VOL. 24, NO. 4
WINTER 2011
BENEFITS LAW
JOURNAL
From the Editor
Saving Private Pension Plans:
Reversing Regulations That Hurt
Those They Intend to Help
M
y bookshelves groan with the weight of thousands of pages of
laws, regulations, and IRS rulings designed to encourage employers to include their lower-paid workers in their retirement plans and
keep the plans from providing management and other high-paid
employees with “too much” in benefits. The fact is, ever since creation of the federal income tax in 1913, Democrats and Republicans
alike have maintained a love/hate relationship with retirement plans.
Even as Congress trumpeted its efforts to make plans “fair” for lowerpaid workers, legislators were bemoaning the consequent “lost” revenue. (The feds view allowing taxpayers to keep their own earnings
as a loss to the government.) As early as 1937, President Roosevelt
attacked pension plans as “a legal [but] highly immoral avoidance of
the intent … to collect revenue from those able to pay.”
Incredibly, at almost no time during this century-long regulatory crusade did the federal government ever step back to consider
which—if any—of these rules had its intended effect. About the closest the federal government came to an inward look at whether its
regulations were actually working seems to have occurred during a
1981 Presidential Commission which observed that pension plan participation “was not expected to increase significantly under current
policies.” Yet over the next 30 years, Congress added to the cascade
of benefits legislation—and buried its collective head in the sand on
whether any were hitting the mark.
The current state of pensions provides clear evidence that these
regulatory efforts backfired in some serious respects. Imposing limits on
From the Editor
contributions and benefits for executives and other high-paid employees effectively decoupled worker and management benefits, giving
employers an incentive to curtail and even abandon defined benefit
(DB) plans. Indeed, nonqualified executive-only plans were born in the
wake of ERISA’s (Employee Retirement Income Security Act) first-ever
introduction of caps on pension benefits.
An excellent paper published in 2000 by a college professor and
two actuaries came to that very conclusion. It found that “changes in
pension regulations have not expanded coverage among low-income
workers” and actually curtailed future benefits for many middle and high
income workers. (Clark, Mulvey, and Schieber, “The Effects of Pension
Nondiscrimination Rules on Private Sector Pension Participation.”)
Over-regulation clearly isn’t the only headwind faced by pension
plans, but it’s the only one Congress can do anything about. The
government needs to examine which forms of regulation actually
work, instead of relying on untested intuition concerning what it
thinks should work. Also, a realistic understanding is needed of the
actual tax revenue “lost” as a result of employee retirement plans.
I’ll cover the revenue side in a future column. For now: why are
DB plans spiraling into oblivion (the number of terminations far
exceeds plan adoptions and active participation levels are rapidly
shrinking) and what can be done to reverse course?
THE RISE
To understand the fall of DB plans, it’s crucial to first review the reason for their rise in popularity. Workers’ coverage in private sector pension plans hit its heyday after World War II, when companies of all sizes
adopted DB plans in droves. By 1960, some 15 million people—over
one third of all full- and part-time employees—had coverage. By 1970,
coverage hit 21 million. The most likely factors: a booming economy
and increased hiring, high income tax rates (maximum rates during this
period ranged from 70 to 92 percent), and the Supreme Court’s 1949
Inland Steel decision, which made pension benefits subject to collective
bargaining. In the 1960s and early 1970s, the number of participants
continued to grow, but only at roughly the rate that the workforce itself
was expanding. Importantly, however, employers began voluntarily
adding and liberalizing plan vesting rules, so while coverage rates had
leveled off, participants were much more likely to actually receive a
benefit than earlier generations. Eventually, coverage of part- and fulltime private sector employees stabilized at around one in three.
THE PLATEAU
The initial fallout from the 1974 passage of ERISA was a wave of
plan terminations. In 1975 and 1976 alone, over 13,000 DB plans were
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From the Editor
terminated, many by small employers (with fewer than 100 employees)
who concluded that the out-of-pocket cost of compliance outweighed
the benefits. However, the pension world did not end with ERISA, and
eventually the overall level of participation continued to grow, with
enrollment reaching a peak of nearly 41 million participants (including
retirees and vested former employees) in 1984. (As noted below, the
sketchiness of available participation data makes it difficult to perform
an apples-to-apples analysis of coverage levels through the decades.)
