 4
Certner, David, director, Federal Affairs, AARP.................. 6
English, Glenn, CEO, National Rural Electric Cooperative
Association.................................................... 7
Bowers, Cynthia S., vice president of compensation & benefits,
Smurfit-Stone Container Corporation............................ 8
Prepared statement........................................... 8
Gebhardtsbauer, Ron, senior pension fellow, American Academy of
Actuaries...................................................... 10
Trumka, Richard, secretary-treasurer, AFL-CIO.................... 11
Prepared statement........................................... 12
Kimpel, John, senior vice president and deputy general counsel,
Fidelity Investments........................................... 14
Schutz, Pamela, president and ceo, retirement income and
investments, Genworth Financial................................ 14
Prepared statement........................................... 15
Friedman, Karen, director of policy strategies, Pension Rights
Center......................................................... 18
Covert, Kevin M., vice president and deputy general counsel,
Honeywell...................................................... 19
Dunbar, Mark K., president, Dunbar, Bender & Zapf, Inc........... 20
Henrikson, C. Robert, president, Metlife......................... 21
Prepared statement........................................... 22
Garrison, Douglas, manager, Global Benefits Design, Exxon-Mobil.. 29
Fuerst, Don, worldwide partner, Mercer Human Resource Consulting. 31
McNabb, William, managing director, Client Relationship Group,
Vanguard....................................................... 32
Sperling, Gene, senior fellow, Center for American Progress...... 33
Houston, Dan, senior vice president, Principal Financial......... 35
Salisbury, Dallas, president and ceo, Employee Benefits Research
Institute...................................................... 36
ADDITIONAL MATERIAL
Statements, articles, publications, letters, etc.:
Comments on Ways to Simplify the Rules for Small Employers,
by Daniel J. Houston, senior vice president, Principal
Financial Group............................................ 55
Weller, Christian E., PhD., prepared statement............... 56
Additional comments by John Kimpel, senior vice president,
FMR Corporation............................................ 70
Thomas, Hon. Craig, a U.S. Senator from the State of Wyoming,
prepared statement......................................... 71
Questions of Senator Thomas.............................. 72
English, Glenn, chief executive officer, National Rural
Electric Cooperative Association, prepared statement....... 72
England, Robert Stowe, Conversation on Coverage, prepared
statement.................................................. 73
Conversations and Recommendations of Working Group I, report
on......................................................... 76
Conversations and Recommendations of Working Group II, report
on......................................................... 102
Conversations and Recommendations of Working Group III,
report on.................................................. 119
(iii)
PRIVATE-SECTOR RETIREMENT SAVINGS PLANS: WHAT DOES THE FUTURE HOLD?
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TUESDAY, MARCH 15, 2005
U.S. Senate,
Committee on Health, Education, Labor, and Pensions, and
Committee on Finance,
Washington, DC.
The committees met jointly, pursuant to notice, at 9:30
a.m., in room SD-G50, Dirksen Senate Office Building, Senator
Enzi [Chairman of the Committee on Health, Education, Labor,
and Pensions] presiding.
Present: Senators Enzi, Hatch, Grassley, Thomas, Burr,
Kennedy, and Reed.
Opening Statement of Senator Enzi
The Chairman. It is 9:30. We would like to start on time. I
will call this hearing to order.
I want to welcome you to this joint forum, conducted by the
Senate Finance and the Health, Education, Labor, and Pensions
Committee. I think it is historic. Chairman Grassley and I
believe that Congress should be proactive on the future of our
Nation. Today we will be taking a long-term perspective on the
future of our Nation's retirement plans in the private sector.
Our Nation is facing a changing workforce that is growing
older and becoming more adaptable as workers are changing
careers more frequently, and therefore changing companies more
frequently. In addition, many companies face global market
pressure.
This forum is to address many of these issues, to collect
as much information as possible in as short a period of time
from as many experts as possible, so that we can be proactive
toward helping workers and employers design retirement security
plans for the future. We do not want just a short-term fix, we
want to fix it. I believe fervently that we must save defined
benefit plans so that employers and employees will have this
valuable option in the future. The HELP and Finance Committees
are committed to enacting responsible, comprehensive pension
reforms this year that will stabilize the defined benefit
system, that will strengthen the PBGC, and that will reduce the
Agency's deficit.
We will accomplish these things this year, which means
there is a long-range future for defined benefit and defined
contribution plans for us to be discussing here today.
I also have a particular interest in how we can provide
more small business employees with retirement benefit coverage
and how small business owners can provide retirement benefit
plans.
I appreciate everybody's attendance, and look forward to
the roundtable discussion.
Chairman Grassley.
Opening Statement of Senator Grassley
Senator Grassley. Thank you very much. First of all,
Senator Baucus will be along in a little while, but in the
meantime I want to put a statement in the record from Senator
Baucus.
[The prepared statement of Senator Baucus follows:]
Prepared Statement of Senator Baucus
Thank you, Chairman Enzi and Chairman Grassley, for holding this
forum on the future of employer-sponsored retirement plans. I am
pleased to be here with Senator Kennedy and other members of our two
committees, to learn from the stakeholders who have joined us today.
Winston Churchill said: ``It is always wise to look ahead, but
difficult to look further than you can see.'' Retirement savings is a
long-term challenge ahead. Today we try to see into that long term, to
see as far as we can see.
Two weeks ago, the Finance Committee held a hearing on the
financial status of the Pension Benefit Guarantee Corporation, and the
administration's funding proposal for defined benefit plans. It was a
timely hearing about a difficult subject that we have to address in the
next few months.
But today we get to climb above those immediate concerns and lift
our eyes to the challenges of the future.
Not the least of these challenges will be accelerating global
competition. We have to work to create an environment where we can
compete successfully on the global stage.
But in doing so, we must remember why success matters. Success
matters so that American workers can have a good life, so that
Americans who work hard can share in the success of this country. It is
thus important to see the future through the lens of benefits for
workers. And that is why we are here today.
James Thurber said, ``It is better to know some of the questions
than all of the answers.'' Then we are on the right track with this
forum. We have thought-provoking questions to focus our discussion, and
a diverse group of experienced individuals here to join us in our
exploration.
I expect that we will hear different opinions not only of how the
future will look, but how it should look. In other words, when we leave
today, I expect that we will have more questions than answers. And that
will be a good thing.
I look forward to today's far-sighted discussion. And then I look
forward to tackling the challenges that we will see.
Senator Grassley. For my part, I welcome all the
participants, all of you as experts for your insight on the
future of private retirement plan systems, and I particularly
welcome Dan Houston of Principal Financial from my home State
of Iowa.
It seems to me that all of you people bring a wealth of
information and experience and insight to this meeting, a
perspective on how things operate out there in the real world,
and you are all here today because of sharing one common goal,
improving our private retirement system and the retirement
security of Americans everywhere. So I thank you for
participating.
This is a year in which retirement security, thank God, has
come very much to the forefront of our national dialogue, and
with the baby boom generation on the cusp of retirement, this
dialogue could not have been more timely.
For his part, the President has advanced the dialogue by
bringing to the forefront ways to strengthen and improve Social
Security, but we all know that security retirement depends on a
heck lot more than Social Security, employment based retirement
plans and private savings, our other two critical legs of our
three-legged retirement stool. So here today we are going to
focus attention on those other two legs. We will focus our
attention not just on where we are today but where we should be
going.
Too often here in Congress we find ourselves responding to
the latest crisis or doing damage control. This is an
opportunity to be ahead of the curve, and I am pleased also
that we are holding this hearing jointly with Senator Baucus
and Senator Kennedy and our two committees, because we have had
great success in recent years working retirement security in a
bipartisan way. In the 1990s we passed a series of bipartisan
pension reforms that brought new life to our private retirement
system, and we have to work on those successes of the past, and
so we look forward to this forum being a part of our foundation
for doing that.
Thank you, Mr. Chairman.
[The prepared statement of Senator Grassley follows:]
Prepared Statement of Senator Grassley
Good morning, I want to begin by extending a very warm welcome to
all of the participants--many of whom have come from far away,
including Dan Houston [how-stin] from Principal Financial in my home
State of Iowa--to share their insights on the future of our private
retirement plan system.
The people we have in this room really are the experts. They bring
a wealth of experience and insight. They bring a perspective on how
things operate in the ``real world'' outside of the beltway. And they
all are here today because they share one common goal--improving our
private retirement system and the retirement security of Americans
everywhere.
Thank you to all of you for making time to be here today.
This is a year in which retirement security has taken a central
place in our national dialogue. With the baby boom generation on the
cusp of retirement, this dialogue could not be more timely. For his
part, the President has advanced this dialogue by asking us to look at
ways to strengthen and modernize Social Security. But we all know that
a secure retirement depends on more than just Social Security.
Employment-based retirement plans and private savings are the other two
critical legs of our three-legged retirement stool.
Here today, we will focus attention on those other two legs. And we
will focus our attention not just on where we are today, but where we
should be going tomorrow. Too often, here in Congress, we find
ourselves responding to the latest crisis, or trying to do ``damage
control'' when we become aware that problems exist.
Today, we have an opportunity to get out of ``reactive mode'' and
look proactively to the future. I am pleased also to be here today with
Chairman Enzi and Senator Baucus and Senator Kennedy. We all know that
the only way to get things done in the United States Senate is to work
together.
We've had great success in recent years working on retirement
security in a bipartisan manner. In the 1990's, we passed a series of
bipartisan pension reforms that began to breathe new life into our
private retirement system.
In the bipartisan 2001 tax relief bill, we enacted a bipartisan and
far-reaching set of retirement savings reforms. This year, I hope we
can work together in a bipartisan way to strengthen Social Security. At
the same time, I hope we can work on a ``next generation'' of
retirement reforms, including:
making the 2001 retirement savings reforms permanent;
protecting workers' retirement plan benefits by making
sure that pension plans are fully funded and that 401(k) participants
have the right to diversify out of company stock; and
expanding savings opportunities for all Americans.
And as we look farther into the future here today, I hope that we
can continue to work in a bipartisan spirit on these issues, so that we
can confront head-on the challenges that we know are sure to lie ahead.
The Chairman. Thank you.
Senator Kennedy.
Opening Statement of Senator Kennedy
Senator Kennedy. Thank you very much, Mr. Chairman. I want
to thank Senator Enzi and Senator Grassley, as well as Senator
Baucus for bringing us all together.
We have to let our wonderful witnesses know today that we
hope you are on your toes because Senator Enzi has filled out
ERISA forms--[Laughter]-- himself, and he is a trained and
skilled auditor. So he is at a particular advantage over the
rest of us here today. He said he just cannot wait to get into
the facts and figures of the challenge. Well, he will have a
pleasant day if that is what he is really looking forward to.
I want to thank all of our great experts and old friends
who have joined with us for the discussion of the future of
private pensions.
Retirement security is a critical issue for all Americans,
as we all know. The national debate now under way is
questioning all aspects of our current system which is founded,
as Senator Grassley has mentioned, on a three-legged stool of
private pension, Social Security and private savings. The
private savings rate is at its lowest level in more than 40
years. We know wages are stagnant, and it is related to
savings, related to wages.
The President is proposing to change the structure of
Social Security. This makes insuring a private pension, I
believe, all the more important. Despite our efforts in
Congress over the years to secure retirement from private
pensions still remains a remote goal for too many Americans.
The statistics tell the story. Our economy is still weak,
and compounding the problem, only half of American workers have
a pension plan at work, a proportion that has failed to improve
over the past 30 years. Pension coverage is even less adequate
for women, minorities, and employees in small businesses. As
the chairman pointed out, the pension system as a whole is
increasingly shifting to require workers to bear more and more
risk. Today only 1 in 5 workers have a defined benefit plan,
and the defined contribution plans and individual retirement
accounts have an increasing role in our retirement policy.
In theory, the defined contribution plans and IRAs can
provide a comfortable retirement, but experience shows this is
not happening. Half of the workers 55 or older who have a
retirement account have less than $55,000 in their 401(k)s or
IRAs, not nearly enough to live on in retirement.
There are other problems with the defined contribution
plans. Nearly 30 percent of the employees eligible to
participate in 401(k) plans do not do so. Many of those who do
are at risk of over investing in stock of the company that they
work for. Retirees also bear the risk of outliving their money;
an unforeseen medical emergency or drop in the stock market can
be devastating.
As we look to the future we must also find ways to meet the
new challenges of a changing economy, workforce and the effects
of increased globalization on benefits for employers and
retirees. Manufacturing jobs are being lost to competition
overseas. Such jobs long provided good wages, good pensions,
retiree health benefits, but today's low wage jobs, service
sector jobs, part-time jobs, often do not.
Other changes also influence our policy. Employees are more
likely to change jobs or work part time. And increasing numbers
of women are entering the workforce. These workers should not
be left behind in earning a pension.
Overall the Nation's retirement policy needs to better
reflect our values of fairness and equality. People who have
worked hard all their lives should not have to live in poverty.
Surely the janitor who cleans the office tower has as much
right to retire in dignity as the CEO in the corner office.
Retirement security for every employee is good policy for our
society, good policy for our economy as well.
We have much to do and I look forward to hearing from the
experts here today the most effective ways to build a strong
pension system for the future.
Thank you, chairman.
The Chairman. Thank you very much.
Today's forum will proceed in a different manner than
typical Senate hearings. The primary purpose of this forum is
to hear from you, the participants, and get your discussion on
the long-term evolution of the private sector retirement
benefit plans. Accordingly, today's format will be a
roundtable. There will be no official oral statements made by
the participants. However, any of the participants can submit
statements that will be part of the record if you desire. That
can even be based on something you may not have gotten to say
today that you want to turn in to us.
So if any of you would like to answer a question that is
being asked by us, or would like to respond to a comment made
by one of your colleagues, just stand your nameplate on end--I
am hoping they are sturdy enough to do that--and that will be
an indication that you want to speak, and I will call on you
according to your raised nameplate. Occasionally we will vary
the format to fit the discussion or to pursue something in
particular.
Before we begin the discussion, I would like to introduce
our distinguished panel of participants. I want to thank them
for their efforts to get here, and then also to change the
schedule to accommodate our schedule so that we could be doing
both budget and White House meetings and a number of other
things.
First we have Cynthia Bowers, who is the Vice President of
Compensation & Benefits for Smurfit-Stone Container
Corporation; David Certner, the Director of the Federal Affairs
for AARP; Kevin Covert, the Vice President and Deputy General
Counsel for Honeywell; Mark Dunbar, President of Dunbar, Bender
& Zapf, Inc.; Glenn English, the CEO of the National Rural
Electric Cooperative Association; Karen Friedman, the Director
of Policy Strategies, Pension Rights Center; Don Fuerst, the
Worldwide Partner of Mercer Human Resource Consulting; Douglas
Garrison, the Manager of Global Benefits Design of Exxon-Mobil;
Ron Gebhardtsbauer, Senior Pension Fellow for the American
Academy of Actuaries, another number person; C. Robert
Henrikson, the President of MetLife; Dan Houston, the Senior
Vice President of Principal Financial; John Kimpel, the Senior
Vice President and Deputy General Counsel of Fidelity
Investments; William McNabb, the Managing Director of Client
Relationship Group, Vanguard.
Dallas Salisbury will be joining us later. He is the
President and CEO of Employee Benefits Research Institute. The
change in schedule affected that.
Pamela Schutz, the President and CEO of Retirement Income
and Investments, of Genworth Financial. Gene Sperling will--oh,
he is here, glad you were able to shift your schedule around
too--Senior Fellow for the Center for American Progress; and
Richard Trumka, the Secretary-Treasurer of the AFL-CIO.
We will begin with question No. 1. Our purpose for
convening this forum today is to find out what the private
sector initiatives for retirement benefits will look like 20 or
30 years from now. This will help us in Congress to fashion
private pension laws accordingly. The three questions that we
have asked participants to consider are:
(1) How will private sector retirement savings and pension
plans evolve 20 years in the future and beyond? Question (2),
How will our Nation's changing workforce affect the development
of the retirement benefit plans and to what extent will our
aging population, the need for portability of plans and the
adequacy and coverage of plans for workers determine the future
of private sector retirement savings and pension plans? And
finally, what role will global competitiveness and U.S.
companies' ability to compete in the global market, as well as
to retain workers, determine the development of the private
sector retirement savings and pensions?
To start the discussion, I would like to direct everyone's
attention to Chart No. 10 from the Bureau of Labor Statistics
Occupational Outlook Handbook. The chart shows that certain
industries such as the service sector professional and office
support will increase dramatically in the coming years. Gone
are the days when a worker stayed at one company for his entire
life. I have read that today's student will have up to 14
different occupations, and 10 of those jobs have not even been
invented yet.
How will the companies adapt to this changing workforce
structure?
Will companies be able to increase participation of workers
in retirement benefit plans?
In addition, what structure will retirement plans develop
to allow for changing careers of future employees?
That is probably a big enough bite, and there are probably
some other places you want to go anyway, so we will begin. Does
anyone want to throw out some answers? We are desperately
searching for answers.
Senator Grassley. If you knew how much we got paid per
minute, you would not waste a minute. [Laughter.]
The Chairman. Mr. Certner?
STATEMENT OF DAVID CERTNER, DIRECTOR, FEDERAL AFFAIRS, AARP
Mr. Certner. I guess I would want to just make one
beginning comment on this. It seems pretty clear that with the
changes in the workforce you are going to have a much smaller
population of younger workers coming on board, and from our
perspective, we think that part of that gap will need to be
filled with the increasing number of older workers that we have
in this country.
So we think that looking at the future you are going to
see--and we have already seen this trend in the last few years
somewhat--and up-tick in the number of older workers who either
want to remain, employers want them to remain or who choose to
remain in the workforce, some because they need the money, but
many because they want to stay active. We think it is going to
be important that as we look at the benefit structure in the
future that is very accommodating to making sure that older
workers want to stay on, and we encourage older workers to stay
in the workforce because we are going to need those older
workers in order I think to keep this economy running.
The Chairman. Mr. English?
STATEMENT OF GLENN ENGLISH, CEO, NATIONAL RURAL ELECTRIC
COOPERATIVE ASSOCIATION
Mr. English. Mr. Chairman, I think that we are somewhat
unique as I understand it in this whole matter in that we are a
multiple employer group. Electric cooperatives are in 47 States
across the country. There are some 950 cooperatives who are
part of our overall program. Our defined benefit program has
been in existence since 1948; our defined contribution plan has
been in existence since 1967. Our plan allows all of our
members to participate even though they are very small electric
cooperatives, and as such, they are able to pool their
resources and share the risk, exposure if you would. It also is
a way in which it gives them portability. They can move between
cooperatives, move between States and retain this.
As far as looking to the future and what we might be able
to contribute, geographically we are in about 83 percent of all
the counties in the United States. As cooperatives we are
actually owned by the people who use the electric power that
are generated by electric cooperatives.
What we think is a possibility for the future is that we
may open up our program to every member of the electric
cooperatives, so you could have small businesses and 83 percent
of the counties in the United States who would participate in
this overall benefit plan, multiple employer plan. We think
that that is a way in which a lot of small businesses in
particular could offer this kind of a program, a defined
benefit, defined contribution to their employees, and be able
to afford it, and be able to share the risk that is involved.
We have total assets for roughly 60,000 employees right now of
$7 billion, and as I have mentioned, it has worked extremely
well for us and is continuing to do so today.
What we would be troubled by is anything that would
restrict multiple employers from working together in this kind
of a plan, and we would hope that in the future it would be
made easier. There are some contradictions in the law, both
from a standpoint of ERISA and the IRS that make this more
difficult. So as throwing out a suggestion, an idea, Mr.
Chairman, I would suggest that that is one that the committee
may want to examine, particularly for smaller communities and
rural areas in this country.
The Chairman. Thank you. It would be helpful, and you
probably already have written down those restrictions and ways
that it can be made easier to share with us.
Mr. English. We will submit that for the record, Mr.
Chairman.
The Chairman. Thank you.
I believe Ms. Bowers was next. Ms. Bowers.
STATEMENT OF CYNTHIA S. BOWERS, VICE PRESIDENT OF COMPENSATION
& BENEFITS, SMURFIT-STONE CONTAINER CORPORATION
Ms. Bowers. Smurfit-Stone is a leading packing company. We
employ about 27,000 employees. We have about 400 employees in
Iowa. We have about 600 employees in Massachusetts, and about
500 employees in Montana, Missoula, Montana.
We are a large employer in a lot of small cities, and I am
really concerned about the future of pensions because I am not
a benefit actuary, I am not an attorney. I am the person in the
company that has to justify to our senior management that
defined benefits are what is good for the company and what is
good for employees. When you speak about the three-legged
stool, we really do have a three-legged stool in our country
for Social Security income, but a couple of those legs are
getting wobblier and wobblier every year.
We have 401(k) plans, defined contribution as well as
defined benefit plans, but in our 401(k) plan our salaried
employees about two-thirds participate in that. I wish it were
100 percent but it is only two-thirds. More unfortunate is that
our hourly workforce, only one-third of our hourly employees
participate in our 401(k) plan, and that is with significant
company matches. On our salaried program we match 70 cents on
the dollar and with 50 cents on a dollar for hourly employees,
and it is still not enough to entice employees to save on their
own.
So if we have an opportunity to strengthen and to make sure
that defined benefit plans are in place in the future, that is
what I would like to ensure.
The problem is, is that what we are encountering today and
what we see in the future is that the cost of maintaining these
programs are going to become increasingly overburdensome to our
company. In the last 4 years we have contributed over $500
million to our pension trust, and we have a goal of staying at
a 90 percent funding target, but if we continue to see what is
happening on the forefront, we believe that our costs will more
than double. I tell you, I am a pretty good person in trying to
persuade people, but I do not know if I can persuade my
management to double our costs, because we are diverting other
business opportunities that we could be putting that revenue
toward and putting it toward our pension plan.
My concern is to how to keep the system viable, healthy and
there in the long haul.
[The prepared statement of Ms. Bowers follows:]
Prepared Statement of Cynthia Bowers
Chairman Enzi and Grassley, Ranking Members Kennedy and Baucus, I
am pleased to provide the Senate Health, Education, Labor, and Pensions
Committee and the Senate Finance Committee with a formal submission
summarizing the comments made in the open forum on March 15, 2005.
These comments are submitted on behalf of my company, Smurfit-Stone
Container Corporation.
Smurfit Stone Container Corporation (SSCC) is a leader in the
packaging industry employing over 35,000 employees throughout North
America with an $8 billion revenue base. Our company's multiple Single
Defined Benefit Plans cover approximately 25,000 active U.S. employees,
16,000 retirees and approximately 9,000 terminated vested employees in
almost every State, including almost 400 employees in IA, 500 in
Montana, 600 in Massachusetts. We also have approximately 4,000 in
union multiemployer trust plans. Both my company's management and
employees support retaining defined benefit plans as a central
component to retirement security.
We cannot look to the future of pension plans without recognizing
the three major components of any individual's retirement income
stream. Our employees have the ability to retire with three separate
income streams: defined benefit plan, 401K savings plan and social
security. Given the current state of affairs on pension plans and their
future viability, it is uncertain as to how long companies such as SSCC
can continue significant contributions into a pension trust under some
of the proposals before Congress.
For example, the Administration's proposal for reform of the
Defined Benefit Plan system could more than double our cost of
compliance with funding requirements, thus reducing cash flow available
to continue reinvesting in our business which is required to remain
competitive in today's global marketplace. As a mature industry with
long-term defined benefit commitments and capital intensive
investments, altering the funding rules can have a major impact.
Over the last 4 years we have invested almost $500 million in our
pension fund and expect to make a similar investment over the next 4
years. We have a capital budget of between $225 and $275 million per
year. The Administration's pension reform provisions will virtually
eliminate our capital reinvestment capability.
The fundamental issue is that Americans, on their own don't save
enough for the future. On a national average savings are trending
toward depression-era levels around 1 percent of earnings. According to
American Benefits Council the average person would have to save 7
percent of earnings over their career in order to amass enough savings
for a stable retirement. Our company's 401K savings plan reflects the
general savings trend of the country. For hourly employees only \1/3\
contribute, even though they can get company-matching contributions.
So, if there is no evidence that people are motivated to save on
their own for retirement, and companies are overly burdened with the
type of proposals before Congress today, the future looks bleak. In
time, companies will be forced to cease offering defined plans to an
even greater extent than already reflected in the last 10 years, as the
number of pension plans have decreased by 60 percent.
This situation will inevitably harm Americans as defined benefit
plans provided a source of income to individuals who may not have
otherwise saved for retirement. Without this guaranteed income,
Americans will become more reliant upon Social Security income as a
primary source, thus further burdening a system that is under duress.
This loss of income will have a severe impact on the quality of life of
many Americans.
Smurfit Stone is a responsible company. Over the last 5 years, we
have been between 90 percent and 98 percent funded in our pension plan
and have followed existing law in providing the level of contributions
in advance of requirements, despite strong market pressures slowing
industry growth. Any new funding requirements should not be based upon
the perceived financial strength or weakness of a plan sponsor. Funding
requirements should be based upon quantitative targets and objectives
consistently applied to all plan sponsors.
We are concerned that legitimate efforts to assure long-term
sustainability and viability of the PBGC may in fact lead to a
precipitous decline in affordability, reliability and predictability in
maintaining defined benefit plans. Our 35,000 employees would be
severely disadvantaged from receiving future benefits if the
Administration's proposal were to pass as currently constructed.
Rather than helping secure the future of our defined benefit plan,
assumptions embedded in the yield curve methodology would create
unnecessary financial burdens that could lead to reduced future
reliance on a predictable retirement income. An actuarially-sound
replacement of the 30-year Treasury rate with a 4-year weighted average
of the long-term corporate bond rate would address these concerns.
Utilizing the 4-year weighted average of the long-term corporate
bond rate with some sort of smoothing would provide more
predictability. In addition, this option is transparent and provides an
accurate rate base, it steers a middle course between what is earned
and what is owed. Imposing a 90-day smoothing concept into a yield
curve places undue short-term pressures on companies for a long-term
condition. The reason we encourage 30-year mortgages is to encourage
purchasing of homes. If home owners had to pay a disproportionate
amount of the cost up front, rather than over a longer term, fewer
homes would be affordable. Likewise, we need to allow companies who are
voluntarily providing long-term benefits to employees to spread a long-
term cost over a longer period of time and not be subject to short-term
volatility.
New proposals for funding targets, contribution requirements,
deduction limits, benefit restrictions and increased premiums will in
fact jeopardize our company's ability to continue to offer a defined
benefit plan for new employees. Providing for predictability and
reducing volatility in funding plans can be achieved with existing
smoothing mechanisms for assets and interest rates.
Eliminating tax deductions for over funded plans is a short-term
revenue benefit to the Treasury at the expense of longer-term
opportunities to actually enhance the viability of pension funds while
helping strengthening a company's position in the marketplace.
I am pleased to present these views and contribute to the debate so
that we can find a means by which defined benefit plans can continue to
be offered by companies for their employees with a degree of
predictability and encouragement rather than penalties for being in a
growth cycle, recessionary market or specific debt condition. Losing
our defined benefit plans as a retirement benefit could seriously
affect our ability to attract the talent necessary to successfully grow
and prosper as a company.
Thank you for the consideration of these comments.
The Chairman. Thank you.
Mr. Gebhardtsbauer.
STATEMENT OF RON GEBHARDTSBAUER, SENIOR PENSION FELLOW,
AMERICAN ACADEMY OF ACTUARIES
Mr. Gebhardtsbauer. Thank you. One of the things we have
seen is that the future demographics are going to be very
different than the demographics in the past. In the 1970s we
have baby boomers coming in, women coming into the workforce.
So DB plans were developed in the past, and they are going to
be very different in the future because of different
demographics. Back then there was so much labor coming in that
it made sense for a pension plan to have people retiring at
early ages and incenting people to come in at early ages, and
retiring at early ages like 55. But in the future the supply of
the labor is going to shrink a lot after the baby boomers
leave.
So as you were talking about, we need ways in which to
encourage people to continue working. And DB plans are very
flexible. If the law allows they can just do about anything you
want, and we have tried all kinds of things in the last 5, 10
years like cash balance plans, hybrid plans. There is a new
idea called DBK that would take some of the futures of DB plans
and bring in the ideas of some 401(k) ideas so that it is
simpler, the employees can sort of follow it. Another advantage
of the 401(k) is that the employer actually has to sell it to
the employees, and the more they sell the lower income
employees into it, the more the higher income employees can
participate. So there are all kinds of new ideas that are
coming along.
But we cannot do the DBK idea, for instance. People are
very uncertain about whether they can do this cash balance
idea. Companies have had it for a long time but now the rules
are kind of uncertain. So again, a lot of the criticisms that
people are having of DB plans, for instance, that they do not
work for a mobile workforce, actually you can modify the
traditional DB plan into something that does make sense for a
mobile workforce. For instance, the cash balance idea is
something that gives the same amount to everybody so that it is
good for people who are in and out, it is good for women who
are in and out of the workforce. But it is difficult to come up
with these new ideas when the rules are kind of tight. In the
world that we have today where we need to make these changes to
be able to compete, then the rules need to be flexible enough
so that we can make some of these changes to our DB plans, and
either the rules need to be flexible or when a new idea comes
up we need rules that can change, so that Congress can be
responsive and quickly change to some of the new ideas.
So those are some of the things I think would be valuable
to enable DB plans to change for the workforce of tomorrow.
The Chairman. Thank you.
Mr. Trumka.
STATEMENT OF RICHARD TRUMKA, SECRETARY-TREASURER, AFL-CIO
Mr. Trumka. Thank you, Mr. Chairman. I think it bears worth
stating at the beginning that pension and pension security
cannot be addressed in a vacuum, that all the other policies
that we are dealing with or all the other challenges that we
are seeing in the country affect dramatically workers' pension
plans and savings. And I will refer to things like the budget
deficit, the trade deficit, outsourcing, the stagnation of
wages. All of those things affect, one, the ability of
companies to provide pensions and two, the ability of workers
to force savings or to have savings.
Having said that and restating the obvious, I guess I would
say the following. Unless there is a change in current policies
and the current business environment, some retirement plan
trends will continue. The share of private sector workers
participating in defined benefit plans will continue to decline
following a quarter century trend. In 1979 we had 39 percent of
workers who had a defined benefit plan. Today it is only 21
percent. Retirement plan participation will likely remain flat
at 50 percent of the workforce as it has over the past 2
decades, and participation has remained flat even though we
have seen a shift away from DB plans to DC plans, and it is not
clear right now that any of the simplification reforms and the
increases in contribution limits enacted in the mid 1990s will
have any meaningful effect on the coverage. I think fewer
workers will be receiving annuities in retirement. Defined
contribution plans do not offer those annuities, so we will see
fewer of those happening.
And as more plans allow workers to take lump sums, I think
workers will begin to use their retirement savings accounts for
purposes other than retirement income, all of which are
dangerous when we are looking for our retirement security.
I would also point out, Mr. Chairman, that when it came to
defined benefit plans, a union that I came out of, the United
Mine Workers, had one of the first if not the first. It was
signed in 1947. It was a multiemployer plan, and I would just
like to remind everybody the purpose for that plan. Back then
many of the mines that the Nation's miners worked in were small
mines, employing 25, 30, 35 or 40 people. Those mines would
come into business and go out of business every 2 or 3 years.
The employers would leave their employees without any
retirement. As a result of that we needed a mechanism to be
able to harness that existence of those small entries and exits
out of the mining industry. The defined benefit plan,
particularly the multiemployer benefit plan, was the perfect
vehicle because you had portability and you could take your
benefits from company to company. As Mr. English said, we need
to have the flexibility to be able to combine those and to have
more people join into those plans so that we can share the risk
even further so that we have professional management of those
plans in a meaningful way.
I would also say, Mr. Chairman, that we really do have to
grapple with a series of touch questions when it comes to
things like 401(k)s or other forms of savings. What will happen
to the low and middle income workers? How effective are
employers' plans at helping workers manager their accounts?
Will middle income people even have enough retirement?
Only 50 percent of workers have any kind of a savings
account, retirement savings accounts, and their average amount,
as Senator Kennedy said, is about $55,000. If you convert that
out that comes out to about $230 a month in savings, which is
not likely to be able to support people very long out into the
future.
All of those things are important to us, so when we look at
things I guess we would say that we really need to protect
workers' pensions by making funding rules work for single-
employer or multiemployer defined benefit plans. We think we
have to enact rules that will strengthen pension funding and
promote employer sponsorship of single-employer defined benefit
plans, and we have to give multiemployer plan trustees and the
relevant bargaining parties additional tools to protect their
pension plans.
Also one subject I would really like to touch on just
briefly is to protect workers' 401(k)s when employers file for
bankruptcy. We just had a lot of talk on the Hill about
bankruptcy and a bill passed. But while workers' wages get a
priority, they only get a priority to $4,500. That is a number
that has not been moved in decades. That low priority cap
affects how much workers can get back in missed 401
contributions and in stolen 401(k) money. The other thing that
we really need to look at in bankruptcy is to make 401(k)
participant claims for security and pension fraud a priority
claim in bankruptcy. As it is right now, you do not see that
happening. They get to the end of the line. This kind of
problem could be solved in the future by giving 401(k) plans
and plan participants priority in bankruptcy for fraud and
breach of fiduciary duty claims arising out of their holdings
in stock or anything else.
Those are just a few of the things, Mr. Chairman. I would
like to submit for you additional items that can be done to
help retirement security.
[The prepared statement of Mr. Trumka follows:]
Supplemental Statement of Richard L. Trumka
Mr. Chairman and members of the committee, thank you for the
opportunity to present these additional views on the future of private-
sector retirement plans.
Tax Policy and Retirement Plans
One roundtable participant suggested that replacing the Federal
income tax with a consumption tax would have a beneficial impact on
national saving. While there was no follow-up discussion, it is
important to note the potentially large negative impact such a shift
could have on private retirement plans. This issue is particularly
relevant since President Bush has appointed an Advisory Panel on
Federal Tax Reform to consider fundamental changes in the tax system
and submit recommendations for reform by July 31, 2005.
As a 2001 Congressional Research Service report noted, ``[w]ith
both defined benefit and defined contribution plans, the typical
consumption tax eliminates all pecuniary incentives for employer
sponsored pension plans.'' \1\ Such a fundamental shift in the tax
system ``could cause a sharp reduction or a wholesale elimination of
existing pension plans.'' \2\
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\1\ Steven Maguire, Congressional Research Service, ``Consumption
Taxes and the Level and Composition of Saving,'' updated Jan. 11, 2001,
p. 7.
\2\ Report of the Working Group on the Impact of Alternative Tax
Proposals on ERISA Employer-Sponsored Plans, 1996 Advisory Council on
Employee Welfare and Pension Benefit Plans, U.S. Dept. of Labor, Nov.
13, 1996.
---------------------------------------------------------------------------
The elimination of job-based retirement plans clearly would
undermine the national policy objectives underlying the current job-
based retirement plan system, with particularly negative consequences
for many low- and middle-income Americans. Current tax code
nondiscrimination and coverage rules governing employment-based defined
benefit and defined contribution plans act to increase retirement
benefits and savings among low- and middle-income workers. Further, as
was noted by several hearing participants, the payroll deduction
feature of 401(k)'s and similar retirement savings plans is very
important, a point strongly supported by comparisons to the very low
participation rates in Individual Retirement Accounts.
At a minimum, any discussion of fundamental tax reform must include
a thorough analysis of its impact on pensions and retirement savings
plans. Unfortunately, this relationship has been given scant attention
in the past. As the Department of Labor's Advisory Council on Employee
Welfare and Pension Benefit Plans concluded in 1996, ``the complex and
far-reaching implications of fundamental tax reform for the Nation's
retirement and pension system have not been given adequate attention or
analysis through existing policy channels, either in Congress or in the
Executive Branch, especially given the complexity of the issues and
uncertainty that surrounds them.'' \3\ It remains to be seen whether
these issues will be given the due they deserve in the upcoming tax
reform debate.
---------------------------------------------------------------------------
\3\ Report of the Working Group on the Impact of Alternative Tax
Proposals on ERISA Employer-Sponsored Plans.
---------------------------------------------------------------------------
Retirement Savings
One focus of discussion at the hearing was developing effective
ways to get more Americans to save and to save more for retirement.
Many people, as I stated at the hearing, simply do not make enough
money to save much or at all for retirement. In fact, many families
have trouble paying for basic items and services. For example, the
Economic Policy Institute (EPI) has found that 3 in 10 (29 percent)
families with pre-teen children have insufficient incomes to cover a
basic family budget in their communities, excluding any level of
savings for retirement, education or even emergencies.\4\ The EPI study
was based on a budget of necessities, like food, housing,
transportation, childcare and medical care. In other words, many
families do not have sufficient income to maintain a safe and decent
standard of living. For them, the lack of adequate retirement savings
(or any savings at all) is not a result of consuming too much, the
favorite explanation of some commentators, but instead a symptom of an
economy and a labor market that do not provide them with enough to meet
basic needs.
---------------------------------------------------------------------------
\4\ Heather Boushey, et al., Economic Policy Institute, Hardships
in America: The Real Story of Working Families (2001). The report
focused on families with one or two adults and one to three children
under 12.
---------------------------------------------------------------------------
Pension Funding
Although not a focus of the roundtable discussion, I and other
participants raised serious concerns about the implications of certain
proposed changes to the pension funding rules for the future of defined
benefit pension plans. In particular, changes that would result in
greater volatility in the pension funding requirements--no matter how
intellectually elegant they may seem to some--are likely to drive many
employers to freeze or terminate their existing plans, with an ultimate
negative effect on Americans' pension security.
Specifically, legislation proposed by President Bush and others
would eliminate many of the features of the current funding rules
designed to make funding requirements more predictable by tempering
interest rate and asset value volatility. Under these approaches,
liabilities would be measured using market or near-market interest
rates and assets would be marked to market values. Also, interest rates
used to measure liabilities would be taken from a yield curve based on
the duration of the liabilities, increasing the liabilities for
companies with older participant and beneficiary populations. The
stated reasons for these changes are protecting the Pension Benefit
Guaranty Corporation (PBGC) and improving pension security.
This radically new approach to plan funding likely will have
effects opposite those intended by its supporters. Volatility in
required contributions is a major concern to plan sponsors, with three
out of five employers listing volatility as a top threat to defined
benefit plans, in one survey. In an environment in which the playing
field already is tilted significantly in favor of defined contribution
plans, the shift to a yield curve based on near-market rates likely
will induce more employers to freeze or terminate their defined benefit
plans and make it even less likely employers will create new defined
benefit plans. This outcome will hardly benefit the PBGC, the premium
payer base of which will be reduced, or workers, whose pension benefits
will be cut.
It is the view of the AFL-CIO that pension security can be improved
without introducing the harmful effects of volatile funding
requirements. A proposal by Dr. Christian Weller at the Center for
American Progress illustrates this point. He has shown that funding
rules based on long-term interest rate averages both decrease funding
volatility and improve plan funding levels. A key benefit of Dr.
Weller's approach is that the funding rules become more pro cyclical,
``lowering the burden during bad economic times and increasing it
during good economic times, when employers are best able to contribute
to their pension plans.'' Attached is testimony he recently gave to the
House Committee on Ways and Means Subcommittee on Select Revenue
Measures addressing these issues in greater detail. Policymakers should
seek out these kinds of win-win proposals to build greater retirement
security.
On a separate but related matter, policymakers need to give
multiemployer pension plan trustees and the relevant bargaining parties
additional tools to protect their pension plans. Current rules do not
provide the flexibility needed to protect pension plans until it is too
late.
The Chairman. Thank you. I appreciate it.
Mr. Kimpel.
STATEMENT OF JOHN KIMPEL, SENIOR VICE PRESIDENT AND DEPUTY
GENERAL COUNSEL, FIDELITY INVESTMENTS
Mr. Kimpel. Thank you. I would like to take a slightly
different tack and talk about what I am most concerned about
looking at 20 years. It is not the pension system itself, but
rather the extent to which retirement savings will increasingly
be eaten up by health care costs. We estimate that a couple
retiring today will need at least $175,000 to cover that
couple's out-of-pocket medical expenses. I do not think the
issue is DB versus DC or annuitization versus nonannuitization.
Those are important issues, but the real issue, in our
judgment, is regardless of how much people are saving today,
they are not saving enough to cover the massive health care
costs that they will be confronting 20 years out from now, and
unless and until we focus on that and figure out ways to
integrate health care savings with retirement savings we will
not be saving enough.
The Chairman. Thank you.
Ms. Schutz.
STATEMENT OF PAMELA S. SCHUTZ, PRESIDENT AND CEO, RETIREMENT
INCOME AND INVESTMENTS, GENWORTH FINANCIAL
Ms. Schutz. Thank you very much. I represent an insurance
company, Genworth Financial, and I will come at this from a
little bit different angle.
We see the landscape is very much changing, and that the
burden for guaranteed retirement income shifting more to the
individual. You see that with the decline in defined benefit
plans, that guaranteed paycheck for life that people had, and
exacerbated by the fact that Americans are living longer. The
defined contribution plans do not offer those guarantees. They
do not substitute a defined benefit plan. They do not guarantee
for investment risk and longevity risk.
So what we see is insurance companies being able to step in
and fill some of that vacuum and gap to give people peace of
mind, a paycheck for life, because that is what they do. They
pool investment and longevity risk. So we see the insured
defined contribution plan concept and annuitization becoming
more and more important and valuable as we look ahead in
retirement savings and security.
[The prepared statement of Ms. Schutz follows:]
Prepared Statement of Pamela Schutz
Thank you for organizing this important forum and inviting me to
participate on behalf of Genworth Financial. With 15 million valued
customers, more than 5,000 skilled professionals, and more than $103
billion in assets (as of December 31, 2004), we are one of the world's
largest insurance organizations. We serve three major customer needs:
protection, retirement income and investments, and mortgage insurance.
introduction to the problem
Helping Americans improve their ability to enjoy a financially
secure retirement is one of the most challenging domestic issues faced
by this Congress. Americans are spending a greater portion of their
lifetimes in retirement than previous generations. Today, more than
half of all workers retire before their 62nd birthday, and the average
retiree can expect to spend approximately one-fourth of his or her life
in retirement. Retirement is also the most difficult financial planning
exercise that the average individual will face in his or her lifetime
because the stakes are so high--the potential consequence of making a
mistake is to live the last years of one's life in poverty.
A comprehensive retirement income system should be built to deliver
results on all facets of the ``Three-Legged Stool'': Government Social
Security, employer sponsored plans, and individual personal savings. As
the focus of this forum is the trend in employer sponsored plans, it is
important to recognize the degree to which the burden of assuring an
adequate retirement income is shifting to the individual, who typically
has not been given the tools to meet this challenge. This shifting to
the individual of responsibility for a financially adequate retirement
will continue as long as the availability of traditional Defined
Benefit (DB) plans continues to decline. Employees are faced with a
loss of guaranteed income during retirement and they have limited
options in replacing that ``paycheck'' for life.
Further exacerbating the problem of achieving an adequate
retirement income is the simple fact that Americans are living longer.
A longer life is something to be thankful for, but it means that we
each will need income that will match that longer lifespan. Today, 50
percent of healthy 65-year-old women will live past age 85. In fact,
one in three will live past age 90 and one in 10 will live past age 95.
In addition, women spend even more time in retirement than men and are
less likely to have participated in employer sponsored retirement
plans. Forty-four percent of female workers lack a pension from any
employer, compared to 36 percent for male workers. These factors mean
that both men and women face a difficult challenge in managing their
savings during retirement years.
the lack of guarantees for the individual
At the center of the challenges and concerns individuals have about
their retirement security is the lack of guarantees, in particular the
lack of a guaranteed income that will last regardless of how long the
individual lives and no matter how the stock market performs.
In their current design, Defined Contribution (DC) plans do not
replace the guarantees that are associated with a traditional DB plan.
There is no guaranteed minimum income, there is no guarantee that the
retirement income will last a lifetime, and there is no guarantee on
the performance of the individual's overall retirement portfolio.
Without these guarantees, the employee is faced with having to mitigate
six key retirement risks on his or her own. These six key risks are:
long-term rate of return risk (will your assets perform as
expected),
inflation risk (will your returns outpace inflation),
excess withdrawal rate risk (how much can you safely
withdraw),
point-in-time risk (can you weather a down market at the
time of retirement),
longevity risk (will you outlive your assets), and
health care risks (will your income stream support rising
healthcare costs).
potential solutions
Life insurance companies are in a unique position to help employees
manage these risks by partnering with DC plan sponsors and mutual fund
companies. Life insurance companies can pool longevity and investment
risks across a large number of participants--thereby providing
guarantees at the individual participant level. These guarantees are
provided by financial institutions that are highly regulated by the
States to assure that individuals receive the benefits they have been
promised.
There is widespread recognition that the purchase of income
annuities, ``annuitization,'' at the point of retirement would help
mitigate some of these risks. It is a common practice for life
insurance companies to:
convert an account balance into a guaranteed income stream
that will last a lifetime,
offer guaranteed payouts over the life of a single
individual or the life of the individual and his or her spouse,
increase a fixed payout stream for an expected inflation
rate,
guarantee that payments will continue for a minimum period
whether the individual lives or dies, and
allow the individual to participate in equity market
performance.
As a consequence, an emerging market is developing in what Genworth
calls ``Insured Defined Contribution'' plans. Insurance companies like
Genworth, MetLife, and others are building new annuity products that
allow sponsors to offer defined benefit investment options to their
employees within a 401(k) plan. The importance of an Insured DC option
is that the individual throughout his or her working career, without
having to wait until retirement, is able to determine with certainty
how much guaranteed lifetime income his or her current 401(k) account
balance will buy at a future retirement date.
An Insured DC option can be made portable, thereby addressing the
issues created by an increasingly mobile workforce. In addition, some
designs can be structured to provide upside potential through equity
participation in order to offset the risk of inflation. Our consumer
research into the Insured DC option has indicated significant interest
on behalf of 401(k) participants. Here are the highlights of our
findings:
69 percent of participants age 25-34 would invest in an
Insured DC offering if given the opportunity, 70 percent of all
participants would do so.
23 percent of those who say they would invest in an
Insured DC option would increase their contributions to their 401(k)
plan if able to participate in such an option.
54 percent of the individuals who choose not to
participate in their employer's 401(k) plan would participate in the
plan if an Insured DC option was available.
95 percent of participants found the guaranteed minimum
income for life feature of an Insured DC option attractive (63 percent
said very attractive).
93 percent of participants said portability of the Insured
DC guarantee was attractive (53 percent said very attractive).
the need for education
A key predicate to successfully managing the risks that Americans
face in retirement is making sure that they understand those risks.
Most Americans have not had the opportunity to prepare for the
responsibility they will face at retirement. Financial planners report
confusion about retirement planning and many working people do not
understand how to convert assets into enough income to cover a lifetime
of non-discretionary expenditures. This conversion of account balance
into lifetime income at a future retirement date is a very
sophisticated calculation. In order for Americans to understand the
dynamics of this retirement reality, we as a country must address the
significant education gap that exists today.
The following simple question illustrates the complexity in this
area: If you were 65 today and were to retire today, would you feel
wealthier if you had $500,000 in your 401(k) plan or had a pension
guaranteed to pay you and your spouse $32,500 per year for the rest of
your lives? It becomes a harder question to answer when given the added
information that many advisors would say that no more than $20,000
should be withdrawn annually from a $500,000 balanced fund in order to
be reasonably assured that the money will last 30 years. However, even
at this safe withdrawal rate, there is no longevity or investment
performance guarantee, so it is still possible to outlive this money.
To help Americans understand the retirement security issues they
face and the solutions available to them, retirement education needs to
focus on three components:
the basics of personal finance, including the discipline
of saving, starting to save early in your working life, and the value
of compound interest,
the conversion of savings into a reliable income stream,
and
the value of guaranteed income, a ``paycheck for life,''
and the benefit of pooling longevity and investment risk with others.
While many valuable financial education initiatives have been
undertaken in recent years by both the public and private sectors, more
can and should be done.
the importance of life contingent annuities
One of the most important, and often least understood, sources of
financial risk comes from uncertainty about how long one will live.
According to a 2001 study by the Society of Actuaries, 67 percent of
retired women and 55 percent of retired men underestimated the average
life expectancy of a 65-year-old. This uncertainty means that there is
a real risk of experiencing a reduction in living standard at older
ages, even if one has tried to prepare for retirement. Saving is not
enough; one must also be a careful manager of one's savings.
Individuals should be encouraged to manage their savings during
retirement in a manner that accommodates their daily needs, but also
ensures that their savings will not be exhausted when they have more
years to live. This is why life contingent annuities are so important.
