ERISA at 50: A New Model for the
Private Pension System
Pamela Perun and C. Eugene Steuerle
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Occasional Paper Number 4
URBAN INSTITUTE
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ERISA at 50: A New Model for
the Private Pension System
Pamela Perun and C. Eugene Steuerle
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Occasional Paper Number 4
T
The Retirement Project
ABOUT THE SERIES
THE RETIREMENT PROJECT IS A MULTIYEAR
research effort that will address the challenges and opportunities facing private and public retirement policies in the
twenty-first century. As the number of elderly Americans
grows more rapidly, Urban Institute researchers will examine this population’s needs. The project will assess how
current retirement policies, demographic trends, and
private-sector practices influence the well-being of older
individuals, the economy, and government budgets.
Analysis will focus on both the public and private sectors
and will integrate income and health needs. Researchers
will also evaluate the advantages and disadvantages of
proposed policy options. Drawing on the Urban Institute’s
expertise in health and retirement policy, the project will
provide objective, nonpartisan information for policymakers and the public as they face the challenges of an
aging population. All Retirement Project publications
can be found on the Urban Institute’s Web site,
http://www.urban.org. The project is made possible by a
generous grant from the Andrew W. Mellon Foundation.
This study was made possible by a generous grant from the
J.M. Kaplan Foundation.
Copyright © March 2000. The Urban Institute. All rights reserved. Permission is
granted for reproduction of this document, with attribution to the Urban Institute.
The nonpartisan Urban Institute publishes studies, reports, and books on timely
topics worthy of public consideration. The views expressed are those of the authors
and should not be attributed to the Urban Institute, its trustees, or its funders.
Table of Contents
About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ERISA at Zero . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ERISA at 25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
ERISA at 50 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Coda: Retire ERISA at 65 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Endnotes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Appendix. Summary of Selected Rules circa 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
FIGURES AND TABLES
Figure 1. ERISA at Zero . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Figure 2. ERISA at 25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Figure 3. ERISA at 50 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Figure 4. ERISA at 65 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Appendix. Summary of Selected Rules circa 2000: Part 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Appendix. Summary of Selected Rules circa 2000: Part 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ABOUT THE AUTHORS
PAMELA PERUN IS A CONSULTANT TO THE
Retirement Project at the Urban Institute. She holds a law
degree from the University of California at Berkeley and a
Ph.D. in developmental psychology (adult development
and aging) from the University of Chicago. She has practiced as a benefits lawyer for 10 years in Boston and Washington, D.C., and also has held research appointments at
Duke University, Wellesley College, and Harvard Medical
School.
C. Eugene Steuerle is a senior fellow at the Urban
Institute and author of a weekly column, “Economic Perspective,” for Tax Notes magazine. He has worked under
four different U.S. presidents on a wide variety of social
security, budget, tax, health, and other major reforms,
including service both as the deputy assistant secretary of
the Treasury for tax analysis (1987–89) and as the original
organizer and economic coordinator of the Treasury’s
1984–86 tax reform effort. He is the author or coauthor of
over 150 books, articles, reports, and testimonies, including the recent Urban Institute Press books The Government
We Deserve: Responsive Democracy and Changing Expectations, Retooling Social Security for the 21st Century, The New
World Fiscal Order, Serving Children with Disabilities, and The
Tax Decade.
ERISA at 50:
A New Model for the
Private Pension System
INTRODUCTION
IN 1999, THE EMPLOYEE RETIREMENT
Income Security Act of 1974 (ERISA), the primary law
regulating the private pension system, turned 25.1 For the
most part, people agree that ERISA is showing its age and
is in need of substantial reform. However, few agree on
the shape such reform should take.2 Since its enactment,
ERISA has expanded in often unanticipated and irrational
ways. As a result, the private pension system is now burdened with overly complex rules, regulations, and plan
types that inhibit its ability to generate adequate retirement income to millions of Americans. This paper proposes a new model for ERISA of vastly simplified plans
and rules intended to make the private pension system
more accessible by employers and employees alike.
ERISA AT ZERO
Twenty-five years ago, the pension world was a much
simpler place. This was the basic structure of the U.S.
pension system circa 1974 (figure 1).
ERISA, as originally conceived, was a sensible and
rational approach to pension regulation. Its primary goal
was to create a basic regulatory framework for the U.S.
pension system that would remedy perceived inadequacies in participant rights and enforcement, benefit security, funding adequacy, and government oversight.3 The
expectation was that the reforms embodied in ERISA
would, in the long run, foster the expansion of the pension system.
In some respects, it was a revolutionary statute. It
established requirements for reporting and disclosure
and standards for fiduciary responsibility, administration,
and enforcement where previously none existed. In
other respects, it was largely evolutionary. It reformed
tax code rules for retirement plans that had been evolving over the previous 50 years for eligibility, participation, coverage, vesting, benefit accrual, and funding.
ERISA, at birth, gave us a comprehensive set of rules
designed to promote uniformity, consistency, and predictability in the pension system. It was a difficult and
complex statute, but it was also a practical and workable
statute whose reforms were well reasoned and well
intentioned.