THE FALL
The decline began in the mid 1980s. From 1984 to 2004, the number of active pension plan participants fell from 23 million to 16 million, even as the US labor force continued to grow. According to the
PBGC (Pension Benefit Guaranty Corporation), the decline was most
pronounced with small employers, where the number of plans plummeted from 90,000 to slightly under 18,000. At the same time, many
larger employers instituted “soft” freezes, closing their plans to new
hires. Since 2004, the number of these soft and hard freezes (in which
existing participants also stop earning benefits) has steadily risen.
SKETCHY DATA
The lack of a consistent federal government methodology for
capturing pension plan data makes it difficult to uncover and analyze the historical trends. For example, much of the published data
failed to distinguish between active and total (including retirees and
vested former employees) participants, or sometimes (but not always)
excluded part-time, young, and/or agricultural workers, or focused
only on those employed by either large or small employers. Some
data relied on surveys rather than hard counts and, worse, often was
unclear whether it considered all retirement plans or just DB plans.
While the statistics on current participation rates are quite useful, it’s
hard to go back in time and reconfigure the old data. That makes
it tough to get a clear reading of what the long-term trends are, let
alone what they mean. (Here I must extend my heart-felt gratitude
and thanks to Barbara Tanzer, a superb law librarian, who helped
uncover and make sense of the available information.)
OUTSIDE FORCES
Economic forces outside the control of Washington seem to be
one factor in the decline of pension plans. Pension coverage was
always dominated by manufacturing and unionized employers, so
that the shift to a more service-based economy coupled with shrinking union membership led to a corresponding decrease in pension
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From the Editor
participation. One economist at the Bureau of Labor Statistics estimated that declining union membership caused a 5 percentage point
decrease in pension participation between 1992 and 2003. (William
Wiatrowski, “Declines in Benefits,” Monthly Labor Review, August
2004.) Additionally, while the bull market of the 80s and 90s allowed
employers to reduce or totally skip cash contributions to their plans,
subsequent trends of poor investment returns and declining interest rates (which increase reported pension liabilities) dramatically
escalated employers’ pension costs. Further, as markets and interest
rates were gyrating, the accounting rules for reporting pension costs
and liabilities were in a constant state of revision, giving heartburn
to corporate chief financial officers. Finally, another supposed factor
was the reported disinterest in DB plans among job-hopping Baby
Boomers, who were never going to be around long enough to earn
a meaningful pension (or perhaps even grow old). But as these same
Boomers approach retirement, many are now bemoaning the fact
that they don’t have a guaranteed pension to look forward to, perhaps showing that job-hopping wasn’t as big a cause as previously
thought.
GOVERNMENT POLICY
The decline in pension coverage also coincided with a slew of new
legislation intended to encourage participation by making plans more
“fair” and limiting benefits to highly paid employees. The theory was that
restricting benefits to senior managers would coerce them to increase rank
and filers’ benefits to protect their (managers) own pensions. Plus, the
new rules were viewed as a populist revenue raiser, since they reduced
the amount of taxes that could be deferred by highly paid workers.
What follows is a quick look at several decades of alphabet soup legislation aimed at pension “reform”—and the unintended consequences.
•
1974 ERISA. The granddaddy of retirement plan legislation
instituted some much-needed improvements to the vesting,
fiduciary governance, and funding rules. However, ERISA
also established the Internal Revenue Code “Section 415
limits,” imposing a $75,000 annual cap on pension benefits
(or 100 percent of pay, if lower) and a $25,000 limit (or 25%
of pay, if lower) on employer contributions to a profit sharing or other defined contribution (DC) plan, with both limits
indexed for inflation. Had Congress not thereafter periodically meddled with cost of living indexing, today the caps
would be around $315,000 and $105,000, respectively.
•
1982 TEFRA (Tax Equity and Fiscal Responsibility Act).
Succumbing to calls for more “fairness” (and more revenue),
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From the Editor
Congress trimmed the annual cap on pensions to $90,000 a
year and the DC ceiling to $30,000 (a steep cut from the then
limits of $136,425 and $45,475). Future inflation adjustments
were postponed to 1986. TEFRA also added the infamous
“top-heavy” rules targeting small business, which imposed
minimum benefit and vesting, as well as a $200,000 limit on
compensation that could be counted in calculating benefits.