An annuity that continues to make payments for as long as you live
(often called a ``life contingent'' annuity) is an affordable, powerful
retirement tool that allows individuals to manage many of their
personal retirement risks. The life contingent annuity is a combination
of investment expertise and insurance that gives individuals the
ability to insure against the financial risks of retirement by pooling
their assets, and their financial risks, with a large number of other
policyholders.
For many individuals, guaranteed lifetime income payments from an
annuity may be the most effective way to ensure that retirement savings
will not be depleted during their life. Outside Social Security and
employer sponsored DB plans, only an annuity can guarantee that an
individual will receive regular, guaranteed income payments for as long
as he or she lives.
A life contingent annuity is designed specifically to address the
financial planning problem of guaranteeing that individuals will not
outlive their income no matter how long they live. The annuity can be
designed to give consumers the flexibility to transform accumulated
savings--both savings inside an employer plan and those accumulated
outside of a plan--into a variety of forms of guaranteed streams of
retirement income based on each individual's needs.
Annuities have a variety of features and options that allow
individuals to provide for their own retirement needs and to provide
for a spouse or heirs after death The payment stream itself can take a
variety of forms depending on the individual's needs. It can guarantee
payments over a person's life (a life contingent annuity), over two
peoples' lives (called a joint and survivor annuity), over a specified
period (called a period certain annuity), or over a life or lives with
a minimum period of payments guaranteed, e.g., 10 years (called a
certain and life annuity). Annuities that combine life contingencies
with period certain features are particularly attractive because they
protect against longevity risk while at the same time providing the
ability to bequeath amounts to heirs (either in a lump sum or as
continued periodic payments) upon a death during the period certain.
Annuity payment streams can be designed to make fixed income
payments (called a fixed annuity), or can be designed to protect
against inflation by making payments that increase or decrease with
market performance (called a variable annuity). Some variable annuity
products also guarantee minimum income levels while providing the
upside potential of the equity markets, thereby protecting against
investment risk in addition to inflation and longevity risk.
The key point is that life contingent annuities, in whatever flavor
may best suit a particular individual's circumstances, provide
individuals with the guarantee of an income stream that will continue
throughout their retirement years, no matter how long they live.
conclusion
The combination of more and improved retirement education, the
growth of Insured DC options in employer plans, and encouraging more
individuals to manage retirement risk through life contingent annuities
would benefit the Three-Legged Stool: employers would have a
predictable and stable funding vehicle for the retirement benefits they
offer and have employees that value and appreciate the benefits
offered; employees would have an option for guaranteed retirement
income for life and would be motivated to begin addressing the concern
earlier in their working lives; and the government would have the other
two legs of the stool helping to bear the load of retirement security.
Once again, we appreciate being included in this timely forum and
look forward to discussing the many different alternatives available to
resolve some of these critical retirement savings and income issues
faced by our country.
The Chairman. Thank you.
Ms. Friedman.
STATEMENT OF KAREN FRIEDMAN, DIRECTOR OF POLICY STRATEGIES,
PENSION RIGHTS CENTER
Ms. Friedman. Hi. Thank you very much for enabling us to be
here today.
I wanted to say a few things first from the Pension Rights
Center's perspective when you are looking 20 years in the
future. Certainly we need to take into account that there is a
changing workforce. We want to make sure that while there is a
shift from defined benefit plans to more individual account
plans, that we do as much as we can to keep defined benefit
plans, recognizing that employers have a real role to play in
providing retirement income to people of all income levels, and
I want to start with that.
What I wanted to emphasize today, and many people around
the table actually know about this, the Pension Rights Center
has convened a national public policy dialogue over the last 3
years with several of the people around the room, MetLife,
AARP, the AFL-CIO, Fidelity, the American Academy of Actuaries,
are all cosponsors of this initiative called the Conversation
on Coverage. I know Dallas has been an advisor. We are working
with Principal. Vanguard has just joined one of our working
groups.
The Conversation on Coverage is a forward-thinking forum to
address the very questions that you are asking today. We have
been looking at how do we increase coverage for the 50 percent
of the working population that now has no pensions or savings
to supplement Social Security. We assume that that challenge is
going to get even greater in the years forward. The great thing
about the Conversation--and I can say this because I am just
the neutral facilitator and am not part of the working groups,
and John Kimpel is one of our co-chairs right there--the
Conversation has come up with--and I am not going to go into it
now, but I would be happy to a little bit later--has come up
with the kinds of innovative solutions that Ron was talking
about.
Working Group 1 looked at how do we increase coverage
through defined benefit plans, and looked at new forms of
hybrids, even looked at DBK proposals but also looked at a new
kind of proposal called a gap, which actually starts with a
money purchase structure.
Working Group 2 looked at ways of encouraging savings both
by making it easier for people to participate in 401(k) plans,
but also came up with a new structure for a centralized system
of individual accounts about Social Security.
Senator Enzi, you talked about the challenges to small
business. Working Group 3 looked exactly at that challenge and
came up with what they called a new Model-T plan, which is
essentially a new kind of multiple employer plan that would be
marketed through financial institutions to small employers,
possibly in a small community, and we are going to be looking
to do a demonstration project on that.
So I just want to point out that the Conversation on
Coverage has put out some initial recommendations, and we are
going to be working to refine those over the next year.
The Chairman. Thank you.
Mr. Covert.
STATEMENT OF KEVIN M. COVERT, VICE PRESIDENT AND DEPUTY GENERAL
COUNSEL, HONEYWELL
Mr. Covert. Thank you, Mr. Chairman. I would like to spend
a couple minutes coming at this a little less from a policy
perspective and a little more from a real world employer
perspective company that actually sponsors these plans.
Honeywell is a multinational company with 108,000 employees,
60,000 in the U.S. We provide both defined contribution 401(k)
plans and defined benefit plans to all of our U.S. employees.
We actually believe that is the proper mix, to encourage
both the DC plans giving employees the opportunity to invest
their own money and share in the largesse of a growing economy
and good times, but also to provide benefit plans where you
provide a safety net for employees in their retirement.
Unfortunately, when we look into our crystal ball we see a
world of almost exclusively defined contribution plans 20 years
from now. We already see it with our colleagues in the Fortune
100 companies, huge companies with large U.S. populations that
have frozen their plans on the DB side, Tyco, Time-Warner,
Xerox, Sears, Rockwell, IBM. The list is large and it covers an
awful lot of employees.
As an employer we see the reason for that being twofold,
first the funding issues. What CEOs and CFOs need in this
global economy is predictability. We cannot survive with our
competitors either in the U.S. or globally if we have huge
volatility swings on funding requirements because as you all
know, we do not plan for 2005 in 2005. We plan for 2005 in the
year 2000. That is how we manage our cash. That is how we
manage our capital outlays, research and development and so
forth.
Second, we have perverse incentives. In a system whereby we
ratchet funding requirements and PBGC premiums in lean economic
times, forcing companies that would rather stay in the system
out of the system, and yet in good economic times there are all
types of restrictions to companies being able to put excess
money, when they have it available, into their plans, so that
when lean times come their plans are adequately funded.
The other obstacle we see ongoing is uncertainty. Most
large employers like Honeywell have hybrid plans of one type or
another that cover some of their population. Because of the
District Court decision in Illinois, that has had a very
detrimental freezing effect on companies in terms of
willingness to adopt new plans and to maintain their plans.
That was the reason given by IBM for why they froze their plan.
They got hit with a huge judgment. They were concerned about
it, and they could not very well go to their CEO and say, well,
we are just going to maintain this plan and let that potential
liability spiral up.
So we as employers need to know that the plans we sponsor
are legal. If we do not have that certainty, I as a general
counsel advising my CEO cannot go to him and say, well, I think
we should continue to let these plans go, continue to bring new
employees in, continue to accrue benefits in them with no
guarantee that we are not going to get hit with a multibillion
dollar judgment down the road.
Thank you.
The Chairman. Thank you.
Mr. Dunbar.
STATEMENT OF MARK K. DUNBAR, PRESIDENT, DUNBAR, BENDER & ZAPF,
INC.
Mr Dunbar. My presence here, I think I am one of the few
that represent small employers. My company is a small plan
sponsor, and I also do a lot of work with small employers. I am
actually a pension actuary, so I am one of the few here that
has that hat on.
Some of the comments that have been made I think are
clearly from a large plan perspective. I think with the small
employer, I think one of the first comments I would make is
that the small employer needs to have control. So they are
going to be more interested in a plan design where they have
the flexibility that they need to be in or out. The ability to
fund, as Kevin mentioned, is important, to be able to fund in
good years and not have a huge requirement in bad years. So
that flexibility is there in both small and large plans.
I think one of the prior comments was about the DBK
concept. We have seen interest in the small employers in cash
balance type arrangements. Obviously, the legal uncertainty is
of concern. One of the other problems with the cash balance on
the small employer is the requirement to tag lump sums to GATT
rates and whipsaw, if any of you are familiar with whipsaw.
That restricts the interest rate that you can credit on a cash
balance and that is a deterrent to these types of plans for the
employees. With the larger employers, they tend to get around
that by not offering lump sums, but on the small employer that
is not an option. So that is a big issue.
If Congress could address the cash balance issues and look
at the type of designs like the defined benefit (k)
arrangements, I think that would make the defined benefit area
more attractive to the small employer.
When we talk to a lot of our small employers, they are
willing to commit to a small level fixed contribution, for
example, safe harbor 401(k)s with a 3 percent fixed
contribution. Many small employers are willing to agree to
that, knowing that they can change it in a future year if they
need to. So they are willing to commit to a low level and then
put more in if they have a good year. I think that if that
arrangement was there on the defined benefit side also, it
would increase the interest in that type of arrangement.
Other issues, a lot of your small employers, again, you are
taking dollars away from other sides. If there was incentive
for them to put plans in, even initially, that would help at
least not have an expense. I think often with our small
employers getting hit with document costs over and over again
as we have to resubmit documents is an issue. From the small
employer employees, talking about participation rates, you have
in the code now some saver credit dollars that go to low-paid
employees. If you could increase those dollar limit numbers to
hit more employees, I think that would help with getting your
low-end employees in at the early years. Once employees are
into a plan they tend to stay in and continue to contribute. It
is getting those 20- to 30-year-olds in the plans at an early
age that is difficult. They tend to have other uses for their
dollars as to ``what am I doing this weekend?'' So if you could
find a way to give those low-paid employees incentive, it is
meaningful.
Thank you.
The Chairman. Thank you. Do you feel a tremendous burden
representing 90 percent of the businesses in the United States?
Mr. Covert. I do. I do. [Laughter.]
The Chairman. Thank you.
Mr. Henrikson.
STATEMENT OF C. ROBERT HENRIKSON, PRESIDENT, METLIFE
Mr. Henrikson. Yes. First I would like to--it strikes me
listening to everyone speak that I would like to thank
everybody for this opportunity because for those of us who have
been--and most of us have in one way or another--in the pension
business all our lives, this is a unique opportunity.
One of the things I think you will notice is that despite
the fact everyone comes from a little bit different place and a
position looking at these problems, the language will be very
similar and I do not think you are going to find a lot of
disagreements on the major issues.
One of the things I wanted to mention about the three-
legged stool is that I remember being part of the Council for
Economic Development back 7 or 8 years ago studying this very
problem. On my first meeting--and I was going to be good and
not say anything until the conversation got going--and the
opening statement was by the chairman at the time, ``One of the
things we need to have in our opening page is a statement that
basically says `This generation needs to learn how to save for
their retirement like we did.' ''
And I came out of my seat because I think certainly the
people in that room, no one was living a retirement based on
what they had saved, I will tell you that, basically a group of
CEOs. [Laughter.]
So one of the things about the three-legged stool that I
would say--and certainly this experience with my parents--the
most important thing about the three-legged stool is that two
parts of that stool, two legs of that stool produce an income
off of which people live. After all, that is what most people
live off of, income. If you ask them why their status is what
it is or why they send their kids to the schools they do or
where they live or what kind of home they buy and whatnot, it
is based on their income. The three-legged stool, certainly in
my dad's situation, the day he retired the biggest paycheck he
got every month was from his defined benefit pension plan. He
was a middle income person, worked for many years at one
company. The second biggest payment he got was his Social
Security check. And then he had his savings which he watched
like a hawk for the rest of his life because he was worried
about it. He did not live off of it.
A few years went by and before you knew it his largest
paycheck was the Social Security paycheck because it had been
indexed for upward prices and so forth, then the pension plan,
and he was still watching his savings, scared to death the
older he got that he was going to somehow lose that bag of
cash.
What we are asking employees to do today, my point is, we
are asking people to do something that has never been asked of
people before in the history of the United States. We are
basically asking them to fund and finance the rest of their
lives dependent on how much they save, what kind of investment
decisions they make, and then the big challenge is how do you
manage that money after you are retired, such that it can
provide you an income that you can live off of? It is very,
very difficult.
The biggest thing that--to tackle what a couple of other
people have said--the biggest thing lost in terms of security
when the employers go out of the defined benefit business is a
mortality pool. That mortality pool makes it possible for
someone to not have to worry how long they are going to live.
This is something that cannot be self-insured. It has been
provided by defined benefit plans for years. It certainly is
provided by Social Security, and now with a defined
contribution system, to Pam's point, someone is going to have
to encourage people to understand what the value of being part
of the mortality pool is, and that is a very, very big issue.
In terms of defined benefit plans I would just say we have
business with many of the Fortune 100 companies in the United
States. Unfortunately, I think the traditional defined benefit
plan at the large end of the marketplace the cat is out of the
bag. The employer has agonized over decisions to get out of the
defined benefit plan. It was not an easy decision for them to
make. To think of them reversing that decision at this point, I
think is very difficult to envision.
The small plan, the small employer, one of the great things
about a defined benefit plan is that the employer who has
worked to build that business and may not have been able to
afford a retirement plan in the early years, can reach back in
time to give themselves and their employees past service credit
on the defined benefit system. And for that reason I think that
defined benefit plans might grow in the small business
community.
[The prepared statement of Mr. Henrikson follows:]
Prepared Statement of C. Robert Henrikson
Our Nation is at a retirement crossroads and the next decade will
prove to be critical for the long term retirement security of
individuals.
By now most of us are aware that many Americans have not saved
enough for retirement. There are other factors at work that are
compounding the problem. First, we are living longer than at any time
in our Nation's history. Second, fewer and fewer people will be able to
rely on the security and guarantee of a fixed level of lifetime income
afforded by traditional pension plans. We expect that over the coming
decades, especially as the Baby Boomer generation enters their
retirement years, these factors will become even more pronounced. The
convergence of these factors has created the real possibility that many
retirees will outlive their retirement assets or be forced to adjust
their lifestyles and standard of living.
To better understand the magnitude of the problem the country
faces, a discussion of the demographic and market forces that have led
us to this point is instructive. Research results that speak to
people's overall retirement preparedness will be highlighted and we
will review some of the risks that are unique to retirees. Finally, one
important solution to the need for lifetime retirement income--
annuities--will be discussed and we will share with you some of the new
product innovations that allow individuals to convert their nest egg
into a guaranteed stream of income that they cannot outlive.
The Impending Retirement Crisis
The looming crisis facing us today is not one that happened
overnight. We have slowly been evolving to this point over the last 20
years as the burden of saving for retirement has been steadily shifting
to the individual. Over that time the number of defined contribution
plans (DC) has been accelerating rapidly while the number of defined
benefit programs (DB), with their guarantee of lifetime income, has
been steadily decreasing. This trend will likely continue over the
coming decades as defined benefit plans continue to face an uncertain
future (see Chart 1):
The Department of Labor, in a Government Accountability Office
(GAO) study released in July 2003, reported that the percentage of
workers who participated in a primary defined benefit plan fell by 16
percentage points while the percentage participating in a primary
defined contribution rose by 20 percentage points (see Chart 2):
The PBGC estimated that the number of active employees covered by a
traditional single employer defined benefit pension plan was 10.5
million in 2000, down from the peak of 22.2 million in 1988. Of note is
the fact that half of today's plans allow employees to take their
distribution in a lump sum rather than as a lifetime monthly paycheck.
We believe the movement away from traditional pension plans will have a
significant adverse impact on Baby Boomers' retirement security over
the next 20 years.
The shift away from traditional defined benefit plans has put
increasing pressure on retirement savings plans such as 401(k)s to be
the primary source of retirement income. With it comes a tremendous
challenge for our citizens as they are being asked to determine largely
on their own to how much to save, how to invest that money wisely and
how to prudently draw down their savings so they are not depleted
prematurely. Although retirement savings levels are insufficient for
many workers to enjoy a comfortable retirement, the larger issue is how
those retirement savings will be managed in retirement so that they
last a retiree's lifetime.
So what choices are people making at the point of retirement? In
its report on private pensions, the GAO analyzed the types of pay-outs
workers actually received at retirement from defined benefit and
defined contribution plans. The analysis covered the period 1992-2000.
They found that retirees in greater numbers are selecting benefits in a
form other than a guaranteed lifetime payment (i.e., annuities). An
increasing proportion of more recent retirees chose to directly roll
over lump sum benefits into an IRA or to leave their assets in the
plan. From 1992-1994 retirees choosing either of these options
represented about 32 percent but grew to 47 percent by 1998-2000.
Clearly, much of this can be explained by the shift toward defined
contribution plans, less than one-third of which offer an annuity
option. But the report went on to state that a growing percentage of
retirees who reported having a choice among benefit pay-out options
chose pay-outs other than annuities. An analysis conducted by the
Employee Benefit Research Institute (EBRI) supports the GAO findings.
All indications are that when given the choice to replicate the benefit
provided by a traditional pension (i.e., an annuity), few individuals
are making that choice (see Chart 3):
There are a number of reasons why people are choosing distribution
options other than annuities. The two most significant reasons,
however, are the lack of familiarity with longevity risk and not fully
understanding how much their retirement savings are worth in terms of
an income stream.
Given the clear trend away from traditional pensions, people will
be relying on programs such as 401(k) plans that do not provide the
same guarantee of benefits. They will be largely left on their own to
replicate the security previously provided by defined benefit plans--
security that was created by teams of actuaries, pension experts,
investment professionals, benefit consultants, accountants, attorneys,
and by the government through the protection offered by the Pension
Benefit Guaranty Corporation. Stripped of this expertise and
protection, employees need our help.
Consumer Preparedness
Increases in life expectancy, greater responsibility falling to the
individual and the financial challenges faced by government supported
programs are creating a period of great risk with regard to retirement
security. This triple threat is magnified exponentially when you factor
in that the 36 million Americans over the age of 65 will grow to 72
million 25 years from now. If that sounds far off, consider that the
first Baby Boomers will reach the traditional retirement age of 65 in
just 6 years (see Chart 4):
So how prepared for retirement are these millions of people? In
June 2003, MetLife created the Retirement Income IQ test. Twelve
hundred men and women in the survey between 56 and 65 years of age and
within 5 years of retiring were asked 15 questions to assess their
level of retirement preparedness. Ninety-five percent of the
respondents failed the test and the average score was 33 on a scale of
100 points. Perhaps most disturbing was the misunderstanding
surrounding how long people will live. A 65-year-old man has a 50
percent chance of living beyond his average life expectancy. That's
what average life expectancy means--about half the population will live
past that point and the other half won't. Yet when we posed that
question to 1,200 individuals, the majority of them thought there was
only a 25 percent or less likelihood of living beyond average life
expectancy. Only 16 percent of respondents replied correctly that a 65-
year-old couple have a 25 percent chance that one of them will live
beyond age 97 (see Chart 5):
Respondents also underestimated how much money experts recommend
they need for retirement and they overestimated the recommended rate at
which they can safely withdraw from savings to help make their money
last throughout their retirement. Over one-third believe they can
safely withdraw 7 percent from their savings annually, even though
planning professionals suggest limiting annual withdrawals to no more
than 4 percent. When you combine underestimating longevity with these
other findings, the picture becomes very unsettling.
The results from the Retirement Income IQ are corroborated by many
other industry studies. EBRI's 2004 Retirement Confidence Survey notes
that less than one-half of workers have even done a basic retirement
calculation. Other results of note from this survey include:
Approximately one-third of respondents are not confident
of having enough money to live comfortably in retirement.
One out of six workers said that they were not too or not
at all confident of having enough money to take care of basic expenses
in retirement.
Nearly 4 out of 10 workers believe they will need seventy
percent or less of their pre-retirement income while retired, a sharp
contrast to the 90 percent to 100 percent that some financial experts
estimate individuals will need.
66 percent of all workers have given little or no thought
as to how they will manage their money in retirement so that it doesn't
run out.
MetLife's 2004 Employee Benefits Trend Study found that nearly half
of workers rank ``outliving their assets'' as their greatest fear. More
than half of Baby Boomer employees ages 41 to 60 describe themselves as
``behind schedule'' in saving for retirement, with 28 percent reporting
that they are ``significantly behind'' and an additional 27 percent
described themselves as ``somewhat behind.'' Only 3 percent have
reportedly reached their goals. Other results of note from the survey
include:
Nearly half of all those surveyed report that they manage
their finances by living paycheck-to-paycheck.
Young workers between the ages of 21 and 30 are the most
unprepared, with nearly half lacking retirement goals and/or savings.
What is the answer? Individuals must receive better retirement
planning education. It is our belief that the most successful programs
are those that are made available through the workplace and then
targeted to employees at various life stages (e.g., singles,
established families, pre-retirees, and retirees). Beyond that, we
believe individuals must receive investment advice so they understand
how to maximize their retirement dollars. We also need to shift the
conversation from retirement assets to focus on retirement income and
offer tools to make this happen. Even those who have built a relatively
large nest egg do not know how much income that nest egg will produce
throughout their retirement. In short, Americans don't know what their
savings are really worth.
Risks in Retirement
Once they reach retirement, there are certain risks people face
that they did not have to confront during their working years.
A significant concern for retirees and pre-retirees alike is
inflation. According to EBRI's 2003 Retirement Risk Study, over half of
retirees and nearly two-thirds of pre-retirees are very or somewhat
concerned that they will not be able to maintain the value of their
savings and investments relative to inflation. In addition, pre-
retirees expressed a greater concern than retirees over the possibility
of not having enough money to pay for good health care (58 percent of
pre-retirees are very or somewhat concerned as opposed to 43 percent of
retirees). Pre-retirees are also more concerned about their ability to
pay for quality long-term care.
Market volatility is another risk that can have a unique impact on
retirees. Recent stock market experience has taught us all how quickly
and how adversely our savings can be affected when exposed to a bear
market. But for people who are still saving they have the benefit of
time on their side and have a reasonable expectation of seeing their
assets return to or even surpass pre-downturn levels. However, for
retirees market downturns can have a devastating impact, especially
early on in their retirement years. Too often people rely on averages
and base their planning (if any) on the assumption that their account
will return the average. They research the historical market returns,
plan to withdraw an amount less than the historical average return and
then feel confident their money will last them well into their
retirement years. However, a market downturn in retirement can have a
much greater impact on a retiree's nest egg if they are taking
withdrawals than if they are simply saving and still have time to
recover from any stock market losses. Using average returns while
planning is dangerous because the market does not earn averages in any
given year and once you withdraw in a down market, you realize losses
never to be recovered.
However, we believe that the biggest risk facing retirees is
longevity. An earlier graph illustrated the average life expectancies
for males, females and couples. When we shared these statistics with
consumers most expressed shock and some even disbelief. But the numbers
are accurate and, as we continue to make advances in medicine and adopt
healthier, more active lifestyles, life expectancy will stretch out
even longer.
The reason we believe longevity is the greatest retirement risk
retirees face is because it is the only risk an individual cannot
manage on his or her own. Market risk can be alleviated somewhat
through asset allocation and inflation risk can be addressed by
investing in growth equities or inflation indexed bonds. Not only is
longevity the one risk individuals cannot manage by themselves, it
actually exacerbates these other two risks by increasing the length of
time individuals are exposed to them.
Managing Longevity Risk
How long one individual will live is extremely uncertain. People
can take a guess as to how long they are going to live . . . plan so
that their retirement assets last the right amount of time . . . and
then hope that they haven't miscalculated their life expectancy.
Fortunately, there is a better way to manage life expectancy. Join a
mortality pool and ensure that you will not outlive your retirement
assets.
The pooling concept is a powerful one that's at the heart of all
insurance products and defined benefit plans. Longevity is a small risk
for the sponsors of large defined benefit pension plans since the ``law
of large numbers'' permits them to fund for the average life expectancy
of the entire group of retirees. When a large group of retirees is
pooled together, the retiree who lives a long time is offset by the
retiree who dies early.
By contrast, individuals cannot self-insure the risk of outliving
their money because they cannot accurately predict how long they will
live. Whereas an individual can decrease his investment risk by
changing his investment strategy, there is no way that an individual
can, on his own, reduce his longevity risk. The only way that an
individual can manage this risk is by converting his savings to an
annuity. With annuities, a retiree can manage longevity risk and may
choose to keep some portion of investment risk (along with its
potential return) through a variable income annuity. Or a retiree can
manage both longevity and investment risk with a fixed income annuity.
An income annuity, also known as an immediate or payout annuity, is an
insurance product that converts a sum of money into a stream of income
that is guaranteed to last throughout the lifetime of the policyholder.
The Next Generation of Retirement Income Solutions
In the coming decades, we believe that annuities will be a critical
part of the solution to helping people turn their nest egg into
guaranteed lifetime income in retirement. Market research indicates
that there is greater receptivity to annuities once their benefits are
explained. Furthermore, we are beginning to see more innovative product
designs that are intended to meet the needs of today's--as well as
future--retirees. Companies such as MetLife are helping to
revolutionize how employees prepare for the 20, 30 or even 40 years
that they will live in retirement. The insurance industry has
introduced some of its most innovative retirement products during the
past 2 years. This ``new generation'' of income annuities--which are
supported by a range of educational programs and tools--allow
individuals to convert their nest egg into guaranteed income that they
can't outlive. To reflect the needs of today's retirees and the
retirees of the future, income annuities have become more flexible,
more affordable and portable, while retaining the product's core value
of guaranteed lifetime income.
One recently introduced income annuity is a type of longevity
insurance--designed to generate income starting at a later age when an
individual's retirement savings may be running out. The individual may
elect to receive the monthly income from the product, for example, on
his or her 85th birthday--the average life expectancy for Americans who
have reached age 65--or at any point during an individual's retirement.
Since the individual would typically buy this income annuity between
the ages of 55 and 65, she is deferring the income start date 20 or
even 30 years into the future. It allows her to set aside a smaller
portion of her retirement savings in order to generate a steady stream
of guaranteed income in the later years when many of us need it most.
It also allows her to manage her remaining retirement assets to a
limited time horizon.
Insurers are also introducing income annuity products that are
targeted to a younger audience. These new products allow employees to
create their own ``personal pension.'' Offered as a complement to, or
as an option within, a 401(k) plan this type of product is unique in
that--unlike traditional savings vehicles--every contribution an
individual makes is immediately converted to a specific future income
benefit that is guaranteed to last a lifetime. This is similar to a
defined benefit plan. The product is also portable so workers can take
it with them when they switch jobs. The need for portability is clearly
important since, as reported in the National Longitudinal Survey of
Youth, the average Baby Boomer held 10 jobs by the age of 36.
We are also seeing more income annuity products that offer
liquidity options that allow purchasers to access money in an emergency
and inflation options that link benefit increases to changes in the
CPI. In addition, products are offering features (e.g., more investment
choices, transfers, and rebalancing) that provide individuals with the
flexibility and control that they are used to seeing within their
401(k) plans.
During the last Congress, the House Ways and Means Committee marked
up legislation that takes important steps in educating individuals
about the value of income annuities by including a targeted income tax
exclusion for retirement plan distributions taken in the form of
annuity payments. The bill also contained important fiduciary safe
harbors for employers that offer a specific annuity or IRA at the time
of distribution, which will encourage employers to offer annuities to
401(k) plan participants. Finally, a new pension bill to be introduced
in the near future not only includes these provisions but also
recognizes the value of longevity insurance by excluding the amount of
money used to purchase such insurance from the required minimum
distribution rules.
We believe that a concentrated effort to educate consumers about
the benefits of annuities, coupled with legislative proposals, will go
a long way in helping us meet and overcome the retirement crisis facing
the country.
The Chairman. Thank you.
Mr. Garrison.
STATEMENT OF DOUGLAS GARRISON, MANAGER, GLOBAL BENEFITS DESIGN,
EXXON-MOBIL
Mr. Garrison. Thank you, Mr. Chairman. I applaud the
committees for this forum. I think this is, as Mr. Henrikson
said, it is a very useful opportunity to share ideas among
ourselves with the different perspectives that we have.
The point I would like to make would be to rise a little
bit above some of the details, and my sense is that what we
fundamentally face is a need for retirement security 20 years
out. That need is going to be high considering the proportions
of unprepared baby boomers that we have, the extended life
spans, the increasing cost of health care, the limits on Social
Security and the like. I think there is no doubt that the need
for retirement security is going to be there.
I would like to point out that I think business objectives
that are served by retirement plans are still there. Some of us
in the company that I work for, Exxon-Mobil, has both a DB and
a DC plan. I am also the chair of the ERISA Industry Committee
and represent approximately 120 large employers. Many of our
companies believe that our business objectives are well served
by retirement plans. We attract and retain people. We enhance
productivity. We reinforce corporate culture. We reward long
service. We facilitate the renewal of the workforce. These are
corporate objectives that are served by retirement plans, and I
think those corporate objectives will continue to exist 20
years out.
In terms of the plans themselves, they are going to be
shaped, in my opinion, by the business needs, by employee wants
and desires, what the employees are looking for, by the
regulatory environment and by the technology and sophistication
of the industry.
I would like to point out that I believe there are a number
of advantages of employment linked plans, primarily the
discipline in the accumulation phase, as well as in the
discipline in the spend down phase. In my company, for example,
we have approximately 96 or 97 percent of our eligible people
participate in the DC plan. We have designed it really to
induce participation. You do not get any match if you do not
put 6 percent of your own contributions in, and folks get
matched dollar for dollar for that 6 or 7 percent. It is a very
high cost that you pay if you do not choose to participate.
There are a number of other very innovative ideas out in
the marketplace today in terms of automatic participation and
increasing percentages of contributions as pay goes up, which I
think the employer can provide some discipline to help promote
the sense among participants, employees, of the need to set
aside resources for their retirement.
I guess the key question for me is the degree to which
policymakers will facilitate the creation of plans that cover
more workers while enabling plan sponsors to retain the
flexibility to stay competitive.
I think we need, as others have mentioned this morning,
stable and predictable ground rules. I think we need nationally
more interest in saving for retirement among workers, and we
probably need a longer time horizon among plan sponsors and
investors.
Thank you.
The Chairman. Thank you.
Mr. Fuerst.
STATEMENT OF DON FUERST, WORLDWIDE PARTNER, MERCER HUMAN
RESOURCE CONSULTING
Mr. Fuerst. Thank you, Senator. I share the belief of a
number of people that we need diversified assets to really
secure retirement. Like an investment portfolio that needs to
be diversified to provide real security, financial assets in
retirement need to be diversified. The three-legged stool needs
three strong legs.
The problem that we see demonstrated by the chart behind
you is that one of those legs have been declining for a large
number of our Americans, and my work as a consultant to large
companies, helping them design and finance these, I would echo
the comments that others have made earlier, it is difficult to
justify to senior management why they are taking on the cost of
these benefits. An even more challenging situation is to try to
explain to a company that does not have a defined benefit plan
why they might want to add one for the benefit of their
employees.
They can recognize many of the benefits, that defined
benefit plans generally provide universal coverage for
everyone, that they provide a relatively uniform benefit for
most employees, that there is no leakage from the plan through
early withdrawals and loans, that they can offer special
benefits when they have layoffs, window benefits or past
service benefits as others have mentioned, that the longevity
pooling resulting from defined benefit plans can create an
enormous amount of value.
But they also recognize that they are taking on an enormous
amount of risk with that plan, and that the risk is not
justified in many of their viewpoints. The volatility of
contributions is an enormous problem for financial executives
today to justify that.
Many of them were very happy in the 1990s when we had what
we called funding holidays. In retrospect, those funding
holidays were very detrimental to the long-term security of the
plans. We need major revisions in the funding rules of these
plans that will enhance both the solvency of the plans but also
the predictability of the contributions. Both of those elements
are extremely important.
We need greater certainty about the legality of these
plans. There are many innovative ideas about how to design new
pension plans that respond to the needs of a mobile workforce,
but most of those right now are under an enormous cloud of
uncertainty about the legal aspects, and companies are not
willing to implement these new plan designs that would enhance
portability and the mobile workforce when they see enormous
legal risk to those plans.
Finally, there is just very little incentive or even
appreciation for many employees, particularly young employees
because of the deferred nature of these benefits. We need more
incentives for companies to adopt these plans and more
incentives to make the plans attractive to employees. We have
had enormous creativity with respect to savings plans and
defined contribution plans over the past 30 years. Employees
can put money into these plans on a pretax or after-tax basis.
They can now even have the flexibility of taking their tax
benefit when they put the money in or when we take the money
out. We now have plans that can provide tax-free income in
retirement.
We have a lot of creativity in the design of defined
contribution plans through issues like automatic enrollment or
investment funds that automatically change asset allocation
throughout an employee's career, but we cannot make those types
of innovative changes in pension plans today because of the
uncertainty under the law. We need more incentives for
employers to first of all be clear that these are legal and to
provide a financial incentive.
I would suggest a couple ideas. For instance, perhaps a tax
credit for a company that maintained both a defined benefit and
a defined contribution plan to encourage the diversity of that
financial security. To employees to make the plans more
attractive, the ability to get tax-free income from a
retirement plan. An exemption from taxation of a portion of the
benefit paid as a lifetime income to an individual would create
enormous grass roots supports for these plans. Employees would
be demanding from their employers that they establish a plan
that would provide that type of income to them. So these are
the kind of changes that we need to reverse some of the trends
that we have seen over the past 20 years.
The Chairman. Thank you.
Mr. McNabb.
STATEMENT OF WILLIAM MCNABB, MANAGING DIRECTOR, CLIENT
RELATIONSHIP GROUP, VANGUARD
Mr. McNabb. Thank you, Mr. Chairman.
At Vanguard we deal with a huge array of different types of
investors including IRA investors, defined benefit plan
sponsors, as well as defined contribution plan sponsors. And as
we talk to them and due research amongst them in terms of where
they see the future going and where they would like to see the
future going, what actually strikes us is the commonality that
you hear among them even though you are dealing with very
different constituencies.
Among the plan sponsors, be they large or small, the two
common themes we hear, and we have heard this from some of the
other panel members, are plan sponsors need to know what their
benefit programs are going to cost, that that need for specific
knowledge around the cost of the program is very important. The
advent of 401(k) plans really in the early 1980s when many of
us began in that business, was that was a big part of it was
the cost was known. You could predict year from year from year
what the cost was going to be, and I think that was a lot of
the attraction to corporate CFOs, and again, you have heard
that from some of your other members.
The other issue that rises among plan sponsors, whether
they are large or small, is this whole mobility of the
workforce that you referenced in your opening comments, the
fact that people are going to have 10 or 12 jobs, portability
becomes a very important concept.
It is really to that end, when you look at sponsors as well
as individual investors who may be in IRAs, the themes that
come across are common. One is portability, the ability to move
from one kind of plan to another. If you think about our system
today we have 401(k) plans, 403(b)(7) plans, 457 plans, 401(a)
plans, SEP IRAs, simple IRAs, simple 401(k), etc, and it is
very complex. And how you move, what the rules are to move from
one plan to another are very arcane. So the whole concept of
portability and simplification is something that really
resonates with investors, again, whether they are small
businesses or large corporations.
The other big theme we keep hearing is we have to do things
to make it easier for people to invest, and again, people have
referenced some of these programs, the auto enrollment or the
auto increase programs that you mentioned in your opening. Auto
increase, we have some experience with that. We have 200 plan
sponsors covering about half a million workers today where
there is an auto increase component in the plan. And we have
seen among those plans the average savings rate go up in the
last 12 months about 1\1/2\ percent, so those are the kind of
programs that seem to work.
What we hear from sponsors and participants is, what are
the incentives to do that? It is not necessarily tax credits or
financial incentives, but it may be--it may take the form of
fiduciary relief in terms of if we structure a plan a certain
way, will we have some level of fiduciary protection? I would
reference on the fiduciary side, several years ago, 404(c), the
interpretive bulletin came out for 404(c), and I think again
many of us here worked with that. What that did, for those of
you not familiar with it, is it gave plan sponsors of defined
contribution plans a certain level of fiduciary protection.
If you want to see how positive a legislative change can
be, you could look at 401(k) plans before 404(c), 401(k) plans
after, and what you see is a huge increase in participation
rates and a huge level of increased diversification. We think
those same kind of principles could apply in terms of
portability, the auto savings programs and so forth.
So as we think forward, looking out 20 years, what you
would hope would happen is rather than building a more and more
complex system, we would actually strip away some of the legacy
systems and make a simpler more incentivized system for people
to save.
The Chairman. Thank you.
Mr. Sperling.
STATEMENT OF GENE SPERLING, SENIOR FELLOW, CENTER FOR AMERICAN
PROGRESS
Mr. Sperling. Thank you very much, Senator. The statistic
that Senator Kennedy gave at the beginning about the median
being $50,000 is actually in some ways too optimistic. That is
for those who have those savings. Over half of people 55 to 59,
over half have less than $10,000. I mean that is a stunning
statistic. Over half of all Americans 55-59 have less than
$10,000 in a 401(k) or IRA, which seems to me pretty clear we
either have to be or together both increasing the role of
defined benefits and finding out how that can be more viable.
But I guess I want to concentrate my comments on how we
should be making the 401(k) model more targeted to actually
doing what I consider to be our goals for having incentives,
which is to increase our private savings rate, to increase
retirement security among the second and third leg of our
retirement system.
Our system today of incentives could not be more upside
down. We have one system essentially for encouraging savings in
our country, tax deductibility. When tax deductibility is your
only incentive for savings, it turns our progressive tax system
on its head. So when Senator Kennedy talked about the CEO and
the person who might be cleaning their office, the person
cleaning their office, if they can somehow manage to save a
dollar gets a 10 percent deduction. The CEO gets 35 percent
deduction. Now, what in a sense happens is we have a system in
which we are giving the least incentive to those who need the
most help saving and the most incentive to people who need the
least help.
What is very clear is that we have incentives now. We spend
hundreds of billions of dollars over a decade incentivizing
people to shift savings, well-off people to shift savings from
nonpreferred savings to tax-preferred savings. We are not doing
that to increase our private savings rate. And I think that we
need to take a look at whether this notion of just providing
incentives through tax deductibility makes sense because what
is happening now is that it is an upside down system. It is
funny, if you are a public servant like myself, not that I am a
well-off person, but you make a little bit more savings you can
really feel it. When you are really struggling, there is very
little for you. When you start to make a little you can get a
SEP IRA, the world comes at you. You get 35 percent deductions.
You get 401(k) matches. We have a very divided society right
now, and I see that division as going greater.
I think we need to think about how we can use what we know
works best and use public policy to encourage it. What we know
works well is when people have money automatically dedicated,
where they have a significant match for them. How significant
that match might be is important. It may need to be quite a lot
higher for more low-income people who we now do the least for.
So the question is how could we do this? My view is that we
should be moving toward a kind of a universal 401(k), where in
a sense every single American at all times will essentially
have the model that the people in the very best or most
generous plans that we have heard get. In other words, any time
a person invests a dollar who is middle income, that they could
get a tax credit for that dollar.
Now, we had a small step with the saver's credit but it is
a tiny step. It is not refundable. It does not go up to cover
that many people. We are trying to do this on the cheap. Were
we to do a system, were we to give a tax credit, a refundable
tax credit for low income people that might be 2 to 1 and a 1
to 1 credit for more moderate or middle income people, we would
be turning our tax incentive right side up. We would be putting
the greatest number of incentives to the people who need it
most.
I will just very quickly say what that would do. One, it
would actually leverage private savings to the degree the
government was giving a dollar in tax incentives, it would only
be going to the degree it was targeting people who were not
saving now. Therefore rather than the embarrassing statistic we
saw in the New York Times, which is that the amount that we
were giving away in tax incentives was more than our overall
private savings rate, we would be targeting incentives to
leveraging additional private savings.
Second, the automatic 401(k) models are good, but a company
has to provide it. If you had a generous tax incentive it would
make it more easy for companies to want to provide a
deductibility option if they knew their employees were going to
get a significant match. It would make it easier for private
sector employees to give an attractive match if the government
was sharing in that, and they would have an incentive to do
that to the degree that it helped fix their--made it easier for
them to meet their nondiscrimination rules.
For the part-time contingent workforce right now when they
drop off they have no pension and they have no incentive to
keep their pension. So one of the things we have not talked
about is that most people cash out. But if people could roll
over into a universal 401(k), where even as they worked part
time or even as they were home for child care, they could still
get a matching incentive, that would encourage more people to
do this.
So I really think we need to think very seriously about our
incentive system and turning this upside down system around so
that our tax incentives are targeted to the people who are not
saving now instead of just encouraging people to shift savings
from one account to the other.
The Chairman. Thank you. I want to reiterate that if others
of you--I am going to take two more people to speak, Mr.
Houston and Mr. Salisbury, and then we will move on to another
question. I know a lot of you have some additional comments.
Hopefully you will share those with us.
Senator Grassley had to leave to go to the White House and
have some discussions there that include some retirement, and--
--
Senator Kennedy. I hope not mine. [Laughter.]
The Chairman. I think it includes yours. [Laughter.]
And Senator Kennedy has some obligations on the floor so he
will have to leave shortly. Senator Reed has already been here.
Senator Burr is here, Senator Hatch, Senator Thomas. We
appreciate all of you being here and know that you have staff
that was here before you came, and there are other members of
both committees that have staff here that have been collecting
your comments and that will be doing some additional research.
We actually do not do all of our own research, and they will
provide us with some summaries and help us to get through this
issue.
We will continue on this question for two more people, and
then move on to a second question. Mr. Houston.
STATEMENT OF DAN HOUSTON, SENIOR VICE PRESIDENT, PRINCIPAL
FINANCIAL
Mr. Houston. First let me just say it is an honor to have
the opportunity to have an open discussion on these very
important issues.
The Principal Financial Group has about 40,000 small- to
medium-size customers. About 1 out of 11 small employers with
fewer than 100 employees have their retirement benefits with
the Principal Financial Group, which is about 3 million
American workers. This week at the end of the week I will be in
Tucson with the Inc. 500 group. It is the 500 fastest growing
companies. And if it is anything like it was last year, what
they would tell you is top of mind for them is growing their
businesses; the second is capital formation; third is health
care like we heard earlier; and the fourth one would be around
retirement benefits. With these small employers they typically
will talk about how onerous some of the rules are as it relates
to compliance and being in compliance as a small employer. So
again, if the question is, are there things we can do to
simplify retirement rules and regulations, I think it would be
well received by small- to medium-size businesses, and again,
we can submit that, Chairman, for your review, some ideas that
we have in this area.
Mr. McNabb spoke at Vanguard about what can happen locally
to help better increase pension coverage, and again, we have
similar experience in that when we put salaried employees with
small- to medium-size group employees with one-on-one meetings
we can see participation go from 75 percent to 90 percent. We
can see average deferrals increase by 1\1/2\ to 2 percent. I
would also tell you that when we can sign them up for auto
enrollment and step up, they will start at 4 percent and end up
at 8 percent. And again, I think Mr. Salisbury would comment
that if we can get American workers to save between 10 and 15
percent we can reduce pension liability significantly.
And that really leads me to my last point, and that is I do
not think we can forget the responsibility the American workers
have to do a better job. They simply are not saving enough, and
no matter how much policy we develop, if a young worker is not
putting away 10 to 15 percent of their salary from the day they
start employment, they simply will not adequately fund for
retirement. And again, if they were at that level, they would
not need the fallback position of a defined benefit program.
Thank you.
The Chairman. Thank you.
Mr. Salisbury.
STATEMENT OF DALLAS SALISBURY, PRESIDENT AND CEO, EMPLOYEE
BENEFITS RESEARCH INSTITUTE
Mr. Salisbury. Senator, thank you very much, and I
appreciate being here.
Just to build on the comments others have made with a
slight twist, and the last one is I think that part of what we
are seeing is if we look at today's retired population, about
22 percent have pension income from a private defined benefit
plan, and that is actually lower than it was as recently as 10
years ago. If we look at that in replacement of those now
retired, about 21 percent of their income for public and
private sector retirees comes from an annuity income from a
pension. That is projected for late boomers, if the system
simply stays as it is, to decline to 10 percent. If the system
continues to have employers eliminate new employees from those
plans, which by our estimates occurred in at least 20 percent
of defined benefit plans within the last 12 months, then those
numbers are going to be even lower.
If we look at what is happening then, the trend lines, as
Mr. Trumka and others have said, can be expected to continue,
most Americans, frankly, have always been on their own other
than Social Security. And if we look at current retirees,
Social Security is providing 38 percent income replacement, for
the generation of late boomers it is projected to provide 31
percent income replacement.
Savings plans and defined benefit plans, as other speakers
have noted, but defined benefit plans, importantly, have moved
away from the traditional annuity provision. Over 25 percent of
existing plans in the defined benefit realm are now cash
balance. I am only aware of one that does not offer lump sum
distributions. In those that do offer them, about 98 percent of
participants choose a lump sum. Of the other 75 percent of
existing private defined benefit plans, half now offer lump sum
distributions, and depending on what survey you look at,
between 67 and 97 percent choose the lump sum distribution.
So if there are two things in this realm that Congress
needs to focus on, I would suggest they did in this last
legislative round, one is the tremendous importance of
financial literacy education and getting basic education and
savings education into our schools early, and doing better, as
Rob noted, with future generations making the effort to save
than past generations did. And the data makes clear that past
generations did not.
Second, it is longevity education. That has been described
by people here vis-a-vis annuities, but the sad fact of the
data is individuals, when given the choice between an annuity
and a lump sum, do not select annuities. And a large part from
our retirement confidence survey research that is indicated by
the fact that most Americans today think they will die far
sooner than statistically they are likely to live. In other
words, the general population believes when we use the term
``life expectancy''--which most in this room know means
average, 50 percent will live beyond that--most Americans think
life expectancy means that is the longest I am going to live.
So my dad, now 91, still getting that defined benefit
pension check, who thought he would be dead about 20 years ago
because of childhood diseases and other things, his only income
beyond Social Security is now that pension check. It was always
smaller than Social Security. For 25 years it was a fraction of
income from selling off their primary residence and other
assets, but now it is the only thing they have. If it had been
left to my parents at the time they retired, ``Do you want an
annuity or a lump sum,'' my father tells me, as a former life
insurance man, he would have selected the lump sum distribution
because he did not think it would in the long-term mean
anything to him.
Second, vis-a-vis the trend line of if we do have
additional change, two issues that Congress is dealing with or
has on its table where, as other speakers have noted, it could
fundamentally change or determine what the world looks like 20
years from now. One relates to accounting treatment, and in the
congressional sense last year the Congress dealt with the
interest rate for funding purposes, and the debate was between
the yield curve proposals of the administration, which matched
what the Financial Accounting Standards Board is talking about
doing, or allowing pension funds, defined benefit plans to
continue to be funded with so-called smoothing, assuming
midline for the future. We have historical experience now on
what this does to the defined benefit system.
In Great Britain over the last 12 months, 65 percent of
defined benefit pension plans have been frozen against new
entrants because of FAS 17 and the move in the United Kingdom
to mark to market accounting similar to the yield curve. That
may or may not mean you want to do it. But if that is the
direction public policy and accounting policy goes, it is
predictable that most of the remaining defined benefit system
for future workers will go away.
The second is cash balance clarity. As has been noted,
whether one loves them or hates them, wants them or does not
want them, the effect of an absence of regulatory clarity is
day in and day out leading to the closing down for future
workers of cash balance defined benefit plans. So the absence
of clarity is essentially a decision that one wants them to
disappear. We do not lobby. We do not take positions. I am not
saying you should feel one thing or the other.
I will just emphasize that in terms of whether those late
boomers manage to get 10 percent replacement from defined
benefit plans or zero is largely in the hands of the Congress
today vis-a-vis the combination of the accounting issue and the
cash balance clarity issue. On stock options and other issues,
there have been issues of do you tell FASB what to do? This is
one where if the private regulation takes place, then the fate
of defined benefit plans, if it follows what it has in the
United Kingdom, will fundamentally change the trend lines on
the charts behind you, and defined benefit plans will markedly
be, if you will, gone 20 years from now.
Finally, in terms of that long-term trend I just underline
where I started. The education point, is with longevity
increases and with individuals needing to contemplate. In my
case I used the longevity calculators. I have an aunt who is
105. My father is 91, my mother is 88, and individuals in my
family have lived into their 80s for over 100 years. The
calculators tell me 103. I want to find an insurance company to
take that risk. [Laughter.] But it requires trust, and it is
the one thing I would underline. One of the reasons individuals
today take a lump sum instead of an annuity is because of an
absence of trust that their employer will still be there, an
absence of trust that their employer will keep the promise. The
reason they tend, based on research, to not buy annuities is an
absence of willingness to trust that the offering insurance
company will be there 40 or 50 or 60 years from now.
So while we talk about short-term, one of the most
important issues vis-a-vis education as well, and legislating,
is trying to figure out how vis-a-vis that 20-year margin to
bring trust back into the system so that the public will think
about longevity risk.
Thank you.
The Chairman. Thank you very much. I have to cut off
discussion on that and will reiterate that if any of you want
to expand on your comments or provide us with information or
counterpoints that has been brought up, it would be very
helpful. We have had a truckload of information, and one
advantage to this format is that we have been able to get
information from a lot more people than we would be able to do
in a hearing.
I am going to switch gears a little bit and go to a
different question because we do not operate in a vacuum. There
is little doubt that the global marketplace has a broad effect
on U.S. companies that are planning for the future. Today many
companies do have overseas operations. I know one in Cowley,
Wyoming--anybody here know where Cowley, Wyoming is? The mayor
there told me that I could say that he lives a half a block
from downtown and a block and a half from out of town.
[Laughter.] But he runs a little overseas operation that
provides lamps, those tubular great lamps that go in the front
of big office buildings, and he ships those all over the world.
So all sizes of business have this problem too, and they are in
competition with companies in other parts of the world. Many of
the bigger companies have overseas operations, and therefore
have retirement pension and benefit plans in those countries as
well.
How do overseas private sector pension and benefit plans
and initiatives affect the U.S. companies' decision on
retirement benefits for their workers? How do we expect this to
change in the long-term for U.S. workers? What are the
international implications here? Anybody want to start us off?
Yes, Mr. Salisbury?
Mr. Salisbury. I will just add off of the UK experience in
talking to consultants in companies that because of the changes
in the United Kingdom have chosen to terminate or freeze their
defined benefit plans in the UK. That has ended up feeding
decisions to make changes in their U.S. plans as well, and it
has basically made it--their choice of words--easier to
rationalize recent decisions to not make the defined benefit
plan available here to new hires because it will no longer be
available in the United Kingdom. The two nations in the world
with the strongest defined benefit systems up until last year
were the United Kingdom and the United States.
So I think as we see change in other countries taking
place, the International Accounting Standards Board is expected
to extend FAS 17 to all nations, and with that change, we are
likely to see a world pressure in that direction of more
freezings of existing defined benefit plans.
The Chairman. Before we go to--we will do Mr. English, and
I think that Senator Hatch has had a question that he wants to
kind of throw out here too as a result of the discussion.
Mr. English.
Mr. English. Thank you, Mr. Chairman. I think--and I am
following up a little bit on the point that Dallas was making.
There is a difference, I think, as we look at this issue,
between those who are offering service, those that are in
competition and those that are not. That may start having a
dramatic impact with regard to this entire issue. Ours is a
service industry. You are not going to go overseas and get
electric power and bring it in to rural America. We are not
going to be in competition. A lot of small business in this
country is not going to be in competition, unlike the example
that you used, Senator. They are not going to be in competition
overseas.
There may be something of a watershed that develops here
between small business, those who in the service industries
that do not face competition overseas and those that do. It is
going to be an interesting reversal if you have greater
benefits in people living in rural American and small towns and
in small businesses than you do in some of the largest
corporations in this country. But I think you could very well
see that take place.
Also there is a difference with regard to the employees
themselves. It is not unusual still in rural America to see
employees stay with one company throughout their entire history
as an employee. Certainly with electrical operatives, most of
our employees do in fact stay with the same electric
cooperative, live in the same small town throughout their
history. And this defined benefit program and the defined
contributions that have been in existence for our employees for
so long obviously is--we are reaching a point in which they may
in fact be better off in retirement than many of those who live
with some of those more generous contributions that are made
from a wage salary standpoint in some large corporations.
So it may be that we are seeing a reversal now for those of
us who come from small towns and rural communities. We see this
as a wonderful thing that is developing, because if you want to
live well and you want to have good defined benefits and
defined contributions over an extended period of time, you
better move to rural America. Cities cannot give it to you
anymore because most of their businesses are in competition
overseas, and they simply cannot afford that particular
benefit. That may be a bit extreme but you know it is an
interesting development that may come about as a result of
this.
Again, I would make the point that what has stopped people
in small businesses and particularly those in rural communities
is they simply have not had the resources to put together a
defined benefit program, and certainly they cannot maintain it.
They cannot take care of it. They cannot have that kind of
expense and certainly do not have that level of sophistication.
Again, we would strongly urge that you look at the multiple
employer approach as a way in which you can pool those kinds of
resources and offer those kinds of benefits to people in small
business in this country, and particularly those who may not be
in competition overseas.
Thank you, Senator.
The Chairman. Of course we are always tempted to make some
comments about the comments, but I will withhold.
We do have the extreme pleasure of having Senator Hatch
here, who not only serves on the Health, Education, Labor and
Pensions Committee, but he is also on the Finance Committee. So
he is the joint person at the joint meeting. And it is kind of
historic that our two committees are working well together to
come up with some solutions. And so the man that holds it
together.
Senator Hatch. The joint person on the joint committee who
feels disjointed about this subject. [Laughter.]
I would just like to ask you what new tools or savings
plans are needed to get new entrants into the labor force to
start saving early on in their careers? Somebody may have
answered this before because I was not here earlier, but I
would like to have you take a crack at that. What are some of
the tools that would help us in that area?
The Chairman. Mr. Henrikson.
Mr. Henrikson. Yes, I will take it. It has been discussed
to some degree. I think the strongest statement which also
tells us a little bit about what is being expected of
employees, I think is what I would call an automatic enrollment
approach. In other words, if you can get people to have as the
default option that they are part of a plan, that would have a
great effect.
The problem, however, one of the things that is sort of
implicit in that is if employees need to have an automatic
enrollment program to take advantage of something that might
give them an immediate 50 or 75 percent return on their money,
we are asking those same employees to make decisions after they
start to build money, relative to their mix of stocks and bonds
and so forth and so on, and then at retirement, as if crossing
65 were sort of crossing a finish line, that is the beginning
of the most difficult time they are going to have.
In a syndicated column not too long ago it just struck me.
Someone said, ``Now that 401(k) plan participants are
comfortable income averaging in to the marketplace, what they
really need to do is as markets go up and down, they should
learn to save more when the stock market declines. They should
be value averaging in.'' What this says to the retiree, of
course, is that you ought to learn how to value average out. If
the market goes down, simply live off of less every month if
you are taking periodic withdrawals.
So saving is great. It is great to have increased savings,
but the question is, are the savings going to turn into a
secure retirement income?
Senator Hatch. Thank you. Anybody else?
The Chairman. Mr. Trumka.
Mr. Trumka. I want to go back to a point I made at the
beginning. First of all, none of the pension stuff is done in a
vacuum, so Mr. Houston said that young people are not saving
enough money. There is a reason for that. Many of them cannot
save money and will not ever be able to save money. They have
stagnant wages. They have health care costs that are going off
the chart. They have an educational system that they may have
to pay back school loans. Many of them in industries like steel
or airlines are living on wages that they were paid in 1980.
Inflation has gone beyond them. They cannot save. That is why
defined benefit plans are so absolutely essential in all of
this.
And it all ties together because you take the manufacturing
crisis that we are seeing. We have lost 3,000 manufacturing
jobs. Most of those jobs were high paying jobs that provided
pension benefits. They are not there right now. You take a
trade bill that is not enforced with China. They manipulate
their currency. They give an employer a 45 percent advantage by
going offshore and manufacturing in China. They will go
offshore for 45 percent. The trade bill is not enforced in
other areas. It gives them another 40 percent because they do
not enforce their child labor laws, their prison labor laws.
That gives them another incentive to go offshore, take the jobs
away that take the pensions and the means to provide those
pensions with them. You take a tax code that rewards people for
going offshore. That also affects the ability, and that is how
globalization has tied into all of this stuff.
Well, I cannot get past one other thing, Mr. Chairman, we
have talked about, and I want to come back to this. We have
talked about clarifying one area of the cash balance plan. We
would agree with the status of cash balance plan needs to be
clarified, but because they play a valuable role in retirement
security under the right conditions, but we also want to
emphasize that that needs to be accompanied by protections,
that needs to be accompanied by protections for older, long
service workers and cash balance conversions because you wake
up one morning and you think you have a plan that is going to
give you 30, 40 percent of your retirement income, is going to
replace that, and you find out that it has not done that. And
so you end up too late to be able to save more. So they need to
be protected as well.
All these things tie together. We believe that defined
benefit plans are very, very important for young workers and
old workers because many workers in this country, young, middle
age and approaching your retirement, cannot save. Let me repeat
that again. Many workers in this country cannot save. It is not
a matter of wanting to or not wanting to. They cannot because
their economic circumstances will not allow them to do that.
The Chairman. Senator Hatch's question has touched off
quite a run here. I am going to ask everybody to keep their
comments under 2 minutes so that we can get more comments and
perhaps some other questions.
Mr. Covert.
Mr. Covert. Thank you, Mr. Chairman.
First of all, to address Senator Hatch's comments,
obviously auto enrollment would be helpful. Plan design
incentives for employers that increase the match, thereby
drawing more people, incentivizing them to come into the
system. And also investment education, the ability to provide
investment education to employees without employers having to
worry about whether or not they are going to get sued for
violating ERISA.
To answer the chairman's question, we have operations in 98
foreign countries. The pension systems in those 98 foreign
countries are a patchwork to say the least. Some countries like
France have mandated social plans like our Social Security
system, and that is how defined benefit pensions are delivered.
Other countries like the UK have a similar system to ours. The
same with Canada.
The reason why a lot of employers, including Honeywell,
have frozen their plans in those countries is over regulation.
You have these perverse rules where if you close a facility or
consolidate facilities or even do legal tax restructurings of
your subsidiaries, that can trigger funding obligations on the
employer on what they call a wind up basis, a termination
basis, in our parlance, essentially forcing an employer with a
plan that is already adequately funded to contribute basically
double what they would ordinarily otherwise have to contribute
even though nothing in reality has happened to the overall
solvency of the plan, from Honeywell's perspective.
So what we do internationally does not really impact what
we see in the United States. However, I guess what I would say
is to the extent more and more of our competitors do not have
the cost associated with maintaining defined benefit plans,
there is obviously pressure on us because we need to be smarter
and more competitive with that pension burden that we have. We
are committed to staying in the system, but that is the types
of things that we look at, so even though what we do in the UK
for example does not impact what our thinking is in terms of
U.S. pension plans, overall it is a global company and we have
to budget and plan around cash flow, capital investment and so
forth. A company like Honeywell that provides defined benefit
plans to its employees is at a disadvantage against companies
that do not provide defined benefit plans.
The Chairman. Thank you.
Mr. Gebhardtsbauer.
Mr. Gebhardtsbauer. Thank you.
Senator Hatch asked how can we get more people into these
retirement plans, and automatic enrollment has been talked
about, so that you are in unless you elect out. Another way
that it has been discussed to do all these decisions right at
your date of hire so that you do not see your big paycheck and
after you enroll you have a smaller paycheck, so bring them in
in the beginning, but some of the rules make it difficult to
bring people in right away because of the participation rates.
The people at the low end are maybe not as likely to be as
good.
One other thought that I have is also in the area of DB
versus DC. Originally the 401(k) plan was seen as the
supplement plan, and so it was understandable that not
everybody would be in the 401(k) plan because was in the DB
plan, and so the way we have moved in the past 10 years is
toward less DB plans. In fact, that slide in the middle behind
Senator Enzi, the green line going up is the 401(k)
participation rates, so you will see when ERISA was passed in
the mid 1970s there were really none of them, and now I guess
it is around 40 percent of the workforce is covered by 401(k)s.
Whereas DB plans used to be at 40 percent and now they are down
below 20 percent.
I happen to know these numbers because I did the slide.
[Laughter.] My glasses are not this good. [Laughter.] And the
red line is something called the money purchase plan. That was
sort of a DC plan, but it is pretty much where everybody was
involved and was covered in the DC plan. It is a money purchase
plan. And you will see that it is going down. It is below 10
percent and it may go away.
One of the reasons why DB plans and money purchase plans
are going away is because, as some other people I think, Don,
mentioned, we have been very creative at improving the rules
for 401(k) plans so that everybody wants to get into the 401(k)
plans. And we have not kept the DB rules up. We have not kept
the money purchase rules up. We have not improved them, and it
is getting harder and harder to have a DB plan, as Dallas was
mentioning, for many reasons. These DB plans were the ones that
covered everybody, and we are moving to a world maybe if there
is no DBs, maybe there will just be 401(k)s, and so maybe we
need to tighten up some of the 401(k) rules.
Right now the rule to encourage more participation in a
401(k) is done through--if you get 70 percent of your lower
income employees participating in the 401(k), then 100 percent
of your higher income employees can participate. So the
American Academy of Actuaries, where I work, does not actually
take a position, but one area where you could do, is you could
change that 70 percent rule. Not everybody is going to like
that rule, so there will be people pro and con around the table
maybe on this. But maybe you could raise the 70 percent to 80
percent, saying you need to have 80 percent of your lower
income employees participating in order to get 100 percent of
your higher paid people participating.
Another area would be in how much the contribution is, so
you would not only want someone to contribute, but you want
someone to contribute more, and so if there are ways to change
the rules so you could get more contributions from the less
highly compensated people.
A slightly different topic--I apologize. I will just make
this really quick because I may be going over my 2 minutes.
This is a new topic, that whenever Congress wants to do
something good, the budget rules make it difficult, so Congress
has actually tied its hands through the budget rules, the cash
rules. Whenever they create a rule to come up with some of
these new great ideas that Karen has brought up or I think Mark
and Don and Gene, in order to get more companies to have
pension plans, in order to get more people participating, that
means more deductions today, meaning less tax today. So of
course that is a negative and so your cash budgeting reflects
that. But it is not a total escape from taxation because
eventually this money that went into the pension plan
eventually comes out, and so it is not escaping tax, it is not
tax exempt. It is tax deferred, so eventually the government
gets the taxes back when the distribution is made when you are
retired.
So in fact that is actually a good thing because actually
we need taxes more in the future than we need right now, so one
way to untie Congress's hands would be to not only have a cash
budget to score all your changes on a cash rule, but also to
have some sort of accrual rule accounting, so that you reflect
the good things that are way out there in the future. More
people are going to have pensions and more people are going to
get taxed on their pensions out there in the future, and
somehow bring that in today. So everybody says that is very
difficult to do, but actually we have a rule already called the
Credit Act of 1990 that affects education loans. So the
government eventually gets the money back 30 years from now,
and they actually bring that into the budget. So it would be
great to untie Congress's hands so that it could score things
like more pension coverage as a good thing, not a bad thing.
The Chairman. Thank you.
Mr. Sperling.
Mr. Sperling. Senator Hatch I will start with an anecdote
some of us live through. If you go from a campaign into the
White House, which is campaign young people are probably the
worst savers. They are a transient group, risk takers. They
come into the White House or into the government and suddenly
you have this Thrift Savings Plan. And you get virtually a
dollar to dollar match on your Thrift account. It is very
interesting. You watch a lot of people who never thought about
saving at all, but when they are given the opportunity to have
it deducted right out of their paycheck and get that
significant of a match, it is interesting how many turn to
savers.
Now, Dallas's charts we would show you, it still does not
quite work for a lot of the lower income types, people making
lower incomes. But I think that what you are hearing here is
there is a lot of studies that first of all say if people were
automatically put on, or as Ron is saying, even right from day
one, that people very rarely choose to move out of it.
Second though, the question is--and I think Mr. Garrison
talked about with his company--that you really have to give a
strong incentive to get people to save. So the question is how
could we replicate this among around the workforce, and I think
we do have the ability, through our tax code, to do more. I
mean we give people $1,000 tax credit for having a child, and
you get it every single year. You could have a refundable
credit that goes to people, and you can make it quite generous
in the IDA model at lower incomes, but if you did that, you
would be doing something. One, you would be encouraging more
employers to allow automatic deduction if it helped them meet
the 70 percent rule. So imagine if you have a tax credit that
encourages employers to allow all their lower and moderate
income workers to automatically deduct money out--and they are
telling them, look, if you are lower income, you may get a $2
to $1 match or dollar to dollar match. That is a fairly
significant incentive. When the person leaves--young people
right now, even if they started savings they usually just cash
out. So the second part of the question really should be how to
get them to start to save and how not to get them to just cash
out as soon as they leave their job.
So I think we are having this whole discussion within the
Social Security context which is dividing us, but this context
of how we could use refundable tax credit and incentives to get
people essentially a universal 401(k) that they feel like they
can always contribute a dollar and get that match, so it is not
just the lucky few who find themselves in the TSP, but
something we could do for all workers, I think really is the
future and I think it is an area where one could have a lot of
common ground around a savings and ownership agenda.
The Chairman. Mr. Houston.
Mr. Houston. I will keep this under 2 minutes. I think we
could search for a long time to try to find the silver bullet
on what we could do, Senator Hatch, to increase participation
and encourage participation, and I suspect whether it is Chile
or Australia or Hong Kong, where there is required
contributions, that is probably where we will need to end up.
Again, I do not think a required contribution is a bad thing.
I think one thing you would have to step back from, in
responding to Mr. Trumka, is whether or not we truly are over
consuming in this country, of which I am a strong proponent
that we are. We consume way more than we can afford and the
resulting factor is we have very little left to save. I do not
know if we have drifted up too highly, what our standard of
living is, but in a global workforce, as we continue to move
these jobs around the world, I think increasingly, whether it
is for health care expenditures, retirement for DB, DC, wages,
whatever the case is, we will be head to head in competition
with a global workforce which will cause us to reconsider
priorities around consumption versus savings.
That rural electric angle, I like that one. That has
potential maybe on job safety. [Laughter.]
Thank you.
Senator Hatch. Let me interrupt you on that, because one of
the questions I have--and it relates to Mr. Trumka's comments
as well--are defined benefit plans sustainable as they are
shrinking--which is to say that the average age is rising and
there are more retirees than there are active workers?
Mr. Houston. Again, I think it has been hit on from a
couple of different angles. One is the very large
multinationals have been able to grind it out and maintain
their position to still be a sponsor of a defined benefit
program, although we are making it increasingly challenging to
do so because of some of the uncertainty around defined benefit
legislation. For the very small private corporations, who are
small private practices, there is a real growth, an emerging
market there. There is a fairly high take up rate among those
55-year-olds with a half a dozen other employees who would very
much welcome the opportunity to support a defined benefit plan.
But if we are talking about small to medium size companies,
25 employees to a thousand, there is very little appetite to
take on the liability of the required funding levels for
defined benefit, and most of them would tell you that something
that has variable contributions, profit sharing, 401(k),
discretionary match is the preferred plan design. Again, as I
mentioned earlier, to the degree we can reduce the burdensome
compliance nature of the small employers, I think the take-up
rate would be higher.
The Chairman. Mr. Kimpel.
Mr. Kimpel. Thank you. I will be quick. I just want to make
one point in response to Senator Hatch's first question. I
fully agree with Mr. Henrikson's remarks about auto enrollment,
but I do not think auto enrollment in and of itself solves the
problem. Mr. McNabb earlier made reference to Section 404(c).
One of the problems with auto enrollment, which the law now
allows is that if it is automatically enrolled the money
defaults into a particular investment option under the plan.
What virtually every employer does today because of 404(c) is
they default to a money market fund, which in terms of long-
term saving is not the right thing to do.
What we need is a fairly simple legislative fix that would
enable employers to match automatic enrollment with a default
to a life cycle fund, where there would be appropriate
diversified asset allocation based on the participant's age
that would change over the course of his or her career.
The Chairman. Thank you.
Ms. Schutz.
Ms. Schutz. Thank you. To your question on what are the
tools available, education is a real fundamental gap, and I see
it on really three levels. One is savings and the value of
compounded interest and earnings, and the lack of awareness and
literacy around that. The second is the lack of understanding
of how much in savings is required to create an income stream
for retirement. I do not think most individuals understand that
and the math. And the third area is the value of guaranteed
income sources, annuitization being one of those, in that an
individual can lay off risk to an insurance company or the
employer for longevity, for long-term earnings rates, timing
risk in the market.
I think that there is really a fundamental education gap
today that needs to be filled.
The Chairman. Thank you.
Ms. Friedman.
Ms. Friedman. Thank you. I think my remarks are going to
kind of be an amalgamation of what a lot of people are talking
about.
In response to your question, Senator Hatch, certainly the
kinds of solutions that people are recommending today,
automatic enrollment and other kind of automatic devices in
401(k) plans are very important. But I want to reiterate what
Rich Trumka said, which is for a lot of people, they just
cannot save. It is great if people could put away 20 percent of
their income, but people are being asked to save for everything
now, for their education and their health savings accounts and
their medical savings accounts, and we have to have something
that takes some of the risks out of people's investments. And
that is why we feel strongly that defined benefit plans still
have to be encouraged.
You were talking about education, Pamela. One of the things
that I have been thinking about--and again, I am not sure how
this is done--but, you know, Dallas is part of ASEC, which is
the American Savings Education Council, and they have had a
whole campaign to educate people about the importance of
individual savings. It seems to me that people in this room
could work together to do a campaign to educate employers and
employees about the importance of defined benefit plans as a
way of addressing those issues.
There are also--and I said this at the beginning of my
comments and it has been reflected throughout the day--that
there is now an exploration of different kinds of hybrid plans
that take into account the best parts of defined benefit plans
in terms of the employer puts the money in and assumes the
risk, and they are guaranteed, with some of the best features
of 401(k) plans like portability and transparency. I do want to
say, because I have heard this a lot today and I know that this
is way beyond the purview of this, but if we are going to
resolve the cash balance situation we have to do so in a way
that balances the interests of both employees and employers,
and particularly takes into account adequate transition
benefits for older workers in those situations. But we are
certainly willing to look at interesting new plan designs.
The Chairman. Thank you.
Mr. Covert, you had your sign up and you put it down.
Mr. Covert. I spoke already. Thank you.
The Chairman. Thank you.
Ms. Bowers.
Ms. Bowers. Thank you, Senator.
Senator Hatch, you are asking two wonderful questions.
Today the savings rate of the average American, as you are
hearing, is somewhere between 1 percent and 3 percent. I heard
3 percent, and then when you factor out the Microsoft dividend
returns I have heard that it is down to 1 percent on NPR.
People are not saving. What can we do to encourage them to
save? There are a lot of techniques that we can do, but in the
long run what will people have to save to replace defined
benefit plans should they be removed from an offering in most
employers? That is a big question and that is going to be a
difficult area to replace. I think everyone in this room would
agree that if we can find ways to keep defined benefit plans as
being something that employers want to offer their employees
and to continue these plans, that is what we should work
toward.
Unfortunately, right now we are getting a lot of pressure.
We can give you lots of different ways. Through the Treasury
Department's support of the yield curve, we are finding that
that creates volatility in the way we have to predict our
contributions for our plans that a lot of companies will not be
able to move forward without some type of stable smoothing that
we have today. So we need to continue the relief that we have
today.
We have pressures from companies that are looking at their
ability to fund their pension plans and also be able to fund
other business opportunities and having to make some tough
decisions on where they need to put their moneys. Do they put
their moneys in trying to grow their business, or do they put
their moneys in trying to maintain their pension trust? How
long will it be until we are able to get some kind of stability
in those contributions?
I reported earlier this morning, my company, Smurfit-Stone,
which is a large company throughout the United States with
27,000 employees and about 60,000 people that participate in
our defined benefit plan, we are placed under continued
pressure to make sure we keep our funding at an adequate level.
And there are some proposals out today that would require us to
fund at even higher levels. We are funded at about a 90 percent
funding, and if we were to be required to fund at 100 percent,
our contributions would be increasing by double what we are
paying today or even more so over the future.
So if we want to be able to maintain the ability for
defined benefit plans, we have got to have some stability in
those plans, we need to have some relief on how we can project
what our costs are. And all these benefit programs are looking
at what happens 10, 20, 30 years into the future. We cannot try
to solve that problem by taking a snapshot in today's time and
trying to fix it with short-term limited time basis of fixing
this problem. This is something that we have to look at over
the long haul to make sure that we have a solution that people
can live with, that the average American is not going to be
compromised. Today the average American is not saving enough to
replace what will be lost if defined benefit plans are not
maintained in this country.
Thank you, Senator.
The Chairman. Thank you.
Mr. Fuerst.
Mr. Fuerst. Thank you, Senator. With regard to increasing
participation in these plans, there are many innovative
solutions that have been recommended by several people. All of
these will help. Frankly, I think we have done a reasonably
good job. If you look at the chart again behind you, 30 years
ago we did not have 401(k) plans. We have created enormous
assets through these plans and IRA plans.
But over that same time period, where these plans have
increased enormously, if you look at the net savings of
Americans, in 1980 it was approximately 10 percent. It was down
to under 2 percent in 2003 and even lower last year according
to preliminary reports. We are not saving despite the fact that
employer sponsored plans are increasing significantly and
people are contributing to those plans. Yet they are dissaving
in other areas. At the same time that they might put a
contribution into a 401(k) plan, they are refinancing their
house, taking equity out and spending that.
Consumption has been enormous in the United States,
consumption growth in the past 10 years. The consumer led the
economic boom throughout the late 1990s, and through the
recession it was consumer spending that helped moderate the
degree of the recession that we had in the early 2000s.
The problem is not so much participation in employer
sponsored plans. The tax incentives are there to get people to
get the tax deduction of pretax contributions to these plans,
but on the other side there is no incentive for them to save
overall. There is in fact a--because our tax system is based on
income rather than consumption, there is an incentive to reduce
your taxable income but still spend as much as you can. If you
really wanted to look at a very different approach to the whole
system--and I know that this has been discussed to some
extent--a consumption-related tax rather than an income-related
tax would enormously encourage savings. It would have a lot of
other impacts also that you certainly have to consider, but it
would enormously impact savings.
With regard to the global competitive issue, I think that
companies that compete on a global market are concerned about
their total compensation cost, not just their benefit cost or
their salaries. They make a decision on where to produce goods
based on their total cost. We may make a decision on how to
allocate that total cost between benefits and direct
compensation, but it is the total cost that really drives it.
If our employees in America want to allocate more toward
benefits, we can work that out within a total cost
consideration.
The real concern though on the global market is being able
to predict what that is and knowing how volatile your costs are
going to be. Our problem with respect to pension benefits is
the volatility of the cost, not the level of the cost. Pensions
are actually a very efficient way of delivering compensation to
our employees. It is the volatility that is uncertain.
That goes also to the comment that was made about is the
defined benefit system sustainable? It is if we have better
rules about controlling this volatility. During the late 1990s
companies had significant benefit cost for pension plans.
People were accruing more and more benefits each year. Yet we
were precluded from funding those. In fact, if we put money
into a pension plan to fund those costs, we would have to pay
an excise tax when we were at that level. The funding target
that says if you have assets greater than your liabilities,
that you cannot make a deductible contribution, really puts 100
percent funding as a ceiling to the plan, not as a target. And
if we are going to have volatile markets we have to have
funding allowable above that level also. If companies were able
to make a consistent contribution every year, we would not have
some of the funding problems with these plans that we have
today.
Thank you.
The Chairman. Thank you.
Mr. Certner.
Mr. Certner. Thank you. I want to address the question on
getting more people to save, and I think one of the ways we
have seen that has been most successful to get people to save
is through a salary reduction arrangement. I think that shows
why the Thrift Savings Plans and 401(k) plans, for example,
have been much better at getting people to save than something
like an IRA. People just do not have the money, as Mr. Trumka
and others have said, to save, and certainly if it is not
coming directly out of their paycheck every 2 weeks, the
chances of them having a lump sum of money to put in at the end
of the year are much more nonexistent particularly for people
at the lower and middle ends. We know that they prefer to save
by having the money taken directly out of their paycheck. So
having a 401(k) or a Thrift Savings Plan available for everyone
would I think essentially be a good goal for this country.
I mean right now you only have an advantage of being able
to do that if you are with an employer who has that kind of
arrangement, and I think if we could make a standard in this
country that no matter where you worked you would have some
kind of a salary reduction arrangement, that that money would
be going somewhere, whether it be an employer plan or even to
your own individual IRA, you would be able to get more savings.
You would be able to encourage that by building also on the
saver's credit that we have right now. We have employer matches
that encourage to get in, but we also have now the saver's tax
credit that encourages people at the lower end, and hopefully
if we can raise that a little bit more to middle income
earners, so you would have both a salary reduction arrangement
with a matching contribution. We know that that is at least an
effective tool to begin to get people in. Others have talked
about other tools like automatic enrollment. Again, we know
that boosts participation way up, almost close to 100 percent
in many circumstances.
But that only gets us part of the way there. That only just
gets the money in to people's accounts. We also need to make
sure we keep that money from coming out. What we see now is a
significant amount of leakage from the system in the form of
lump sums or cash-outs pre-retirement. So just getting the
money in is not going to help if we have the money come right
out. So you need either auto enrollment, better financial
literacy, to make sure that people keep that money in the
retirement income stream and do not just see this as another
savings pot that they are going to dip in immediately when they
need a car, need a vacation, or even do things like send their
kids to college. Those are all useful things if you are going
to be buying a house and sending your kid to college, but it
means you are not going to have any money for retirement
either. We need to make sure that we encourage this money for
retirement savings not just savings in general.
Another point on the cash balance arrangements that were
talked about, we think it would be very important to get
certainty into this other kind of plan option, and we have said
for years we needed to have that certainty come along with the
protections for those, all the workers who were in the old
system for so many years, and we think that could provide
another type of plan option, but again, you have that same lump
sum problem you need to deal with.
I also want to note--and I think some others have--that we
do have another problem here with high health care costs in
this country, and I think you see high health care costs
squeezing out retirement costs. Health care is a need we have
now, and both employers and employees need to make those
payments now, and so the retirement income needs falls behind
that. So higher and higher health care costs both squeeze out
the employers' and the employees' ability to contribute money
for retirement income. So keeping health care costs down I
think would help very much on the retirement side as well.
The Chairman. We are also in charge of keeping health care
costs down, so we will do some other forums on that too. Good
point.
Senator Hatch. Not doing too well, however. [Laughter.]
The Chairman. We have exceeded our allotted time, so I will
allow Mr. Henrikson, Mr. Garrison and Mr. Dunbar to add their
comments, and then we will have to close.
Senator Hatch. Mr. Chairman, I am going to have to leave. I
apologize for leaving without getting all of these answers, but
I will pay attention to you. These are big problems, and of
course I think this has been a very stimulating panel. I just
want to thank all of you for taking time to be here with us. It
has been very stimulating to me. I just wish I could have been
here a little bit earlier. But we are grateful to you, and
frankly, if you will forgive me, I am going to have to slip
out. I know the chairman will keep good track of these things.
The Chairman. Thanks for being here.
Mr. Henrikson.
Mr. Henrikson. I have three quick comments to make it
short. One of the things, mortality pooling, I had mentioned it
earlier, the other side of mortality pooling which was
emphasized, someone had said before that defined benefit plans
are extremely efficient. One of the reasons they are so
efficient is that mortality gains, that is, when someone dies
early, are retained in the plan to help pay the benefits for
people who live a long time. So if you have defined benefit
plans, not to put a damper on anything--and I have no problem
with hybrid plans--but when you start adding features to
defined benefit plans like take the money with you, leave the
money to your heirs, portability and so forth, the efficiency
per dollar to benefit is lost to a great degree. So you cannot
take money out of the system that previously was held in the
system and not feel the brunt of that.
To put it another way, for an individual to save and have
anywhere near, less a high probability that they will be able
to use that money for the rest of their lives, they would have
to save probably about 30 percent more to overcome the value of
mortality gains if they go into a pool. I would make that
point. I did not mean to sound difficult or convoluted on that.
But I do not care what kind of a plan it is, whether it is
Social Security, whether it is a defined benefit plan, take
mortality gains out of the system and it costs a lot of money.
The other thing I would say, just in terms of a default
option on DC, it is kind of odd to us that have been in the
business for years, DC plans were around a long time before
there was any option for employees to have different investment
options. So whether they were profit-sharing plans that said
zero to 15 percent of covered compensation not to exceed
profits, that went into your account and then that account was
managed by the trustees, similar to the way it was in a defined
benefit plan. So I just would point out that it is sort of odd
that we then make it hard for people to have a default option
that is broad based.
I am sorry Senator Hatch left, but I would just make a
comment. He asked if plans are sustainable. In some businesses
it is very difficult. If you look at a company that is in a
manufacturing business that has 6 or 7 times more retirees than
actives, and perhaps even more important than that, they are
not even in the same business that those legacy employees are
in, and that is going to be very, very difficult. So when you
are talking about exporting your expertise in the benefits
arena, for example, across the ocean to another country, you
probably would not want to replicate that problem.
The Chairman. Thank you.
Mr. Garrison.
Mr. Garrison. Just two quick points, Mr. Chairman. With
respect to the global issue, we at Exxon-Mobil, look at it in
terms of a total remuneration package. That is to say some
portion of the compensation is going to be paid as cash and
some portion may be put away in terms of a retirement program.
I think what we are really arguing about here or discussing is
the proportion that is dedicated to retirement security as
opposed to current consumption in terms of cash. I think we
have flexibility. Certainly there are issues associated with
change from one State to another, but ultimately I think what
the panel may be recommending is that we need more of an
emphasis on the retirement savings component of the total
package and perhaps less on the total consumption or the
current consumption.
With respect to Senator Hatch's question, I think an
additional point, which will not solve all the problems, is
that we need more of a culture of savings in this country. I
think in our particular company we preach from day one as new
employees come in about the three-legged stool and the shared
financial responsibility, so that it is implicit in the
employee that he or she is going to help contribute toward
their retirement, and they understand that is expected of them,
that is part of the culture of the company, and I guess I would
say that we make it easy for them to do the right thing by
having an attractive match that they would forego if they do
not choose to participate.
But I do think that the culture and the discipline of
private employers to incent people and to gently encourage them
to do what they need to do should not be overstated.
The Chairman. Thank you.
And our final word from Mr. Dunbar.
Mr Dunbar. Just again wanted to hit just the small employer
perspective on this, but a lot of small employers delay putting
plans in until they have the resources to put money aside. They
are going to look at defined contribution plans first. I think
a lot of the comments around the room have been that your lower
paid employees cannot afford to defer. I think we see that in
the small employer, especially if the intent is to try to give
incentive for the small employer to put plans in and look at
defined benefit plans as an option. Then the regulatory
environment has to be cleaned up a little bit so that it is not
as onerous, because right now it is onerous as far as the
burdens regulatory wise.
I think you also need to build some flexibility into
defined benefit plans so that they can have some flexibility on
funding. As far as incentives to employers to put plans in and
incentives for employees to defer, I think those have been
kicked around.
Last comment, lump sums. The small employer, they almost
have to have lump sums built into their plan because when that
small employer retires that plan is going to disappear, so it
would be very difficult not to have lump sums built into those
plans. I think you could restrict possibly the rollover of that
money so that employees do not have access, you know, maybe
make it more onerous for people to just take money out for
different possibilities, but I do think lump sums have to be
there for small employers.
Thank you.
The Chairman. Thank you very much. I want to thank
everybody for their participation. I know there are other
comments out there. I am still inviting you to submit those
along with any other information you think would be helpful to
the committees. On my global question, one of the things that
struck me during the discussion is that we in the United States
expect to be paid the highest and have the highest benefits,
but we want to buy cheapest. Somehow there seems to be a little
bit of a conflict there.
I wish we could go on with this.
I would want to mention that Mr. Brad Belt, who is the
Executive Director of the PBGC has spent the morning with us.
He is over there on the side, and I very much appreciate him
listening to your comments as well. It is not often that we get
that kind of participation from somebody directly involved in
the process, and quite often agencies show up, do their
testifying and leave. But he has been here the whole time, and
that is worth mentioning.
As you can tell from the discussion today the private
sector initiatives on retirement and security benefits are
evolving. The defined benefit system is clearly a worthwhile
retirement security plan for both workers and their companies.
In addition, the rise of defined contribution plans are
expected to become an even greater part of the private sector
retirement security system. As the changing demographics, the
greater need for portability of retirement plans and the
globalization of our economy continues, Congress should take
these into consideration as we draft current and future laws
affecting the private sector retirement benefit plans. Today
was just the first of a comprehensive look at the long-term
future that we are going to need.
Again, I want to thank all the participants. I know you had
to rearrange your schedules dramatically to be here and then to
coincide with our little earlier opening. We will leave the
hearing record open for 10 days for questions from members as
well as additional responses you might want to make.
Thank you very much for being at the hearing, and I
appreciate the great participation of people watching too.
[Additional material follows:]
Additional Material
Principal Financial Group,
Des Moines, Iowa 50392,
March 25, 2005.
Hon. Michael B. Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
U.S. Senate,
Washington, DC 20510-6300.
Dear Mr. Chairman: Thank you for the opportunity to appear before
you and the members of your committee and the Senate Finance Committee
at the joint forum entitled, ``Private-Sector Retirement Plans: What
Does the Future Hold?'' I found the exchange of ideas and opinions to
be stimulating and hope it helps as you and the committee members work
through the many facets of retirement issues and opportunities.
At the forum, I was asked to provide comments on ways to simplify
the rules for small employers. It is my opinion that employers are
hesitant to sponsor retirement plans because they feel the
administration and recordkeeping of the plan will be too costly, find
compliance with pension legislation and regulations too confusing, and
have concerns about fiduciary liability. They are also concerned with
the fact that some employees may not be able to save as much as they
would like because other employees choose not to participate in saving
for their own retirement. This is especially true for smaller
employers, i.e. those with less than 100 employees.
The Principal Financial Group knows the small- to medium-sized
business market as well as anyone. To help encourage more growing
employers to sponsor a retirement plan for their employees, Principal
provides the following plan design suggestions that would simplify the
administration, fiduciary liability, nondiscrimination, government
reporting, and plan document requirements of a traditional 401(k) plan
while at the same time providing meaningful benefits for their
employees. This design option would only be available for employers
with less than 100 employees. We offer the following suggestions:
Administration and Nondiscrimination Testing
Over the last 15-20 years, numerous pension laws have been enacted
that added overlapping rules in an attempt to raise revenue and limit
abusive plan situations. These rules merely created more administrative
complexity and administrative/recordkeeping burdens with only
incremental assurance rank and file employees are treated fairly. The
limits include the IRC 402(g) salary deferral limits, IRC 415
contribution limits, IRC 401(k)/(m) tests, IRC 401(a)(17)
compensation limit, IRC 401(a)(4) nondiscrimination rules and IRC
410(b) coverage tests, as well as the top heavy rules added in the
early 1980s. In addition, there is the overall deduction limit of IRC
404 that further restricts contributions to employer sponsored plans.
In place of this myriad of complex and overlapping or redundant rules,
Principal suggests a very straightforward approach to simplify 401(k)
plan rules for smaller employers by establishing just two overall
restrictions to meet:
Employee salary deferrals will be limited to the current
402(g) dollar limit, indexed to $14,000 in 2005.
Any employer match will be capped at one third of the
402(g) dollar limit or $4,667 in 2005.
Under these simplified rules, employees would be automatically
enrolled in the plan 401(k) no later than the start of the second pay
period after their date of hire. Automatic deferral rates could be set
by the employer at any reasonable rate between 1-6 percent of pay, with
reasonable annual automatic increases of 1 percent per year up to 6
percent of pay maximum. There would be no other entry or coverage
requirements. Top heavy rules would not apply and all participants
would be 100 percent vested, further reducing the administration
burden.
Contributions will be portable and can be transferred to any other
401(a), 403(b) or 457 contribution plan.
If desired, the employer may also decide to make profit sharing
contributions to the plan participant. The employee would have the
flexibility to use any of the currently acceptable forms of allocation
methods (pay-to-pay, integrated, age-weighted and comparability). The
ability to make these additional contributions will allow employers the
needed flexibility to design a plan that better meets the needs of all
their participants but if they do so, any additional contributions
would be subject to coverage, nondiscrimination, vesting and other
rules and to restrictions such as compensation and contribution time
limits.
Fiduciary Rules Under ERISA
ERISA provides very important protection for plan participants and
under our simplified plan design approach Principal wants to ensure
plan sponsors continue to be held to very strict fiduciary standards.
We offer these suggestions to provide sponsors with minimum fiduciary
standards that must be followed for plans to remain in compliance with
ERISA. These include:
Absent employee direction, the default of all
contributions to a Lifestyle fund corresponding to an employee's normal
retirement age of 65 is required.
All ERISA 404(c) rules must be met for participant-
directed accounts.
Annual employee statements must be provided in print or
acceptable electronic means and must include:
1.Contributions summary
2. Account balance and projected normal retirement benefit
3. Access to (print and electronic):
Fund performance
Fund performance benchmarks
Fund summaries/prospectuses
Fund manager information
Fund management fees
Employee education tools such as retirement
calculators, asset allocation models, deferral calculators, investment
quizzes and benefit projections
4. Employee summary plan descriptions must be provided upon entry
or every 5 years unless the plan is amended more frequently. These may
be provided in print or acceptable electronic means.
Government Reports
There would be a simplified government report for this type of
plan. It would be an annual registration statement similar to the
current form 5500R filed with the IRS/DOL and would contain the plan
data of the 5500R as well as basic information on the plan's assets,
types of investment funds and a summary of contributions made and
benefits paid for the year.
Copies of this simplified report must be made available to
participants upon request.
Plan Documents
The IRS will provide guidance on required wording for this
simplified 401(k) plan. In addition, plan documents must be written
only on a pre-approved IRS prototype.
Again, thank you for the opportunity to appear and to offer these
additional comments. If you have further questions, please do not
hesitate to contact me.
Sincerely,
Daniel J. Houston,
Sr. Vice President,
Principal Financial Group,
Retirement and Investment Services.
______
Statement of Christian E. Weller, Ph.D.
(The following is testimony on the President's Proposal for Single-
Employer Pension Funding Reform before the U.S. House of
Representatives' Committee on Ways and Means' Subcommittee on Select
Revenue Measures, March 08, 2005, Securing Retirement Income Security
Through Sensible Funding Rules.)
Thank you very much, Chairman Camp and Ranking Member McNulty, for
inviting me here today to testify on proposed rule changes regarding
single-employer defined benefit plans. Retirement income security
occupies much of the public policy debate these days. While most of the
attention is focused on attempts to privatize Social Security, the
security of defined benefit pension plans is also in the balance.
Pensions have received a lot of attention recently since falling
interest rates and stock prices left DB plans with fewer funds than
they need to cover all promised benefits. In extreme cases, pension
plans were terminated, leaving workers with substantially fewer
benefits than they had expected and resulting in shortfalls at the
Pension Benefit Guaranty Corporation (PBGC).
Public policy can address the problems plaguing defined benefit
pension plans through sensible reforms. In considering these reforms it
is important to keep the following goals in mind:
1. Maintain the security of pension benefits;
2. Promote and sustain sponsorship of defined benefit plans; and
3. Maintain the ability of the PBGC to support DB plans.
The administration recently proposed a set of rule changes for
single employer DB plans. Characteristic of the crucial aspects of this
proposal is a greater tendency to link pension fund assets and
liabilities to the market. Such a move would fail the goals for public
policy reform. By increasing the volatility of pension funding,
employers would have very strong incentives to terminate their existing
pension plans, further lowering retirement income security for workers.
A closer look at pension funding and proposed rule changes shows
the following:
Current funding rules are counter-cyclical. Employers are
required to contribute more to pension plans during bad economic times
than during good times.
The administration proposal would exacerbate the counter-
cyclicality of pension funding and increase the uncertainty associated
with pension plans. Employers would likely terminate their plans
instead of absorbing the additional costs associated with attempts to
reduce funding volatility by investing solely in bonds.
Alternative funding rules could provide for greater leeway
in averaging fluctuations in pension funding over the course of a
business cycle and improve the outlook for pensions. This process is
called ``smoothing.''
As a result of smoothing, the burden on the PBGC would be
reduced through better-funded pension plans. Employers would benefit as
pension funding would become less counter-cyclical, lowering the burden
during bad economic times and increasing it during good economic times,
when employers are best able to contribute to their pension plans.
Plan Sponsorship Linked to Counter-Cyclical Funding Volatility
Changes in the way pensions are regulated will inevitably affect
employer behavior. Employers are mainly concerned with unpredictable
demands for outlays for their pension plans (Hewitt, 2003) This is
typically more important than other issues, such as simplifications to
the rules. Changes in funding contributions arise, when the funding
status of a plan changes. For instance, a deterioration of a plan's
funding status would increase the financial demands on employers in two
ways. For one, they would have to make additional contributions to
their plans, as is discussed below, and second, they may have to pay
higher insurance premiums to the PBGC. Typically, the size of
additional contributions can easily dwarf the size of additional
insurance premiums. The primary focus should thus be on the
determinants of funding contributions. If changes in funding rules lead
to more volatility in the funding status of pension plans and thus to
increased uncertainty about employers' future obligations to their
plans, employers would become more likely to terminate their plans than
is currently the case.
In a defined benefit (DB) pension plan, the employee is guaranteed
a fixed benefit upon retirement, usually based on years of service, age
and either final earnings or a benefit multiplier. Accrued benefits for
private sector DB plans are insured, up to certain limits, by the
Pension Benefit Guaranty Corporation (PBGC), which is funded by
insurance premiums from employers with DB pensions as well as
investment income and assets from terminated pension plans.
Although DB pension coverage has declined for some time, millions
of employees and their families still depend on this benefit. The share
of private sector workers with a DB plan has declined from 39 percent
in 1975 to 21 percent in 2004 (PWBA, 1998; BLS, 2004). By 2002, the
last year for which data are available, more than 34 million
beneficiaries could still expect to receive some benefits from DB
pensions (PBGC, 2003).
The funding of a DB plan's liabilities (promised benefits) is
usually the employer's responsibility. Up until 2000, many employers
could not contribute more to their plans, as their pensions were well
funded due to the strong stock market performance and rising interest
rates. However, after 2000, pension funds faced large shortfalls and
employers sponsoring them had to contribute large amounts to their
pension plans. Many large firms with pension plans have faced
persistent shortfalls. PBGC (2004) estimated that the combined
shortfall of all single-employer DB plans as of September 2004 was $450
billion. Consequently, firms had to contribute new money to their
plans. For instance, 90 percent of DB plans offered by companies
included in the S&P 500 index showed a loss. When contributions rose,
corporate earnings were often adversely affected, although some firms
passed the additional costs on to consumers in the form of higher
prices (Kristof, 2003). In extreme cases, the demand on employers'
resources from the weak economy and pension plan underfunding
contributed to corporate bankruptcies and plan terminations. The PBGC
took over plans from Bethlehem Steel, LTV Steel, National Steel, TWA,
U.S. Airways and Polaroid, among others. All of these terminations were
among the 10 largest since 1974, totaling $8.5 billion in claims and
covering 263,861 participants (PBGC, 2003).
Even though the PBGC insures benefits, it does so only within
limits. By statute, PBGC's insurance is capped, currently at $45,600
per year for a retiree at age 65 under the agency's single-employer
pension insurance program. This maximum, though, is reduced for early
retirement benefits. Other reductions are taken for survivorship and
disability benefits and recent benefit improvements. Beneficiaries can
also not accrue further benefits after the plan has been terminated.
Hence, a plan termination leaves workers with less retirement security
than expected.
To discuss the magnitude of recent pension plan shortfalls, it is
important to understand the mechanics of pension plan funding. A plan's
funding status depends on how assets compare to current liabilities.