•
1984 DEFRA (Deficit Reduction and Fiscal Responsibility
Act). Congress extended the freeze on the $90,000 and $30,000
Section 415 benefit limits by an additional year, to 1987.
•
1986 TRA (Tax Reform Act (TRA ’86). The most significant change in this dense layer of new regulation affected all
higher-paid employees by imposing a $200,000 limit on the
compensation that could be counted in figuring their pensions and other retirement benefits. Congress also reduced the
Section 415 limits further by imposing lower limits on early
retirement benefits. TRA ’86 also tightened the integration rules
by reducing the bump-up in benefits for employees earning
above the Social Security wage base and replaced the undefined “pornography, I know it when I see it” nondiscrimination standard with a bright-line definition of “highly compensated employees” and precise mathematical testing formulas.
(Incredibly, TRA ’86 also would have penalized individuals
whose DB or DC payments were “too large,” although this
poorly conceived “success” tax was subsequently repealed.)
•
1993 OBRA (Omnibus Budget Reconciliation Act). After
taking a breather from its pension meddling, Congress once
again slashed the maximum compensation that could be
considered in benefits calculations from an inflation-adjusted
$235,840 to $150,000.
•
Ongoing Anti-Funding Rules. Washington’s schizophrenic
approach to pension regulation is perhaps best evidenced by
the labyrinth of rules both limiting and increasing employer
contributions to DB plans. In a nutshell, the government’s
approach is to punish both under- and over-funding of plans.
ERISA struck a blow against sound financial management by
limiting funding to previously earned benefits but prohibiting employers from sensibly socking away extra money
in flush times against the inevitable rainy day. (The rule
punishing rainy day contributions was curtailed by the 2006
Pension Protection Act.) Worse, TRA ’86 added a 10 percent
excise tax on an employer’s recapture of any over-funding
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From the Editor
on a plan termination, prompting many employers to terminate their plans before the tax kicked in. In 1990, the tax
on reversions was increased to 50 percent (20 percent if the
excess was used to pay certain retiree health benefits). For
an excellent analysis of how the funding rules harm pension
plans, see John Kilgour’s “The Pension Plan Funding Debate
and PPA” in the Fourth Quarter 2007 Benefits Quarterly.
Ironically, the group most likely to be harmed by these rules has
been some of their intended beneficiaries, i.e., part-timers and the
lowest-paid employees. Based on my clients’ actions over the past
30 years, it’s clear to me that pushing down on the benefits of more
highly paid employees hasn’t resulted in better benefits for everyone
else. Without benefit limits and compensation ceilings, everybody
eats out of the same pot. Before the benefit and compensation limits
were imposed, small business owners and public company CEOs
alike (and the employees advising the bosses) were very aware that
if they wanted a pension equal to half their pay, they had to offer the
same benefit to their rank and file. But limiting management’s pensions means they have to provide disproportionately higher benefits
to those lower down the salary scale or, worse, makes it impossible
for the moguls to receive a significant (for them) benefit. The natural
reaction is, “why bother?” Unfortunately, it became preferable for
employers to just eliminate the defined pension plan altogether and
compensate the top tier in some other manner.
Our government cannot legislate solid stock market returns or bend
the global economy to its will. But it can rewrite the current poorly
conceived rules to give small and large employers a reason to create,
or at least to maintain, pension plans. While it may be politically incorrect, Congress should start by removing the benefit and compensation
ceilings to increase pension coverage for workers generally. And, as
I’ll show in a future column, it won’t cost the feds a dime.
David E. Morse
Editor-in-Chief
K & L Gates LLP
New York, NY
Copyright © 2011 CCH Incorporated. All Rights Reserved.
Reprinted from Benefits Law Journal Winter 2011, Volume 24,
Number 4, pages 1-6, with permission from Aspen Publishers,
Wolters Kluwer Law & Business, New York, NY, 1-800-638-8437,
www.aspenpublishers.com
Law & Business
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