Current liabilities are the sum of payments to current retirees and of
benefits that workers have already earned. In earnings-based plans,
future benefits are forecast given reasonable assumptions about life
expectancy, inflation and other relevant demographic and economic
variables. Based on these forecasts, pension plans determine how much
in assets they need to fund benefits payable in the future. Thus, they
assume how much interest they expect to earn on their assets. The
higher this interest rate is, the fewer assets are needed today. It is
in a plan sponsor's interest to assume a high interest rate since this
would lower the amount of assets required to be set aside to pay
benefits. To avoid abuse, regulators set a range of interest rates that
pension plans can choose from in calculating current liability. Pension
plans must choose an interest rate that is between 90 percent and 105
percent of the 4-year weighted average of the 30-year Treasury bond
yield. \1\
---------------------------------------------------------------------------
\1\ The Pension Funding Equity Act of 2004 required that plan
sponsors use a discount rate between 90 percent and 100 percent of a 4-
year weighted average of a blend of investment-grade corporate bond
yields for plan years beginning after December 31, 2003, and before
January 1, 2006.
---------------------------------------------------------------------------
A pension plan's funding status is then determined by looking at
the ratio of the plan's assets to its liabilities. Plans can choose a
number of options to value their assets, although many large plans use
fair market valuation. Assets are evaluated at prices for which the
assets could be sold on the valuation date.
By the nature of funding rules, pension plan funding is tied to
changes in interest rates and stock prices. The main problem is that
both of these tend to decline around the time of a recession, when
corporate earnings are also declining.\2\ From 1927 to 2001, there were
a total of 12 recessions. Only in one recession, from 1973 to 1975, did
interest rates not decline. The stock market is a forward looking
indicator. Typically, the stock market peaks about a year before a
recession starts and continues to decline in a recession. On average,
stock prices are about 7 percent lower in the year after a business
cycle peaks than before. That is, pension plans are losing with their
assets before and during a recession, which brings additional pressures
due to lower corporate earnings and lower interest rates that translate
into a higher valuation of a plan's liabilities.
---------------------------------------------------------------------------
\2\ Interest rates refer to the long-term treasury bond rate and
total rates of return refer to the year-on-year change in the stock
market plus the dividend yield. Stock market data are for the S&P500.
---------------------------------------------------------------------------
The recent recession posed a particular challenge since stock
prices fell sharply and interest rates stayed lower, and lower longer,
than in prior recessions (Weller and Baker, 2005). From the start of
the recession in March 2001 to the end of 2002, the stock market fell
by 25 percent. From its peak in August of 2000 to its low point in
February 2003, the stock market lost 44 percent of its value. At the
same time that the stock market sustained severe losses, interest rates
declined more and stayed low for a longer period than on average in
previous recessions (figure 1). In this recession, the treasury rate
declined by 0.22 percentage points, slightly above the average of 0.19
percentage points for prior recessions. However, in the first year of a
recovery, interest rates generally rise by 0.10 percentage points,
whereas they fell by another 0.34 percentage points in this recovery.
Thus, in this recovery employers did not see the usual help in funding
their pensions that would come from rising interest rates.
The problem of falling asset prices and declining interest rates in
the recent recession was further exacerbated by the fact that companies
had not built up more reserves during the prior expansion. This can be
traced back to two aspects of the current regulatory system. First, if
a pension plan reaches a certain funding threshold, the employer either
no longer has to contribute or has to contribute only minimal amounts.
Second, there are regulatory disincentives to contribute more to a
pension plan when it is already fully funded. If pension plans are
fully funded, employers face excise taxes on their contributions to the
tune of 50 percent. On top of that, they can no longer deduct their
pension contributions from their tax liabilities. The contribution
limit beyond which further contributions are discouraged by the tax
code is 100 percent of current liabilities. Thus, largely due to
beneficial financial market trends--rising interest rates and higher
stock prices--the average funding ratio of PBGC insured pension plans
jumped from 116 percent in 1999 to 145 percent in 2000 (PBGC, 2003).
However, for many plans, this reserve was insufficient to weather the
crisis that followed as the stock market bubble burst and the liability
discount rate sunk to and remained at historically low levels. In 2002,
74,138 new beneficiaries started receiving payments from PBGC, compared
to 40,473 new beneficiaries in 2001 and only 11,091 in 2000 (PBGC,
2003).
Administration Proposal Will Exacerbate Funding Problems
The administration recently released its own proposal to reform
funding rules, among other changes to the pension system (DOL, 2005).
Funding burdens are already counter-cyclical, requiring employers who
sponsor DB plans to contribute more during bad times than during good
times. The administration's proposal could exacerbate this volatility
in addition to the overall costs of some plans. First, the current
rules require the use of a 4-year weighted average of the 30-year
Treasury bond rate to determine current liabilities. The administration
is proposing to eliminate the 4-year weighted average and to replace
the single treasury rate with a range of bond rates, the so-called
yield curve. This would mean that liabilities--future benefits--that
come due at different future dates are discounted by different interest
rates. For example, a benefit that is due in 10 years will be
discounted by the interest rate on corporate bonds with 10-year
maturity; a benefit that is due in 5 years will be discounted by the 5-
year rate, a benefit in 15 years by the 15-year rate and so on. The
applicable rates would be averaged over 90 days, instead of 4 years.
Second, the administration proposes that all assets be valued at fair
market value, thus eliminating the current option to average stock
price fluctuations over short periods of time. If these changes are
enacted, plan sponsors worried about the predictability of their future
contributions would have strong incentives to abandon their plans.
The administration's proposal would raise the costs of mature plans
immediately. Employers who have a disproportionate number of older
workers, e.g. in well established industries, will face rising costs
from the administration's yield curve proposal. This is because older
workers are likely to retire sooner than younger workers and their
benefits will have to be paid out sooner than those for younger
workers. The discount rate is tied to corporate bonds with shorter
maturities. Those interest rates are lower than those for corporate
bonds with longer maturities. A lower discount rate translates into a
higher liability and higher cost for the employer. According to
estimates by the Employment Policy Foundation (2005), the liabilities
for workers 55 and older could increase by 3.5 percent and the
liabilities for workers between 50 and 54 could rise by 2.0 percent.
This would particularly hurt the struggling manufacturing sector. That
is, the administration's proposal would fall short of the first goal to
secure existing benefits.
In addition to raising the costs for some plans, the
administration's proposal on changes to the interest rate would
exacerbate cyclical fluctuations, just like the use of fair market
value for assets does, as already discussed.\3\ Employers would become
more likely to see larger contributions during bad economic times,
mainly because the smoothing of interest rates over even the minimal
period of time of 4 years is eliminated. From the 1930s to the present,
the spot interest rate for long-term Treasury bonds would have declined
by an average of 0.18 percentage points during recessions. In
comparison, though, the 4-year weighted average of the long-term
Treasury bond rate would have risen by 0.47 percentage points. The fact
that the discount rate is on average 0.65 percentage points higher with
smoothing than without means that employers face fewer demands on their
cash flow when they can least afford them. However, it also means that
they face higher funding obligations during good years, when they can
actually afford them.
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\3\ Employers could theoretically insulate themselves from these
fluctuations by matching assets to liabilities. However, such a ``bonds
only'' strategy would substantially raise the costs for employers to
provide this benefit and thus give another strong disincentive to
abandon their plans.
The use of a yield curve, using a variety of interest rates with
different maturities for separate liabilities, would also exacerbate
the funding burden during economic downturns, especially for pension
plans with a more mature workforce. Specifically, the spread between
short-term and long-term interest rates tends to rise during
recessions, largely because short-term interest rates tend to fall
faster than long-term interest rates. Short-term Treasury interest
rates, in this case for 3-month bills and bonds, have typically
declined by 1.6 percent during recessions (figure 3). This is an
increase that is almost eight times as large as the average decline of
long-term Treasury bond rates during recessions. During a recession,
employers with an older labor force will see their costs rise much more
rapidly than employers with a younger workforce.
The use of a yield curve would increase the volatility of pension
contributions for employers, thus providing an incentive to terminate
DB plans. That is, the administration's proposal falls short of the
second goal to maintain and strengthen future benefit security.
Immunization Not a Viable Alternative
Fluctuations in liabilities and assets can lead to changes in the
funding status of pension plans. When interest rates and asset prices
fall, plans can become underfunded. The administration's proposal would
increase the volatility of the future funding status of a DB plan.
Employers could theoretically respond to this surge in volatility by
matching assets and liabilities by investing in bonds that reflect the
maturity of a pension plan's liabilities. This process is also referred
to as immunization.
To understand how immunization works, consider the way a pension
plan's liabilities would be calculated under the administration's
proposal. Future benefit payments would be discounted by the interest
rates that would apply for treasury bonds with the same maturity as the
benefit obligation. To finance new obligations, pension plans have to
purchase additional assets. To avoid fluctuations in funding status
under the administration's proposal, pension plans could purchase a
corporate bond with the same maturity and thus the same interest rate
as the maturity of the benefit obligations (Bodie, 2005). As a result,
assets would theoretically be matched to the liabilities and the two
could not move apart over time. Underfunding would thus be reduced.\4\
---------------------------------------------------------------------------
\4\ Perfect matching would likely not be possible since the
administration's proposal allows for discount rates to be smoothed over
90 days.
---------------------------------------------------------------------------
Although the logic of immunization is appealing, it has one major
drawback, aside from the potential complexity of implementation, that
would ultimately hurt pension beneficiaries substantially. Immunization
would significantly raise the costs of pension plans for plan sponsors.
Typically plans diversify their assets between different types of
securities, largely bonds and stocks. By doing so, plans can expect to
earn a higher rate of return over the long-run than they could by
merely investing in bonds, while reducing the risks. Through
immunization, plans would eliminate the added earnings from investing
in stocks. This loss can be severe. Over 20-year or even 35-year
periods, the chance of a typical mixed portfolio of a pension plan--60
percent stocks and 40 percent bonds--is unlikely to perform worse than
bonds. The chance that a mixed portfolio will on average see a rate of
return that is at least 1 percentage point higher than a pure corporate
bond allocation is more than 80 percent (figure 4). The chance of
seeing a rate of return that is at least 3 percentage points greater is
50 percent over 20-year periods and 17 percent over 35-year periods.
These are the potential earnings that pension plans would give up
through immunization. This loss of earnings would require an offset
from higher employer contributions to their pension plans.\5\ As costs
of pension plans would rise, employers would have again a strong
incentive to abandon their plans.
---------------------------------------------------------------------------
\5\ Mixed portfolios will not always do better than pure bond
portfolios. There is a chance that stock market fluctuations are large
and it takes long periods of time for stocks to recover those losses
(Weller, 2005).
Notes: Data are based on S&P 500 and corporate bonds (AAA) from 1919 to
---------------------------------------------------------------------------
2004. Sources are TradeTools.com, Shiller (2000), and BOG (2005).
However, if pension plans do not immunize, they can face market
fluctuations from investing in stocks. Uncharacteristically large
fluctuations in the stock market substantially contributed to the
decline in pension funding after 2000. This leads to two questions.
First, who should bear this risk, and second, is there another way to
handle the risk exposure of pension plans, which does not increase the
volatility of pension plan funding for employers and thus does not
raise the specter of plan terminations? The answer to the first
question is that pension plans are better equipped than individuals to
handle market risks. The answer to the second question is detailed in
the next section.
Pension plans are better equipped than individuals to handle the
risks associated with investing for retirement. However, if funding
rule changes provide employers with strong incentives to terminate
their DB plans, individuals would have to increase their efforts to
save for retirement through private accounts, such as 401(k)s or IRAs,
to maintain the same level of retirement income. Even if individuals
invest prudently, they still face large market fluctuations. Some
workers would thus retire with substantially less retirement income
than they were counting on, while others would do better than expected,
depending on how well the market did during their lifetime (Weller,
2005). The problem is that individuals can often not wait for the
market to improve again since many of the reasons for retirement, such
as deteriorating health, will likely get worse with age. In contrast,
pension plans are going concerns that can expect additional income as
they pay out benefits for the foreseeable future. Because pension plans
generally do not have to liquidate their assets on a given date, they
can, at least to some degree, wait for markets to improve. After all,
this is the logic behind using an average interest rate to calculate
pension plan liabilities. Thus, pension plans are much better equipped
than individuals to withstand the risks associated with investing in
stocks.
As a result of the administration's proposal, pension plans would
be faced with an unappealing choice. They would either face increased
volatility in their pension contributions or the costs of funding their
pension plans would rise substantially. In either case, employers would
have strong incentives to reduce their commitments to their employees
through their DB pension plans and shift the risks of saving for
retirement onto their employees. While pension plans are better
equipped than individuals to handle long-term fluctuations in the stock
market, the question still remains whether there are alternative
funding rules that could help to reduce the volatility of pension
contributions for employers and lower the incentives to terminate
pension plans, without jeopardizing the security of pension benefits
now and in the future. The answer is yes and the details are provided
in the next section.
More Smoothing Improves Benefit Security
The problem as described above is that, under current funding
rules, employers are more likely to have to make contributions to their
pension plans when times are bad. When times are bad, more employers
are unable to make payments to their pension plans. Therefore, pension
terminations spike and the burden on the PBGC grows. The rules proposed
by the administration would exacerbate this problem, while also raising
the costs for employers with an older workforce. However, it is
possible to change the funding rules, so that benefits are protected,
employers have more certainty associated with the funding of their
pension plans, and the PBGC will end up with fewer terminations.
The basic premise underlying these funding rules is that they
should be more pro-cyclical, allowing employers to contribute more
during good times and contribute less during bad times, when they can
least afford it.
Such an approach is also more consistent with the nature of a
pension plan than the administration's approach. The proposals laid out
here give a clearer summary view of how well a pension plan is prepared
for mastering the challenges of the medium-term future, when it is
expected to pay benefits. By comparison, the administration's proposal
to move towards a process of ``marking to market'' provides only a
snapshot of the pension plan at the time of valuation. This is a
consistent and accurate view only if it is assumed that the pension
plan will terminate shortly after valuation. Under all other
circumstances, the assumptions are too volatile to provide an accurate
glimpse of the plan's future.
Three funding rule changes seem especially relevant. First, one way
to reduce the cyclicality of pension funding is to use a long-term
average of the benchmark interest rate, e.g., a 20-year average. This
would substantially reduce the volatility of calculating pension fund
liabilities and it would de-couple funding requirements from the
fluctuations of the business cycle, since the period over which the
interest rate is averaged is longer than any business cycle. A 20-year
period is also a much closer match to the average duration of pension
plan liabilities. Moreover, because interest rates have recently been
so low, the longer-term average would be higher than even the 4-year
weighted average. Thus, switching to a longer-term average could give
plan sponsors some funding relief in the immediate future, while also
improving funding certainty over the long term.\6\
---------------------------------------------------------------------------
\6\ One of the reasons for changing pension funding rules is that
the 30-year treasury bond rate is no longer an appropriate bench mark
because the treasury has stopped issuing these bonds. It appears
reasonable to use the 10-year Treasury bond rate instead. The benchmark
rate is supposed to be risk free and reflect the long-term nature of
pension liabilities. Both the 10-year and the 30-year treasury bond
reflect the most secure assets. The 10-year treasury bond yield
reflects the long-term nature of pension liabilities. The Federal
Government will have outstanding debt that is likely to grow. Its
financing instrument with the longest maturity is the 10-year Treasury
bond. Thus, its yield reflects the long-term nature of the Federal
debt. Further, data on the 10-year Treasury bond rates are available
since 1953--longer than for the 30-year treasury, which was introduced
in 1977.
Second, to mirror the rule change for liabilities, one can also use
a 20-year smoothing for stock prices (Weller and Baker, 2005).\7\ This
process essentially assumes that stocks will adjust towards a long-run
average over a long enough period of time. If stock prices are above
long-term averages with respect to corporate earnings, they are
discounted with the assumption that the adjustment process will take 20
years. The same holds when stocks are too low.
---------------------------------------------------------------------------
\7\ At the same time that more smoothing is allowed, the current
practice of credit balances is eliminated.
---------------------------------------------------------------------------
Lastly, one of the problems associated with the recent funding
crisis was that pension plans had not built up enough reserves to
weather the storm that ensued after 2000. The administration has
recognized this problem and has proposed that employers would be
permitted to contribute to their plans even after they meet the full
funding target. However, many employers already could have contributed
more to their pension plans if they had wanted to during the 1990s
(Ghilarducci and Sun, 2005). Hence, the lack of a cushion was to some
degree the unwillingness of employers to increase the funding status of
their plans, even when times were good. Therefore, a proposal to
require companies to fund up to 120 percent of liabilities over a
period of 30 years seems reasonable.\8\
---------------------------------------------------------------------------
\8\ The baseline assumes normal cost contributions up to 100
percent.
---------------------------------------------------------------------------
The effects of these rule changes on a hypothetical plan can be
simulated.\9\ To evaluate their effect, though, two questions should be
asked. First, does the contribution pattern become less cyclical?
Second, does the funding status of a plan weaken because of the rule
changes? The changes in the funding status are evaluated using the
ratio of assets at fair market value to current liabilities at the 4-
year weighted average of the long-term Treasury rate. In addition, the
probability of falling below a funding status of 75 percent is
calculated.
---------------------------------------------------------------------------
\9\ The technical details of the simulation from Weller and Baker
(2005) can be found in the appendix.
---------------------------------------------------------------------------
The alternative rules would have maintained or reduced the burden
on plan sponsors compared to the baseline (table 1). That is, on
average, employers would have had to contribute less, especially during
bad economic times. Using a smoother discount rate would have resulted
in contribution holidays from 1998 to 2002 (model (2)); the alternative
asset valuation method would have resulted in a contribution holiday
after 1999 until 2002 (model (3)); and the requirement of contributions
up to 120 percent of current liabilities would have meant no
contribution holiday during this 5-year period, but contributions would
have been equal or less compared to the baseline model (model (4)).
When all three changes are in place, the fund would have enjoyed
contribution holidays for all 5 years (model (5)), reflecting the
build-up of sufficient reserves during the preceding good years.\10\
---------------------------------------------------------------------------
\10\ The easing of the funding burden during the 5 years from 1998
to 2002 was a result of substantial build-ups in reserves and thus did
not reduce the funding adequacy and the security of benefits. The
current liability (CL) funding ratio would have been higher in each
case than under the baseline (table 1).
---------------------------------------------------------------------------
To see this, the long-term performance of the alternative funding
rules is tested, using the past 50 years as an example (table 2). From
1952 to 2002, average contributions would have been approximately the
same under all scenarios, or sometimes a little bit less than under the
baseline.
However, plans would have built up more reserves due to the funding
rule changes. In each case, the CL funding ratio would have been higher
than under the baseline scenario. That is, evaluated at current rules,
the security of pensions would have improved. Also, in almost all
cases, the chance of the funding ratio falling below 75 percent is
reduced compared to the baseline (table 2). This again highlights the
improved security of pension benefits under the new set of benefits.
To test whether the proposed rules would make pension funding less
counter-cyclical, contributions during recessions and non-recessions
are considered. From 1952 to 2002, only the alternative asset
assumptions would have lowered the contributions during the recessions
compared to the baseline model. But for the period from 1980 to 2002,
all models would have lowered contributions during recessions. Thus,
during the past 2 decades, employers would have enjoyed more
predictability in the funding of their pension plans.
Table 1: Funding Status of Model Pension Plan with Different Funding Rules
Baseline model Model (2) Model (3) Model (4) Model (5)
Discount rate for liabilities...... 4-year weighted 20-year average of 4-year weighted 4-year weighted 20-year average of
average of long-term long-term Treasury average of long-term average of long-term long-term Treasury
Treasury bond yield. bond yield. Treasury bond yield. Treasury bond yield. bond yield.
Asset assumptions.................. Fair market value..... Fair market value..... Adjustments for level Fair market value.... Adjustments for level
and ROR on stocks, and ROR on stocks,
and long-term and long-term
average interest average interest
rate for bonds. rate for bonds.
Contribution limit................. 100 percent........... 100 percent........... 100 percent.......... 120 percent.......... 120 percent
Contribution Contribution Contribution Contribution Contribution
as share of CL funding as share of CL funding as share of CL funding as share of CL funding as share of CL funding
salary ratio salary ratio salary ratio salary ratio salary ratio
1998..................................................... 0.0 100.7 0.0 119.7 8.3 137.1 3.3 97.7 0.0 243.1
1999..................................................... 4.8 98.2 0.0 117.6 6.7 142.2 3.1 97.8 0.0 253.5
2000..................................................... 0.0 101.9 0.0 118.7 0.0 149.7 2.2 100.1 0.0 255.2
2001..................................................... 3.6 87.6 0.0 102.7 0.0 131.0 3.6 87.5 0.0 220.6
2002..................................................... 6.0 76.4 0.0 87.6 0.0 113.2 6.0 76.3 0.0 188.3
Notes: All figures are in percent. Source is Weller and Baker (2005).
Table 2: Summary Measures for Different Funding Rules, 1952 to 2002
Baseline model Model (2) Model (3) Model (4) Model (5)
Discount rate for liabilities...... 4-year weighted 20-year average of 4-year weighted 4-year weighted 20-year average of
average of long-term long-term treasury average of long-term average of long-term long-term treasury
treasury bond yield. bond yield. treasury bond yield. treasury bond yield. bond yield
Asset assumptions.................. Fair market value..... Fair market value..... Adjustments for level Fair market value.... Adjustments for level
and ROR on stocks, and ROR on stocks,
and long-term and long-term
average interest average interest
rate for bonds. rate for bonds
Contribution limit................. 100 percent........... 100 percent........... 100 percent.......... 120 percent.......... 120 percent
Prob. Prob. Prob. Prob.
Avg. Avg. of less Avg. Avg. of less Avg. Avg. Prob. of Avg. Avg. of less Avg. Avg. of less
cont. to fund. than cont. to fund. than cont. to fund. less than cont. to fund. than cont. to fund. than
salary Ratio 75% salary ratio 75% salary ratio 75% salary ratio 75% salary ratio 75%
1952-2002............................ 2.6 98.6 4.1 2.0 116.6 3.4 2.7 101.1 0.7 2.4 109.1 3.0 2.5 137.2 7.7
(2.7) (13.6) (2.7) (28.1) 3.0 (13.9) (1.5) (18.1) (3.4) (38.7)
1980-2002............................ 3.0 100.3 9.5 0.0 144.4 106 2.8 102.6 0.1 1.7 115.4 4.6 0.0 176.2 0.0
(3.5) (19.3) 0.0 (16.9) (3.4) (18.7) (1.6) (23.9) 0.0 (14.5)
Notes: All figures are in percent. Figures in parentheses are standard deviations.
Table 3: Contributions during Recessions and Non-Recessions
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline model Model (2) Model (3) Model (4) Model (5)
---------------------------------------------------------------------------------------------------------------------------------
Non- Non- Non- Non- Non-
Recession recession Recession recession Recession recession Recession recession Recession Recession
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1952-2002..................................................... 2.2 2.8 2.5 1.8 1.7 3.2 2.6 2.2 3.4 1.8
1980-2002..................................................... 2.0 3.4 0.0 0.0 0.7 3.8 1.8 1.6 0.0 0.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: All figures are in percent.
There are clear benefits from implementing more smoothing in
pension funding rules. Employers would gain predictability in the
funding of their pension plans, while the funding status of pension
plans would generally improve. Thus, employees would enjoy greater
security of their benefits and the PBGC would ultimately see a
reduction in the probability of plan terminations.
This proposal would also introduce funding rules that are more
consistent with the going concern nature of pension plans. Using long-
term averages assumes that pension funds will buy and sell securities,
and that these transactions will occur at different interest rates. The
time frames over which the smoothing occurs are generally consistent
with the typical duration of pension liabilities. The proposals laid
out here give a clearer summary view of how well a pension plan is
prepared for mastering the challenges of the medium-term future, when
it is expected to pay benefits.
Numerous proposals, including the administration's, have recognized
the benefits and the consistency of smoothing in funding rules for the
future well-being of pension plans. However, such proposals allow for
more smoothing on the plan contribution side, rather than on the asset
and liability valuation side (DOL, 2005; Towers Perrin, 2005). This
still leaves the problem that ``marking to market'' does not provide an
accurate view of how well the plan is prepared for the future.
Furthermore, even those who propose more smoothing of contributions
don't necessarily believe that it will actually work. When introducing
the administration's plan, Secretary of Labor Elaine Chao was quoted as
saying in the New York Times on January 30, 2005, that workers will
``pressure their employer to more adequately fund the underfunded
pension plans.'' Secretary Chao's comments indicate that the
administration is counting on the large volatility of pension funding
that would result from its new funding rules to scare workers into
demanding more pension contributions from their employers. That is,
regardless of the funding rules, employers may be forced to increase
pension contributions to stave off employee dissatisfaction. However,
this may only be a short-term phenomenon. Because the funding status of
a pension plan would become more volatile, the contribution demands
from employees at one point in time may become quickly obsolete as
asset prices and interest rates change. The result would be frustration
on the part of employees and large short-term pressures on employers,
with the likely result that more and more employers would abandon their
pension plans. Instead, the proposal laid out here would provide
employees with a more accurate picture of the long-term health of their
pension plans and stabilize the contribution stream of employers to
their pension plans.
Conclusion
After 2000, defined benefit pension plans experienced severe
underfunding. While the magnitude of the problem was unprecedented, the
combination of the underlying factors was not. Employers should expect
a regular recurrence of declining interest rates and asset prices
during a recession. Current funding rules reflect this regularity and
the administration's proposal to change these funding rules will not
make the problem better, but exacerbate the counter-cyclical volatility
of pension funding. Thus, the administration's proposal falls short of
the standards laid out in the introduction. It would reduce the chance
that future benefits will be maintained and it could jeopardize the
pension security in well established pension plans through higher
costs.
Instead of increasing the volatility of pension funding, which
would drive more employers to terminate their pension plans, there are
rule changes that would allow for more smoothing of pension liabilities
and assets and thus stabilize pension funding. Empirical results show
that this would result in more stable employer contributions to pension
plans and to higher average funding ratios. Employers would benefit
from greater certainty about the future of their pension plans, while
employees and the PBGC would benefit from greater security of pension
benefits. Thus, these alternatives would meet all three goals of
sensible funding rule changes. They would secure existing benefits,
help to maintain benefit security in the future, without unduly
burdening the PBGC.
Thank you very much for this opportunity to present my views on
pension funding rules. I am looking forward to your questions.
References
Board of Governors of the Federal Reserve System (2005). Release H.1
Select Interest Rates (Washington, DC: Board of Governors).
Board of Governors of the Federal Reserve System (2003). Release Z.1
Flow of Funds Accounts for the United States, March (Washington,
DC: Board of Governors).
Bodie, Z. (2005), Less is Less, The Milken Institute Review, First
Quarter:38-45.
Bureau of Labor Statistics (2004). Employee Benefits Survey, Percent Of
All Workers Participating In Defined Benefit Pension (Washington,
DC: BLS).
Employment Policy Foundation (2005). Pension Funding Reform: An
Analysis of the Bush Administration's Proposal, EPF Policy
Backgrounder (Washington, DC: EPF).
Engen, E.M., Gale, W.G., and Uccello, C.E. (1999). The Adequacy of
Household Saving, Brookings Papers on Economic Activity 2, 65-165.
Ghilarducci, T., and Sun, Wei (2005, January). Did ERISA Fail Us
Because Firms' Pension Funding Practices are Perverse? Paper
presented at the 57th Annual Meetings of the Industrial Relations
Research Association (Philadelphia, PA).
Hewitt Associates LLC (2003). Survey Findings: Current Retirement Plan
Challenges: Employer Perspectives 2003 (Lincolnshire, IL: Hewitt
Associates LLC).
Kristof, K. (2003, April 25). Study Details Pension Plan Shortfalls--
Nearly 90 percent of S&P 500 Companies with Defined Benefit
Programs Were Underfunded Last Year. Los Angeles Times, Business
Section, Part 3:4.
Pension and Welfare Benefits Administration (1998). Abstract of 1994
Form 5500 Annual Reports. Private Pension Plan Bulletin No. 7
(Washington, DC: PWBA).
Pension Benefit Guaranty Corporation (2004). Annual Performance and
Accountability Report (Washington, DC: PBGC).
Pension Benefit Guaranty Corporation (2003). Pension Insurance Data
Book 2003 (Washington, DC: PBGC).
Shiller, R., 2001, Irrational Exuberance, Princeton, NJ: Princeton
University Press.
Tradetools.com, 2005, Weekly Long-Term Financial Market Database
(1927), tradetools.com.
Towers Perrin (2005). A Towers Perrin Proposal for Pension Funding
Reform. White Paper. Retrieved from www.towersperrin.com.
U.S. Department of Labor (2005). Strengthening Funding for Single-
Employer Pension Plans (Washington, DC: DOL).
Weller, C., 2005, Social Security Privatization: The Retirement Savings
Gamble, CAP Report, February, Washington, D.C.: Center for American
Progress.
Weller, C., and Baker, D. (2005). Smoothing the Waves of Pension
Funding: Could Changes in Funding Rules Help Avoid Cyclical
Underfunding? forthcoming in Journal of Policy Reform.
Appendix: Technical Details of Pension Model
The basic simulation model referenced here is developed in Weller
and Baker (2005).
Asset Valuation Method
First, the difference between market price and trend price is
calculated for the current period:
Next, it is assumed that the difference between market price and
trend price disappears over a period of 20 years, which generates an
adjustment factor, AF, to the market price of stocks of:
Since the expected rate of return to stocks is the sum of the rate
of capital appreciation and the dividend yield--dividends relative to
market price--the adjustment made to the price also affects the
expected dividend yield, such that the adjusted dividend yield is equal
to the ratio of dividends, D, to the adjusted market price, P*.
We also assume that the difference between the actuarial value and
fair market value disappears after 20 years, and that assets other than
stocks earn the same long-term interest rate as for liabilities plus 50
basis points.
Basic Pension Plan Design
The number of workers is assumed to have been 10,000 in 1952,
equally distributed from age 20 to 65, with 80 percent of workers blue
collar and 20 percent white collar, labor force growth equal to 1
percent annually, and annual wage growth equal to 3 percent. Assumed
attrition is 5 percent, equally distributed, and the number of vested
workers is proportional to that of job leavers. We use the age earnings
profile for blue- and white-collar workers from Engen et al. (1999).
Retirement benefits are based on average final pay, with retirement
benefits equaling 1 percent of the average of the last 5 years of
earnings for each year of service, with 5 years of vesting, and no
ancillary benefits. Current liabilities are then calculated using the
unit credit method. Assets are held in stocks and bonds. From 1952 to
2002, the pension plan's asset allocation into equities is equal to the
share of directly held corporate equities out of assets for all pension
plans (BoG, 2003). The rate of return earned on stocks is set equal to
the increase in the S&P 500 plus the dividend yield, and the rate of
return on bonds is equal to the treasury rate plus 50 basis points.
______
FMR Corporation,
Boston, MA 02109,
March 24, 2005.
Hon. Michael B. Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
Washington, DC 20510-6350.
Hon. Edward M. Kennedy,
Ranking Member,
Committee on Health, Education, Labor, and Pensions,
Washington, DC 20510-6350.
Hon. Charles Grassley,
Chairman,
Committee on Finance,
Washington, DC 20510-6350.
Hon. Max Baucus,
Ranking Member,
Committee on Finance,
Washington, DC 20510-6350.
Re: Joint Hearing on Private-Sector Retirement Savings Plans
Dear Chairman Enzi, Chairman Grassley, Senator Kennedy and Senator
Baucus: Thank you for the opportunity to participate in the recent
joint forum, ``Private-Sector Retirement Savings Plans: What Does the
Future Hold?,'' held by the Senate Committees on Finance and Health,
Education, Labor and Pensions (HELP). I found the hearing to be quite
productive and look forward to working with you and your staffs
regarding the important issues surrounding the need for Americans to
better prepare for their retirement.
Three issues raised at the hearing merit additional attention, and
I would like to offer the enclosed written materials for your review.
These issues are as follows:
Savings for Retiree Medical Expenses. As I stated at the hearing,
Fidelity estimated in 2003 that a couple retiring in 2004 at age 65
would need to have accumulated at least $175,000 in savings at that
time to fund out-of-pocket medical expenses in retirement,
notwithstanding Medicare coverage (including the prescription drug
benefit) available to retirees at that age. We believe very few
retirees, even those who have participated in an employer-sponsored
defined benefit or defined contribution plan, will be adequately
prepared to pay for these enormous retiree medical costs. We therefore
believe much more needs to be done to educate workers about these
expected costs and to offer them appropriate vehicles in which to save
for these costs while they are still working.
To provide further information on this issue for the committees, I
have attached a white paper prepared by Fidelity on the subject titled
``Retiree Health Care Accounts: The Next Step Toward a Workable
Solution.''
Lifecycle Funds. As I stated in the hearing, the current
Department of Labor regulations under ERISA 404(c) provide no
fiduciary liability protection for employers with regard to the
investment option to which accounts are defaulted when participants
make no affirmative investment election. As a consequence, most
employers designate a money market fund as the default fund instead of
a more appropriate lifecycle or similar fund. This problem is
exacerbated in the case of plans that provide automatic enrollment
since those plans, by definition, result in a higher number of
participants being allocated to the default fund. We believe a simple
solution to this problem would be an amendment to 404(c) that
provides a shield from fiduciary liability when a properly-designed
lifecycle or similar fund is designated as the default investment
option.
To provide further information on this issue to the committees, I
have attached two white papers prepared by Fidelity on this topic,
entitled, ``The Case for Age-Based Lifecycle Investing'' and ``Putting
Lifecycle Investing Theory into Practice.''
Longevity Risk and Lifetime Income Planning. Many of the
participants in the hearing highlighted the importance of the risk in
retirement income planning and the beneficial consequences of
annuitization. Fidelity likewise recognizes the importance of longevity
risk, but we also recognize the importance of other risks in retirement
income planning with regard to which annuitization may have a less than
beneficial effect, including inflation risk and issuer risk. To
encourage retirement planning, Fidelity has developed tools that allow
retirees to better determine the appropriate level to annuitize their
retirement income, taking into account all of the relevant risks. We
therefore urge Congress to proceed cautiously with regard to the issue
of providing incentives to retirees to annuitize their retirement
income stream to assure that all of the relevant risks are balanced.
To provide further information on this issue to the committees, I
have attached a white paper prepared by Fidelity on this topic entitled
``Lifetime Income Planning.''
I would be happy to discuss any of these issues at greater length
with you or your staffs. Again, thank you for offering me the
opportunity to participate in the joint hearing.
Sincerely yours,
John M. Kimpel,
Senior Vice President and
Deputy General Counsel.
______
Prepared Statement of Senator Thomas
As public attention has recently been drawn to the subject of
retirement security and the discussion that has ensued over the
government's role of providing Social Security benefits, I'm very glad
that we're taking the time here to address at least some of the role of
the private sector. While I still believe that ultimately
responsibility for an individual's retirement lies largely with the
individual--as illustrated by my introduction of the SAVE initiative
last week--to the extent that private employers choose to provide
pension benefits for their workers, those benefits should be reliable.
In other words, it's extremely important that we have an effective,
well-regulated--but not overregulated--system. I very much appreciate
the time each of you has taken to be here today to discuss this
important issue.
______
Question of Senator Thomas
Question. As we look at what makes a good pension system, I think
we have to remember that private pensions are entirely voluntary and
that employers can either offer them or not. Hopefully, most will want
to offer them to attract and retain the best employees. That said, we
must be careful going forward that we do not hamstring employers that
try to offer these plans. It is incredibly important that we strike the
right balance between protecting the employee and keeping employer
compliance simple and straightforward. What are your suggestions for
striking and maintaining this delicate balance?
______
National Rural Electric Cooperative Association,
March 25, 2005.
Hon. Mike Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
Hon. Edward M. Kennedy,
Ranking Member,
Committee on Health, Education, Labor, and Pensions,
Hon. Charles Grassley,
Chairman,
Committee on Finance,
Hon. Max Baucus,
Ranking Member,
Committee on Finance,
U.S. Senate,
Washington, DC 20510-6350.
Re: ``Private-Sector Retirement Savings Plans: What Does the Future
Hold?'' Additional Submission for the Record Highlighting
Challenges for ``Multiple Employer'' Plans
Dear Chairman Enzi, Chairman Grassley, Senator Kennedy and Senator
Baucus: Thank you once again for inviting me to participate in last
week's Senate Forum dedicated to examining the future of private-sector
retirement savings plans. We at NRECA appreciate the opportunity to
continue our strong working relationship with the committees on these
important issues that impact over 55,000 of our members' employees
alone.
As you know, NRECA sponsors both a Defined Benefit (DB) multiple
employer pension plan, and, a Defined Contribution (DC) multiple
employer pension plan (401(k) Plan) under 413(c) of the Internal
Revenue Code (collectively, the ``Plans'') for our members' employees.
NRECA is the primary source of retirement savings services for the
Cooperative community, with 77 percent of NRECA's member systems
offering the DB Plan, 84 percent offering the 401(k) Plan, and 74
percent offering both plans.
During the Forum, I stated that while we believe our story is a
success that should be shared and encouraged, administering and
participating in a ``multiple employer'' plan does not come without
significant challenges. Further, I described how the ``multiple
employer'' plan structure is often overlooked or is an afterthought in
legislative proposals, resulting in an unclear legal and regulatory
environment that increases financial risks to both plan sponsors and
participating employers. The Administration's DB pension proposal to
determine a plan's funding target or liability based on a company's
credit rating is the latest example of this--Administration officials
have publicly admitted that they never considered ``multiple employer''
plans in developing their proposal, which simply does not work in that
context.
Chairman Enzi asked that I describe some other ``multiple
employer'' issues for the record as the committees continue to examine
legislative proposals to preserve and enhance the private retirement
savings system for the future, and I do so here:
1. Under current law, the Internal Revenue Service (IRS) has
established the Employee Plans Compliance Resolution System (EPCRS) to
enable an employer that maintains a plan that has experienced a problem
with an applicable Code requirement to correct the problem and
simultaneously preserve the tax benefits available for employers and
employees.
The ECPRS system permits plan sponsors to correct qualification
failures and thereby continue to provide their employees with
retirement benefits on a tax-favored basis. One component of the EPCRS
is the Audit Closing Agreement Program (Audit CAP), which permits a
plan sponsor to pay a sanction and correct a plan failure while the
plan is under audit.
Under Audit CAP, any penalty is a negotiated percentage of the
amount of taxes that would be owed if the plan were disqualified. For a
``multiple employer'' plan, this could mean that the penalty would be
based on the assets of the entire plan, even where for example, an
operational error relates solely to a plan sponsor's treatment of just
one participating employer's part of the plan.
We believe this is a disincentive for small employers to work
together, to leverage group purchasing power and economies of scale, to
create ``multiple employer'' pension plan arrangements. While NRECA has
never been subject to Audit CAP, we believe that the Congress should
provide clear direction to the IRS that in the ``multiple employer''
context, this concept must be refined. That is, in situations where a
violation is solely attributable to the participation of fewer than all
participating employers, any negotiated percentage of taxes that would
be owed if the plan were disqualified should only be based on the
portion of the plan attributable to those particular employers and
should not be based on the other parts of the plan attributable to the
other employers.
2. Section 4010 of ERISA requires notification to the PBGC for
plans with unfunded vested benefits that exceed $50 million (the $50
million section 4010 gateway test). Significant employer
identification, plan information, and financial information must be
included in the PBGC filing. While the PBGC notification requirement
was clearly intended to apply only to large companies, the number of
plans subject to the 4010 filing has greatly increased in recent years
due to historically low interest rates.
The PBGC is interpreting the statute to apply the $50 million
threshold to a ``multiple employer'' plan in total, even if for each
individual employer participating in the plan there is no question that
the value of unfunded vested benefits is well below $50 million. These
reporting requirements place an unnecessary and unreasonable burden on
all employers, but particularly small employers participating in a
``multiple employer'' plan.
We believe this is a disincentive for small employers to work
together, to leverage group purchasing power and economies of scale, to
create ``multiple employer'' pension plan arrangements.
We hope to continue our work with the committees to address these
kinds of issues so that ``multiple employer'' plans continue to be a
viable vehicle for companies committed to doing the right thing--
providing meaningful retirement benefits to their employees. If you
have any questions, please feel free to have your staff contact me or
Chris Stephen here in my office at 703-907-6026.
Sincerely,
Glenn English,
Chief Executive Officer.
______
Prepared Statement of Conversation on Coverage
introduction
The private sector retirement system in the United States is in
many ways a great success story, providing much-needed benefits in
addition to basic Social Security benefits for millions of older
Americans. But millions of others, who will be equally in need of a
supplement to Social Security, are left out of the system.
Although there has been tremendous growth in the number of
workplace retirement plans, the number of people covered by retirement
plans, and the dollars invested for retirement, the percentage of
American workers participating in a pension plan has remained at
roughly 50 percent of private sector workers for the past 2 decades.
The retirement plan coverage locomotive is stalled and is not
gaining ground. This is true despite an intensive debate for more than
a decade on how to improve coverage and the emergence of many
innovative policy recommendations. Suggestions have been put forward by
Presidents, Members of Congress, business groups, employee advocates,
pension specialists, and professors. Some suggestions for simplifying
rules and establishing new types of retirement plans have been made
into law. The new plans have prompted some employers who had not
previously offered plans to do so, while some new rules have prompted
employers to offer an existing plan to more employees.
The Conversation on Coverage was envisioned as a vehicle to bring
together retirement plan experts representing a wide diversity of
viewpoints in an effort to reach common ground on recommendations to
increase the rate of retirement plan coverage of American workers.
There remains a clear need for new ideas to increase coverage,
especially those aimed at raising coverage rates among low- and
moderate-income workers.
Background: The Work Place and Retirement Benefits Today
In 2004, 59 percent of all full-time and part-time private sector
American workers had access to a pension plan sponsored by the company
where they worked, according to the Department of Labor. However, only
about 50 percent of all workers actually participated in these
corporate pension plans.
In 2004 total enrollment in the private sector plans was 51.6
million of the 102.3 million private sector workers, the Department of
Labor reports.
Today, as was the case in the early 1980s, higher income workers
and older employees with job tenure are likely to work at a company
with a retirement benefit. However, low- to moderate-income people and
younger employees are less likely to have a retirement benefit. There
is also a big gap between full-time workers, who have a 53 percent
coverage rate, and part-time workers, who have an 18 percent coverage
rate, according to the Department of Labor.
Companies with more than 500 workers are most likely to have a
retirement plan. In medium and large companies, a good employee
benefits package is seen as key to attracting and retaining skilled
workers.
Small businesses (with 99 or fewer workers) often face a different
workforce situation. With a high worker turnover rate, there may be
less employer or worker interest in benefits with a long-term horizon.
Smaller companies are where there are the most workers without
retirement benefits. Among firms with 100 or more workers, the
participation rate in retirement plans was 65 percent, compared with 35
percent for employees at small businesses.
Some of the lower coverage rates among small businesses is due to
the fact that small businesses are more likely to have part-time
workers--and part-time workers, as noted, are more likely to be without
retirement plan coverage. Among the smallest businesses--those with
less than 10 workers, 41 percent of the workers are part-time,
according to the U.S. Census Bureau. By comparison, in slightly larger
companies--those with 10 to 24 workers--the proportion of part-timers
drops to 33 percent.
An overall coverage rate of 50 percent at any one time does not
mean that half the work force never has coverage. The likelihood that a
single individual will be covered increases with age.
Overview of the Conversation on Coverage's Working Group Reports
The Conversation on Coverage tackled the issue of expanding
coverage in its first gathering in July 2001. That event produced a
number of innovative concepts, and a commitment among the diverse
constituencies that care about pension issues to find ways to work
together to improve pension coverage.
The second phase of the Conversation on Coverage began in early
2003 with the establishment of a Steering Committee and the creation of
three Working Groups, each with its own assignment, and each with
members representing a broad range of views and expertise in retirement
issues. Members of these groups met for an intensive series of day-long
meetings during the period from May 2003 through February 2004. The
groups each had five or six full sessions, numerous subgroup meetings,
and extensive further communications by telephone and e-mail.
The 45 experts on the three Working Groups represented a wide
diversity of viewpoints. They came from businesses large and small,
from academia, from the legal and employee benefits professions, from
the union movement, from retiree and women's organizations, and from
insurance and investment companies. They worked together many hours to
find common ground. Starting from different points on the ideological
spectrum, they ultimately came together to reach agreement.
The starting point for most members of the Working Groups was a
belief in perpetuating the voluntary private retirement system while
finding ways to expand it to include more workers. Along the way, some
members said they preferred new mandates; but, the Working Groups in
the end reached a consensus on voluntary approaches.
The private, off-the-record sessions gave the participants a chance
to explore and debate different concepts without concern that they
would suggest something that might meet with objection--whether
practical, political or academic--before it had been more thoroughly
vetted. It was a chance to let their intellectual hair down, explore
ideas and share common understandings. Nothing was taken for granted.
The general theme was to build on the successes of the existing system
and to look for new ways to make it work better and to reach more
workers.
The result of all these efforts is an impressive package of
proposals that are likely to advance the coverage debate significantly.
The synthesis of thinking among members of the group is now offered for
consideration and deliberation by others, including workers, employers,
Members of Congress and the general public. The Working Groups did not
attempt to evaluate all retirement plan proposals. Instead, they chose
to focus on the broad framework of new plans they helped design and
which they felt had particular merit. Due to the broad diversity in the
membership of each of the Working Groups, and the considerable time and
energy devoted to the task, the ideas that have been recommended in
this report emerge from this process with a stamp of approval that
increases the odds they can eventually be perfected, piloted and
adopted.
Key Recommendations of the Working Groups
Four new promising ideas for new types of retirement plans emerged
from the Working Groups. They are summarized below.
The Guaranteed Annuity Plan (GAP) takes an employer-funded
defined contribution plan, the money purchase plan, and adds new
twists: the employer guarantees the rate of return on account balances
of workers. The money purchase plan is a retirement savings plan
financed by the employer through regular contributions based on a
percentage of the compensation of each worker. GAP also provides higher
contribution limits. The normal form of GAP's final benefit is an
annuity, although employers can offer lump sums. (Working Group I)
The Plain Old Pension Plan (POPP) is a new variation on
the traditional defined benefit plan that starts with a modest
guaranteed benefit that employers can boost in any year and then reduce
back to the basic benefit in future years. It makes an employer's
funding obligation more predictable. The normal form of the final
benefit is an annuity and no lump sums are allowed. (Working Group I)
The Retirement Investment Account (RIA) Plan proposes the
creation of a government-authorized, privately-run central
clearinghouse to accept contributions from all workers at all
businesses. Employers will not have to administer the plan or take
fiduciary responsibility for the investment choices of their employees.
This plan is aimed at providing more individual workers with access to
a payroll-deduction retirement saving plan through their workplace.
(Working Group II)
The Model T Plan is a proposed multiple-employer plan that can be
offered by financial institutions, such as banks, insurance companies,
brokerage firms and mutual fund companies. The institutions will
administer the plans and assume fiduciary liability for a simplified
array of investment choices in the plan. This plan is likely to expand
coverage by encouraging more small businesses to offer a plan to their
workers. (Working Group III)
These proposals have several common elements. They reduce and/or
transfer administration costs away from employers and reduce employer
worries about the costs of funding the plan. They expand the number of
workers eligible to participate in a plan. They also provide more
opportunities to provide benefits--and in some instances--increase the
level of benefits for low- and moderate-income workers. In addition,
the proposals create approaches that are more appealing to the small
and medium-sized businesses where coverage is the lowest.
This report contains a detailed discussion of each of these
proposals and other recommendations that emerged from the Working
Groups, preceded by an Executive Summary for each of the Working Group
reports.
Understanding the Language in the Working Group Reports
In the individual reports that follow, the reader will come across
the frequent use of the term ``generally agreed.'' It will help in
understanding the recommendations that have been made to know how that
term is defined for purposes of this report. The goal of the group was
to try to reach consensus. ``Consensus'' did not necessarily mean
having 100 percent agreement by all parties at all times. There was an
understanding by the Working Groups that if nearly all members agreed
on something, then it would be fair to say that the group ``generally
agreed.'' By that, it is meant that there was only token opposition
from a few members, usually no more than two.
Beyond the area of ``general agreement,'' you will also note that
there are other areas with varying degrees of agreement. It was decided
from the beginning that there would be no vote per se, as voting was
seen as working against agreement and could be polarizing. The meetings
were covered by officially-designated reporters, and the co-chairs
frequently polled members for their views. The range of views, in fact,
often did not fall into simple ``for'' or ``against'' categories. As
people were making compromises, they might be ``for'' with a caveat, or
``against'' but with some reservation. And sometimes Working Group
members compromised on one item if they thought it was for the greater
goal of moving the proposal forward and possibly getting something else
in return on other ideas. Sometimes, rather than get bogged down in
contentious issues, the Working Group members agreed to list a range of
options and to come back later to the issue if there were more time.
There are times in the report when it helps to know what level of
agreement existed, since there is a fairly large range of possible
levels of agreement between no agreement and ``general agreement.''
Thus, the reader will encounter such descriptions as ``the majority''
favored a given view. Or, ``most'' members supported an approach. When
views were more evenly divided or diverged in ways that were difficult
to tally, the text is likely to say that ``the group was divided'' on
this issue.
Efforts are made to include minority views, especially when they
are strongly expressed or held. So, even when there may be ``general
agreement'' on a point, the reader might find that ``a few'' or
``some'' members held a different point of view. Sometimes, when there
was disagreement, the report offers suggestions offered by members for
addressing the issue at hand.
It is important to understand the context in which these new
proposals are being offered. They are not considered finished concepts,
but initial recommendations. It is hoped that these proposals will
prompt a host of constructive suggestions for improving them, as well
as even more new ideas for expanding coverage.
Lastly, these reports also contain comments and suggestions about
the recommendations voiced by participants in the Conversation on
Coverage's July 2004 National Policy Forum.
Robert Stowe England
______
Report on the Conversations and Recommendations of Working Group I
working group's assignment
answer this question
How do we increase coverage by encouraging incentives for both
traditional and new forms of defined benefit plans?
february 7, 2005
Co-Chairs: Melissa Kahn and Norman Stein
Working Group Members: Phyllis Borzi, Ellen Bruce, David Certner,
Charles Cole, Patricia Dilley, Lynn Dudley, Ron Gebhardtsbauer, Deene
Goodlaw, Brian Graff, Nell Hennessy, Mike Johnston, Judy Mazo, Shaun
O'Brien, and Bob Patrician
executive summary
The Working Group held a series of meetings between May and
November of 2003 to discuss ways to increase the number of workers in
the workforce who work at companies that offer a defined benefit plan.
Such plans typically promise a benefit that provides a guaranteed
stream of income for life after retirement. Defined benefit plans are
funded by the employer and the promised benefit level does not depend
on the actual performance of the plan assets. An increase in workers
covered by a defined benefit plan can be achieved both by encouraging
employers that already sponsor defined benefit plans to extend coverage
to more of their workers and by efforts or policies that prompt more
employers to offer a defined benefit plan.
Defined benefit plans have several advantages for employees. Since
employers fund the plan, employees do not have to determine how much
they need to save to receive a defined benefit at retirement. Nor do
they need to make contributions to receive the benefit.\1\ The
employer, and not the employee, bears the market risk associated with
investment performance. The employer, and not the employee, decides how
to invest the income and reallocate assets over time. And, to the
extent that retirees take their distribution in the form of a lifetime
annuity, they are relieved of the task of creating a budget for drawing
down over time the funds in a lump sum, as well as deciding how to
manage and invest the funds after retirement age.\2\ Further,
retirement income provided by defined benefit plans is federally
guaranteed \3\ with coverage provided by the Federal Pension Benefit
Guaranty Corporation.
The members of the Working Group reviewed recent proposals for new
types of defined benefit plans that were designed to appeal to
employers who currently do not offer a defined benefit plan (See
Appendices A and B). They looked at traditional plan designs and new
types of plan designs that contain features of defined benefit plans.
After reviewing those suggested approaches, the Working Group put
together the basic outlines of two new proposals--the Guaranteed
Account Plan (GAP) and the Plain Old Pension Plan (POPP)--aimed at
employers who may be interested in sponsoring a defined benefit plan
but who are also wary of the liabilities and burdens associated with
traditional pension plans.
Guaranteed Account Plan. The Working Group generally agreed on the
key design features of this proposed plan, listed below.
The proposed plan is a new kind of hybrid plan that takes
the existing money purchase plan and adds a guaranteed account balance.
The money purchase plan is a retirement savings plan financed by the
employer through regular contributions based on a percentage of the
compensation of each worker.
The account of each participant is credited with an annual
employer contribution.
Benefits are funded by the employer, based on standardized
and conservative funding assumptions; employees could also elect to
contribute on a pre-tax basis.
The plan guarantees the annual rate of return on
participants' account balances.
The employer invests the plan assets so employees do not
self-direct the investments.
The plan offers an annuity as the automatic payment
option, but participants may also be offered as an alternative a lump
sum equal to the amount credited to the participant's account.
With this basic design, GAP transfers from the employee to the
employer the risks associated with choosing appropriate investments, as
well as the financial market risk of how well investments perform.
The Plain Old Pension Plan. The Working Group generally agreed on
the key design features of this proposed plan, which are listed below.
The plan is a simple, easy-to-understand traditional
defined benefit plan that provides a modest basic benefit to allay
employer concerns about funding the plan.
The final basic benefit is based on a percentage (as low
as 1 percent) of an employee's career average pay multiplied by the
number of years of service.
The plan would allow employers to fund bonus benefits in
any given year or years that would raise the final benefit without
having the bonus benefits become part of the permanent benefit
structure.
The plan would permit, but not require, a generous past
service credit that would be attractive to small business owners.
All benefits from the plan would be paid in the form of an
annuity. Lump sum distributions would not be permitted.
Tax Credit Provisions. The Working Group also supported a number of
tax credit provisions that would encourage employers to adopt and
maintain a defined benefit plan, as well as to expand the number of
workers covered by a defined benefit pension plan.
Some of the proposals adopted may require changes in public policy
and some may be pursued through demonstration projects. This will be
determined in a refinement and implementation stage in 2005.
the mission
The mission of Working Group I was to develop proposals that would
expand the aggregate number of workers covered by a plan that offers a
defined benefit. A defined benefit plan is a retirement plan offered by
an employer who is legally obligated to fund the plan's promise to
provide a monthly retirement benefit to each eligible employee and
surviving spouse based on years of service and earnings. (See box on
plan type definitions page TK for more information on types of plans.)
The group generally agreed that expanded coverage would include
providing coverage to employees at firms that previously did not have a
plan with defined benefits, as well as extending coverage to groups of
employees at firms with a defined benefit plan that were not previously
covered by the plan.
The Working Group also sought to find ways to help prevent further
erosion of the number of workers currently covered by defined benefit
plans. To support this goal, the group generally agreed to support
proposals that would encourage employers who currently sponsor defined
benefit plans to continue sponsoring such plans. The group also
generally agreed it should not support proposals that might discourage
employers who sponsor defined benefit plans from continuing to do so.
This approach was seen as being similar to physicians who take the
Hippocratic Oath: ``First, do no harm.''
background
The defined benefit plan is no longer the preeminent and preferred
method of providing retirement income for employees. The plan's
dominant position has been eroded in a single generation, as the
proportion of the private sector workforce covered by a defined benefit
plan was cut in half from 38 percent in 1978 \4\ to 19 percent in
1998.\5\
Meanwhile the proportion of workers with a defined contribution
plan as their primary retirement plan rose sharply over the same period
from 7 percent to 27 percent, making the defined contribution plan the
dominant type of plan in the workforce.\6\ A defined contribution plan
is an employer-sponsored retirement savings plan that accumulates
assets from employee contributions and/or employer contributions. There
is no specific promised benefit at retirement and the investment risk
falls on each individual employee. In the 401(k) and 403(b) models now
predominant (both defined contribution plans) employees determine how
much they should save and often choose how to invest their retirement
savings. (See box on plan type definitions for more information on plan
types on page TK.) The employee's retirement income is based on the
contributions made into the account and the accumulated earnings at
retirement.
Federal pension data illustrate the extent of the decline in
defined benefit plans and employees covered by such plans. The number
of workers covered has declined and the number of plans has fallen
sharply. According to a Congressional Research Service paper, the
number of workers covered fell from 29.3 million in 1983 to just under
23 million in 1998.\7\ At the same time, the number of plans fell from
175,000 to 56,400, with most of the loss of plans occurring among small
businesses (those with 99 or fewer workers). The proportional decline
has been greatest among small plans. Between 1983 and 1998, for
example, the number of workers in small plans fell by a disturbing 65
percent, from 1.86 million to 648,000. That represented a loss of more
than 1.21 million workers. For the biggest firms, however, there was an
even greater decline: with only 5.8 million of workers enrolled in
defined benefit plans. In 1983, the number of active participants in
defined benefit plans at large companies stood at 28.1 million. By
1998, it had declined 21 percent to 22.3 million.\8\
The Pension Benefit Guaranty Corporation provides estimates on the
number of plans and the number of participants and beneficiaries of
those plans based on premiums that are paid to the agency. PBGC reports
that in 2001, there were 22.35 million active workers in plans insured
by the agency, representing 19.7 percent of the 113.5 million private
sector wage and salary workers.\9\ This represented a tiny drop in
workers covered from 22.38 million in 2000.\10\ In 2003, the number of
single-employer plans fell to 29,512 from 31,229 the previous year. The
number of multiemployer plans stood at 1,623 in 2003, down from 1,671
the previous year.\11\
The data suggest that while the defined contribution plan has
become a more popular method for providing retirement benefits, it has
not achieved the success that the defined benefit system enjoyed before
the rise of the defined contribution plans, particularly 401(k) plans.
And despite its relative decline, the defined benefit plan remains an
important part of the employee benefits system, especially at larger
firms. In 1998, for example, private sector defined benefit plans paid
out $107.8 billion in benefits, mostly in the form of annuities
disbursed from plan assets. They also purchased an additional $3.4
billion in annuities from commercial insurers.\12\ Also, the defined
benefit plan continues to be the plan of choice for Federal, State and
local government employees and for workers in the unionized sector of
the economy.
the advantages of defined benefit plans
Defined benefit plans are often seen to have a number of inherent
advantages for rank and file workers. Significantly, all or almost all
the contributions are made by the employer. Thus, the burden of
determining how much to save and how to invest those assets is shifted
away from the employee to the employer or, in a negotiated plan, to the
bargaining table.
Participants in defined benefit plans also enjoy a further
advantage in that the investment risk is shifted away from the employee
and the normal form of pension benefit is usually in the form of a
lifetime annuity in an amount that can be calculated from the formula
in the plan. More importantly, as recently as 1997, fewer than 25
percent of participants in defined benefit plans even had an option to
take benefits in a non-annuity form, such as a lump sum.\13\ In
addition, the benefits provided by defined benefit plans are federally
guaranteed with insurance provided by the Pension Benefit Guaranty
Corporation.
Providing the retirement income benefit as an annuity eliminates
the longevity risk for the retiree; that is, the retiree does not have
to worry about outliving the pension, since the pension is defined as
an income stream to be provided throughout the retiree's life span. It
also fully meets the goals of the substantial Federal tax subsidy for
qualified retirement plans by providing income only during the
retirement years of the employee and his or her spouse, and cannot be
dissipated after a pre-retirement termination of employment or
accumulated as a tax-favored asset for the next generation.
The benefit of having an automatic annuity in a defined benefit
plan has, however, been eroded in recent years as more plans have opted
to offer lump sums as an option and employees have chosen to take lump
sums instead of annuities. In 2000, for example, 43 percent could take
their benefit as a full or partial lump sum.\14\
problems facing defined benefit plans
In order to develop new plan designs and fashion new incentives to
attract employers to the defined benefit form, the group felt it was
important to understand the reasons for the decline of defined benefit
plans. Thus, the group explored the reasons why defined benefit plans
now have less appeal to employers and, in some cases, to employees.
The Employer's Uncertainty about the Pension Liability. Many
members of the group agreed that defined benefit plans have become less
popular because of the unpredictability of the annual contribution
employers have to make to keep their plans fully funded under Federal
pension laws. Such contributions are based on a series of actuarial
calculations that take into consideration the promised benefits for
workers, the value of assets currently in the plan, the expected rate
of return that assets in the plan will likely earn in the future, and
actuarial assumptions such as mortality rates and the rate of employee
turnover that bear on the cost of benefit liabilities.
Employers who regularly make required contributions into their
pension plans to meet future obligations can still fall short of the
funding goal due to changes in the value of assets in the financial
markets and due to changes in the prevailing interest rate used to
evaluate liabilities. Changes in the benchmark interest rates, for
example, may result in reported funding deficiencies for previously
well-funded plans.\15\
In recent years, declining interest rates have required employers
to contribute larger sums of money. The required contribution was also
increased because the value of assets in many plans declined
substantially in 2000, 2001, and 2002. These year-to-year changes can
make the amount of the funding obligation--the amount the employer
needs to put aside now to pay benefits later--rise and fall
dramatically. Thus, swings in interest rates and the market value of
assets can make the funding obligation volatile. This volatility has
been a key concern of employers, since it can require companies to
divert financial resources needed to run the company into the pension
plan. Requirements for large contributions often come when the company
may not be profitable and when the failure to invest in the future of
the company can weaken its prospects for success or even survival.
Funding shortfalls are not always predictable since they may arise from
market forces not within the employer's control.
The volatility in actual funding requirements can cause serious
cash-flow problems for employers. This volatility also shows up on
employers' financial statements, as accounting standards require that
pension assets and liabilities be recorded both on the income statement
and the balance sheet. That can have a serious impact on employers'
cost of capital. Proposals under consideration by the accounting
profession for ``mark-to-market'' reporting would heighten that
accounting volatility by disallowing the use of some actuarial
smoothing techniques used to value assets and liabilities for
accounting purposes.
Employees Do Not Always Value Defined Benefit Plans. The group
generally agreed that one of the reasons that employers do not consider
adopting defined benefit plans is that employees do not ask for them or
appreciate them. Indeed, younger employees, who may expect to change
jobs several times, may see a 401(k) or defined contribution plan as
more valuable, since they know what assets are in their individual
account and can see the assets grow over time through regular
statements from the plan. However, the group also generally agreed that
employees have lately shown more interest in plans that accrue funds at
a regular pace with a guaranteed rate of return in response to the
performance of the financial markets from 2000 to early 2003, when many
employees saw the value of their 401(k) accounts plummet.
How Much Benefit for the Owners and/or Senior Management? One of
the concerns about devising new defined benefit plans is not peculiar
to this type of plan, but applies to all plans. Since most large and
medium-sized employers have some type of employer-sponsored pension
plan, most of the expansion that could occur is among small businesses.
In these businesses, the owner and senior management are likely to be
part of the plan that is offered, according to several members of the
working group, and would expect to receive a very large share of the
pension benefits that would be financed in the plan.
People who are in the business of selling defined contribution
plans, such as 401(k) plans, and profit-sharing plans--both popular
among small and medium-sized employers--report that the owner and/or
senior management of very small businesses normally expect to receive
as much as 60 to 70 percent of the benefit. According to those who
market plans, there is a tipping point for the owner and/or senior
management when it is easier for the owner to simply take a similar
amount of money out of the company without any tax deduction at all and
set it aside for retirement outside of any qualified pension plan. Some
members of the group felt this reality of the marketplace creates an
obstacle to expanding coverage. While coverage can be said to be
increased if more small businesses adopt plans, this may not be
significant if most of the benefit goes to higher paid workers while
rank-and-file employees do not receive meaningful benefits.
Members of the group disagreed on where new plans should set the
dividing line between the portion of the retirement benefits provided
to the owners and highly paid managerial employees and benefits for
regular employees. Some members of the group were concerned that
potential plan designs that directed too little of the contribution to
owners and other highly paid employees may not be attractive enough to
employers to prompt them to sign up for the plan. Others were concerned
that little would be gained if new plans merely benefit owners and
senior management with few benefits for the rank and file of the work
force.
how the working group went about its assignment
The members of the Working Group held six meetings and several
subgroup meetings between May and November, 2003. In the initial
meetings the group reviewed a number of proposals for new types of
plans that promised a defined benefit.
Members were invited to express their opinions about proposals and
the group sought to reach consensus on as many points as it could. Due
to the nature of the process of the Conversation on Coverage, members
of the group often ``took off their advocacy hats'' and often started
from a position in the ``middle'' in an effort to find places where
they could generally agree. At times the group was unanimous or nearly-
unanimous in supporting or rejecting a given point. In this instance,
the group was said to have ``generally agreed'' or ``generally
disagreed'' on that point. At other times, the group found substantial
agreement, but not unanimity. Sometimes the opposition was strong. When
the group disagreed on a point or provision, members were invited to
offer different options that might address a particular issue. This
report reflects those differing opinions and varying viewpoints.
The group began its work by reviewing several defined benefit or
hybrid plan proposals that were included in a binder that was given to
all working group members. Hybrid plans have some of the
characteristics of both a defined contribution and a defined benefit
plan. (See Definitions of Plan Types at on page TK.) The group
considered hybrid plans that would, at a minimum, offer a standard
annual contribution by the employer (which might be waived
occasionally) and a specified rate of return for the accumulated funds
in the account that would be guaranteed by the employer or a financial
institution or company that offers the plan.
The group devised a set of criteria \16\ for reviewing proposals
for new types of plans and also for reviewing proposals for tax
incentives and other ideas to make existing defined benefit plans more
attractive to employers and employees.
The group generally agreed that proposals should be attractive to
employers and employees, make good public policy sense, and be regarded
as marketable by the financial institutions and consultants who would
have to sell them to employers.
For employers, the group generally agreed that the following
criteria should be considered: reduced regulation, low administrative
costs, low contribution costs, high benefits for owners and officers,
attractiveness to prospective employees, designs that are helpful in
retaining current employees, designs with tax benefits to the company
and owner, designs with contribution flexibility for the owners.
For employees, the group generally agreed the following criteria
should be considered: low costs in terms of contributions and high
returns on assets in the plan, protection against investment risk,
employee control over assets, portability of assets, protection against
longevity risk, protection against inflation, tax benefits,
psychological benefits of owning assets, simplicity and fairness for
employees, and the adequacy of benefits provided under the proposal.
From a public policy standpoint, the members generally agreed that
proposals should be measured by the effectiveness of the revenue
dollars spent, and the degree to which savings are preserved for
retirement rather than withdrawn earlier for other purposes. Proposals
were also judged on how well they could be sold to Congress, employers
and employees. They were also judged on how marketable they might be by
financial institutions and benefits consultants.
The group generally agreed that the target employer market for the
proposals they reviewed would be small and medium-sized businesses.
Some members, however, hoped that some of the proposals that the group
reviewed and eventually favored would also appeal to large businesses
that may or may not have a defined benefit plan.
the group expresses interest in db-k plans
Early in its conversations the Working Group expressed a preference
for supporting some type of DB-K plan, with the DB referring to defined
benefit and the K referring to a 401(k) plan. A DB-K plan would be,
then, a defined benefit plan with a 401(k) feature. The idea behind
such plans is to combine two goals into one plan: one side of the plan
would provide a more secure benefit based on a guaranteed rate of
return while the other side of the plan, the 401(k), would give
employees a way to save for retirement through contributions that are
excluded from taxable income.
The Working Group identified several potential benefits of a DB-K.
It would allow employers to offer in one plan a defined benefit based
on pay and length of service, as well as a retirement savings plan. It
would provide a ``safe harbor'' for the defined benefit plan where the
employer provides a minimum benefit formula for all eligible employees,
such as 1 percent of final average compensation times up to 20 years of
service. Employers who provide this minimum benefit would be deemed to
have met the requirements of the nondiscrimination rules, including the
rules applicable to 401(k) plans--giving them a safe harbor from those
rules. This would eliminate the need to do costly nondiscrimination
testing \17\ required by the Internal Revenue Code. It would allow
employers to imaginatively combine the best features of defined benefit
plans and 401(k) plans.
The group generally agreed to support the overall concept of a DB-K
plan that would have a guaranteed benefit in one arm and a 401(k)
feature in the other arm. The group, however, did not generally support
any one of the three plans it reviewed. The three DB-K proposals that
were discussed are described in Appendix A.
The Working Group at one point expressed interest in DB-K Proposal
No. 1, which had one arm that could be either a traditional defined
benefit plan or a cash balance plan. The Working Group was interested
in improving on the basic features offered in DB-K Proposal No. 1 to
make it more attractive for both employers and employees. The group was
interested, for example, in finding ways to make it less costly for the
employer by reducing the minimum required contribution.\18\ The Working
Group generally agreed that employers would be more likely to adopt
such plans if they were less costly. The group was also interested, for
example, in allowing for withdrawals at age 59\1/2\ instead of normal
retirement age to make phased retirement possible at that age, as is
already possible in 401(k) plans.\19\
The member who had introduced the original DB-K Proposal No. 3
suggested that the group replace the cash balance option with a new
hybrid: the Guaranteed Account Plan, an adaptation of the money
purchase plan, a defined contribution plan. The money purchase plan is
a retirement savings plan financed by the employer through regular
contributions based on a percentage of the compensation of each worker.
(See definitions of plan types on page TK for more information on money
purchase plans.)
Working Group Offers Two Plans for Consideration
After reviewing a number of pre-existing potential designs for new
types of plans with defined benefits, the Working Group settled on two
proposals: the Guaranteed Account Plan (GAP) and the Plain Old Pension
Plan (POPP), whose designs are described below.
The Working Group members generally supported the broad conceptual
design of these two proposals. Members also generally agreed on a
number of key building blocks of design elements for each of the plans
with reservations on some aspects of the design for the two plans.
In some key provisions, members could not reach agreement on single
provisions alone without considering their impact as a whole (see
section in this report on Working Group I within the discussion of GAP
titled Four Policy Areas Linked in Discussions). Some members said they
wanted to be sure that the package of provisions as a whole would
provide lower paid workers a sufficient share of the benefits in return
for the greater flexibility and higher benefit the plan would allow
higher paid employees.
The Working Group generally supported POPP on a broad conceptual
level, and there was agreement on some of its potential provisions.
However, on some provisions there was disagreement. Those areas of
agreement and disagreement are discussed later in this report. In some
cases there are options offered for resolving issues and points of
dispute.
the guaranteed account plan
areas of broad agreement on the design of gap
The Working Group reached general agreement on some of the key
design elements of the proposed Guaranteed Account Plan. These elements
are discussed here as individual building blocks of the overall plan.
Basic Plan Design of GAP. The group unanimously agreed on the
following basic design points.
The proposed plan is a money purchase plan with a
guaranteed account balance.
The employer credits the account of each participant with
an annual contribution.
Benefits are funded by the employer, based on standardized
and conservative funding assumptions.
Employees can also elect to contribute on a pre-tax basis.
The employer guarantees the annual rate of return on the
assets in participant accounts.
The employer invests the plan assets in the accounts and,
thus, the employees do not self-direct the investments.
The plan offers an annuity as the automatic payment
option.
Participants may also be offered as an alternative to an
annuity a lump sum equal to the amount credited to the participant's
account.
With this basic design, GAP transfers from the employee to the
employer the risks associated with choosing appropriate investments, as
well as the financial market risk of how well investments perform and
annuity purchase rates at any given time. The group did not agree on
such elements as what the annual guaranteed rate of return should be
and what limits should be placed on employer and employee contributions
to control the extent to which highly paid employees might
disproportionately benefit from the plan.
One member strongly objected to GAP on the grounds that it was a
defined contribution plan with a guarantee and not a true defined
benefit plan and, thus, fell outside the group's mission. Nevertheless,
there was general agreement among members to support the broad outlines
of GAP, while views differed on key provisions. Members who supported
the proposal stated it preserved some of the best elements of defined
benefit plans and avoided the legal controversies surrounding cash
balance plans.
How Some Compromises Were Reached. In the consensus that emerged in
support of key design features of the GAP, many members of the group
expressed concern that some of the legislative and regulatory changes
made over the years have allowed too much leakage of accumulated
benefits that should be saved for retirement. Some members also
expressed concerns that Congress and Federal Agencies have been far too
willing to allow plans to favor higher paid employees in terms of
contributions and benefits. As a practical compromise, some members
agreed to retain in proposed new plans, like GAP, many of what they
considered to be ``bad'' features of current law as a practical
compromise.
This was done in response to the contention that if one were to
tighten existing rules for the new proposed plan, employers would be
less likely to adopt the proposed plan and might either drop their
current defined benefit plan in favor of the new proposed plan, or move
to a defined contribution plan.
For example, many of the members would have preferred to recommend
that the GAP disallow any lump sums except for the smallest accounts.
However, since employers already have a lump sum option in their
defined benefit plan, it was difficult to support tougher rules for
GAP. As the point illustrates, the outcome on some key points on which
agreement was reached was not entirely satisfactory to some concerned
members. However, they decided as a practical reality they had to
preserve incentives to keep employers in existing defined benefit
plans. Thus, even where members supported new various provisions in
GAP, they made a point of noting that it was not an ideal structure to
deliver retirement benefits and that, given the constraints of current
law, it was the best compromise they could make.
With the above caveats, below are the areas where there was general
agreement:
How Long Employees Work to Vest in Retirement Benefit. An employee
is said to be ``vested'' in a pension when the employee becomes
entitled to the benefits of the plan, including employer contributions
to a plan and their earnings. The time until a benefit is vested is
defined under guidelines set forth in Federal pension law.\20\ The
Working Group generally agreed to propose that GAP would allow
employers to offer one of two types of vesting for plan participants.
One choice would be to vest in the entire benefit balance all at once
after 3 years from the date of employment, an approach called cliff
vesting. The group also generally agreed to allow for gradual vesting
over a 6-year period. Under this approach the portion of the benefit in
the plan that is vested rises each year and reaches 100 percent after 6
years. The vesting options under GAP are the same as those that apply
now for 401(k) plans and are more generous than the rules governing
traditional defined benefit plans. Shortening the vesting requirement
benefits employees.
Simplified Funding Rules. Most defined benefit plans have a
complicated set of rules that govern how much in new funding an
employer has to contribute each year. When the total assets in a plan
fall below a level that would make it difficult to meet the future
benefit obligation, employers are required to close the funding gap.
There are also limits on the maximum amount that can be contributed in
a given year. The Working Group sought to simplify the rules in order
to make GAP more appealing to employers.
The Working Group generally agreed that the employer be required to
fund the plan in a manner designed to assure that plan assets are at
all times adequate to meet current obligations. When the funding level
of the plan falls below what it will need to meet future obligations,
the plan has to schedule additional contributions to make up the
amount. The Working Group generally agreed that when the plan becomes
underfunded due to market performance of the assets in the plan, the
gap should be closed over a 5-year period, which is shorter than would
be required under a traditional defined benefit plan and, thus, seen as
better protection of workers' earned benefits. The employer would also
be allowed to make additional contributions above those required that
could raise the level of assets in the plan to 150 percent of its
current liability.\21\ This is a higher limit than current law.
The proposed funding rules for GAP reduce the amount of time the
employer has to close the funding gap, compared to traditional defined
benefit plans.\22\ This makes it more likely plans will close their
underfunding gap after they experience losses. The increase in the
maximum contribution allows employers to make additional contributions
in good years when the company can afford those contributions and,
thus, make it better prepared for lean years, when the employer may
find it difficult to make required contributions.
Increased Credit for Past Service. Members stated that plan designs
that allow for past service credit may be more appealing to older
employers. This feature would allow employers who have not yet set up a
defined benefit plan to do so and then make contributions for the years
employees worked before the plan was set up and, thus, help provide a
better benefit at retirement. The Working Group generally agreed that
GAP could provide for up to 7 years of past service credit. The credit
would be earned 1 year at a time for all the years of prior service
credit. Thus, it would take 7 years to allow for sufficient employer
contributions to cover 7 years of past service credit. All employees--
including low and moderate income workers, as well as highly-
compensated employees--would be eligible for the increased credit for
past service.\23\ Consequently, the grant of past service credit would
be deemed to satisfy the nondiscrimination requirements. Further, the
Working Group agreed that when past service credit is allowed, it would
count toward the vesting requirements of the plan.
Joint and Survivor Annuity. The Working Group generally agreed that
the normal benefit offered at retirement would be a joint and survivor
annuity (or a single-life annuity for unmarried participants), based on
the value of the participant's account at retirement. That means the
value of a participant's account would be used to purchase a
commercially annuity, reasonably priced, that would be issued jointly
to the plan participant and spouse and that the spouse would continue
to receive the annuity should the plan participant die. Employers would
be able to decide whether or not their plans would offer lump sums.
However, if a participant decided he or she preferred to take a lump
sum, spousal consent would be required to change the distribution from
the normal requirement that it be a joint and survivor annuity. Spousal
consent for a lump sum is currently required for money purchase plans,
as well as for defined benefit plans.\24\
A GAP with a 401(k) Feature. The Working Group generally agreed
that a GAP could also include a 401(k) feature. Employees could, under
such plans, make elective contributions \25\ to the GAP or the 401(k)
plan.
Employer Matching Contributions. The Working Group generally agreed
that employers could make matching contributions to the GAP when
employees made contributions to a plan including a 401(k) feature. The
Working Group agreed this should be allowed in accordance with current
Tax Code requirements for matching contributions, including safe harbor
rules.\26\
Caluclation of Lump Sum. When employees in a defined benefit plan
leave a company before retirement and they are vested in a defined
benefit pension plan, they frequently receive a lump sum payment.
Current pension rules governing defined benefit plans, including cash
balance plans, require a complicated calculation \27\ to arrive at the
value of the lump sum. The group generally agreed that rather than
applying the complicated rules that now affect cash balance plans, that
individuals would simply receive the balance credited to their
accounts, using the rules that apply to defined contribution plans.
Members stated this would be fair to employees and to employers and
would simplify administration.
gap design elements with some, but not general agreement
Rules Governing Terminations of a GAP with Surplus. The Tax Code
contains provisions that penalize companies when they terminate
overfunded pension plans. Under the proposed GAP, if employers
guarantee a specific rate of return, such as 3 percent, and the plan's
assets experience higher returns, the plan will accumulate surplus
assets (to the extent the funding method does not fully correct for the
mismatch). An employer may wish to take a reversion on a portion of
those assets. A reversion occurs when an employer terminates a plan to
take out excess pension assets.
There was strong support, but not general agreement, for the following
suggestions:
20 Percent Excise Tax on Reversions up to 130 Percent.
Employers could terminate a GAP and take the surpluses or amounts in
the plan and pay a 20 percent excise tax for amounts that are up to 30
percent above the 100 percent level of account balances.
50 Percent Excise Tax on Reversions Above 130 Percent. If,
however, the surplus is greater than 130 percent of account balances,
the employer would have to pay a 50 percent excise tax on the portion
above 130 percent.
This feature was thought by members to make GAP more attractive to
employers who might otherwise wish to avoid taking on the risk of
guaranteeing the rate of return on account balances. This approach, one
member said, would be more lenient than current law, but would not give
employers ``a complete [free] pass.'' Nevertheless, several members
strongly objected to a reduced excise tax for part of the surplus. They
argued that without a significant penalty, companies would be tempted
to take the surpluses and terminate plans.
Pension Benefit Guaranty Corporation Insurance. Defined benefit
plans in the private sector are insured by the Pension Benefit Guaranty
Corporation in Washington, D.C. When underfunded pension plans are
terminated, the plan assets are transferred to the PBGC and the agency
takes over the payment of pension benefits. The agency guarantees
pension benefits at normal retirement age and most early retirement
benefits.\28\ The agency provides a maximum benefit guarantee, which is
adjusted every year and is $3,801.17 per month for 2005 for workers who
retire at age 65.\29\
Most of the Working Group members supported a suggestion that GAP
be insured by the PBGC. One member was strongly opposed to the
guarantee, arguing that PBGC guarantees were inappropriate for a plan
that was not a true defined benefit plan, but a defined contribution
plan with a guaranteed rate of return.
Most of the Working Group also supported charging a lower $5
premium per member in a GAP. By contrast, the flat rate premium for
single-employer defined benefit plans is $19 per member per year. (In
early 2005 PBGC proposed raising the flat-rate premium to $30 as part
of an effort to strengthen its finances.) Plans that are underfunded
have to pay an additional adjustable rate premium.\30\ A lower premium
was recommended to mitigate one of the objections that employers have
to adopting defined benefit plans; namely, the cost of pension
insurance premiums. Most, but not all, members of the group believed
that the lower premium for GAP would not represent risk to the PBGC
because of the low risk of a GAP benefit default.
Higher Contribution Limits and Maximum Annual Annuity Benefits.
Under the Internal Revenue Code, employers can contribute more annually
for high-paid older employees into defined benefit plans every year
than they can with defined contribution plans.\31\ The Working Group
discussed whether or not GAP, which is a hybrid plan, should have the
contribution limits specified for defined benefit plans or those for
defined contribution plans.\32\ The contribution limits for defined
benefit plans are generally more favorable to older workers, which the
group anticipated would often be business owners and higher-paid
workers of businesses that adopted a GAP.
A majority of the group's members agreed that employers should be
given a choice of whether to use defined benefit or defined
contribution limits. However, some members strongly objected to this
provision as providing too much of a potential benefit to owners and
top executives, who are often older than the average rank-and-file
worker.
The Working Group mostly agreed that GAP could use 5.5 percent as
the interest rate for converting the annuity to a lump sum for purposes
of the maximum defined benefit limit. The Working Group also mostly
agreed that if Congress were to change the law to provide a new
interest rate assumption, the new interest rate assumption would apply
to GAP.\33\
Four Policy Areas Linked in Discussions About GAP
As members discussed what provisions to approve for GAP, four key
issues were frequently tied together in the conversations:
Minimum guaranteed rate of return on account balances.
Maximum benefits allowed for higher paid and older
workers.
Minimum employer contribution credits for all workers.
Flexible testing methods for nondiscrimination.\34\
There were varying levels of agreement on each of these areas. In
addition, members generally agreed that whatever design the GAP
proposal would have in the end would depend heavily on the combination
of these four provisions. Some members suggested that it would not be
possible to decide what was appropriate for each of these plan design
elements in isolation without knowing what the other three would be.
A driving concern for some was a desire to be sure that lower paid
workers were able to obtain a sufficient share of the benefits in
return for the greater flexibility and higher benefits the plan would
allow higher paid employees. For others, the concern was that employers
be given sufficient flexibility and higher contribution and benefit
levels in return for minimum contributions to all workers and
guaranteed rates of return on account balances.
The four issues revolve around complicated rules of the Tax Code
governing whether or not retirement plans are ``qualified,'' that is,
whether plans generate favorable tax benefits for the employer and
employees. Those benefits, generally, are as follows: immediate tax
deductions for employer contributions, deferral of income recognition
for employees until benefits are distributed, and tax exempt status for
the plan's funding vehicle. The most important of those rules are the
complex provisions on when plans are considered to discriminate too
much in favor of highly-paid employees and, thus, invalidate the tax
qualified status of the plan.
Minimum Guaranteed Annual Rate of Return on Account Balances. The
minimum guaranteed rate of return is a key provision since it makes the
money purchase plan, a defined contribution plan, a hybrid plan with
defined benefit characteristics.
The Working Group generally agreed that the rate of return could be
either a fixed rate or a variable rate, meaning that it is tied to a
market indicator or index. It was suggested by one advocate for the
plan that the minimum be set at a 3 percent annual rate of return. That
would mean that account balances in the account would be credited with
at least a 3 percent gain each year. The Working Group could not agree
on an appropriate fixed rate of return. The Working Group, however,
generally agreed that if the rate of return were variable, it should
still be the same for all employees at any given time.
Some members of the Working Group felt that the 3 percent minimum
return was unreasonably low and does not provide adequate benefits for
rank and file workers. These members preferred a 5 percent guaranteed
rate of return. Some members argued that because higher-paid employees
would be able to contribute more under the higher contribution limits
and more flexible nondiscrimination tests of the GAP, they would take
too great a share of the potential benefits under the plan. Other
members said that if the plan required a 5 percent rate of return, more
employers who adopted the GAP would probably opt for a variable rate to
avoid this requirement.
Larger Contributions for Older Workers in Top Heavy Plans. It was
proposed to require a contribution minimum of 5 percent of compensation
for all workers regardless of age, in top heavy plans,\35\ which are
plans where key employees have amassed benefits greater than 60 percent
of the entire pool of benefits. Tax Code regulations require top heavy
plans to make minimum contributions to all employees. Most small
business retirement plans eventually become top heavy because the
compensation of key employees is higher and because there is more
turnover among other employees. This turnover means fewer of them
accumulate benefits.
The group also considered a second option for top heavy plans that
would allow for higher contributions to older workers and lower
contributions to younger workers. Supporters of this option said it
would give employers more flexibility in designing plans to meet the
age demographics of their work forces. The proposed formula was as
follows: Workers age 30 or under would receive contributions equal to 3
percent of compensation. Workers age 30 but not over age 50 would
receive 5 percent of compensation. Workers over age 50 would receive 7
percent of compensation.
The Working Group was divided on whether to support the option to
provide higher contribution minimums for older workers. Some members
who were opposed said that the low annual rate of return on account
balances would harm younger workers. Some members who supported higher
contribution rates for older workers noted that the plan would still be
subject to nondiscrimination testing.
Flexible Approaches to Nondiscrimination Testing. Congress requires
all qualified retirement plans to satisfy nondiscrimination rules,
which are intended to ensure that such plans do not overly favor
highly-compensated employees over other employees. The group engaged in
lively discussions about whether GAP should import the
nondiscrimination rules applicable to defined contribution plans,
including complex testing methods known as age-weighting or cross-
testing.\36\
In a nutshell, cross-tested methodologies allow employers to
contribute substantially more (as a percentage of pay) to older plan
participants, without violating the nondiscrimination rules--even if
most of the older employees are highly compensated.\37\ This
methodology is based on the premise that a contribution to an older
plan participant is inherently less valuable than the same contribution
to a younger plan participant since the latter contribution will have
more time to accumulate investment returns. Small firms whose owners
and other favored employees were older than rank-and-file employees
often used cross-testing methodologies to favor those employees. Recent
variations on cross-testing methodologies allow some firms to deny the
benefits of cross-testing to older rank-and-file employees by creating
subgroups of participants for nondiscrimination testing, provided they
contribute at least a minimum 5 percent of pay contribution on behalf
all rank-and-file employees. (Plans that use these methodologies are
sometimes called new comparability plans.) \38\
Some members of the group believed that GAP should be able to use
age-weighting methodologies to prevent GAP from being at a competitive
marketing disadvantage compared to defined contribution plans. Other
group members argued that these methodologies were highly technical
ways of directing benefits to highly compensated employees and should
either not be permitted in GAP or only permitted if plans using them
were required to direct additional benefits to lower-paid employees.
The group had a lively discussion on this issue, with group members
articulating various views. Most of the members of the group agreed
that subjecting GAP to more exacting nondiscrimination rules than those
applicable to defined contribution plans would essentially mean that
employers would not adopt them. One group member observed that more
than 75 percent of new defined contribution plans were using cross-
testing and new comparability methodologies. Moreover, the Department
of Treasury, after lengthy consideration, adopted new regulations that
provided minimum contribution requirements for many new comparability
plans. These same rules, including the minimum contribution
requirements, would apply to GAP. People who expressed this view also
noted that if policy demanded limiting cross-testing methodologies,
they should be limited for defined contribution plans as well as GAP
and that this was an issue that was outside the Conversation on
Coverage's focus on creating new plans. These group members also
suggested that there would, in fact, be fewer plans if cross-testing
methodologies were limited generally.
A few members of the group argued that GAP's features would attract
employer interest regardless of whether or not cross-testing
methodologies are available, particularly given that older highly-paid
individuals could earn larger benefits in GAP than in a defined
contribution plans. These members said that since a key objective of
the Conversation on Coverage is to focus on rank-and-file employees,
GAP should be designed in a manner that directs meaningful levels of
benefits to such employees.
The group generally agreed that the use of cross-testing
methodologies be conditioned on the employer providing a higher minimum
benefit than would be provided for a non-cross-tested GAP. For example,
under current regulation, the minimum contribution for cross-tested
defined benefit plans is 5 percent. Consequently cross-testing
methodologies would only be permitted for a GAP if the employer made a
5 percent minimum gateway contribution for all employees.
The group also discussed what minimum ``gateway'' contribution
percentage made to all employees would be appropriate for a safe harbor
from nondiscrimination rules if the employer wanted to use the higher
defined benefit plan maximum contribution rules. A majority of the
group supported allowing cross testing only if the employer contributed
6 percent of pay gateway contribution for all employees in the plan.
Some members said they would be willing to support allowing cross-
testing methodologies for the designated minimum gateway contribution
levels above if the GAP plan also provided that the minimum annual rate
of return on account balances was higher than 3 percent.
Minimum Contribution Requirements for Nondiscrimination Safe
Harbor. The members of the Working Group discussed what minimum level
of contributions would be required to allow employers to avoid
nondiscrimination tests.\39\ Several potential arrangements were
discussed: a minimum contribution for a stand-alone GAP, a minimum for
a combined GAP with a 401(k) feature, and a minimum for a top-heavy GAP
either alone or in combination with a 401(k). No agreement was reached
on this point.
Converting from an Existing Plan to a GAP. In recent years some
employers who converted their traditional defined benefit pension plans
to cash balance plans encountered charges of age discrimination. Some
employers were criticized for the method they used in calculating how
the value of the benefit accrued under the traditional plan was
determined and transferred to an opening balance in the cash balance
plan.\40\ As a result of strong objections that were raised, cash
balance plans encountered legal and political obstacles that have yet
to be resolved. To avoid the problems encountered by cash balance
plans, the Working Group considered whether or not it should bar an
employer with a traditional defined benefit plan from converting to a
GAP.\41\ Several members opposed allowing a conversion to a GAP from a
traditional plan. Some members warned, however, that if a conversion to
a GAP is disallowed that employers might instead convert to a defined
contribution plan, a less desirable outcome than converting to a GAP,
according to most group members.
The Working Group also considered whether or not to allow an
employer to convert a cash balance plan to a GAP. There were some who
favored allowing such a conversion provided the cash balance plan had
not previously been converted from a traditional pension plan and
provided the GAP were not started up by an employer following the
termination of a converted cash balance plan.
The Working Group discussed whether or not it should prohibit the
adoption of a GAP by a company that freezes an existing traditional
defined benefit plan. There were some who opposed allowing a freeze and
new GAP, unless the change was part of an agreement negotiated by a
union. Some members suggested that such a prohibition might lead
employers to adopt a defined contribution plan after freezing a
traditional plan.
the plain old pension plan
Areas of Broad Agreement on the Design of POPP
The Plain Old Pension Plan proposal was originally introduced by a
member of the group and later revised by that member and presented
again to the group for discussion. In some cases, discussions
surrounding issues that arose with GAP also proved helpful in
discussing the provisions of POPP.
The Working Group generally agreed to the components of the plan as
spelled out in this section. The basic design elements are as follows:
The plan is a simple, easy-to-understand traditional
defined benefit plan that provides a modest basic benefit to allay
employer concerns about funding the plan.
The final basic benefit is based on a percentage (as low
as 1 percent) of an employee's career average pay multiplied by the
number of years of service.
The plan would allow employers to fund bonus benefits in
any given year or years that would raise the final benefit without
having the bonus benefits become part of the permanent benefit
structure.
The plan would permit, but not require, a generous past
service credit that would be attractive to small business owners.
All benefits from the plan would be paid in the form of an
annuity. Lump sum distributions would not be permitted.
Basic Plan Benefit. The basic plan benefit would accrue at 1
percent a year of the career average income times the number of years
of service. To make the calculations simpler, plans could rely on
tables published annually by the Treasury Department or the Pension
Benefit Guaranty Corporation that would be expressed as a table using
age and compensation to determine the contribution each year. The
amounts set forth in the table would be determined by the governmental
agency using very conservative actuarial assumptions. Employers would
calculate each year's required contribution by aggregating the
contributions on the table for each participant. Some members of the
Working Group suggested that the government publish the actuarial
tables required in this plan every 5 years instead of annually. The
actuarial assumptions in the tables would be conservative, to make
funding shortfalls unlikely.
Employees Covered. The plan would cover all employees who meet the
minimum service requirements, including part-time employees. Employers
would not be required to cover seasonal employees (but could, if they
wished). Thus, the plan would typically cover a secretary who worked 3
days a week, but not a college student working for the summer. If the
employer has separate lines of business, the plan could be adopted for
one line of business only.
Vesting. An employee is said to be ``vested'' in a pension when the
employee becomes entitled to the benefits of the plan, including
employer contributions to a plan and their earnings. The time until a
benefit is vested is defined for most plans under guidelines set forth
in Federal pension law.\42\ As modified, this proposal would allow for
either 3-year cliff vesting or 2- to 6-year graded vesting. With cliff
vesting the participant becomes entitled to the benefit balance that
has accrued all at once after 3 years from the date the participant
joined the plan. Under graded vesting, the portion of the benefit in
the plan that is vested rises in equal portions each year until it
reaches 100 percent after the graded vesting period. Vesting would only
count service from the date POPP was adopted unless the employer chose
to count years prior to adoption of POPP.
Past Service Credit. The plan allows for past service credit for as
many years as the employer would like. The past service credit would
have to be amortized; that is, funded in regular installments over a 7-
year period. Likewise, employees would accrue the past service credit
over a 7-year period.\43\ An employer could give past service credit
for benefit purposes without giving vesting credit for those years.
Bonus Benefit. In years when the investments in the plan do very
well, in years when the company's profits are strong, or at any other
time, the employer may give a bonus benefit to employees without
committing to a permanent benefit increase. For example, in good years
employees could accrue a benefit of 2 percent of compensation instead
of 1 percent. Or, the employer might increase the benefit by the cost-
of-living, and such COLAs would be treated as a bonus benefit for the
years they covered.\44\ Past service credit could also be given for a
bonus benefit.
Minimum Benefit. There would be no required minimum benefit even if
the plan is top heavy because the minimum benefit is built into the
benefit formula, which provides the same level of benefits for all
employees.
401(k) Feature. The plan could contain a 401(k) feature.
Participants could ``buy'' more retirement income through contributions
using the Government tables to determine the cost. Or, the employer
could offer a separate 401(k) plan with an employer match for employee
contributions and profit sharing contributions that would be invested
in the traditional 401(k) investments.
Simplified Funding Rules. POPP was designed to simplify the funding
rules and reduce employer concerns about the plan developing large
unfunded liabilities that might overwhelm a small business. For this
reason, the plan will allow for an approach that will smooth changes in
actuarial assumptions, as well as gains and losses in the assets held
in the plan. As proposed, the plan would be subject to periodic
actuarial valuations, primarily to assess investment experience since
mortality and interest rates would be covered automatically under
tables. Investment experience would be smoothed by using a 10-year
rolling average of the asset valuation (or, if less, the number of
years since the plan was established). Investment shortfalls would be
funded in installments over 5 years. However, the use of conservative
actuarial assumptions is likely to significantly reduce the chances
that plans will have funding shortfalls.
Joint and Survivor Annuity. The plan was designed to have
withdrawals from the plan be made only in the form of a qualified joint
and survivor annuity. Lump sums would not be allowed.
Terminated Participants. Under the proposed plan design, the
benefits of terminated participants could be transferred to the Pension
Benefit Guaranty Corporation, the Federal Agency that insures pension
benefits--or held in the plan for distribution at retirement age.
Pension Benefit Guaranty Corporation Insurance. The plan would be
insured by the PBGC and would pay $5 premiums, lower than those paid by
traditional pension plans. When plans are terminated, the plan assets
are transferred to the PBGC and the agency takes over the payment of
pension benefits.\45\ The agency guarantees pension benefits at normal
retirement age and most early retirement benefits.\46\ The agency
provides a maximum benefit guarantee, which is adjusted every year and
is $3,801.17 per month for 2005 for workers who retire at age 65.\47\
By contrast, the flat rate premium for single employer defined benefit
plans is $19 per member per year. (The PBGC in early 2005 proposed
raising the flat rate premium to $30 as part of an effort to strengthen
its finances.) Plans that are underfunded have to pay an additional
adjustable rate premium.\48\ A lower premium was recommended to
mitigate one of the objections that employers have to adopt defined
benefit plans; namely, the cost of pension insurance premiums.
Plan Termination. If the plan is terminated, there would be no
reversion of any surplus assets to the employer. Under current law,
overfunded plans can be terminated and a portion of the surplus can be
transferred to the employer who sponsored the plan. The process of
transferring the funds back to the employer is called a reversion.
Under this provision, the excess would be used to increase benefits of
current employees to compensate them for the lost opportunity to accrue
more benefits and could also be used to increase benefits for retirees.
Some members of the Working Group objected to the proposed reversion
rules and suggested instead that the plan be governed by existing
reversion rules.
Conversion to Traditional Defined Benefit Plan. The plan could be
amended at any time to become a more traditional defined benefit plan.
The converted plan would be permitted to use all available
nondiscrimination testing methodologies available to regular defined
benefit plans.\49\ After conversion, the employer would adopt its own
actuarial assumptions and run the converted plan like a traditional
defined benefit plan, including provide a minimum benefit to all
workers eligible to participate if the plan is top heavy.\50\
Tax Credit. As proposed, the plan would allow employers a tax
credit equal to 5 percent of the contributions made to fund benefits
for non-highly compensated employees \51\ for a period of 5 years. The
credit would be recaptured by the Internal Revenue Service if the
employer terminates the plan within 5 years. This provision would help
employers cover the costs of providing the benefits to all workers,
including part-time workers who are not seasonal workers.
The Working Group generally agreed that the tax credit should be
higher than 5 percent and should be similar to the level of the Saver
Credit, which provides a 50 percent credit for contributions up to
$2,000. Members also said the tax credit for POPP could be similar to a
temporary tax credit that was offered on contributions to PAYSOPS,
Payroll Stock Ownership Plans.
Some members of the Working Group were worried that the tax credit
might be an incentive for an employer to convert a more generous
traditional defined benefit plan to a POPP. A member suggested that the
tax credit be limited to the first 5 years of the plan.
Required Legislative Changes. The proposed provisions of POPP are
mostly available under current law. However, legislation would be
needed to authorize the PBGC to issue contribution tables, to operate
terminated, sufficient plans, and to act as a clearinghouse for rolled
over or transferred benefits. Legislation would also be needed to
permit a 401(k) feature in a defined benefit plan, and enact the tax
credit for contributions for non-highly compensated employees.
The Working Group discussed POPP and its proposed provisions and
generally agreed that the plan had attractive features and that they
should offer it as a plan to be considered by employers, employees,
consultants, plan providers and policymakers. The Working Group also
agreed that the plan would garner more attention from potential
employers and plan providers if the required legislative changes were
enacted by Congress.
Several members expressed doubt that Congress would be interested
in supporting a new type of defined benefit plan. One member suggested
that while Congress might not be receptive to the idea of supporting a
new defined benefit plan, it was helpful nevertheless for the Working
Group to put forward an idea that the members generally agreed had
merit. Some members remained skeptical that POPP was sufficiently
attractive to employers and some questioned whether it would be
marketed by financial institutions and other prototype plan providers.
One member said that the proposed benefit based on 1 percent of income
might be too low to attract the enthusiasm of employees.
tax incentives for expanded coverage
The Working Group submitted ideas for tax incentives that would
encourage employers to maintain or extend defined benefit plan coverage
to more employees. These included ideas to reward companies for
retaining a defined benefit plan, ideas for adopting specific
provisions that would expand coverage, as well as incentives to start-
up new defined benefit plans.
The members considered 13 tax credit ideas and adopted some and
rejected others.
Tax Credits Generally Supported by the Working Group
Immediate Vesting. The Working Group generally supported giving
employers a tax credit to provide immediate vesting of benefits.
100 Percent Coverage of Employees in a Single Line of Business. The
Working Group generally supported tax credits for this goal.
Reduction of the 1,000 Hours Requirement for Plan Participation and
Benefit Accrual/Allocation. The Working Group generally supported the
idea of reducing the requirement to 500 hours for part-time workers.
They also agreed that seasonal workers could be excluded from the 500-
hours requirement.
Tax Credits With Some Support by the Working Group
Establishment and Maintenance of a Defined Benefit Plan. The
Working Group discussed several options for rewarding employers for
establishing and maintaining a defined benefit plan. One member
proposed giving employers a tax credit equal to the cost of PBGC
premiums every 5th and 10th year. Other members thought this would be
too expensive.
Defined Benefit Plans Providing an Annuity Option Only. There was
support within the Working Group for tax credits for plans that provide
that benefits be offered only as an annuity, provided there was a
threshold level for the requirement. Some supported a policy of
exempting balances of $50,000 from the annuity requirement, while
others suggested that the group should not set a dollar amount but ask
the Department of Labor, PBGC, and Treasury to determine a level below
which there is not a viable annuity market. Members supporting this
provision said that the PBGC might be encouraged to offer annuities not
provided by commercial users. One member, however, questioned the
appropriateness of providing tax credits to employers ``to lock up the
money'' of employees and recommended instead that employees be given
the tax credit for taking their benefit as an annuity.
Plans Not Permitting Pre-Retirement Age Distributions. There was
support in the Working Group for tax credits for plans that adopted
this prohibition, with an exception for benefits worth less than
$5,000. It was seen as supporting the goal of building more assets for
retirement. One member suggested that rollovers for those who leave a
company before retirement be made to an IRA that restricted the final
benefit to an annuity. One member, however, questioned the
appropriateness of giving tax credits to employers to limit options for
employees.
No Use of Permitted Disparity. The Working Group considered a
suggestion that a tax credit be provided to an employer that did not
use nondiscrimination testing methods that permit disparity.\52\ The
group was divided on whether or not to support a tax credit for this
prohibition.
what can be done next
The Conversation on Coverage in its next phase will consider what
further steps it can take to promote coverage through adaptations of
the two major new plan designs--GAP and POPP--to emerge from the
Working Group. It could consider demonstration projects for an
adaptation of the proposed two new plan types that would be allowable
under current law in order to build support for making legislative
changes to enact statutory changes to provide for a fuller range of
provisions for the two proposed plans. These demonstration projects
might help in refining the plans and help build support among potential
plan providers for marketing the plans.
Definitions of Plan Types
Defined Benefit Plan
A defined benefit plan is a pension other than an individual
account plan that provides a regular monthly income after retirement
that is determined according to a formula. It is not dependent on the
actual contributions made to the plan or investment performance of the
plan's assets. Benefits typically are determine based on a fraction
\53\ of a worker's average earnings (either career earnings or certain
high earnings years at the end of the worker's tenure) or a flat dollar
amount multiplied by the number of years worked for the employer. For
example, a defined benefit plan might offer employees a monthly
retirement benefit equal to 1 percent of average compensation a year
multiplied times the number of years worked. In this instance, if a
worker averaging $40,000 a year worked 20 years, he or she would earn 1
percent of $40,000 or $400 multiplied by 20 or $800 a month ($9,600 a
year). In the alternative, a plan might promise a benefit of $40 per
month times the number of years worked. If a worker put in 20 years of
service, he or she would also receive $800 a month or $9,600 a year.
The maximum benefit payable by a defined benefit plan in 2005 is
$170,000 a year.
Some newer defined benefit plan designs provide benefits that mimic
the appearance of defined contribution plans, reporting benefits as a
lump sum account balance. (See Cash Balance Plans below)
Private sector defined benefit pension plans must provide
annuities--either single life annuities for unmarried participants or
joint and 50 percent survivor annuities for married participants--as
the default form of benefit. The annuity from a defined benefit plan
helps retirees (and their surviving spouses) by assuring them of a
regular income based on a set formula for the rest of their lives.
Not all retirees receive their defined benefit as a regular monthly
stream of income, known as an annuity. Instead, some employers allow
retirees to receive their accumulated benefit as a lump sum (with the
consent of their spouses). If a retiree elects to take a lump sum where
it is allowed, that retiree is responsible for deciding how to manage
and invest those funds, as well as when and how much to pay out as an
income.
In a defined benefit plan, the worker does not have to make
decisions about how to invest assets contributed by the employer into
the plan. The employer is responsible for determining the amount of
contributions needed to fund the promised benefits, making those
contributions each year, investing the assets in such a way they will
earn a sufficient return to provide for the funds needed to pay the
promised benefit, and making up for any shortfall in the assets. Most
benefits provided by defined benefit plans are guaranteed by the
Federal pension insurance program managed by the Pension Benefit
Guaranty Corporation. The maximum insured annual benefit for 2005 is
$45,614.
Defined Contribution Plan
A defined contribution plan is one that provides workers with an
individual account and pays out benefits equal to contributions to the
account and net investment earnings on the contributions. The 401(k)
plan is the most well-known example of this type of plan. In a 401(k)
plan, contributions can be made by the employer or the worker and
employers often ``match'' employee contributions; that is, they provide
an additional contribution tied to the amount of contribution the
employee makes. In some defined contribution plans--typically 401(k)
plans--employees must decide how to allocate all or part of their
account balances among a set menu of investment options selected by the
employer (e.g., among various mutual funds and employer stock). In
other kinds of defined contribution plans--such as profit sharing,
money purchase, and employee stock ownership plans--contributions are
made by the employer. In these plans, the employer often invests the
money in the employees' accounts.
In most defined contribution plans, workers receive their benefits
as lump sums when they leave their jobs. They may either roll over the
account balance to an IRA or a new employer plan or use the money for
other, nonretirement purposes. Defined contribution plans, other than
money purchase plans (discussed below) are not required to offer
annuity payouts and most do not. Upon retirement, an employee has an
accumulated retirement savings that he or she will have to decide how
to manage. The retiree has to decide whether to take part or all of the
assets as an annuity, if that is an option. Or, perhaps the retiree may
chose to set up a schedule of regular withdrawals. The retiree also has
to decide how to invest the assets in retirement, including whether to
change the asset allocation. With the 401(k), there are minimum
distribution rules, which dictate a minimum withdrawal each year
beginning at the age of 70\1/2\. Defined contribution plans, unlike
defined benefit plans, are not insured by the Pension Benefit Guaranty
Corporation.
Hybrid Plan
A hybrid plan has characteristics of both defined benefit plans and
defined contribution plans. The most common hybrid plan is the cash
balance plan.
Cash Balance Plan
A cash balance plan is a defined benefit plan that defines the
benefit as a stated account balance. In a typical cash balance plan,
each worker is credited on a periodic basis with a pay credit, a
percentage of one's earnings, and an interest credit, which sets the
rate of return for the account balance for that year. The interest rate
can be either a fixed rate or a variable rate. Although cash balance
benefits are reported as individual account balances, these accounts
are only hypothetical. Workers' benefit amounts are unrelated to the
employer's actual cash contributions to the plan and unrelated to the
actual investment performance of plan assets. The benefit is based on
the accumulated amount credited to each employee's account.
As with all defined benefit plans, employers must offer employees
the option of taking the benefit as an annuity as the default form of
benefit.
Money Purchase Plan
The money purchase plan is an employer-sponsored defined
contribution plan that allows employers to contribute a set percentage
of compensation for workers into the plan with a maximum annual
contribution of $42,000 in 2005. This is the maximum for all defined
contribution plans and, thus, is not a unique design element of the
money purchase plan. Once an employer establishes a contribution level,
the amount in subsequent contributions must be maintained until the
employer makes a formal, prospective pronouncement that the
contribution will be decreased or discontinued. Thus, contributions are
made whether or not the business has a profit, which differentiates the
money purchase plan from a profit-sharing plan, where contributions are
made to employees' accounts at the discretion of employers, usually
when there are profits. Unlike other defined contribution plans, money
purchase plans must provide joint and survivor annuities for married
participants and single life annuities for unmarried participants.
appendix a
db-k proposals considered by the group
Three DB-K proposals were considered by the group, one from the
American Society of Pension Actuaries (ASPA), one from the American
Academy of Actuaries (AAA) and one from The Principal Financial Group.
The proposals share common design features. Each provided both a
defined benefit formula and the opportunity for workers to make tax-
deductible contributions from their wages and salaries to a defined
contribution plan. Each plan provided a minimum defined benefit to all
participants. All of the plans are designed to avoid nondiscrimination
testing if they promise minimum benefits, and the plans have simplified
rules for funding the defined benefit portion of the plan.
DB-K Proposal No. 1. Under this proposed plan \54\ from the
American Society of Pension Actuaries, there would be a single trust
established for both the 401(k) and either a traditional defined
benefit plan or a cash balance plan. However, the trust would have
strict recordkeeping requirements whereby the assets of each of the
defined benefit and 401(k) components of the plan would be accounted
for separately. Accordingly, for example, any excess assets associated
with the defined benefit portion of the plan could not be used for
purposes of employer contribution requirements to the 401(k) portion of
the plan.
An advocate of this proposal suggested that many employers would
likely choose a cash balance design over a traditional defined benefit
plan for the defined benefit portion of the plan. The cash balance plan
is a hybrid plan in which the employer credits contributions to a
hypothetical account for each employee and guarantees a rate of return
on money deemed to be allocated to those hypothetical accounts. (See
description of plan types on page TK for information on cash balance
plans.) The accumulated balance is converted to an annuity for payment
at retirement age, but is typically made available as a lump sum
payment.
In order for employers to take full advantage of the concept, the
ASPA proposal would require under the defined benefit portion of the
plan a minimum benefit formula for eligible employees of 1 percent of
final average compensation times up to 20 years of service. The
proposal would offer employers a cash balance design option instead of
a traditional defined benefit design. For the cash balance design
alternative, the proposal contemplates that employers would credit an
annual contribution for eligible employees to their hypothetical cash
balance accounts equal to 5 percent of compensation. However, the
proposal also permits employers to increase contribution levels for
older workers on a graduated basis so that the plan more closely
mirrors the increased benefit values for older workers provided under a
traditional defined benefit plan.\55\ The plan also offered employers
the choice of making a minimum contribution of 5 percent of pay to both
the defined benefit and defined contribution side of the plan. The ASPA
DB-K would also allow for additional accruals to the defined benefit
arm of the plan based on what portion of income is contributed from
compensation to the 401(k) side of the plan. In other words, employers
could match employee contributions to the 401(k) plan by enriching the
defined benefit side of the plan. There was considerable interest among
members of the group in the plan, although there was some concern it
might be an expensive plan, especially the graduated cash balance
benefit.
DB-K Proposal No. 2. The Principal DB-K plan was similar to the
ASPA DB-K plan. However, it offered only a traditional defined benefit
plan and not a cash balance option. The traditional defined benefit
portion of the plan was designed to provide a worker who put in 20
years of service an income equal to 25 percent of career average pay.
It also offered an option where the benefit could also accrue at a
higher rate over 10 years.
DB-K Proposal No. 3. The DB-Plus Plan from the American Academy of
Actuaries would allow employees to make pre-tax contributions to the
defined benefit side of the plan. It would also allow for employer
matches to employee contributions to the defined benefit side of the
plan. Supporters of the DB-K Plus plan would seek legislative or
regulatory clarification on current rules that would allow for
employers who sponsor the plan to offer a higher rate of return for
funds in the defined benefit side than is currently available under
Internal Revenue Service rules to solve the so-called ``whipsaw''
problem.\56\ The plan would also allow for tax credits for
contributions on behalf of low-income employees to be deposited into
the plan.\57\ The plan encourages employers to set up an automatic
default election that would put new employees into the plan with
automatic contributions of 1 percent to 6 percent of pay (with
increases when salaries increased) unless the employee affirmatively
requests otherwise. The DB-K Plus also allows for distributions
beginning at age 59\1/2\ even without termination of employment.
Allowing distributions at age 59\1/2\ would allow members to have a
phased retirement beginning at that age. The PBGC would insure all of
the benefits of the DB-K Plus, as long as it was funded appropriately.
Some members were concerned that because both the defined benefit plan
and the 401(k) are in a single trust, it could mean that the PBGC would
be deemed to have guaranteed the 401(k) side of the combination. Others
raised concerns that the proposal would allow excess assets associated
with the defined benefit component of the plan to be used to offset the
cost of employer contributions under the 401(k) component of the plan.
appendix b
proposals considered and not endorsed
Risk-Splitting Defined Benefit Plans. After its May 2003 meeting,
the group formed a subgroup on risk-splitting. Several suggestions to
share the risk of market performance between the employer and the
employees were advanced for consideration. A proposal was considered
for guaranteeing only 75 percent of the final benefit liability. Under
this approach, the employee would share some of the risk associated
with the funding obligation for 25 percent of the benefit, while the
employer still retained responsibility for 75 percent.\58\ The group
generally did not support any of the risk-splitting proposals. Those
objecting stated such an approach would put additional burdens on the
Pension Benefit Guaranty Corporation (PBGC), which insures defined
benefit plans. The PBGC would face the difficult task of determining
how much of the benefit should be paid if a plan is terminated and
taken over by the agency. One member said that Congress would not be
receptive to the idea of transferring risk to employees.
Some members suggested that risk-splitting raises a question about
whether employees should also share in some of the gains if a plan
over-performs, and also whether employees should have a role in
selecting investments. One member suggested it would be difficult to
determine how much of a plan's underfunding was due to poor market
performance and how much was due to the employer failing to make
regular, adequate annual contributions. There was also concern about
the complexity of the risk-splitting proposals before the group.
Finally, some suggested that risk-splitting could already be
accomplished by an employer sponsoring both a defined benefit plan and
a defined contribution plan. While some members of the group believed
that the concept of risk-splitting had some merit, no one suggested it
should be listed as a group recommendation.
SAFE Proposal. SAFE stands for The Secure Assets for Employees
Plan, which was introduced as legislation in 1997 by Rep. Nancy Johnson
(R-CT) and Rep. Earl Pomeroy (D-ND).\59\ This plan was designed to
provide a minimum defined benefit that would be 100 percent funded.\60\
It would be funded either by an individual retirement annuity or
through a trust. SAFE sought to reduce the regulatory burden on
employers, to reduce uncertainty about potential unfunded liabilities
and to give employers more flexibility in managing the plan than is
possible with traditional defined benefit plans.\61\ Members of the
group discussed the proposal but declined to endorse it.\62\ Members
suggested that the group should come up with new proposals and not
revisit previous proposals. Some members, noting the group's greater
interest in other proposals, cautioned against possibly supporting too
many proposals. Some group members also expressed concern that SAFE
permitted designs under which business owners could capture too much of
the plan's aggregate benefits.
SMART Proposal. SMART stands for a Secure Money Annuity or
Retirement Trust Plan, which was introduced by the Clinton
Administration in February 1998 as a hybrid plan designed for business
with fewer than 100 employees. Like the SAFE proposal, the SMART would
offer a minimum guaranteed benefit at retirement \63\ with the
potential for additional investment return if the assets perform above
the base 5 percent benchmark.\64\ It would also be funded by an annuity
or a trust. Members of the group discussed the proposal but declined to
endorse it.\65\ As with the SAFE, members were in favor of new
proposals rather than revisiting previous proposals.
Improved Cash Balance Plans. The group discussed ways to make cash
balance plans more attractive. Cash balance plans have been criticized
for discriminating against older workers at some companies that
switched from a traditional defined benefit plan to a cash balance
plan. While some members strongly opposed cash balance conversions,
there was some interest in cash balance plans that are started de novo
by a company that previously did not have a defined benefit plan.
Proposals to make cash balance plans more attractive included reduced
insurance premiums for fully-funded cash balance plans and other
ideas.\66\ Despite interest in this challenge, the effort to improve
cash balance plans was eventually set aside, largely because some court
decisions and regulatory issues had clouded the outlook for such plans
and strong political opposition had emerged to the plans.
A List of Incentives to Improve Coverage at Defined Benefit Plans.
The group decided to create a list of tax incentives that would
encourage desired behavior with respect to defined benefit plans,
including such ideas as supporting tax credits for employers who expand
pension coverage to part-time workers. The ideas the group supported
are discussed earlier in this report.
Other Ideas Listed in the Binders. The group also briefly reviewed
other proposals from a list included in the binder and chose not to
consider further any of those plans for endorsement. One proposal
considered was by Ted Groom and John Shoven to eliminate most of the
Federal rules governing pension plans, including nondiscrimination
rules, as well as pension insurance and the Pension Benefit Guaranty
Corporation. It was suggested by Groom and Shoven that more employers
would offer plans if there were fewer rules governing them. The group
also briefly discussed, but did not support, a proposal identified as
the Individual Advantage Plan from Jim Davis of Milliman & Robertson
that would allow workers the choice of the greater of a cash balance or
a traditional formula.\67\
Other Ideas Proposed by Members. The working group also considered
ideas proposed by its members during its discussions. One member
proposed eliminating the lump sum option for defined benefit plans.
Increasingly, workers have chosen to take lump sums instead of an
annuity, which provides a stream of monthly payments that continue as
long as the annuitant lives. This idea was seen by some as being beyond
the scope of the group's mission to expand coverage. The suggestion was
also criticized because it can be costly for small businesses to
purchase individual annuities, which might lead some small businesses
to switch from a defined benefit plan to defined contribution plans.
One member suggested that lump sums could be deposited into a central
clearinghouse and, thus, avoid the high costs of purchasing individual
annuities. There was some support for this approach, with one member
suggesting that the PBGC could be the clearinghouse. The group,
however, did not further refine the proposal.
appendix c
contribution calculations for the guaranteed account plan
Case Study Showing Funding Method Over a 7-Year Period
Synopsis of Funding Calculation
(1) Calculate total of hypothetical contributions for the plan
year.
(2) Calculate the value of the assets as of the valuation date,
before any current contribution is added.
(3) Calculate the sum of the Guaranteed Account Balances (GABs) as
of the valuation date (excluding (1)).
(4) Subtract (3) from (2). If this is a positive number, there has
been an earnings gain. If this is a negative number, there has been an
earnings shortfall.
(5) If (4) is a net loss, calculate the amount that the earnings
shortfall would be worth in 5 years (including the current year) under
the plan's guaranteed rate of return (assume current year guarantee if
the rate can fluctuate).
(6) Calculate the amount that would be required to be contributed
as of the valuation date to amortize the amount in (5) over the 5-year
period.
(7) Calculate the aggregate GABs as of the valuation date,
including the amount in (1).
(8) Subtract the amount in (2) from the amount in (7). This is the
unfunded portion of the GABs. If (2) is larger than (7), the GABs are
fully funded, and this amount is zero.
(9) Minimum funding: The lesser of: (a) the amount in (1) plus the
amount in (6), or (b) the amount in (8).
(10) Maximum funding calculation (maximum deduction):
(a) Calculate 1.5 times the amount in (7).
(b) Subtract the amount in (2) from the amount in (10)(a). If this
is a positive number, this is the most the employer can contribute on a
deductible basis. If this is zero or a negative number, the maximum
deduction is zero (i.e., the full funding limit).
(11) Limitations on funding assumptions: pre-retirement discounts
for turnover and mortality not permitted, no salary scale assumptions.
(12) Plan is a money purchase plan for IRC 412 purposes, but is
subject to the special minimum funding requirements stated above.
Therefore, there would be no quarterly contribution requirement under
IRC 412(m).
(13) When calculating the aggregate Guaranteed Account Balances, a
participant's account must be limited to the maximum lump sum permitted
under IRC 415(b) if the account were to be distributed as of the
valuation date.
Case Study
A GAP is established which promises a 6 percent hypothetical
contribution, and a 5 percent guaranteed rate of return. Contribution
is allocable as of the last day of the plan year.
Year 1: Total participant compensation is $1,000,000.
Normal cost = $60,000.
(This is the total compensation times the hypothetical contribution
rate. There were no prior year contributions, so no guaranteed return
for the first year.)
GABs as of valuation date: $60,000.
No earnings shortfall because the plan does not have any experience
on the first valuation date.
Minimum funding: $60,000.
Maximum funding: $90,000.
Employer's actual contribution: $60,000.
Year 2: Total participant compensation is $1,100,000.
Normal cost = $66,000. This is determined by calculating the
hypothetical contribution for this year (6% x $1,100,000).
Actual earnings since last valuation date: $2,392 (about 4%).
Total value of assets as of the valuation date (before current year
contribution is made): $62,392.
The guaranteed return for this valuation period on the GABs from
the prior valuation date: $3,000.
GABs as of valuation date (excluding current year's contribution):
$63,000 (i.e., the GABs as of the prior valuation date plus the
guaranteed return on those GABs).
Shortfall: $608 (i.e., assets minus pre-contribution GABs). This
would be worth $776 in 5 years under the plan's guaranteed rate of 5%.
Amortization payment for shortfall: $140 (round to nearest $1),
based on a 5-year amortization period.
Normal cost plus amortization payment: $66,140.
Sum of GABs as of valuation date (including current year's
contribution): $129,000 Shortfall on 100% funding: $66,608 (i.e.,
$129,000 minus $62,392).
Minimum funding amount: $66,140 (i.e., the lesser of the normal
cost plus amortization payment or the 100% funding shortfall).
150% x GABs: $193,500.
Maximum funding is: $131,108 (i.e., 150% x GABs minus assets as of
valuation date).
Employer's actual contribution: $66,500.
Year 3: Total participant compensation is $1,340,000.
Normal cost = $80,400. This is determined by calculating the
hypothetical contribution for this year (6% x $1,340,000).
Actual earnings since last valuation date: $1,154 (only a 1% rate
of return).
Total value of assets as of the valuation date (before current year
contribution is made): $130,045.
The guaranteed return for this valuation period on the GABs from
the prior valuation date: $6,450.
GABs as of valuation date (excluding current year's contribution):
$135,450 (i.e., the GABs as of the prior valuation date plus the
guaranteed return on those GABs).
Shortfall: $5,405 (i.e., assets minus pre-contribution GABs). This
would be worth $6,897 in 5 years under the plan's guaranteed rate of
5%.
Amortization payment for shortfall: $1,248 (round to nearest $1),
based on a 5-year amortization period.
Normal cost plus amortization payment: $81,648.
Sum of GABs as of valuation date (including current year's
contribution): $215,850 Shortfall on 100% funding: $85,805 (i.e.,
$215,850 minus $130,045).
Minimum funding amount: $81,648 (i.e., the lesser of the normal
cost plus amortization payment or the 100% funding shortfall).
150% x GABs: $323,775.
Maximum funding is: $193,730 (i.e., 150% x GABs minus assets as of
valuation date).
Employer's actual contribution: $82,000.
Year 5: Total participant compensation is $1,400,000.
Normal cost = $84,000. This is determined by calculating the
hypothetical contribution for this year (6% x $1,400,000).
Actual earnings since last valuation date: $17,224 (6% rate).
Total value of assets as of the valuation date (before current year
contribution is made): $324,362.
The guaranteed return for this valuation period on the GABs from
the prior valuation date: $15,832.
GABs as of valuation date (excluding current year's contribution):
$332,475 (i.e., the GABs as of the prior valuation date plus the
guaranteed return on those GABs).
Shortfall: $8,113 (i.e., assets minus pre-contribution GABs). This
would be worth $10,355 in 5 years under the plan's guaranteed rate of
5%.
Amortization payment for shortfall: $1,874 (round to nearest $1),
based on a 5-year amortization period.
Normal cost plus amortization payment: $85,874.
Sum of GABs as of valuation date (including current year's
contribution): $416,475 Shortfall on 100% funding: $92,113 (i.e.,
$416,475 minus $324,362).
Minimum funding amount: $85,874 (i.e., the lesser of the normal
cost plus amortization payment or the 100% funding shortfall).
150% x GABs: $624,712.
Maximum funding is: $300,350 (i.e., 150% x GABs minus assets as of
valuation date) Employer's actual contribution: $100,000.
Year 6: Total participant compensation is $1,600,000.
Normal cost = $96,000. This is determined by calculating the
hypothetical contribution for this year (6% x $1,400,000).
Actual earnings since last valuation date: $36,368 (9% rate).
Total value of assets as of the valuation date (before current year
contribution is made): $460,729.
The guaranteed return for this valuation period on the GABs from
the prior valuation date: $20,824.
GABs as of valuation date (excluding current year's contribution):
$437,298 (i.e., the GABs as of the prior valuation date plus the
guaranteed return on those GABs).
Shortfall: $0 (the plan is now running at an experience gain).
Amortization payment for shortfall: $0 (round to nearest $1), based
on a 5-year amortization period.
Normal cost plus amortization payment: $96,000.
Sum of GABs as of valuation date (including current year's
contribution): $533,298 Shortfall on 100% funding: $72,569 (i.e.,
$533,298 minus $460,729).
Minimum funding amount: $72,569 (i.e., the lesser of the normal
cost plus amortization payment or the 100% funding shortfall); the plan
will have to be brought to full funding this year.
150% x GABs: $799,948.
Maximum funding is: $339,219 (i.e., 150% x GABs minus assets as of
valuation date).
Employer's actual contribution: $200,000 (Things are going well,
the employer puts in extra for a rainy day and to get a bigger
deduction).
Year 7: Total participant compensation is $2,000,000.
Normal cost = $120,000. This is determined by calculating the
hypothetical contribution for this year (6% x $2,000,000).
Actual earnings since last valuation date: $31,009 (5% rate).
Total value of assets as of the valuation date (before current year
contribution is made): $691,738.
The guaranteed return for this valuation period on the GABs from
the prior valuation date: $26,665.
GABs as of valuation date (excluding current year's contribution):
$559,963 (i.e., the GABs as of the prior valuation date plus the
guaranteed return on those GABs).
Shortfall: $0 (the plan is still running at an experience gain).
Amortization payment for shortfall: $0 (round to nearest $1), based
on a 5-year amortization period.
Normal cost plus amortization payment: $120,000.
Sum of GABs as of valuation date (including current year's
contribution): $679,963 Shortfall on 100% funding: $0 (i.e., assets
exceed the GABs).
Minimum funding amount: $0 (i.e., the lesser of the normal cost
plus amortization payment or the 100% funding shortfall).
150% x GABs: $1,019,945.
Maximum funding is: $328,207 (i.e., 150% x GABs minus assets as of
valuation date).
Employer's actual contribution: $0.
appendix d
Contribution Calculations for the Plain Old Pension Plan
----------------------------------------------------------------------------------------------------------------
$30,000/ $60,000/ $100,000/ $200,000/
Compensation Age year year year year
----------------------------------------------------------------------------------------------------------------
30.......................................................... $585 $1,170 $1,950 $3,900
40.......................................................... $960 $1,920 $3,200 $6,400
50.......................................................... $1,584 $3,168 $5,280 $10,560
55.......................................................... $2,043 $4,086 $6,810 $13,620
60.......................................................... $2,666 $5,333 $8,888 $17,776
65.......................................................... $3,537 $7,074 $11,790 $23,580
----------------------------------------------------------------------------------------------------------------
Mortality Assumption: 1994 Group Annuity Mortality table projected to
2002*
Interest Rate Assumption: 5%
Plan Formula: A lifetime pension = 1 percent times current compensation
at age 65, payable monthly.
*This is the mortality table required by IRS to calculate minimum lump
sums from pension plans.
Endnotes
\1\ Traditionally defined benefit plans were designed to provide
workers with a replacement income that, when combined with Social
Security, would be sufficient enough to maintain their standard of
living. However, some defined benefit plans are not designed to provide
a replacement rate sufficient to maintain a worker's standard of
living. Instead, they may be designed to provide supplementary income
with a predictable income stream to add a worker's retirement income.
For this reason, employees with a defined benefit plan will still need
assess how much they need in retirement and how determine much they may
need to save to provide a sufficient replacement income beyond the
income that will be available from Social Security and a stream of
income from a defined benefit plan.
\2\ The normal benefit is an annuity, but many defined benefit plans
offer a lump sum or other payout options. If a retiree does not elect
an annuity, then the retiree is faced with the task of managing the
lump sum over one's retirement years. Increasingly, retirees from
defined benefit plans can also select a lump sum option. In 2000, 45
percent of full-time private sector employees worked at firms with
defined benefit plans offered a lump sum option, according to the
Bureau of Labor Statistics. To the extent that retirees select a lump
sum option, they must then also devise a plan for managing those assets
during retirement.
\3\ Private sector pensions insured by the Pension Benefit Guaranty
Corporation are guaranteed up the statutory limits, now roughly about
$44,000 if the benefit starts at age 65.
\4\ From Department of Labor data for 2000 and 2001, as reported in
Constantijn W. A. Panis, ``Annuities and Retirement Satisfaction,''
Pension Research Council Working Paper PRC WP 2003-19, The Wharton
School, University of Pennsylvania, mimeo, 2003, p. 8.
\5\ U.S. Bureau of Labor Statistics, Employee Benefits in State and
Local Governments, 1998, Bulletin 2531 (Washington, D.C.: U.S.
Department of Labor, December 2000, Table 1, p.5.
\6\ Panis, p. 8.
\7\ Patrick J. Purcell, ``Pensions and Retirement Savings Plans:
Sponsorship and Participation,'' (Washington, D.C. Congressional
Research Service, October 22, 2003), p. 5.
\8\ Ibid.
\9\ Pension Benefit Guaranty Corporation, Pension Insurance Data Book,
April 2004, Table S-33, p. 57.
\10\ Ibid.
\11\ Ibid, Table S-31, p. 55 and Table M-6 on p. 84.
\12\ U.S. Department of Labor, Pension and Welfare Benefits
Administration (now the Employee Benefits Security Administration),
Abstract of 1998 Form 5500 Annual Reports, Private Pension Plan
Bulletin, Number 11 (Winter 2001-2002).
\13\ U.S. Bureau of Labor Statistics, Employee Benefits in Medium and
Large Private Establishments, 1997, Bulletin 2517 (Washington, D.C.:
U.S. Department of Labor, September 1999), Table 133, p. 107.
\14\ U.S. Department of Labor, Bureau of Labor Statistics, National
Compensation Survey: Employee Benefits in Private Industry in the
United States, 2000, Bulletin 2555, January 2003, p. 66, Table 78.
\15\ The 30-year treasury rate is used for calculation of the deficit
reduction contribution and certain other purposes. In recent years
Congress has provided temporary relief from the 30-year Treasury rate
as the standard for calculating the benefit obligation. For plan years
2004 and 2005, employers can use a corporate bond rate.
\16\ For employers, the group generally agreed that the following
criteria should be considered: reduced regulation, low administrative
costs, low contribution costs, high benefits for owners and officers,
attractiveness to prospective employees, designs that are helpful in
retaining current employees, designs with tax benefits to the company
and owner, designs with contribution flexibility for the owners. For
employees, the group generally agreed the following criteria should be
considered: low costs and high returns, protection against investment
risk, control over assets, portability of assets, protection against
longevity risk, protection against inflation, tax benefits,
psychological benefits of owning assets, simplicity and fairness for
employees, and the adequacy of benefits provided under the proposal.
From a public policy standpoint: effectiveness of the revenue dollars
spent, and the degree to which savings are preserved for retirement
rather than withdrawn earlier for other purposes. Proposals were also
judged on how well they could be sold to Congress, employers and
employees. They were also judged on how marketable they might be by
financial institutions and benefits consultants.
\17\ Nondiscrimination testing is required under Internal Revenue
Service rules to ensure that highly compensated employees do not derive
a much greater benefit from a qualified plan than non-highly
compensated employees. There are two broad tests. One is Actual
Deferred Percentage (ADP) Test which measures the rate at which
employees elect to make contributions. The other is the Actual
Contribution Percentage (ACP) Test that measures the rate of employer
matching and after-tax contributions.
\18\ On the contribution issue, the group explored the possibility that
a combined 3 percent employer contribution for all employees to the
defined benefit and defined contribution side of the plan would be
sufficient to avoid nondiscrimination testing and top heavy rules.
\19\ There was also support for providing a joint and survivor annuity
on the 401(k) side, and for distributions as early as 59\1/2\ years old
on the defined benefit side to make it easier for workers to engage in
phased retirement.
\20\ The chief Federal pension law is the Employee Retirement Income
Security Act of 1974, often referred to as ERISA.
\21\ As explained by the staff of the Joint Economic Committee in 2003
(See reference at the end), the full funding limit is generally defined
as the excess, if any, of (1) the lesser of (a) the accrued liability
under the plan (including normal cost) or (b) 170 percent (for 2003) of
the plan's current liability (including the current liability normal
cost), over (2) the lesser of (a) the market value of plan assets or
(b) the actuarial value of plan assets (i.e., the average fair market
value over a period of years). However, the full funding limit may not
be less than the excess, if any, of 90 percent of the plan's current
liability (including the current liability normal cost) over the
actuarial value of plan assets. In general, current liability is all
liabilities to plan participants and beneficiaries accrued to date,
whereas the accrued liability under the full funding limit may be based
on projected true benefits including future salary increases. The full
funding limit based on 170 percent of current liability is repealed for
plan years beginning in 2004 and thereafter, but is slated to be
reinstated in plan years beginning in 2010. Thus, in 2004 and
thereafter, until 2010, the full funding limit is the excess, if any,
of (1) the accrued liability under the plan (including normal cost),
over (2) the value of the plan's assets, but in no case less than the
excess, if any, of 90 percent of the plan's current liability over the
actuarial value of plan assets, as described above. Reference:
``Present Law and Background Relating to the Funding Rules For
Employer-Sponsored Defined Benefit Plans and the Financial Position of
the Pension Benefit Guaranty Corporation (PBGC),'' Scheduled for a
Public Hearing Before the Subcommittee on Select Revenue Measures of
the House Committee on Ways and Means on April 30, 2003, prepared by
the Staff of the Joint Committee on Taxation, April 29, 2003.
\22\ Traditional pension plans have to make up unfunded balances,
according to descriptions prepared by the staff of the Joint Committee
on Taxation in April 29, 2003 (See reference at the end), there are two
categories of old unfunded liabilities (those that occurred prior to
the plan year just ended). The employer has to calculate a current
contribution required to amortize the unfunded liability for each of
these two categories. The first amount is, in general, the amount
necessary to amortize the unfunded old liability under the plan in
equal annual installments until fully amortized over a fixed period of
18 plan years, beginning with the first plan year that starts after
December 31, 1987. The second amount is, in general, the amount needed
to amortize the additional old unfunded liability over a period of 12
years, beginning with the first plan year that starts after December
31, 1994. In addition, plans have to make a contribution for any new
unfunded liability that occurs in the year just ended. If the plan is
less than 60 percent funded, the employer must contribute 30 percent of
the new unfunded liability into the plan. The applicable percentage
decreases by .40 of 1 percentage point for each percentage point by
which the plan's current liability percentage exceeds 60 percent.
Reference: ``Present Law and Background Relating to the Funding Rules
For Employer-Sponsored Defined Benefit Plans and the Financial Position
of the Pension Benefit Guaranty Corporation (PBGC),'' Scheduled for a
Public Hearing Before the Subcommittee on Select Revenue Measures of
the House Committee on Ways and Means on April 30, 2003, prepared by
the Staff of the Joint Committee on Taxation, April 29, 2003.
\23\ Making the past service credit available to all employees would be
deemed to satisfy the nondiscrimination requirements.
\24\ However, if the plan is a profit-sharing, 401(k) or stock purchase
plan, current law states the plan is not required to offer an annuity
provided the spouse receives 100 percent of the account balance if the
employee dies while covered by the plan. The law also states that if
the plan does not offer an annuity and the employee does not die while
covered by the plan, the employee can withdraw the account balance as a
lump sum or other non-annuity payment without spousal consent when the
employee leaves the plan.
\25\ Elective contributions are contributions voluntarily made by
employees into a retirement savings plan or pension plan.
\26\ Under one safe harbor, the nondiscrimination test would be
satisfied if the employer contributed 100 percent of an employee's
contribution up to 3 percent of compensation and 50 percent an
employee's contribution up to an additional 2 percent of compensation.
\27\ The calculation for lump sums in all defined benefit plans occurs
through a two-step process. This process presents special issues,
however, when the plan in question is not a traditional defined benefit
plan but is, instead, a plan whose benefit is an account balance.
Several courts have held that the above-described procedure must be
used to determine lump sum values for cash balance plans. The manner in
which this is done is to credit interest through an employee's
retirement age, convert the resulting retirement-age balance to an
annuity, and then determine the present value of that annuity.
Generally speaking, if the plan's crediting rate is higher than the
statutory benchmark interest rate, the lump sum amount will be higher
than the participant's balance in his account. Thus, a cash balance
plan is not permitted to pay the account balance in these
circumstances. This phenomenon has been called whip-saw.
\28\ PBGC guarantees ``basic benefits'' earned before your plan ended,
which include (1) pension benefits at normal retirement age, (2) most
early retirement benefits, (3) disability benefits for disabilities
that occurred before the plan was terminated, and (4) certain benefits
for survivors of plan participants. PBGC does not guarantee health
care, vacation pay, or severance pay.
\29\ PBGC's maximum benefit guarantee is set each year under provisions
of ERISA. For pension plans ending in 2004, the maximum guaranteed
amount is $3,698.86 per month ($44,386.32 per year) for workers who
retire at age 65. This guarantee amount is lower if you begin receiving
payments from PBGC before age 65 or if your pension includes benefits
for a survivor or other beneficiary. The guarantee amount may be higher
if you retire after age 65 or if you are over age 65 and receiving
benefits when the plan terminates.
\30\ Underfunded single-employer plans pay an additional variable-rate
premium of $9 for every $1,000 (or fraction thereof) of unfunded vested
benefits. The proposed GAP would have the variable rate premium would
be phased in for the first 5 years as follows: 20 percent for year 1,
40 percent for year 2, 60 percent for year 3, 80 percent for year 4 and
100 percent for year 5.
\31\ The limits for contributions and benefits are within section 415
of the Internal Revenue Code. For defined contribution plans, the
current annual contribution limit is currently $41,000 a year for 2004.
For defined benefit plans, employers can contribute each year toward
providing a maximum benefit at retirement of $165,000. However,
employers face maximum tax deduction limits, too, that can limit the
amount that can be contributed in any given year into defined benefit
plans.
\32\ The Tax Code sets the rules for converting the maximum allowable
annuity into a lump sum for purposes of applying the maximum benefit
limit applicable to defined benefit plans. Under that limit, defined
benefit plans can pay no more than $165,000 a year as an annual
retirement benefit. At the time the Working Group was meeting, the Tax
Code required that plans use the 30-year Treasury rate for converting
the annuity benefit into a lump sum for this purpose. Treasury has
discontinued issuing 30-year bonds and the 30-year rate has declined
considerably in recent years. This has meant that lump sums based on
the 30-year interest rate assumption have been sharply higher than in
the past.
\33\ In fact, Congress in April 2004 passed a law to temporarily
replace the 30-year Treasury rate with a 5.5 percent interest rate for
2 years (2004 and 2005) for purposes of calculating the maximum defined
benefit limit.
\34\ Nondiscrimination testing is required under the Tax Code to ensure
that highly compensated employees do not derive a much greater benefit
from a qualified plan than non-highly compensated employees. There are
two broad tests. One is the Actual Deferred Percentage (ADP) Test which
measures the rate at which employees elect to make contributions. The
other is the Actual Contribution Percentage (ACP) Test that measures
the rate of employer matching and after-tax contributions.
\35\ Plans are top heavy when key employees amass benefits greater than
60 percent of the entire pool of benefits. A key employee is any
employee who during the plan year was: (1) an officer of the employer
who received more than $130,000 (adjusted for cost of living) in
compensation from the employer, (2) a 5 percent owner of the employer,
or (3) a 1 percent owner who received more than $150,000.
\36\ The name ``cross-testing'' refers to the rationale for these
rules. The rationale is as follows: the present value of annual
accruals in traditional defined benefit plans is larger for an older
employee than a younger employee. For example, if a 25-year old
employee and a 60-year old employee are each promised an annuity
benefit of $1 at age 65, the employer must make a larger contribution
for the older employee than for the younger employee because there will
be less time for the contribution to earn interest. Treasury
regulations permit a defined contribution plan to test an allocation to
an employee's account as if it were a defined benefit with a present
value equal to the contribution. Thus, the contribution is ``cross-
tested'' as if it were a benefit under a defined benefit plan.
\37\ The maximum contribution, however, is limited to $41,000 annually,
under section 415 of the Internal Revenue Code.
\38\ Current treasury regulations permit some plans to use new
comparability testing methods only if they provide a 5 percent
``gateway'' contribution for all plan participants.
\39\ Nondiscrimination testing is required under Internal Revenue
Service rules to ensure that highly compensated employees do not derive
a much greater benefit from a qualified plan than non-highly
compensated employees. There are two broad tests. One is Actual
Deferred Percentage (ADP) Test which measures the rate at which
employees elect to make contributions. The other is the Actual
Contribution Percentage (ACP) Test that measures the rate of employer
matching and after-tax contributions.
\40\ In some cases, it required some older workers to work several
years before the balance in their cash balance account rose from the
initial balance in the account at the time of the transition. This
period in which no new benefits were added has been described as a
period of wear away.
\41\ The Working Group also discussed whether or not an employer should
be required to wait 2 years after terminating a traditional defined
benefit plan before being allowed to start a GAP. The members disagreed
on this suggestion, with some noting that employers might instead
terminate a defined benefit plan and adopt a defined contribution plan.
\42\ The chief Federal pension law is the Employee Retirement Income
Security Act of 1974, often referred to as ERISA.
\43\ The past service credit would be calculated by adding \1/7\ of the
past service career average compensation to the employee's current
compensation. For example, if an employee has always earned $20,000 per
year and is entitled to 14 years of past service, the employee will be
treated as earning $60,000 for the first X years of the plan for
purposes of calculating the contribution. In this example, the employer
could decide that only 50 percent past service credit is given, so the
employee would only be deemed to earn $40,000 for those years. An
employee who leaves before the full 7-year amortization period will
only received the accrued past service credit that has vested on
termination date. The reason for this is that, if pension benefits are
viewed as deferred wages, the benefits earned after he plan is in
effect are part of the bargained for package, but past service credit
would be a windfall. Seven years of service for full accrual would
encourage employees to give past service credit as a retention device.
\44\ For example, an employer can tell an employee that his or her
benefit at 65 was increased by 3 percent, which translates into an
additional accrual on this year's salary equal to, for example, 1
percent.
\45\ If a POPP were terminated and fully funded, the employer would
have the option of keeping the plan and paying out benefits when due or
transferring the benefit obligations and assets to the PBGC. If the
employer transfers the benefit obligation and assets to the PBGC,
annuitization would no longer be required, as PBGC would pay the
benefit guaranteed under its authority, and lump sums would no longer
be allowed.
\46\ PBGC guarantees ``basic benefits'' earned before your plan ended,
which include (1) pension benefits at normal retirement age, (2) most
early retirement benefits, (3) disability benefits for disabilities
that occurred before the plan was terminated, and (4) certain benefits
for survivors of plan participants. PBGC does not guarantee health
care, vacation pay, or severance pay.
\47\ PBGC's maximum benefit guarantee is set each year under provisions
of ERISA. For pension plans ending in 2004, the maximum guaranteed
amount is $3,698.86 per month ($44,386.32 per year) for workers who
retire at age 65. This guarantee amount is lower if you begin receiving
payments from PBGC before age 65 or if your pension includes benefits
for a survivor or other beneficiary. The guarantee amount may be higher
if you retire after age 65 or if you are over age 65 and receiving
benefits when the plan ends.
\48\ Underfunded single-employer plans pay an additional variable-rate
premium of $9 for every $1,000 (or fraction thereof) of unfunded vested
benefits. The proposed POPP would have the variable rate would be
phased in for the first 5 years as follows: 20 percent for year 1, 40
percent for year 2, 60 percent for year 3, 80 percent for year 4 and
100 percent for year 5.
\49\ The plan could use cross-testing, permitted disparity and any
other formulas permitted under Section 401(a)(4).
\50\ A plan is top heavy when key employees amass benefits greater than
60 percent of the entire pool of benefits. A key employee is any
employee who during the plan year was: (1) an officer of the employer
who received more than $130,000 (adjusted for cost of living) in
compensation from the employer, (2) a 5 percent owner of the employer,
or (3) a 1 percent owner who received more than $150,000.
\51\ Highly compensated employees are those who earn at least $90,000 a
year.
\52\ Under the Tax Code plans that meet the minimum contribution
requirements of a safe harbor plan to avoid nondiscrimination testing
must still also fall within the bounds of permitted disparity.
\53\ The accrual rate is the percentage of final salary or final
average salary which builds up for each year of service or membership
of a defined benefit plan. For example, the plan may specify a
retirement benefit of 1.5 percent of final average salary for each year
of service. The annual accrual rate, therefore, is 1.5 percent (of
final average salary). Can also be referred to as benefit scale.
\54\ If the DB-K has a cash balance plan instead of a traditional
defined benefit plan, the plan would require a 2 percent minimum
contribution for workers under age 30, 4 percent for workers ages 30 to
40, 6 percent for workers ages 40 to 50, and 8 percent for those over
age 50. Or, the plan could have a safe harbor if there is a combined 5
percent of pay contributed to both the defined benefit and defined
contribution side of the plan.
\55\ This alternative would provide a safe harbor from
nondiscrimination testing for plans where the employer contributed 2
percent for employees under age 30, 4 percent for employees age 31 to
39, 6 percent for employees 40 to 49, and 8 percent for employees 50
and over.
\56\ It has been suggested that IRS Notice 96-8 makes it difficult to
provide a rate of return higher than the Treasury rate for employee
contributions in a defined benefit plan. Since employees can get a
higher return in their 401(k) plans, they would have little incentive
to voluntarily contribute to a DB-K plan if the return were going to be
less. This could be done if policymakers clarified that Section
411(a)(7)(A)(i) of the Internal Revenue Code would apply to DB-K plans
and, thus, allow the defined benefit plan to provide a market rate of
return.
\57\ In the Economic Growth Tax Relief and Reconciliation Act of 2001
(EGTRRA), Section 25B provides for a tax credit to match contributions
from low-income employees into a defined contribution plan. The DB-K
Plus proposal would make these credits available for a tax credit match
for employee contributions to the defined benefit side of the DB-K Plus
plan.
\58\ The group also considered an approach that would guarantee only
those benefits that had been in place for at least 10 years. The group
also considered an approach that would set higher premiums for
insurance from the Pension Benefit Guaranty Corporation (PBGC) for
plans that have higher allocations to equities. Typically equities,
over time, earn more than bonds; however, earnings can be very
volatile. Reducing the equity exposure would reduce volatility in the
pension funding obligation, a key employer concern that was identified
by the group as impeding the implementation of defined benefit plans.
\59\ The Secure Assets for Employees Plan Act was numbered H.R. 1656
and introduced in the House of Representatives on May 16, 1997.
\60\ In the case of a SAFE Trust, the employer would be liable for
additional contributions in years when returns in participant account
did not earn 5 percent. SAFE plans would not be insured by the Pension
Benefit Guaranty Corporation.
\61\ Employers would fund the plan with contributions of 1, 2 or 3
percent of pay for each year they worked. In lean years the corporation
could scale back the contribution to 1 or 2 percent. Individuals could
also reap higher benefits than the minimum 5 percent return on funds in
their accounts of the investments performed better than 5 percent.
\62\ One objection to the SAFE plan was that its past service provision
made it too rich for an IRA.
\63\ Employees would be credited with either 1 percent or 2 percent of
their salary for each year they worked, with 3 percent possible for the
first 5 years of the plan.
\64\ In the case of a SMART Trust, the employer would be liable for
additional contributions in years when returns in participant accounts
did not earn 5 percent. The employer who chose the SMART Trust would
pay reduced premiums to the Pension Benefit Guaranty Corporation, which
would guaranty the minimum benefit for the Trust. SMART Annuity plans
would not pay a premium and the benefit would not be guaranteed by
PBGC.
\65\ One objection to the SMART plan was that it did not relax
nondiscrimination rules, but simply provided a safe harbor.
\66\ The group was asked to consider ways to solve the age-
discrimination issues and the problems associated with whipsaw, which
is a situation where an employee can get a benefit after leaving an
employer that is higher than the employee's account balance.
\67\ The Individual Advantage Plan was developed as a way to deal with
cash balance conversions, but was also touted as a way for new plans to
deal with older workers. One member said that he doubted anyone would
start up a new plan that gave such a choice.
______
Report on the Conversations and Recommendations of Working Group II
working group's assignment
answer this question
How do we increase coverage and retirement savings by providing new
incentives to encourage employees to save for themselves, and
incentives for employers to contribute increased amounts for employees
in low tax brackets?
february 22, 2005
Co-Chairs: Regina Jefferson and Randy Johnson
Working Group Members: Dean Baker, Michael Calabrese, Kenneth Cohen,
Mark Iwry, Michael Kelso, John Kimpel, Lisa Mensah, Diane Oakley, Eric
Rodriguez, Eugene Steuerle, and David Wray
Executive Summary
The proportion of workers who participate in workplace retirement
plans has remained at or near 50 percent for many years, despite a
number of efforts by Congress and successive Administrations to adopt
policies intended to expand coverage. One of the goals of Working Group
II was to look for ways to expand participation to include
substantially more of the uncovered half of the workforce and to
increase the level of saving by those who participate. The group was
especially focused on low and moderate income workers--those who are
most likely to lack coverage by a workplace retirement plan.
The group set out to expand coverage and saving by offering to
support proposals that are intended to do the following:
Prompt more employers to offer access to retirement
savings plans.
Expand the number of workers who are eligible to
participate in an existing employer-sponsored retirement plan.
Increase the overall level of saving by workers in
workplace retirement savings plans, especially among those who save the
least--low and moderate income workers.
The group began as a collection of members with a great deal of
expertise on the key issues before them, but with very diverse and
strongly-held views. Over the course of more than half a dozen meetings
of the entire group and additional subgroup meetings, the members
hammered out a consensus in areas where members held common ground,
often outstripping the member expectations about the degree to which
agreement could be reached.
The Retirement Investment Account Plan
The group's chief accomplishment was to reach general agreement on
the broad outlines of a new centralized broadly-based savings account
vehicle, the Retirement Investment Account Plan or MA. This plan is
targeted at workers at companies that do not currently have a
retirement plan, as well as workers at firms where there is a
retirement plan, but where some workers are not eligible to
participate.
Members of the group supported the MA because it was believed that
this approach offers great promise in providing access to retirement
saving for a substantial portion of uncovered workers. One of the
reasons the proposed plan will be helpful is because it largely removes
the administrative burden of sponsoring a plan, a key concern of
employers who do not now sponsor a plan. By giving employees access to
a workplace retirement system, it is likely to also dramatically
increase the chances that workers will contribute toward retirement
savings.
As this report will show, much work was put into the details of a
potential MA plan and much progress was made on many building blocks of
the system. Even where there was not a general agreement on the
details, there was often agreement on the framework in which the
details could be resolved.
The group generally agreed on the following broad outlines of the
RIA plan:
Accounts Will Be Managed By a Central Clearinghouse. The
RIA plan will be offered through a government-authorized central
clearinghouse that would be run by the private sector.
Contributions Can Be Made Through Payroll Deductions. The
system would be set up to receive contributions from employees through
payroll deductions by the employer of amounts indicated by employees.
The system would also be able to receive contributions by employers.
How the Infrastructure Will Work. The employer will send
the employee and employer contributions to the U.S. Treasury, and
Treasury, in turn, will forward contributions to the central
clearinghouse.
Participant Contributions Made in a Default Investment.
Contributions to the RIA plan will be placed in a default investment
pool that will be a balanced, diversified fund which could also be a
lifestyle or life cycle fund.
Participants Can Select From Simplified Investment
Choices. Participants who wish to choose investments beyond the default
choice will have a simplified choice of investment options chosen by
the clearinghouse.
Policies to Expand Coverage in All Retirement Savings Plans
The members of the group also supported a number of initiatives
they felt would increase the level of participation and the level of
retirement saving by and for workers at companies where there is
already a workplace retirement plan. These include:
Automatic Enrollment. The group generally supported
continuing the policy whereby employers voluntarily offer automatic
enrollment to new hires as a way to prompt workers to contribute
regularly to their accounts in the plan.
Automatic Rollovers. The group generally supported
designating the Thrift Savings Plan--an employer-sponsored saving plan
for Federal Government employees--as a central national receptacle for
rollovers for accounts with balances from $1,000 to $5,000 for
employees who leave a firm. This policy would make it easier for many
employers to roll over such sums and would likely preserve retirement
savings for more workers.
Default Investment Mix. The group generally agreed to
support a change in Federal pension law to provide a safe harbor to
allow employers to voluntarily offer employees a default investment
option that would automatically place their contributions in a balance,
diversified fund that could be a lifestyle or life cycle fund.
Saver's Credit. The members generally agreed to support an
extension and expansion of the Saver's Credit, which provides 10 to 50
percent government matches for individual contributions of low and
moderate income workers. The program is slated to sunset in 2007.
Financial Education. The group generally supported a
proposal to encourage high schools and colleges to provide basic
financial education, including education on retirement saving and
health care finances.
The Mission
The mission of Working Group II was to review and discuss proposals
to increase the portion of the work force that participates in a
workplace retirement saving plan, as well as to increase the level of
overall retirement savings in plans. The group also was asked to review
and discuss incentives for employers to contribute increased amounts
for employees in lower tax brackets.
Principles and Standards
Members of the Working Group generally agreed on a list of
principles and standards by which it would evaluate proposals. The
principles include:
The effort would be collaborative while inviting diverse
thinking. It would focus on workers with incomes below the median,
especially low-income workers, and it would consider the unintended
consequences of proposals.
Proposals should be efficient to administer and simple to
communicate to workers and have a nationally consistent set of rules.
Proposals should be judged on whether they are
economically efficient and feasible, both in the short-term and the
long-term, as well as whether or not they involve minimal interference
in economic, investment and labor markets.
Proposals should be judged by whether or not they offer
flexible terms and rules for both employees and employers.
Proposals should be politically viable, both in the short-
term and the long-term.
Proposals should be judged on whether or not they enhance
retirement income security for all U.S. citizens.
Proposals, when considered in total, should be equitable
in their benefits and contributions. They should be equitable
``horizontally'' (meaning that it affects people the same whether or
not they have access to an employer-sponsored plan), as well as when
viewed ``vertically'' (meaning across all income levels).
Background
The goal of providing a retirement plan for all workers is an
ambitious one. In 2003, for example, only about 57 percent of American
workers had access to a retirement plan sponsored by their employer,
according to the Bureau of Labor Statistics. A majority of these
workers--about 51 percent--have access to a defined contribution
retirement savings plan, such as the 401(k) plan.\1\
Employees participating in a defined contribution plan often save
by determining what portion of their wages is to be taken from their
regular pay and contributed to their plan. Employers often match those
contributions. Workers who participate in defined contribution plans
usually have the responsibility of determining how much they expect
they will need to save for retirement and how much they would like to
contribute out of each pay period. Workers also often are given choices
to make between several investment options within a plan. When they
retire, workers with defined contribution plans received lump sum
distributions and, therefore, have to decide how to manage the
accumulated savings to provide income across their retirement years.
Some of the areas where improvements can be made in coverage can be
found in some of the details of the employer surveys of coverage in
different segments of the workplace population. Medium and large
businesses (100 employees or more) had a participation rate of 65
percent, while small businesses (99 or fewer workers) had a
participation rate of 35 percent.\2\ Further, the participation rate
for all full-time workers of all private sector businesses was 58
percent, significantly higher than the 18 percent for all part-time
workers.\3\
Expanding participation in workplace plans is important for other
reasons. It appears to be the best way to increase retirement saving.
If one looks at Federal income tax return data, the proportion of
filers who claim an IRA or Keogh deduction has been both fairly modest
and steadily declining over time. From a peak of 16.2 percent in 1986,
it fell to 3.5 percent in 2000 and 2001.\4\ In contrast, the
participation rate in workplace plans is 66.2 percent of those eligible
for 401(k) plans (a population of workers that represents 32.6 percent
of the private sector workforce).\5\
Increasingly, important decisions that will affect retirement
income fall on the shoulders of individual workers. If more workers are
to be able to save for retirement, more of them need to have access to
and participate in a workplace retirement savings plan. Potential
opportunities to increase the proportion of the workforce with access
to a retirement saving and potential opportunities to increase
participation by those already covered can be created in several ways,
include the following:
Employers who have plans can make it easier for more
workers to participate in those plans.
Employers who do not have retirement plans, which are
predominantly in the small business sector, can sponsor plans. (Working
Group III has focused its efforts on developing a proposal for the
small business sector).
Incentives, such as tax credits for employees and/or
employers, as well as government contributions into accounts, can
increase the level of overall saving in existing retirement plans.
Beyond this, the government can create new saving vehicles
that will be more attractive to smaller employers and self-employed and
contract workers.
Employers who do not have retirement plans can facilitate
access for its employees to new kinds of centralized savings vehicles
that might be created.
Government can also devise programs and incentives that
target lower-income workers.
Finally, efforts can be made to provide opportunities for
financial education in high school and college so that more workers
better understand the need to save for retirement and health care
expenses and to be better prepared to plan for their future needs.
How the Working Group Went About Its Assignment
To meet the challenges set out above, Working Group II decided
initially to focus on ways to increase overall saving in existing
plans, and ways to expand access to employer-sponsored retirement
saving plans to more workers. The group also looked at tax-based
incentives, including tax credits and tax deductions.
The group looked at the existing Saver Credit program to see how it
might be expanded and made permanent. It also looked at a range of
incentives and ideas for improving coverage and saving--including
automatic enrollment, default investment choices, and financial
education--and reached agreement on a number of them. This is discussed
in Section II of this report.
Working Group II also examined ideas for setting up a new type of
savings account program that would be patterned after the 401(k) plan,
but would be more widely available to workers and even non-workers. The
group devoted considerable time to developing a general agreement on
the broad outline for a new individual account system named the
Retirement Investment Account or RIA. The group examined how government
credits and contributions might play a role in promoting retirement
saving by low and moderate income workers, especially those who
presently are not enrolled in an employer-sponsored plan.
Members were invited to express their opinions about the incentives
and proposals to increase saving and coverage, as well as the broad
outline of the RIA. The group sought to reach consensus on as many
points as they could. At times the group was unanimous or nearly-
unanimous in supporting or rejecting a given point. In this instance,
the group was said to have ``generally agreed'' or ``generally
disagreed'' on that point. At other times, the group found substantial
agreement, while there was minor opposition. At other times, the
opposition might be strong. When the group disagreed on a point or
provision, members were invited to offer different options that might
address that particular issue. Members of the group were assured that
strong opposition would be noted in the report.
section i: the retirement investment account plan
Working Group II's primary accomplishment was its success in
reaching general agreement on many of the broad outlines of a proposed
new retirement vehicle, which the group named the Retirement Investment
Account or RIA.
The Retirement Investment Account Plan at a Glance
The group generally agreed that the Retirement Investment Account
would be offered through a new privately-run, centralized
infrastructure overseen by the Federal Government. The areas of general
agreement are described below.
The RIA and the new infrastructure are designed to make it possible
to have a savings account vehicle potentially available to all workers,
whether full-time, part-time, self-employed or contingent workers.
Importantly, the RIA could potentially provide coverage to workers who
are not now covered by a retirement savings plan. The potential for a
broadly-based centralized system to boost retirement savings has long
been a hope for those who would like to see the United States create a
means whereby all working Americans could participate in a payroll-
withholding retirement scheme.
In the interest of a harmonious outcome, the majority of the group
supported making the program voluntary, although a number of members
strongly favored making it mandatory. There was support also for
providing a means for workers to contribute directly to the central
clearinghouse without going through payroll deduction. This could
include making contributions when filing annual income tax returns.
Central Clearinghouse. A government-authorized central
clearinghouse will handle contributions from employees into accounts in
the RIA plan. The members generally agreed that the government will
contract some or all of the services provided by the central
clearinghouse to the private sector.
Employer Facilitates Contributions. Employers will
voluntarily help facilitate contributions from employees to the RIA
plan, but do not have to become involved as plan sponsors; i.e.,
sponsors of the RIA retirement plan. Thus, they do not have to assume
the responsibilities, fiduciary liabilities, and other burdens of being
a plan sponsor for the RIA plan.
Employee Contributions. Employees will indicate the level
or amount of contributions they would like to have deducted from their
wages on a regular basis on a revised W-4 form.\6\ The employer will
transfer to the U.S. Treasury the amount an employee has elected to
contribute to the RIA plan when the employer submits regular tax
payments. Treasury, in turn, will forward contributions as soon as
possible to the clearinghouse.
Employer Contributions. Employers can also make
contributions and matches of employee contributions to the RIA. The
employer contributions, too, are sent along to the U.S. Treasury and
forwarded as soon as possible to the clearinghouse.
Default Investment Mix. Contributions to the RIA system
automatically will be placed into a default investment in a balanced,
diversified fund which could also be a lifestyle or life cycle fund.
Investment Choices. For participants who wish to make a
choice other than the default investment mix, there will be a
simplified offering of investment options chosen by the clearinghouse.
Government Credits and Matches. The RIA plan is set up in
a way that would make it possible to offer government contributions and
matches of employee contributions, as well as government tax credits.
The group, however, while supporting government matches and tax credits
in a general way, did not agree on a specific program.
Offered in Conjunction With Other Plans. Employers at
firms that already sponsor 401(k) and other retirement saving plans can
also offer the workers access to the RIA plans. The target group,
however, consists of workers who are not covered by or are ineligible
to participate in an employer-sponsored plan.
Contribution Limits. The group set limits on participant
and employer contributions and matches at levels that are designed to
prevent the RIA plan from undermining the success and appeal of the
401(k) plan, the SIMPLE,\7\ and other defined contribution plans.
Members of the group looked at initiatives that members felt would
be beneficial without consideration for their budgetary impact and
acknowledge that whatever program that might be proposed would be
dependent on the Federal budget available at the time.
The Design Elements of the RIA Plan
The group devoted many hours to discussing the details of how the
RIA plan would work and how it would fit into the array of existing
retirement plans without detracting from any of them. The group was
able to reach some agreement on some of the design elements, but was
divided on other elements, sometimes strongly divided. Each of the
broad design elements of the RIA plan are presented below, along with
the outcome from the group's discussions.
The Infrastructure for the RIA Plan
The group discussed what type of infrastructure would work best to
make the RIA plan accessible to employees, while reducing the potential
burden on employers. The group also examined what would be needed in
the infrastructure to implement potential government matches and tax
credits for individuals.
Areas of General Agreement
The RIA Will Be Run Through a Central Clearinghouse. The group
generally agreed contributions from employees and employers to the RIA
plan will flow into a government-authorized central clearinghouse. This
infrastructure would allow employees to have a portable plan, to the
extent that a future employer also participates in the RIA plan, and to
the extent other flexible methods were found for employees to
contribute directly.
The Central Clearinghouse Will Be Privately Run. The group
generally agreed that the government-authorized central clearinghouse
would be run by the private sector. This approach was taken so that the
RIA plan would not be seen by critics as creating a big government
bureaucracy.
Employees Will Indicate Contributions on W-4 Forms. The group
generally agreed that employees would indicate what amount of their
regular pay and compensation would be earmarked as a contribution to
the RIA plan.
Employer Will Remit Contributions to U.S. Treasury. The group
generally agreed that employers will remit the employee-designated
contributions to the U.S. Treasury. The group generally agreed that the
employer also will send employer contributions to U.S. Treasury and
will not remit directly to the clearinghouse.
The U.S. Treasury Will Transfer Contributions to the Central
Clearinghouse. The group generally agreed that the U.S. Treasury will
forward contributions remitted by the employer to the central
clearinghouse. The group deferred any decisions on how this should be
done or how quickly it should occur, but generally favored an approach
that transferred the funds in a timely manner.
The Clearinghouse Will Credit Contributions Received from the U.S.
Treasury. The group generally agreed that the clearinghouse will credit
employee and employer contributions in designated individual accounts
as funds are sent to it by the U.S. Treasury.
Areas Where Views Differed
Government Oversight Agency. The group discussed which agency would
oversee the clearinghouse, but members decided that the proposal for
the RIA plan should not get into that level of detail.
Who Is Eligible to Participate?
The group discussed whether or not to include several groups of
workers: those under the age of 21, part-time workers, contingent
workers, contract workers, the self-employed, household workers, and
non-working spouses. Currently, workers from these groups are often
excluded from required coverage for most retirement savings plans
sponsored by employers. Excluding them helps employers meet
nondiscrimination requirements. Self-employed workers do have access to
existing tax-preferred retirement savings plans, such as the SIMPLE
IRA.\8\
Areas of General Agreement
All Wage Earners Eligible to Contribute. The group generally agreed
that the RIA plan should be open to all Americans who earn an income.
There were some, however, who did not agree. Some members preferred to
limit access to the RIA plan to workers earning at least $5,000 a year.
Some opposed to opening the RIA plan to all workers said they were
concerned that it might set up a system that would collapse from having
to administer millions of tiny accounts.
Self-Employed Can Participate in RIA plan. The group generally
agreed that the participation of the self-employed would not be
affected by whether or not employers are required to make the system
accessible to employees through payroll deductions. The reason is that
the self-employed could include their contribution into the RIA plan
when they send the IRS their quarterly income taxes. One member
suggested that participation of self-employed be limited to those who
earn at least $1,250 a quarter, which would maintain the $5,000 a year
limit on participation.
Areas Where Views Differed
Direct Contributions By Employees. The group discussed how
individuals might contribute to the RIA plan if they are not able to
contribute through payroll deductions arranged by their employer. The
group failed to reach agreement on how this might be done. However,
there were several suggestions that were offered.
One member of the group suggested that an alternative method of
contributing be set up that would allow workers to make contributions
to the clearinghouse when they file their income taxes every year.
Another member suggested that workers be allowed to designate a portion
or all of their refund as a contribution into the RIA plan.
Non-Working Spouses. The group could not reach general agreement on
whether or not non-working spouses should be allowed to contribute to a
RIA plan, as is now allowed with IRA's.
Some in the group maintained that non-working spouses already have
access to IRAs and that allowing them to participate in the RIA plan
would make the system unnecessarily complicated. One member suggested,
and others agreed, that the proposal remain silent about spouses but
provide that it will be open to all citizens with earned income, which
arguably would include what is allowed for contributions to IRA's by
default. When spouses contribute to IRA's they are deemed to be self-
employed with no reported income. Others in the group contended that
explicitly offering the RIA to unemployed spouses would assist them in
preparing for retirement.
investment options
The group discussed whether or not participants could be
automatically enrolled in the plan, whether there might be a default
investment choice, and whether there might be additional investment
options in the plan.
Areas of General Agreement
Automatic Enrollment. The group generally agreed that employers
would be allowed to provide automatic enrollment. With this approach, a
new employee would have to choose not to enroll. Otherwise he or she
would be enrolled in the RIA plan.
Automatic Investment in Default Balanced Fund. The group generally
agreed that if employees do not elect to choose an investment
option(s), their contributions to the RIA plan would automatically go
to a balanced,\9\ diversified fund, which could be a lifestyle-oriented
fund.\10\ A balanced fund is a common name for an investment fund which
invests significant portions of its assets in each of the major
investment asset classes: shares or equities, real property, fixed
interest investments and cash. Lifestyle funds are one type of balanced
fund that allocates funds between different classes of investments
based on the participant's age and risk tolerance, and sometimes
automatically adjusts the allocation as a person ages, becoming more
conservative over time.
The group's recommendation regarding the default choice reflects a
growing trend in the 401(k) system in favor of a default choice of a
balance fund or lifestyle fund. When a default option is offered, a
member said, about 75 percent of workers usually accept the default
investment.
Clearinghouse Will Select Simplified Investment Options. The group
generally agreed participants could elect to make a choice among one or
more of a simplified offering of fund options. The group also generally
agreed to let the choice of investment options to be determined by the
clearinghouse.
One member suggested that the range of choices should be limited to
the types of choices offered in the Thrift Savings Plan.\11\ Another
member suggested even fewer options: a balanced fund, an equity fund,
and a short-term interest fund. One member suggested that some people
may want a safer investment, such as Treasury bills or bonds. One
member supported keeping contributions in the default investment in a
balanced fund until the balance had reached a minimum level, which was
not specified.
Employee and Employer Contribution Limits
All defined contribution plans, including the 401(k), have
contribution limits that affect how much employees and employers can
contribute. Such limits are put in place partly to reduce the drain on
government revenues and partly to assure that owners and high wage
earners do not take too great a portion of the overall tax benefits
provided to retirement savings plans.
Over the years Congress has developed a range of simpler defined
contribution plans with different sets of contribution limits than the
popular 401(k). As new types of plans have been introduced, lawmakers
have consciously tried to design them so that they do not work to
undermine the success of existing plan designs.
Areas of General Agreement
Why the RIA Has Contribution Limits. The group agreed that the RIA
plan should have contribution limits for employee and employer
contributions. The contribution limits would accomplish two things:
Limits could help assure that higher paid employees and
business owners do not disproportionally benefit from the MA plan.
The limits could be kept low enough to prevent the
proposed RIA plan from prompting employers to terminate their existing
defined contribution plan, such as a 401(k). Such plans often feature
employer matching contributions to encourage workers to contribute.
This, in turn, increases the overall level of saving and encourages
more workers to save.
Contribution Limits Should Be Lower Than Those For the 401(k) Plan.
The group generally agreed that the contribution limits should be set
lower than those for the 401(k).
One member explained his support for lower limits as follows: If
new savings vehicles are set with limits that are too high, it would be
a disincentive for small business owners to offer an employer-sponsored
plan. Employers would instead offer workers access to the RIA plan. One
member said that his business would drop its 401(k) plans ``in a
heartbeat'' if the RIA plan were created with the same contribution
limits as a 401(k). The reason is that the employer would no longer
have to sponsor a retirement plan, educate workers about saving and
offer matching contributions to get more of the lower paid workers to
contribute so that the plan could pass nondiscrimination tests.
Participant contributions to 401(k) plans are called elective
deferrals in the Tax Code. For 2005, the limit was raised from $13,000
to $14,000. Similarly, the limit on the salary deferrals \12\ was
raised from $13,000 to $14,000 for 457 plans of State and local
governments and tax-exempt. For SIMPLE plans \13\, either SIMPLE IRAs
or SIMPLE 401(k)s, the limit was increased from $9,000 to $10,000. IRA
contribution limits for 2005, by comparison, rose from $3,000 to
$4,000.
Participant Contribution Limits Set at $5,000 to $6,500. The group
generally agreed that participant contribution limits should be limited
to somewhere between $5,000 and $6,500. This contribution limit level
would position the RIA plan in a niche below the 401(k) plan ($14,000
limit) and the SIMPLE ($10,000 limits), but above the IRA ($4,000
limit).
Employer Contribution Limit Set at $4,000. The group generally
agreed that voluntary employer contributions could be allowed to the
RIA plan and that such contributions should be limited to $4,000 a
year. The RIA contribution limit would position the plan in a niche
below the 401(k)'s $14,000 limit and also below the SIMPLE's $10,000
limit.
Employers Can Choose a Nondiscrimination Safe Harbor for
Contributions. The group generally agreed to support a
nondiscrimination safe harbor from having to conduct nondiscrimination
tests. The safe harbor can be achieved in one of two ways:
The employer contributes 2 percent of pay into the RIA
accounts of all workers.
The employer contributes a match of $1 for each $1
contributed by an employee into a RIA account for the first 2 percent
of pay, followed by an employer match of 50 cents for each $1
contributed by an employee for the next 2 percent of pay.
Withdrawals and Distributions from Accounts in the RIA Plan
The group discussed when rules should apply for pre-retirement
withdrawals for either loans or hardship, when changing jobs, when
withdrawals can begin without penalty, and what rules would govern
those withdrawals.
Areas of General Agreement
Plan Allows Hardship Withdrawals, Does Not Allow Pre-Retirement
Loans. The group generally agreed that the RIA plan would not allow
loans on balances in the plan, but would allow for hardship withdrawals
under tight rules. By contrast, in 401(k) plans, participants can take
out loans against their balances and can have hardship withdrawals.
Loans were opposed because they would add to the administrative
burden of the plan for the central clearinghouse. Further, some argued
that it may be difficult to get the loan prepaid because the RIA plan
is not an employer-sponsored plan where the employer can arrange for
payroll deductions to repay the loan. Finally, it was argued that loans
would add difficult complications to implementing potential government
tax credits. One member, however, strongly opposed a prohibition
against loans, stating that the RIA plan should not be inferior to a
401(k) plan. This member further contended that loans could be repaid
through payroll deductions.
Those supporting allowing hardship withdrawals under rules at least
as stringent as those for 401(k) plans noted that it was important for
low and moderate income savers to know that they could have access to
their savings if they had an emergency. Otherwise, some would not
contribute to the RIA plan or might contribute less if no pre-
retirement hardship withdrawals were allowed.
No Need to Withdraw Funds When Employees Change Jobs. The group
generally agreed there was no need for employees to withdraw funds due
to a plan termination by the employer or because an employee changes
job, since the RIA plan is associated with a central clearinghouse.
Even if an employee's new employer does not participate in the RIA
plan, the funds in the account can continue to enjoy gains from its
investments. Also, contributions could potentially be continued
directly to the government when participants file their annual income
tax return.
No Early Withdrawals of Government Contributions. The group
generally agreed that government contributions or matches to accounts
in the RIA plan could not be withdrawn at all before participants are
eligible to withdraw employee and employer contributions without
penalty. This prohibition was supported because it would assure that
government contributions would go toward supporting participants in
retirement and not for pre-retirement living expenses.
Withdrawal Rules Made Consistent for Government, Employer, and
Employee. The group, while disagreeing on what retirement age should
be, did agree to make the age uniform for all sources of
contributions--individual, employer and government--to avoid
administrative complications if one source of funds faced special age
restrictions.
Roll Over Accounts Will Maintain Restrictions on Government
Contributions. The group generally agreed that the prohibition against
early withdrawal of government contributions would apply to funds from
an account in the RIA plan that are rolled over to another retirement
saving plan.
Areas Where Views Differed
Age When Withdrawals Can Be Made Without Penalty. The group was
unable to agree on what age a participant could begin to withdraw funds
from an account in the MA plan without a penalty for early withdrawal.
While the group was agreed that the age should be the same for all
contributions--individual, employer and government--the group was
divided into two groups about when the retirement age should be set for
withdrawals. Some members preferred setting the age at 59\1/2\, which
is the age when participants can begin to withdraw from a 401(k) plan
without penalty. Other members, however, preferred setting the
retirement age the same as those for Social Security, where retirees
can begin to collect a reduced benefit at age 62, and those born in
1940 can collect the full retirement age benefit at 65 and 6 months in
2005 (although the age will increase gradually for later birth cohorts
until it reaches 67 in 2027 for those born in 1960).
Those who favored withdrawals without penalties at age 59\1/2\ said
that the RIA plan should not be designed to be inferior to the 401(k)
plan. The members preferring a later retirement age argued that it
would preserve the government contribution until retirement age. Group
members favoring a higher uniform age argued that a higher age for
withdrawals without penalty could still allow for early withdrawals
without a penalty due to disability, using the disability rules as
defined by the Social Security Administration.
Rollover Rules. The group left unresolved whether or not age
restrictions set for the RIA plan might apply to funds that were rolled
over from a RIA plan to another retirement savings plan. While the
group did support the idea the government funds could not be withdrawn
until retirement age as defined in the MA plan, it was not decided
whether or not the age at which funds can be withdrawn without penalty,
if different, would be transferred to the rollover account in another
retirement plan.
Government Matches and Tax Credits
The group discussed three governmental approaches to supporting
employee contributions to the MA plan:
1. Direct government contributions to the RIA account (which might
be characterized as a refundable tax credit, but one that is
automatically deposited in the account);
2. A cash (spendable) refundable tax credit and
3. A nonrefundable tax credit.
A cash refundable tax credit (No. 2 above) gives the recipient the
full value of the credit even if the credit exceeds his or her income
tax liability. As a result, once the credit has eliminated any income
tax liability the recipient might otherwise have had, any additional
credit amount is paid to the individual in a check from the Treasury
that can be used for any purpose.
A nonrefundable tax credit (No. 3 above) gives the recipient only
the value of the tax credit up to the recipient's tax liability. For
example, a nonrefundable tax credit--such as the Saver's Credit under
current law--would not provide any saving incentive or benefit to a
worker who pays payroll taxes but has no income tax liability. (The
group ranked this last among the three approaches.)
By way of clarification, one member described both the refundable
and nonrefundable tax credits (Nos. 2 and 3 above) as ``spendable'' tax
credits to differentiate them from an automatic direct deposit of the
credit by the government into an RIA account. A ``spendable'' credit is
not automatically added to the individual's savings. Instead, to the
extent that it wipes out the individual's income tax liability, it
frees up other funds that would otherwise have been used to pay that
tax. Such funds can then be used for any purpose; and to the extent
that the credit is refundable and results in a check from the Treasury
to the individual, the individual is, of course, free to use that for
any purpose as well.
The group also discussed whether or not the government could
provide start-up subsidies for the system, as well as tax credits for
employers who made contributions to accounts above and beyond what
would be required under nondiscrimination rules.
Areas of General Agreement
Government Can Offer Matching Contributions to Accounts in RIA
Plan. The group generally agreed that government could match
contributions made by employers to the RIA plan.
Start-Up Subsidy for the System. The group generally supported
providing a start-up subsidy to get the infrastructure of the RIA plan
up and running and able to sustain itself.
Areas Where Views Differed
Government Can Offer Spendable Tax Credits. There was strong
support, but not general agreement that the government could support
the RIA plan by offering ``spendable'' tax credits--that is either a
cash refundable credit or a cash non-refundable credit--as opposed to
limiting government credits to direct contributions into individual
accounts in the RIA plan. Supporters noted that allowing spendable tax
credits gets money into the hands of savers to spend as they wish. One
member strongly supported a view that spendable tax credits paid to
individuals are more likely to increase overall saving for retirement.
However, some members objected to this approach because they felt that
if government matches went directly into RIA accounts instead of into
the hands of employees, it would better serve the goal of promoting
retirement savings.
Government Credits and Matches Deposited Only in RIA Accounts.
There was considerable support, but not general agreement, for
depositing into the RIA plan account all government contributions and
matches of employee contributions for either the RIA or 401(k). Some of
those who supported this approach said it would avoid administrative
complications for the 401(k) system, such as trying to track down a
former employee a year later when a government contribution arrived.
Government matches, likely to be based on income levels, could not be
made until an individual has filed an annual income tax return. Some
members strongly opposed having government funds go only to the RIA
plan, claiming it would undermine the 401(k) system. Another member
favored having government matches be deposited in either the 401(k) or
the RIA.
Government Can Offer Matches and Tax Credits. Some members of the
group supported a policy of both government contributions into
individual RIAs, as well as government spendable tax credits. The group
as a whole, however, did not generally agree to support this approach.
Members supporting an approach that would combine both a match and a
tax credit also recommended making it more attractive to choose the
government match to be deposited into a RIA rather than receive a
spendable credit. For example, a participant could choose between two
options: (1) the government could deposit $500 into an account for a
participant who contributed $1,000 to a RIA; or, (2) an employee who
contributed $1,000 to a RIA could receive a $250 spendable tax credit.
Can Employers Count Government Contributions for 401(k)
Nondiscrimination Testing? The group did not support a suggestion to
allow employers to take into account government contributions to RIAs
for their employees when they conduct nondiscrimination tests for their
401(k) Plans. One member who objected to this approach said it would
lead to fewer employer contributions to 401(k) plans and recommended
instead a tax credit for employers who make contributions to low-income
workers that are above the level required under nondiscrimination
rules.
Government Seed Money and Super Matches. Most of the members agreed
that tax incentives, such as small contributions for some or all RIA
accounts in the system, would be helpful. However, supporters of tax
incentives could not decide on which incentives to support. Some
members favored direct contributions to RIAs for workers making less
than $40,000. Other members favored a super match for initial
contributions that would benefit lower income workers, such as offering
a supermatch for the first $5,000 of lifetime savings. Members of the
group recognized that these types of programs could be relatively
costly, and acknowledged that whatever program that might be proposed
would be dependent on the budget available at the time.
Tax Credits for Employers. There was some support for a suggestion
to provide tax credits for employers who made contributions or matches
that are above and beyond levels employers are required to contribute
to meet nondiscrimination rules and tests. However, the group deferred
discussion on this point and was unable to address the subject again
due to time constraints. Similarly, the group failed to reach agreement
on supporting a tax credit for employers who contributed a higher
percentage of pay to low paid workers than is contributed on behalf of
all workers.
Should Employers Be Required to Provide Access to the RIA Plan?
The working group discussed whether or not to recommend that
employers be required to transfer contributions from employees who
wanted to participate in the RIA plan. Members of the group were asked
whether or not they supported making the MA plan mandatory in any or
all of the following instances: (1) for workers at companies that do
not offer employer-sponsored retirement plans, (2) for workers at
companies that do sponsor plans who are not eligible to participate in
those plans, and (3) for workers at companies that sponsor plans and
who are eligible to participate in the plans.
After discussion, the majority supported making access voluntary on
the part of the employer to garner business support for the RIA plan.
However, there were two members who felt strongly that the MA plan
should be mandatory in all three instances above, while two other
members supported making it mandatory only for workers who do not now
have access to a retirement plan. The majority, however, supported
making access to the MA voluntary on the part of the employer. Some
members suggested that ways should be found to allow workers to
contribute directly to the RIA, such as directing tax refunds to be
deposited in a MA plan account.
Those who supported a voluntary MA plan gave a range of reasons for
their views. One member said he was against government mandates because
they tend to discourage job formation and generally lead employers to
reclassify workers into contract employees. In addition, the member
said, mandates place a burden on small businesses. Another member
argued that the burden of handling contributions would be far more
onerous than some opponents realized. He noted that in his view it was
employers, not the government, that do a great deal of the work
involved with administering the Social Security system. Likewise,
employers are the ones who will make the MA plan work.
Those who supported making access to the MA plan required for
employers felt strongly about the importance of this proposed
provision. One member said that the need to provide retirement savings
opportunities to half the workforce without a plan is so great that it
would justify making access to it mandatory for employers. If it were
required, the member suggested that the next step would be to launch a
massive educational program to convince more workers to participate.
Another member supporting mandatory access said the burden on business
would be trivial. One member said that if the program was not required,
it might be better to devote available resources to expanding the
Saver's Credit to get more workers participating in a retirement
savings plan.
Next Steps: A Pilot RIA
Some members of the group supported a program to introduce the MA
plan on a pilot basis to demonstrate how it can help increase saving
and how it can work along side existing employer-sponsored plans. The
experience from a pilot, it was suggested, might demonstrate that the
RIA plan does not impose an unworkable burden on employers. If this
were to be demonstrated, it could lead to support for requiring all
employers to offer access to the MA plan, one member contended. Some
members questioned whether it was feasible to do a pilot RIA, claiming
it would be difficult to execute a pilot without new legislation and
regulatory rules in place. One member was strongly opposed to a pilot,
claiming that a pilot plan would be expensive to do, negating the low-
cost advantage of the RIA.
section ii: proposals to increase saving in retirement plans
The Working Group discussed a number of tax incentives, regulatory
changes and other approaches designed to increase the number of workers
covered in an already existing defined contribution plan, as well as to
increase the amount of money saved and invested through the plan. They
also looked at ways to increase coverage among low and moderate income
workers who currently are either not in a plan or who save little
through the plan in which they are enrolled.
Automatic Enrollment
When workers are hired, some employers automatically enroll them in
the 401(k) or other defined contribution plan unless the worker
specifically requests on government forms that he or she would not wish
to participate in the plan. The group discussed whether or not this
should be mandated. The group discussed whether special incentives
should be provided to encourage more companies to adopt automatic
enrollment.
The group discussed whether or not employers who have an automatic
enrollment program could automatically place employee and employer
contributions in a balanced fund, including a lifestyle fund. The group
discussed whether special incentives, such as changes in fiduciary
rules, should be provided to encourage more companies to place workers
in a default investment mix. Many employers who have automatic
enrollment presently allocate by default the funds in the account to a
money market or other low-risk, fixed income fund. However, some
employers also already allocate available funds by default to balanced
funds. Others may be reluctant to allocate by default to balanced funds
because of concerns about fiduciary liability for the choices of
participants in the plan in a situation when the participant did not
chose the investment, except by default.
Areas of General Agreement
Automatic Enrollment of Workers. The group generally agreed that
more employers should be encouraged to voluntarily offer automatic
enrollment but that it should not be mandated by law. Under this
approach, an employee would have to choose not to enroll; otherwise, he
or she would be enrolled in the company's retirement saving plan. It
was suggested that during the implementation phase of the Conversation
on Coverage that a study be conducted of incentives to encourage
automatic enrollment.
Safe Harbor for Default Investment Into A Balanced Fund. The group
generally agreed that employers should be given a safe harbor from
fiduciary liability \14\ when they direct the funds of an employee who
has not made a choice among investment options into a balanced,
diversified fund, including a lifestyle fund. Some members noted that
it might be difficult to get Congress and/or regulators to support a
safe harbor for such an approach, since such safe harbors are based on
the assumption that the participant chooses the investment.
Automatic Rollovers
The group discussed whether or not employers should automatically
place rollover funds of $1,000 to $5,000 from workers who have left the
company in an investment other than a money market fund or low-return
investment. When workers leave a company, employers are allowed to pay
out employee balances up to $5,000. Balances between $1,000 and $5,000,
if paid from the plans, are automatically rolled over into an
Individual Retirement Account or IRA unless the employee designates to
the contrary.\15\ Employees also can elect to take the money out of
their retirement accounts.\16\
Areas of General Agreement
Invest Rollovers for Better Earnings. The group generally agreed
that when employees leave a company and are eligible for payouts of
sums up to $5,000, it is important that amounts saved be retained for
retirement purposes and not be spent on current needs.\17\ The group
also generally agreed that it is important that rollovers of sums
between $1,000 and $5,000 be invested in a way that will earn the best
risk-adjusted return for the worker.
Roll Over Small Balances to the Thrift Savings Plan or IRA. The
group generally agreed that it would be helpful if there were a single
national destination for rollovers that any employer could use to
transfer rollovers. This would make it easier for employers to roll
over the sums and encourage employees to save the funds for retirement.
The employers would no longer have to choose an IRA, if they did not
wish to do so, or if they found it to be a burden.
The group discussed whether or not to roll over funds to the
Pension Benefit Guaranty Corporation or to the Thrift Savings Plan \18\
which is a retirement savings plan for Federal Government civilian and
uniformed workers. Some members of Congress have suggested designating
the PBGC as a recipient for rollover funds. However, the group
generally agreed that the Thrift Savings Plan would be the preferred
destination. In addition, the group generally agreed that employers be
allowed to choose between rolling over small balances to the Thrift
Savings Plan and rolling them over to an IRA.
The choice of the TSP as a destination for small balances was seen
as helping alleviate concerns by the employer about choosing an IRA for
a departing employee who fails to make a choice for the rollover. Some
members in the group supported the proposal to roll over small balances
to the TSP. Other members of the group, however, preferred to keep the
option of allowing employers to roll over the small balances into an
IRA. The group reached agreement to allow either one or the other.
Expand Saver's Credit
Currently, low and moderate income workers can receive a Saver's
Credit up to $1,000 to encourage saving in a retirement saving plan.
Enacted into law \19\ in 2001, the Saver's Credit was first available
in 2002 and is slated to end in 2007. The Saver's Credit can reduce the
Federal income tax a worker pays dollar for dollar. The amount of
credit that one can receive is based on one's contributions into an
IRA, 401(k), and other retirement saving plans.\20\
The amount of credit available ranges from 10 percent to 50
percent, depending on adjusted gross income and filing status. Lower
income workers are eligible for a higher credit.\21\ For married
couples filing jointly the credit is available on incomes $50,000 and
under. For single people and married couples filing separately, the
credit is available on incomes up to $25,000. In practice, most of the
benefits have been paid out in 10 percent credits for couples filing
jointly who earn between $35,000 and $50,000.
The Saver's Credit is not refundable. That is, if someone does not
owe any taxes, then they can not receive the credit in cash. The credit
can go only towards reducing an existing tax liability. Although there
are 57 million workers within the income brackets covered by the
Saver's Credit, only about 20 percent are eligible to receive any
benefit.\22\ In this group only about 3.5 million have actually
received a Saver's Credit by contributing to an eligible savings plan,
and most have received only a 10 percent or 20 percent match.\23\
Contributions are made to a 401(k) and rarely an IRA.\24\ Only about
\1/10\ of 1 percent received a 50 percent match on a $2,000
contribution.\25\
The members discussed whether or not the Saver's Credit had
increased coverage or saving. Members disagreed on how successful the
Saver's Credit has been in promoting either goal. One member estimated
that the program cost $10 billion in tax revenues. Members of the group
generally agreed that it would be helpful to get detailed information
on how the program has worked in its initial implementation in order to
evaluate what changes might improve coverage or saving for retirement.
Areas of General Agreement
Extend the Saver's Credit Beyond 2007. The group generally agreed
that the Saver's Credit program should be extended beyond its sunset in
2007.
Make the Tax Credit Refundable. The group generally agreed to an
approach that would make the tax credit refundable and spendable, so
that more workers could enjoy the benefits. This means that workers who
do not have a tax liability sufficient to cover the tax credit would be
eligible to receive a payment for the part not covered by a tax
liability. Supporters stated that refundable tax credits are desirable
because they promote greater saving by more workers. Some of those
supporting a refundable (spendable) credit expressed a preference for
depositing the refundable (spendable) portion into a retirement savings
account rather than sending payments to eligible recipients.
There were some objections, too, to a refundable (spendable) tax
credit. One member was concerned about compliance issues, such as
possible fraud. One member stated that refundable tax credits are less
efficient in promoting saving than government matches. The member noted
that $1 match would result in $2 of savings. A $1 tax credit might,
however, only prompt $1 of saving if the tax credit is spent. There was
also a concern that the government would impose costly complications
that might be difficult to administer.\26\
Areas Where Views Differed
Make the Saver's Program Permanent? The group was unable to agree
on making the Saver's program permanent.
Raise the Percentage Match and Income Levels. The group discussed a
variety of ways to raise the percentage of the credit available at
various income levels, as well as raising income levels eligible for a
credit. While the group did not generally agree on a new income
schedule at which different percentage credits would apply, there was
strong support for raising the tax credit to 75 percent for couples
filing jointly who earn up to $40,000, with the credit phasing down to
50 percent for couples earning $50,000, and then phasing down to zero
for couples earning $60,000. For singles and couples filing separately,
the income limits would be half the level for couples filing
jointly.\27\
Offer a Government Match for Employee Contributions? The group also
discussed a government match for individual and employer contributions.
There was support for a government match, but some members were unsure
about how one would devise a method for determining the match and how
the funds would be transferred into the plan. The issue is complicated
by lack of an infrastructure for transferring the funds. It is also
complicated by the fact that the government match could not be
transferred into an account until after a worker making a contribution
filed income taxes, at which time the worker's annual adjusted gross
income would be known.
Employer Tax Incentives for Matching Contributions By Employers
Currently, employers are not eligible for tax credits or other tax
incentives for making matching contributions to employees. The group
discussed whether or not it was better to offer tax credits to
employers or employees in order to help increase overall saving. They
also discussed whether or not tax credits to employers or employees
would offer the greater net gain in saving. Or, to put it another way,
which would offer the biggest savings bang for the tax credit buck? The
group also discussed whether or not tax credits for employers should be
limited to small businesses and whether credits should be offered only
for contributions to the accounts of workers below a certain income
level.
Areas Where Views Differed
Employer Tax Credit. There was strong support, but not general
agreement, for a suggestion to provide an employer tax credit that
rewarded employer contributions or matches, provided it was tightly
targeted at lower paid workers in both large and small business.
There were concerns about how a tax credit would work even among
supporters of tax credits for employers. One member said that
contributions would have to be ``high quality,'' in the sense that they
were provided only for employer contributions that were made nearly
entirely on behalf of the targeted low-income workers.\28\ Some who
supported a tax credit in principle worried how it might work in
practice. One member who strongly opposed any type of employer tax
credit objected said it is not true that this approach gives a greater
bang for the tax credit buck are not correct. He claimed that if
employees can get an additional tax credit if the employer matches the
employee's contribution, it would have a similar affect on net
retirement savings as providing a tax credit to the employer.
Members Offer Several Suggestions for Tax Credits. The group
discussed several options for designing an employer credit without
deciding to generally support any one of them. One member suggested a
credit for employer contributions that are above and beyond what was
needed to satisfy nondiscrimination tests.\29\
One member suggested a 50 percent tax credit to employers for
contributions to nonhighly-compensated employees.\30\ One alternative
was to offer a credit to employers for contributions to workers earning
up to $40,000 or $50,000.\31\ One member proposed making the employer
credit a complementary part of the Saver's Credit, which is directed at
employees. In this instance, the credit would be only for contributions
above and beyond what an employer makes to the work force
generally.\32\
The group discussed whether or not an employer tax credit might be
limited because the targeted group of small business includes some
companies without a big tax liability. To reach this group, it was
suggested that any employer credit also be refundable and
spendable.\33\
Intelli-Match Proposal to Benefit Low, Moderate Wage Earners
The group discussed the Intelli-Match proposal \34\ that would
provide a higher proportionate match or contribution to low and
moderate income workers than it provides to workers in general.
Before employers could set up an Intelli-Match proposal, Congress
would have to pass legislation to grant employers a safe harbor on
nondiscrimination tests, since some workers would receive matching
contributions at a higher percentage of pay than others. There are
existing safe harbors that would allow employers to do this; however,
they also require immediate vesting, which may be inconsistent with the
business requirements of some employers. For this reason, the Intelli-
Match proposal had a provision that employers would not have to provide
for immediate vesting \35\ to the employer match. This would reduce the
overall cost of an Intelli-Match program for employers.
Areas of General Agreement
The group generally agreed to support an adjustment in the terms of
the safe harbor to make defined contribution plans more flexible for
employers in return for a higher targeted match for workers earning up
to $50,000.
Areas Where Views Differed
The group did not agree on the provision in the Intelli-Match
proposal that would eliminate immediate vesting, although it supported
the broader concept, as noted above, that the employer would be given
some additional flexibility in return for a higher match for low and
moderate income workers.
Payroll Deduction IRAs
The group discussed ways to expand the availability of payroll
deduction IRAs, including requiring employers to offer them at firms
that do not have a retirement savings plan, as well as requiring
employers who have a retirement plan to offer the payroll deduction IRA
to workers who are not eligible to participate in that plan.
Under current law \36\ employers are allowed to provide employees
with the opportunity for making contributions to an IRA through payroll
deductions. In 2005 employees are able to contribute up to $4,000 a
year to a payroll deduction IRA, while workers over 50 can contribute
an additional $500 directly to the bank.
Areas of General Agreement
The group generally agreed that it would be desirable to expand
payroll deduction IRAs.
Areas Where Views Differed
The group was divided on this issue and did not agree to require
employers to offer the payroll deduction IRA. As an alternative, some
members suggested that workers be allowed to contribute part or all of
their refund to an IRA when they file their annual tax returns.
Reducing the Risk in Defined Contribution Plans
The group considered several proposals that were designed to reduce
the market risk than may occur when investment returns perform below
historic averages for an extended period. A period of low returns can
be of special concern if this occurs when workers are nearing
retirement.
Areas of General Agreement
Government-Issued Retirement Bonds. The Group generally supported
encouraging employers to offer inflation-adjusted retirement savings
bonds as an investment option in their plans. The group identified
Treasury Inflation-Indexed Securities (TIPS) as a potential candidate
for this option.
Areas Where Views Differed
Government Insurance for Defined Contribution Plans. It was
proposed that the government insure the difference between a career
average return on investments and the actual return on investment in a
worker's account at the time of their retirement, death or disability.
The group did not endorse any form of government insurance for
contributions or investments in defined contribution plans.
Combination Defined Contribution/Cash Balance Offset Plan. The
group decided against considering a proposal with a defined benefit
component, as it was seen to be within the scope of Working Group I on
defined benefit \37\ plans and not within the scope of the assignment
set for Working Group II. A proposal had been submitted to recommend
adding a cash balance plan to a 401(k) in order to assure that a
portion of the retirement saving would have a guaranteed return no
matter what happens to the markets.
Raising the 70 Percent Coverage Requirement
Under tax law, 70 percent of employees must participate in a
retirement plan in order for the plan to qualify as
nondiscriminatory.\38\ In addition, plans can exclude from this
calculation employees who work less than 1,000 hours a year. Some
members suggested that it might be possible to increase the required
level of coverage to some level above 70 percent of workers. The group
also considered whether or not to recommend that employers be required
to include more part-time and contingent workers to the standard
required to be nondiscriminatory.
Areas of General Agreement
The group generally agreed there should be more study of the impact
of raising coverage above 70 percent and increasing part-time coverage.
Areas Where Views Differed
The group was unable to reach agreement agree on supporting either
raising the 70 percent level or increasing the number of part-time and
contingent workers. There was strong disagreement over the proposal to
increase the number of part-time and contingent workers. Some members
said that the group needed data to demonstrate the impact of both
approaches to determine which would be more effective, while others
were willing to support these approaches with more data.
Other Proposals
Areas of General Agreement
Improving Financial Education and Literacy. The group generally
agreed to support instruction on financial literacy for high school and
college students. However, the group did not recommend making it a
requirement for graduation, as one member had suggested.
Tightening Coverage Rules. While not making any specific
recommendations, the group generally supported the proposition that
coverage rules should be tightened. However, the group also generally
agreed that more studies are needed to measure the impact of various
proposals before endorsing them.
Endnotes
\1\ U.S. Department of Labor Bureau of Labor Statistics, National
Compensation Survey: Employee Benefits in Private Industry in the
United States, March 2003 (Washington, D.C.: Department of Labor, April
2004), Table 1, p. 3.
\2\ U.S. Bureau of Labor Statistics, ``Employee Benefits in the United
States, 2003,'' News, UDSL: 03-489, September 17, 2003, Table 1, p. 3.
From the web site at http://www.bis.gov/news.release/pdf/ebs2.pdf.
\3\ Ibid.
\4\ U.S. Department of the Treasury, Internal Revenue Service,
Statistics of Income Bulletin, (Winter 1984-1985, Winter 1986-1987,
Winter 1990-1991, Winter 1993-1994, Winter Fall 1995, Winter Spring
1996, Fall 2001, and Winter 2002-2003).
\5\ Craig Copeland, ``Retirement Plan Participation and Features, and
the Standard of Living of Americans 55 or Older,'' EBRI Issue Brief
Number 248 (Washington, D.C.: Employee Benefit Research Institute,
August 2002), Figure 2, p. 8.
\6\ The W-4 is the form the IRS requires to be filled out by new
employees for tracking payroll taxes and deductions.
\7\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business with
less than 100 employees, as well as self-employed people. SIMPLE stands
for Savings Incentive Match Plan for Employees.
\8\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business with
less than 100 employees, as well as self-employed people. SIMPLE stands
for Savings Incentive Match Plan for Employees.
\9\ A balanced fund aims to produce high rates of return over the
medium to long term. In terms of risk levels, a balanced fund usually
occupies a middle position. It is more volatile than a fund with
primarily cash and fixed interest investments. It is less volatile than
a fund which invests only in equities and real property.
\10\ In a Lifestyle Fund, the choices about how much to put into
equities, bonds and cash are based on the risk tolerance of the
investors and the investor's goals. Lifestyle Funds allow an investor
to put all the assets in a single fund and not have to review or revise
those investments. The fund periodically adjusts the allocation and
gradually becomes increasingly more conservative as the investor moves
toward retirement age.
\11\ The Thrift Savings Plan offers only a handful of few investment
options, which is generally seen to make it easier for participants to
use and make decisions about investing. The TSP offers, for example,
the following five choices: a Government Securities Investment (G)
Fund, a Fixed Income Index Investment (F) Fund, a Common Stock Index
Investment (C) Fund, a Small Capitalization Stock Index Investment (S)
Fund, and an International Stock Index Investment (I) Fund.
\12\ Some pension plans refer to the contribution made into the plan as
a salary deferral because it reduces the amount of income that is
counted for taxation purposes, while deferring taxes on that income
until it is withdrawn later.
\13\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business
with less than 100 employees, as well as self-employed people. SIMPLE
stands for Savings Incentive Match Plan for Employees.
\14\ Internal Revenue Code 404(c) requires a participant to make a
choice in order to give employers a safe harbor from fiduciary
liability for the participant's choice.
\15\ Congress required employers to rollover sums for departing
employees who do not make a choice in the Economic Growth and Tax
Relief Reconciliation Act of 2001. Implementation of the policy cannot
begin until Treasury issues regulations affecting the rollovers.
\16\ If employees withdraw their money from a 401(k) account after
leaving a job and do not deposit into an IRA or another 401(k) at their
next job, they will owe taxes on the withdrawal, including a 10 percent
penalty tax on amounts withdrawn before age 55.
\17\ Congress required employers to rollover sums for departing
employees who do not make a choice in the Economic Growth and Tax
Relief Reconciliation Act of 2001. Implementation of the policy can not
begin until Treasury issues regulations affecting the rollovers.
\18\ The Thrift Savings Plan offers only a handful of few investment
options, which is generally seen to make it easier for participants to
use and make decisions about investing. The TSP offers, for example,
the following five choices: a Government Securities Investment (G)
Fund, a Fixed Income Index Investment (F) Fund, a Common Stock Index
Investment (C) Fund, a Small Capitalization Stock Index Investment (S)
Fund, and an International Stock Index Investment (I) Fund.
\19\ The Saver's Credit was part of the Economic Growth and Tax Relief
Reconciliation Act of 2001.
\20\ Saver's Credit also available for contributions to 403(b) plans,
457 governmental plans, SIMPLE 401(k) plans or SIMPLE IRA's.
\21\ For married couples filing jointly, workers with income up to
$30,000 are eligible for a 50 percent Saver's Credit for their
contributions into a saving plan. Married couples earning $30,001 to
$32,500 are eligible for a 20 percent credit, and married couples
filing jointly earning $32,501 to $50,000 are eligible for a 10 percent
credit. Those earning over $50,000 are not eligible for a credit. For
single people or married people filing separately, the Saver's Credit
is available for 50 percent of contributions for workers with incomes
up to $15,000. Workers with incomes $15,001 and $16,250 can obtain a 20
percent Saver's Credit. Single workers and married people filing
separately who earn between $16,251 and $25,000 can receive a 10
percent Saver's Credit on contributions. Slightly different earnings
levels qualify a head of household: (50 percent for incomes up to
$22,500; 20 percent for incomes $22,501 to $24,375; and 10 percent of
incomes $24,376 to $37,500).
\22\ Data provided by former Treasury official Mark Iwry.
\23\ Ibid.
\24\ Ibid.
\25\ Ibid.
\26\ A proposal to make the refundable amounts made available by a
special savings bond payable on retirement and not through a tax credit
has been made by Senator Jeff Bingaman (D-New Mexico).
\27\ For singles and couples filing separately, there was support for
raising the credit to 75 percent for those earning up to $20,000. The
credit would be gradually phased down to 50 percent for those earning
$25,000. It would then be gradually phased out to zero for those
earning $30,000.
\28\ The member who proposed this suggestion said the definition of
``high quality'' would have to be further refined.
\29\ Nondiscrimination testing is required under Internal Revenue
Service rules to ensure that highly compensated employees do not derive
a much greater benefit from a qualified plan than non-highly
compensated employees. There are two broad tests. One is Actual
Deferred Percentage (ADP) Test which measures the rate at which
employees elect to make contributions. The other is the Actual
Contribution Percentage (ACP) Test that measures the rate of employer
matching and after-tax contributions.
\30\ Non-highly-paid employees are those who earn less than $90,000.
Highly compensated employees earn $90,000 or more.
\31\ In this proposal, employer contributions would have to meet ``a
certain quality of coverage'' standard in order to qualify for the 50
percent tax credit, such as requiring that the first dollar of coverage
awarded by employers would reach the target population within a given
range. Companies would not qualify if they integrated their benefits
into Social Security or if they engaged in cross testing to meet
nondiscrimination testing requirements. Credit would be made for
matching and automatic contributions. On matching contributions,
employers had to provide at least a 20 percent match. On automatic
contributions, the level would have to be 1 percent or 2 percent of
pay. The credit was capped at 3 percent of pay for the employer
contribution. It could also be provided for a 1 percent non-elective, 2
percent match. The target was low-income people, not just small
business workers.
\32\ The employer credit would be allowed made for employer
contributions to workers earning less than $30,000, and be applied to
contributions 1 percent or 2 percent of wages above the percentage
contribution levels the employer was providing to all employees.
\33\ One member described both the refundable and nonrefundable tax
credits as ``spendable'' tax credits to differentiate them from
contributions deposited into an account by the government.
\34\ One possible Intelli-Match approach would be to provide a 100
percent match for employee contributions up to $2,000 or 4 percent,
whichever is greater. A worker earning $100,000 could contribute up to
$4,000 and receive a $4,000 match. A worker earning $20,000, however,
might contribute $2,000 even though that would represent 10 percent of
the worker's salary. Even so, the worker would still get a $2,000
match. The proposal would also provide a tax credit to the employer for
the amount of employer match contributed to people making less than
$50,000 that is above the percentage match give to owners and highly-
compensated employees.
\35\ An employee is said to be ``vested'' in a pension when the
employee becomes entitled to the benefits of the plan, including
employer contributions to a plan and their earnings.
\36\ In 1975 the Department of Labor issued a regulation describing the
circumstances under which the use of an employer payroll deduction
program for forwarding employee monies to an individual retirement
account (IRA) will not constitute an employee pension benefit plan
subject to Title I of the Employee Retirement Income Security Act
(ERISA) of 1974. Further, as part of the conference report on the
Taxpayer Relief Act of 1997, Congress expressed its view that
``employers that choose not to sponsor a retirement plan should be
encouraged to set up a payroll deduction system to help employees save
for retirement by making payroll deduction contributions to their
IRAs.'' (H.R. Rep. No. 220, 10th Congress, 1st Session at 755, 1997).
\37\ Defined benefit type plans are retirement plans offered by
employers who promise to fund and provide a monthly retirement benefit
to each eligible employee based on years of service and earnings.
\38\ Internal Revenue Code Section 410(b).
______
Report on the Conversations and Recommendations of Working Group III
working group's assignment
answer this question
How do we increase coverage and retirement savings through new
institutions and structures?
february 10, 2005
Co-Chairs: Ian Lanoff and Pamela Perun
Working Group Members: John Ameriks, Chris Bone, Doug Ell, Cathy Heron,
Pat Humphlett, Leslie Kramerich, Robert Nagle, Carol Sears, Javier
Silva, Dick Wartman, Christian Weller, and Janice Winston
executive summary
Despite years of efforts to address the challenge, more than half
the private sector work force does not participate in a retirement
saving plan. Thus, employees are unlikely to accumulate any significant
savings for their retirement years, which are likely to be very long as
Americans continue to live longer. The workers who might be the most
likely to experience poverty in old age are the same workers who are
most likely to be without access to a retirement saving plan today.
Working Group III set out to do something about this uncovered
group that needs the most attention. Its mission was to look for ways
to enroll various financial institutions in new efforts to target the
most important segment lacking coverage: small businesses. In this
segment only 35 percent of employees participate in a workplace
retirement savings plan. The group also wanted to reach part-time
workers. This group represents an even greater area of need since only
18 percent of part-time workers participate in a workplace retirement
savings plan.
The group also recognized that workers are much more likely to save
if they have a way to save through their employer. When such plans are
offered, participation rates are high across the board, even if there
is no employer match. One reason is that savings can be regularly
deducted from a worker's pay check.
After reviewing a range of proposals aimed at reaching the target
group, the Working Group decided to take the bold step of offering its
own clean-slate proposal to reach the masses of uncovered workers.
Taking a leaf from Henry Ford's highly successful strategy of designing
a car for the masses, the group decided to name its plan the Model T.
The new Henry Ford's would be executives at regulated financial
institutions: banks, insurance companies, brokerage firms, and mutual
funds.
All employees--full-time, part-time, contingent workers
and even independent contractors \1\ --would be eligible to participate
if an employer agreed to be part of a plan. This is a striking
departure from existing rules that allow employers to limit which
employees might be eligible for such plans as the 401(k).
Regulated financial institutions could be authorized to
offer a simplified plan to groups of employers.
This multiple employer plan could be targeted to a specific region.
For example, a bank in Peoria, Illinois could offer the plan to
businesses in the Peoria area. The plan could also be targeted toward
business categories, such as a Mississippi insurance company offering a
plan for Mississippi construction and building trade groups.
The group generally agreed that there should be only three
to five investment options and that they would include model portfolios
that would be conservative, moderate and aggressive.
Employers would also be able to automatically enroll
workers.
If workers make no choice among investments, the employer
could designate that their contributions be invested in a mix of
options that would be appropriate for their age and expected date of
retirement.
Small businesses would be more likely to offer such plans because
two of the chief reasons they say they currently avoid plans would be
eliminated. The plan would be administered by the financial institution
that provides it and the employer would no longer be potentially liable
as a fiduciary for the investment choices of employees.
Employers would be allowed to contribute to the plan, but would not
be required to contribute. This, too, would address a concern by small
businesses whose managers and owners worry that the business is too
precarious and profits too uncertain to commit to employer
contributions.
While tax credits for employer and employee contributions were seen
as helpful, they were not deemed to be essential for the plan.
Mission
The broad mandate of Working Group III was to find new institutions
and structures to increase the portion of the workforce covered by a
retirement saving plan and to raise the level of retirement savings.
The members of the group looked at the role that financial institutions
could play in providing new approaches that target workers employed by
small businesses, where coverage and saving are much lower than in mid-
sized and large businesses.
The group generally agreed they should try to develop broad
outlines for a new plan they named the Model T plan, which would be a
simplified, low-cost group retirement savings plan that could be
sponsored by financial institutions, such as banks, insurance
companies, mutual fund companies, and brokerage firms. The group set
out to design the elements of the plan and how it might work to attract
plan providers and employers. In working on the design elements of the
plan, the group sought to find agreement on as many areas as possible
and, where a consensus could not be developed, to identify areas where
more work needed to be done.
Background
The goal of providing a retirement plan for all workers is an
ambitious one. In 2003, for example, only about 57 percent of American
workers had access to a retirement plan sponsored by their employer,
according to Bureau of Labor Statistics. Of that group 20 percent have
access to a defined benefit plan; that is, a plan that is generally
funded by the employer and which usually provides a stream of income
for life.\2\
The number of workers who actually participate in those plans is
somewhat lower. Among all private sectors workers, 49 percent of full-
time and part-time workers participated in an employer-sponsored
retirement plan. That represented 50.5 million in a total private
sector work force of 103.5 million in March 2003.\3\
The employer survey found that different segments of the workplace
population have widely differing participation rates. The participation
rate is 65 percent among the 45.9 million employed last year in medium
and large businesses (100 employees or more). However, the
participation rate was only 35 percent among the 59.6 million employed
last year by small businesses (99 or fewer workers).\4\ There is an
ever sharper divide in participation rates between full-time (58
percent) and part-time workers (18 percent).\5\
Getting small business owners to sponsor plans is difficult, but
not impossible. According to the 2003 Small Employer Retirement Survey
(SERS) by the Employee Benefit Research Institute, 29 percent said they
were likely to start a plan in the next 2 years.\6\ At the same time,
68 percent said they were not likely to start a plan.\7\ This
represents a sharp decline in the number of small businesses that are
likely to start a retirement plan in recent years. In 1998, for
example, 42 percent of small business owners said they were likely to
start a plan in the next 2 years, while 56 percent reported they were
not likely.
The survey looked at a number of factors that could improve the
chances that small businesses would offer a plan. It found that 73
percent of small businesses were more likely to start a plan if it did
not require employer contributions, 67 percent were more likely to
start a plan if the employer could get tax credits for start-up costs,
57 percent were more likely to start a plan if the plan had reduced
administrative requirements, and 55 percent were more likely to start a
plan if it offered easy-to-understand information about the plan.\8\
Fiduciary responsibility is another stumbling block to employers
sponsoring plans.
These data suggest that a plan that has discretionary contributions
on the part of the employer, is easy to administer, reduces fiduciary
liability for the choices of employees, provides tax credits for start-
up costs, and is easy to understand, would likely prompt a good deal of
interest among small business employers.
Employer-sponsored pension plans still appear to be the best way to
motivate workers to save for retirement. The Federal income tax return
data indicate that the proportion of filers who claim an IRA or Keogh
deduction has been both fairly modest and steadily declining over time.
From a peak of 16.2 percent in 1986, it fell to 3.5 percent in 2000 and
2001.\9\ By contrast, the participation rate in workplace plans is 66.2
percent of those eligible for 401(k) plans (a population of workers
that represents 32.6 percent of the private sector workforce).\10\
How the Working Group Went About Its Assignment
Working Group III first examined a range of existing proposals
aimed at employees of small businesses. Instead of recommending any of
those proposals, the group instead decided to start with a clean slate
and design the broad outlines of a new proposal for a simplified
multiple employer \11\ or group plan that would be offered to small
businesses by financial institutions.
In taking this approach, the group was also responding to a
recommendation from the first Conversation on Coverage in 2001 to
examine new types of model group pension plans that would enable groups
of unrelated small employers to pool resources, thereby reducing
administrative costs and fiduciary liability.\12\
Taking a leaf from Henry Ford's Model T, which became the symbol of
affordable transportation for the masses, the group named its new plan
the Model T multiple employer plan. It was the group's hope that it
could be an inexpensive and accessible savings vehicle that could
provide pensions to tens of thousands of workers in small companies.
Under the Model T plan approach the plan providers--banks,
insurance companies, brokerage companies, and mutual fund companies--
would assume fiduciary liability for the investment choices in the plan
and would shoulder administration duties for the plans. The transfer of
these two responsibilities from the employer to the plan provider was
seen by the group as a means of addressing these two of the key
objections by small businesses to starting a new defined contribution
plan. In addition, the simplicity of the proposal was seen as
addressing another key concern of both small business employers and
employees.
the model t plan at a glance
The group generally agreed on the following broad outlines of the
Model T plan.
Multiple-Employer Plan. It will be a multiple-employer
defined contribution group or pooled plan and not an aggregation of
individual retirement accounts.
Workplace Plan. The Model T will be offered by an employer
to employees and independent contractors of the firm.
Administration by Third Party Provider. The administration
of the plan would be the responsibility of the plan provider--a
financial institution--and not the employer.
Financial Institutions Would Offer the Plan. Regulated
financial institutions--banks, insurance companies, brokerage firms and
mutual fund companies--would be authorized to offer the Model T plan,
in much the same way the Internal Revenue Code now authorizes certain
types of financial institutions and corporations to offer IRAs. The
authorized institutions would market the plan to employers.
Limited Investment Choices. The group generally agreed
that Model T plans would be required to offer a limited choice of three
to five options that would consist of model portfolios and/or lifestyle
funds, with the possibility of a guaranteed return investment option.
The choices would be designed to make them easy for the employer and
employee to understand.
Fiduciary Liability Transferred to Third Party Provider.
The fiduciary responsibility for the investment choices will be
transferred from the employer to the plan provider.
Default Investment Mix Option. Plan providers will have
the option of offering participants in the plan the option of choosing
a default mix of investments based on a lifestyle fund or a model
portfolio.\13\
Employee and Employer Contributions. Once an employer
signs up with a plan provider, both the employer and employees will be
able to contribute to the plan.
Securities and Exchange Commission Is Lead Regulator.
While the Internal Revenue Service and the Department of Labor would
play an important role in the regulation of the Model T plan, the
Securities and Exchange Commission would take a leading role in the
regulation and oversight of fiduciary and investment matters.
the building blocks of the model t plan
The group discussed in detail how the plan might be structured and
what policies would govern the various elements of the plan. In many
cases, the group was able to reach a consensus, but in others there
were varying opinions, or dissenting opinions. The outcome of the
discussions of the various elements is presented below.
Building Block No. 1
Plan Providers
The group discussed potential plan providers to offer the plan to
employers. This included banks, insurance companies, mutual fund
companies, brokerage firms, and various financial intermediaries.
Areas of Agreement
Regulated Financial Institutions Can Offer the Plan. The group
generally agreed the regulated financial institutions can sponsor the
Model T plan. This would include banks, insurance companies, brokerage
firms and mutual fund companies. A number of members indicated they
thought that a simplified Model T plan might be attractive to banks,
which have not been as active in offering retirement plans as other
financial institutions.
Plans Can Target Regions and Groups. The group generally agreed
that plan providers could offer plans that are targeted to employers in
a specific geographical or regional area or targeted at employers in
specific categories of business and industry.
Authorized Providers. The group generally agreed to support a
regulatory approach that is similar to the Internal Revenue Code
provisions governing who can offer IRAs \14\ when designing regulations
for designating which financial institutions would be authorized to
provide the plan to employers. They also generally agreed that the
process would be open to eligible financial institutions already
regulated by a Federal or State Agency. This would include banks,
insurance companies, brokerage firms, and mutual fund companies.
Brokers and Intermediaries. The group discussed whether or not
brokers or intermediaries could pool contributions from self-employed
individuals and forward them to a regulated financial institution plan
provider. The discussion included such potential intermediaries as
organizations representing freelance workers. It was generally agreed
that an organization could be allowed to facilitate signing up its
members in a plan offered by a financial institution.
Areas Where Views Differed
Authorization Dependent on Target Participation by Low-Income
Workers. There was a proposal by one member that the authority of
financial institutions to offer the Model T be dependent on the ability
of the plan provider to market the plan in such a way that a designated
portion of the workers covered by the plan--perhaps 20 percent--would
be low-income workers. This would follow the approach taken in the
Community Reinvestment Act (CRA) toward regulating depository
institutions. The group was divided on whether or not to support a CRA-
type approach to licensing. One member who objected said it would
increase the cost of the plan by increasing the level of detail in
administering it. One member supported the use of the CRA-type approach
by institutions offering the Model T but did not want to make it part
of the eligibility requirements for a financial institution seeking to
offer a plan. One member suggested that a study be made of 529 college
saving plans \15\ with CRA-type requirements to see if something could
be adapted to suit the eligibility requirements for the Model T plan.
Commissions for Brokers and Intermediaries. The group also
discussed whether organizations or even brokerage firms could pool
contributions from a group of workers or small employers for a
commission. The group could not agree, however, on whether
organizations could earn fees for their work as facilitators.
Professional Employment Organizations. One member suggested that
professional employment organizations or PEOs that lease out employees
be authorized to offer the Model T to the employees they lease out to
businesses. However, the group did not generally agree to support
allowing PEOs to be plan sponsors.
Building Block No. 2
Employee Participation in the Plan
The group discussed which of a given company's employees would be
eligible to participate in the plan and whether or not employers should
be allowed to automatically enroll workers when they are hired.
Areas of Agreement
All Employees Eligible to Contribute. The group generally agreed
that once an employer agrees to participate in a Model T plan offered
by a financial institution, then all employees will be eligible to
contribute to the plan. This will include full-time workers, part-time
workers, contingent workers and independent contractors. As noted
above, there was interest in having organizations facilitate
contributions from various groups of workers, including the self-
employed.
Automatic Enrollment. The group generally agreed that an employer
participating in a Model T plan could adopt the option of automatically
enrolling a new hire into the plan unless the employee indicated
otherwise.
Areas Where Views Differed
Limits on Employee Contributions. The group deferred discussion on
setting contribution limits for employees and/or employers to the next
phase of the Conversation on Coverage, with the assumption that the
limits would be in keeping with the limits for other defined
contribution plans.
Building Block No. 3
Employer Contributions to the Plan
The group discussed whether or not employers could contribute to
the Model T plan and whether, in fact, employers might be required to
contribute.
Areas of Agreement
Employer Contributions Allowed. The group generally agreed the
employers would be able to contribute to the Model T plan.
Areas Where Views Differed
Mandatory or Voluntary Contributions. The group discussed whether
or not employer contributions would be made mandatory, but remained
divided on this issue. There was strong opposition to mandatory
contributions. One member said that if employer contributions were made
mandatory, then it would create a barrier for signing up employers to
be part of the Model T plan. Another member noted studies--such as the
annual Small Employer Retirement Survey (SERS) by the Employee Benefit
Research Institute--that have found that small business employers would
be more likely to offer a retirement saving plan if employer
contributions were entirely discretionary.\16\
Some members were strongly in favor of mandating employer
contributions. One member who supported a mandate said that if there is
no mandate for the Model T plan, he did not see how it would differ
very much from an IRA. A member who opposed mandatory contributions
said that the Model T would still be a different plan because it would
allow for employer contributions to the plan. One member suggested as a
compromise a flexible policy rule in which employers would be required
to contribute in x years out of five, depending on whether or not there
are profits. Another member suggested requiring the employer to
contribute 1 percent of compensation if the employee puts in 4 percent
of compensation. One member suggested that the Model T allow for
reverse match contributions, where the employer contributes first and
the employee matches the employer contributions.
Building Block No. 4
Investment Options in the Plan
The group discussed how many investment options and what types of
investments should be included in the Model T plan.
Areas of Agreement
Simplified Investment Options. The group generally agreed that the
plan should offer at least three investment options, but no more than
five options. The members also generally agreed that the choices should
include at least three model portfolios or lifestyle funds:
conservative, moderate, and aggressive.
Default Investment Mix. The group generally agreed that when
employees fail to make choices on their own, plan providers should be
allowed to offer participants at firms that join the plan a default mix
of investment options based on lifestyle or life cycle funds--or model
portfolios representing the basic asset classes.
Areas Where Views Differed
Additional Investment Options. The group discussed including an
investment option that would provide a guaranteed rate of return.
Although several in the group strongly supported such an option as key
to encouraging low-income workers to participate, the group did not
reach agreement that this should be a required investment option.
Government Definitions of Investment Options. The group discussed
having the government define exactly what should be in an investment
option, but could not reach agreement on this point.
Two Tiers or One? The group discussed whether or not financial
institutions might have two models or tiers to offer employers: (1) a
simplified incubator model plus (2) a full-fledged plan with more
investment options. Those who supported the concept of two-tiered plans
argued that employers could begin with the simplified incubator plan
and then move on to a traditional qualified plan offered by the
institution offering the incubator plan--or any other institution--when
they were ready. The suggestion was made out of concern that the
simplified plan might not be profitable for plan providers and, thus,
might fail to enlist their enthusiastic marketing of the plan. Members
explained that the Model T might not be as profitable in the beginning
because it would consist of a lot of accounts, each with very small
balances.
The group was divided on this proposal. Some supported an approach
with two plan options, a simplified incubator and a full-fledged plan,
while others supported a single, simplified Model T plan. Members
supporting a single Model T plan argued that while the Model T might
not prove to be as profitable initially as the financial institution
might wish, account balances would grow over time, increasing the
plan's profitability. Further, employers could mature into one of the
whole range of existing single employer plans when they are ready for
more investment options and more bells and whistles in their plan.
Government Sponsored Start-Up Plan. The group discussed whether or
not the government should sponsor a Model T plan for those employers
with many small accounts, clients whose business would not be
profitable for financial institutions that provide Model T plans. The
group was divided on whether or not there should be a government start-
up plan. A member who opposed a government plan said it would be
difficult for the government to start up a plan. Further, it was
suggested that the financial institutions that were interested in
sponsoring Model T plans would be opposed to it. Members supporting a
government start-up plan, however, continued to strongly support this
approach. One asked why financial institutions would be opposed, since
the government plan would be only for unprofitable accounts. A member
opposing a government plan said it would ``get tricky'' to devise a way
for employers to move from the government plan to a private sector
plan.
Building Block No. 5
Regulation and Oversight
Since the Model T plan would transfer administration and fiduciary
liability from the employer to the plan provider, it raised a number of
questions about what regulatory regime would work best to keep the plan
costs low while protecting participants. The group also looked at the
question of who would have fiduciary liability for the investment
choices in the plan and for any malfeasance and fraud that might occur.
The group generally agreed that the employer would be relieved of
fiduciary liability for the choice of investment options in the plan.
Areas of Agreement
SEC is the Lead Regulator. The group discussed what regulatory
roles would be played by the Department of Labor, the Internal Revenue
Service, and the Securities and Exchange Commission. The group
discussed whether the SEC should enhance its role as fiduciary
regulator over Model T plans above the level of scrutiny it applies for
the non-pension related oversight that constitutes its regulatory
focus. They also discussed whether or not the SEC should be the lead
fiduciary regulator instead of the Department of Labor or IRS. The
group generally agreed that the SEC should take the lead role in
fiduciary regulation for the Model T. They also agreed that at the same
time the IRS should be the guardian for tax rules while the Department
of Labor would regulate the employer/employee relationship. The exact
nature of the DoL's regulatory role was deferred for future
consideration.
SEC Will Regulate Model T Plans Offered By Banks and Insurance
Companies. The group discussed whether or not the SEC oversight would
apply beyond brokerage firms and mutual funds to include banks and
insurance companies, which are chiefly regulated by Federal banking
authorities, as well as State banking and insurance authorities. One
member noted that the SEC currently already regulates mutual funds
offered by banks and variable annuities offered by insurance companies.
Thus, the member explained, it is not a departure for the SEC to also
regulate Model T retirement saving plans provided by banks and
insurance companies. The group generally agreed that the SEC could be
the fiduciary regulator for all providers of Model T plans.
Paying for Plan Administration Costs. The group discussed how
administration costs would be paid. The group generally agreed that the
sponsoring financial institutions could charge a fee for administration
(in addition to the fee for investment management). They also generally
agreed that the fee could optionally be borne by participants as a
charge against earnings.
Fees Should Be Low. The group generally agreed that internal fees
charged to manage funds, as well as administrative fees to manage the
plan, should be low. Many in the group supported an approach that would
keep fees below 100 basis points.\17\
Areas Where Views Differed
SEC Will Regulate Fees. Many in the group supported the view that
the SEC would be responsible for regulating fees and determining what a
reasonable fee might be. The SEC would also be responsible for
determining whether or not there should be a cap on fees. This approach
would expand the powers of the SEC, which currently oversees mutual
funds, but does not regulate fees in mutual funds. However, the group
did not generally agree to this approach. One member strongly objected
to having the SEC set rates or caps for funds, stating that putting
this in the proposal would ``seriously derail'' any effort to get
support for the Model T plan. The member objecting also noted that if
the Model T plan had caps, it would reduce the number of players in the
market, while removing the cap would increase competition, which, in
turn, would act to keep fees lower.
Enhanced SEC Fiduciary Authority. The group was divided over
whether or not the SEC should enhance its fiduciary oversight for Model
T plans. Some favored the current level of fiduciary scrutiny applied
to brokerage firms and mutual funds as a way of streamlining regulation
and keeping down costs. Others, however, felt that since the SEC was
the lead regulator, it would have to take on some of the duties
associated with the Department of Labor and some of the more extensive
list of prohibited transaction rules under ERISA.\18\
Study to Address Unresolved Fiduciary Issues. The group generally
agreed that a study should be undertaken to develop an outline for a
regulatory regime for the Model T. For starters, the study could flesh
out the duties of the various regulatory bodies, and address what
enhanced fiduciary regulatory authority the SEC might have over Model T
plans.
Among the unresolved issues is a question of whether or not any
fiduciary liability would remain with the employer. Some suggested that
the employer would retain fiduciary liability for choosing a Model T
provider, even if it transfers to the plan provider the fiduciary
liability for the investment choices offered in the plan. Some
suggested that employers should face restrictions on who they might
choose so ``they could not hire their brother-in-law down the street,''
as one member put it.
There was also discussion about whether or not the plan provider
might escape fiduciary liability for the choices in the plan, if it
follows the required list of investment offerings. The group, however,
did not reach agreement on a suggestion to remove fiduciary liability
for plan providers who chose the recommended investment options. One
member explained that a plan provider could simply offer the investment
options of a business colleague or a relative rather than provide
investment options that were managed for the sole interest of the plan
participants.
Building Block No. 6
Withdrawals and Distributions
The group discussed under what terms and conditions employees could
make pre-retirement withdrawals for hardship or as a loan. They also
discussed the rules that would apply when employees leave an employer
and the rules that would govern distributions of assets when a
participant reaches retirement age.
Areas of Agreement
Hardship Withdrawals Not Allowed. The group generally agreed to
disallow hardship withdrawals. This approach was taken partly because
it would be difficult for plan providers to be able to determine if
there was a genuine hardship. In addition, barring hardship withdrawals
was seen as simplifying the plans, making them less expensive, and also
encouraging workers to retain their accumulated balances until they are
old enough to be eligible to take distributions.
Loans Allowed Up to 50 Percent of Assets. The group generally
agreed that participants would be able to withdraw loans from their
accumulated balances for amounts up to 50 percent of the value of the
assets in their plan. They also generally agreed that if a participant
defaulted, the loan would be treated as income and taxed. This approach
was taken to provide some type of pre-retirement access to the assets
in the plan. This approach was taken on the assumption that workers
tend to contribute more and save more if they know they can withdraw
some of the funds for an emergency. Loans were seen as preferable to
hardship withdrawals, for the reasons noted above.
Lump Sum Withdrawals at Age 59\1/2\. The group generally agreed
that participants could withdraw up to 50 percent of the value of the
assets in the Model T plan beginning at age 59\1/2\, conforming to the
age set for defined contribution plans generally, including 401(k)
plans. If a participant has taken out loans and not repaid them, these
loans would count toward the 50 percent maximum limit that could be
withdrawn as a lump sum.
Required Annuity on 50 Percent of Account Balance. The group
generally agreed that at least 50 percent of the account balance in the
plan should be converted to an annuity or be subject to the current
joint and survivor annuity rules. In addition, employees could elect at
retirement to take out the entire balance as an annuity, with spousal
consent.
Rollover Rules. The group generally agreed that a participant who
leaves an employer can withdraw up to 50 percent of the balance or roll
over the account into another Model T plan where he or she is eligible
to contribute. A participant who leaves a company can also leave the
remaining 50 percent in the account until age 59\1/2\. A participant
would have to either leave the 50 percent balance designated for a
future annuity in the plan or roll it over to a new Model T plan.
No Maximum Age or Minimum Withdrawals. The group generally agreed
that there would be no maximum age at which time withdrawals would have
to begin and no schedule of minimum annual withdrawals after that
designated age. In 401(k) plans, for example, withdrawals must begin by
age 70\1/2\ unless the employee is still working. If retired, annual
withdrawals beginning at age 70\1/2\ are based on the life expectancy
\19\ of the participant--or the participant and his or her spouse, if
married.
Joint and Survivor Annuities. The group generally agreed to apply
existing law governing joint and survivor benefits to the Model T plan.
That means the annuity would be issued jointly to the plan participant
and spouse and that the spouse would continue to receive the annuity
should the plan participant die. Plans would be able to decide whether
or not they would allow the individual to take up to one-half of the
balance at age 59\1/2\. If a participant decided he or she wanted to
take 50 percent of the accumulated balance as a lump sum when it is
offered, current law governing joint and survivor annuities would apply
to the remaining amount in the plan.\20\
Areas Where Views Differed
Other Types of Payment Schedules. Some members suggested that
participants be allowed to set up a regular withdrawal schedule timed
to life expectancy for the annuity half of the benefit. Participants
could, however, outlive the assumed time span for a schedule of
payments, while annuities would make regular payments as long as a
participant or surviving spouse lived, in the case of joint and
survivor annuities.
Government Managed Annuities. One member suggested that balances
dedicated to annuities be transferred to the Social Security
Administration and that SSA could then issue the annuities. Or,
alternatively, the Pension Benefit Guaranty Corporation could assume
control of the balances dedicated to annuities and pay out the
annuities beginning at retirement age. The group, however, declined to
support this approach.
Building Block No. 7
Tax Incentives and Provisions
The group discussed whether or not there should be tax credits for
employers, employees and plan providers, as well as tax subsidies for
employers and providers. The group also discussed how contributions,
gains and distributions would be treated for tax purposes.
Areas of Agreement
Special Tax Treatment Not Essential. The group generally agreed
that while special additional tax benefits for contributions by
employees and employers might be helpful, it was not essential for the
Model T plan.
Current Tax Preferences Favored. The group generally agreed that
the Model T should follow existing tax policy in key issues affecting
contributions, earnings, capital gains, and distributions. Employee
contributions would be excluded from income and, thus, income taxes.
Employer contributions would be considered an expense against corporate
income. Earnings, dividends and capital gains within the Model T plan
would accumulate tax-free. Distributions and withdrawals from the plan
would be taxed as part of ordinary income. Distributions upon
separation from service upon termination of employment would be subject
to the current withholding rules and a possible penalty if not rolled
over to an IRA or another plan. Distributions that result from failure
to repay a loan could be subject to the current early withdrawal
penalty if made before age 59\1/2\.
No Tax Subsidy for Plan Providers. The group generally agreed that
the Model T plan should not provide a start-up tax credit or subsidy
for financial institutions that offer the plan to employers.
Areas Where Views Differed
Tax Credits for Employer Contributions. The group also discussed
whether or not there should be tax credits for employers as an
incentive for them to contribute to the plan or match employee
contributions. While members generally agreed the tax credits for
employers would be helpful, the group did not reach agreement on what
types of credits would be appropriate. One member said it would be more
difficult to get Congress to enact a law to set up the Model T, if it
included tax credits for employer contributions. Another member,
however, said that the plan should call for a tax credit, noting that
one could not get a subsidy if one did not ask. The member also
suggested allowing third parties to offer to match employee
contributions for low-income workers.
Super Deductions for Employers. The group discussed a suggestion to
give employers a super deduction, such as 110 percent, for
contributions to the Model T plan. While some members supported this
approach, the group did not reach general agreement on recommending
this policy.
Start-Up Tax Credit for Employer. The group discussed whether or
not small businesses should get tax credits for costs associated with
starting up the plan, but could not agree on a recommended policy. Some
members noted that the plan was provided by a third party, so start-up
costs would be minimal. Other members noted, however, there would be
some costs associated with setting up the plan and some members
supported a credit for the first few years of the plan as an inducement
to get small businesses to sign up with a plan provider. One member
suggested a limited start-up credit.
Tax Credits for Employees. The group discussed whether or not to
recommend refundable tax credits for employees to encourage
contributions, expanding on the nonrefundable tax credits available
through the Saver's Credit.\21\ The group, however, did not generally
agree to support this approach, although some members strongly favored
it.
Building Block No. 8
Marketing Considerations
The group discussed how the plan might be marketed to assure that
more small businesses would decide to participate.
Areas of Agreement
Description of How the Model T Plan Differs. The group generally
supported providing a description of how the Model T differs from other
retirement and saving plan types as a way to interest and eventually
enlist financial institutions to provide the plan, as well as serving
as a way to draw attention to the plan for employers who might wish to
offer it to their employees.
Demonstration Project. The group generally supported exploring the
possibility of a demonstration project to generate interest in the
Model T plan. Such an effort could be modeled after such successful
campaigns as ``Cleveland Saves,'' which enlisted the Mayor and local
banks in a public education campaign that included ``personal
trainers'' who called up people and asked if they had saved anything
that day. The Model T demonstration project could market a
demonstration plan to small businesses and their employees in a given
community.
Areas Where Views Differed
Government Education Campaign. There was discussion of having the
government mount a public education campaign on the Model T plan so
that financial institutions that offer them will not have to advertise
them. Instead, individuals and small businesses would approach
potential providers. This was seen as a way to reduce the cost of the
plans and prompt financial institutions to offer them. The group,
however, did not reach general agreement on supporting this approach.
Endnotes
\1\ Independent contractors in this context refers to contract
employees and freelancers, but does not include the employees of
professional firms, such as lawyers and accountants, who advise or take
on specific projects for companies.
\2\ U.S. Department of Labor Bureau of Labor Statistics, National
Compensation Survey: Employee Benefits in Private Industry in the
United States, March 2003 (Washington, D.C.: Department of Labor, April
2004), Table 1, p. 3.
\3\ U.S. Bureau of Labor Statistics. National Compensation Survey:
Employee Benefits in Private Industry in the United States, 2000,
Bulletin 2555 (Washington, D.C.: U.S. Department of Labor, January
2003), Table 1, p. 4. The 2000 survey of businesses represents an
employed population of 107,538,277, 85,939,757 full-time and 21,598,520
part-time. The survey does not include workers employed by State and
local governments, the Federal Government or the military.
\4\ U.S. Bureau of Labor Statistics, ``Employee Benefits in the United
States, 2003,'' News, UDSL: 03-489, September 17, 2003, Table 1, p. 3.
From the web site at http://www.bis.gov/news.release/pdf/ebs2/pdf.
\5\ Ibid.
\6\ Small businesses reported as follows: 7 percent were very likely to
start a plan in the next 2 years, while 22 percent were somewhat
likely. Source: Employee Benefit Research Institute, ``The 2003 Small
Employer Retirement Survey (SERS) Summary of Findings'' (Washington,
D.C.: EBRI, June, 2003), p. 2.
\7\ Small businesses reported as follows: 25 percent were not too
likely to start a plan in the next 2 years, while 43 percent were not
at all likely. Source: Ibid.
\8\ Ibid.
\9\ U.S. Department of the Treasury, Internal Revenue Service,
Statistics of Income Bulletin, (Winter 1984-1985, Winter 1986-1987,
Winter 1990-1991, Winter 1993-1994, Winter Fall 1995, Winter Spring
1996, Fall 2001, and Winter 2002-2003).
\10\ Craig Copeland, ``Retirement Plan Participation and Features, and
the Standard of Living of Americans 55 or Older,'' EBRI Issue Brief
Number 248 (Washington, D.C.: Employee Benefit Research Institute,
August 2002), Figure 2, p. 8.
\11\ Multiple employer plans (MEPPs) are controlled by a single plan
document (for this reason they are technically classified as a type of
single employer plan) and do not involve a collective bargaining
agreement. The employers usually have some kind of connection short of
common ownership (``controlled group'' status), and the (typically
employer) contributions are pooled in a single trust. Fiona Wright,
``Working Paper on Pooled Multiple Employer Pension Plans'', mimeo, May
2003.
\12\ Leslie B. Kramerich, ``Confronting the Pension Coverage
Challenge,'' A Report on the Conversation on Coverage Convened by the
Pension Rights Center, July 24-25, 2001, p. 42. From the web site at
http://www.pensioncoverage.net/pdfs/whitepaper.pdf. The report
discussed recommendations for pooled arrangements noting that these
would be appealing to small businesses while also being a good vehicle
for covering part-time and contingency workers.
\13\ Lifestyle or life cycle funds allocate funds across the three main
asset classes: equities, bonds and cash. For participants who wish to
make a choice, there will be a simplified offering of fund options to
be determined by the clearinghouse.
\14\ The Internal Revenue Code's Section 408(a)(2) designates what
institutions can offer an IRA (banks, credit unions and State
corporations chartered by the commissioner of banking, and 401(n)
defines what a bank is. Some non-bank financial organizations that
offer IRA's often have affiliates that meet the definition of a bank.
In addition, the trustee of an IRA can also be ``a person other than a
bank,'' but such a person or entity has to apply to the Commissioner of
the Internal Revenue Service to demonstrate that it can ``act within
the acceptable rules of fiduciary conduct.'' The particulars for this
requirements are spelled out in Treasury Regulations 1.408-2(e)(6).
\15\ So-called 529 plans are college savings programs established and
administered by the States. They are named 529 Plans after the IRS code
section that outlines the details of the plans.
\16\ The 2003 Small Employer Retirement Survey found that 73 percent of
small business would be more likely to start a plan if it did not
require employer contributions.
\17\ A basis point is one one-hundredth of a percentage point. Thus,
100 basis points equal 1 percentage point.
\18\ The group did not explore in any detail what sort of prohibited
transactions might be required in a fiduciary regime. The Employee
Retirement Income Security Act (ERISA) of 1974, for example, sets forth
a list of prohibited transactions to which employee benefit plans are
subject. The Investment Company Act, which governs mutual funds and
brokerage firms, also has a list of prohibited transactions, but not as
extensive as ERISA.
\19\ Withdrawals at age 70\1/2\ are based on life expectancy under a
uniform IRS table or the joint life expectancy of the participant and
his or her spouse if the spouse is more than 10 years younger than the
participant.
\20\ Since the Model T is a defined contribution plan, it follows
current law applicable to such plans, but only on the portion that can
be withdrawn as a lump sum, and only then if the plan does not offer an
annuity on that portion. This policy is based on that fact that defined
contribution plans are not required to offer an annuity provided the
spouse receives 100 percent of the account balance if the employee dies
while covered by the plan. However, current law also states that if the
plan does not offer an annuity and the employee does not die while
covered by the plan, the employee can withdraw the account balance as a
lump sum or other non-annuity payment without spousal consent when the
employee leaves the plan. Thus, if the plan offered an annuity on only
50 percent of the balance, then the lump sum could be taken out without
spousal consent. However, if the plan offered an annuity on the entire
balance, with the option of a lump sum on 50 percent, it would require
spousal consent to take the benefit as a lump sum. Some members
suggested that the process of obtaining consent for the annuity portion
should be streamlined to reduce administrative costs, while others
insisted that the current form of consent--a signature on paper--must
be obtained to protect spousal rights.
\21\ Enacted into law in 2001, the Saver's Credit was first available
in 2002 and is slated to end in 2007. The Saver's Credit can reduce the
Federal income tax a worker pays dollar for dollar. The amount of
credit that one can receive is based on one's contributions into an
IRA, 401(k), and other retirement saving plans. The Saver's Credit is
part of the Economic Growth and Tax Relief Reconciliation Act of 2001.
The Saver's Credit is also available for contributions to 403(b) plans,
457 governmental plans, SIMPLE 401(k) plans or SIMPLE IRA's. The
Saver's Credit works as follows: For married couples filing jointly,
workers with income up to $30,000 are eligible for a 50 percent Saver's
Credit for their contributions into a saving plan. Married couples
earning $30,001 to $32,500 are eligible for a 20 percent credit, and
married couples filing jointly earning $32,501 to $50,000 are eligible
for a 10 percent credit. Those earning over $50,000 are not eligible
for a credit. For single people or married people filing separately,
the Saver's Credit is available for 50 percent of contributions for
workers with incomes up to $15,000. Workers with incomes between
$15,001 and $16,250 can obtain a 20 percent Saver's Credit. Single
workers and married people filing separately who earn between $16,251
and $25,000 can receive a 10 percent Saver's Credit on contributions.
Slightly different earnings levels qualify a head of household: (50
percent for incomes up to $22,500; 20 percent for incomes $22,501 to
$24,375; and 10 percent of incomes $24,376 to $37,500).
[Whereupon, at 11:44 a.m., the joint committee forum was
adjourned.]