FIGURE 1.
ERISA at Zero
ERISA at Zero
§ 401(a)
Qualified
Plans
Defined
Benefit Plans
Money
Purchase
Stock Bonus
Defined
Contribution
Plans
Profit Sharing
§ 403 TaxSheltered
Annuities
§ 403(a)
Annuities
Thrift
Executive
Compensation
Arrangements
§ 403(b)
Arrangements
Employee
Contributions
Only
Employer
Contributions
ERISA was a product of its time. It was based on the
assumption that defined benefit plans would be the mainstay of the pension system. It emphasized replacement
ratios, rather than account balances, as a measure of pension adequacy. The long-term viability of such plans,
which contain an inherent age bias, was not questioned,
even though the baby boom was just then entering adulthood and the demographic significance of such a large
cohort was well recognized. Nor did ERISA’s proponents consider how plans should evolve if life expectancies increased and the demand for labor changed. ERISA
may have been appropriate for the benefits world of its
day, but many of the design decisions made 25 years ago
have since proven problematic.
ERISA AT 25
Life has gotten more complicated in the last 25 years,
and the U.S. pension system is no exception (figure 2).
The number and types of plans continue to multiply.
Special purpose plans, such as employee stock ownership plans (ESOPs), have been invented or expanded.
Families of plans, such as simplified employee pension
plans (SEPs) and individual retirement account–based
savings incentive match plans for employees (SIMPLE
IRAs), have been created for special employers, such as
small businesses. Plans with special tax rules, such as
Roth IRAs, have also been made available. New plan
designs, such as cash balance plans and 401(k) plans,
have transformed older plan formats.
ERISA’s regulatory framework has also become more
elaborate. In the past 25 years, successive pieces of legislation have modified the operation of the pension system,
almost always in a patchwork fashion. While the basic
framework set in place by ERISA remains, critical elements of its infrastructure—funding, participation, coverage, vesting, and nondiscrimination—have been
continually amended.4 Some of these changes had laudable outcomes. For example, the acceleration of vesting
requirements improved worker ownership of benefits.
Spousal rights to survivor benefits have been strengthened. Others had positive intentions but more mixed
results. For example, the development of quantitative
nondiscrimination rules and similar measures had the
positive intention of promoting pension equity for
lower-paid workers but may have induced the negative
outcome of reducing plan sponsorship by small businesses. Despite their potential merits, the sheer accumulation
of changes has added multiple layers of complexity to
ERISA. The appendix illustrates some of the basic rules
that apply to the more common types of plans in 2000.
This modest summary requires four pages of charts, and
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P R O J E C T
it does not attempt to discuss multiple plan interactions,
different rules for different employers, or instances in
which ERISA does and does not apply.
Over the past 25 years, the tax code has spawned an
extraordinary number of incentives for saving, each
with its special plan design and its own separate limits,
exceptions, and requirements. At the same time, the
pension system is also vulnerable to changes in the fiscal health of the federal budget. When times are tight,
the pension system is an obvious candidate for raising
additional tax revenues. During these times, pension
tax provisions are amended to restrict contributions and
tighten other limits. For example, the reimposition of
limits on deductible contributions to IRAs in the 1980s
was in part designed to finance tax reform. When times
are flush, Congress becomes generous in offering new
ways to save. For example, previously imposed limits
are often raised or there is a political desire to do something new so even more savings incentives are created.
By the time the cycle is complete, pension law has
become more complex and less rational.
Current proposals to change pension law illustrate
this process well. With budget surpluses available, the
pendulum has swung away from the contribution
restrictions and cutbacks prevalent during the past 15
years. Many legislators now advocate adding new
incentives for saving, such as more Roth IRA−like contributions, to the private pension system. Others would
like to expand the current system with an upward
adjustment to almost all existing limits on contributions.
A number of such proposals were incorporated into the
Taxpayer Refund and Relief Act of 1999, vetoed by
President Clinton, and may be added to other bills in
the near future. If enacted, these changes would substantially reverse the direction that pension policy has
taken in recent years. Whatever their economic merits,
these changes would inevitably add more regulatory
complexity to plan administration.
POPULAR PROPOSALS INCLUDE:
·
·
·
·
·
·
Increasing the amount of allowed annual contributions by employers and employees.
Counting higher amounts of compensation
in benefit calculations.
Permitting Roth IRA−type contributions in
employee savings plans.
Creating “catch-up” elections for more savings by older employees.
Relaxing nondiscrimination, top-heavy, and
coverage rules for qualified plans.
Enhancing portability of benefits between
plans and IRAs.
FIGURE 2.
ERISA at 25
ERISA at 25
§ 403 TaxSheltered
Annuities
§ 401(a)
Qualified
Plans
Defined
Benefit Plans
ERISA at 50: A New Model for the Private Pension System
Traditional
Defined
Contribution
Plans
Money
Cash
Balance Purchase
ESOPs
With
401(k)
Feature
Stock
Bonus
§ 403(a)
Annuities
Thrift
Without
401(k)
Feature
§ 403(b)
Arrangements
Individual
IRAs
Employee
Employer
Profit
Contributions
Contributions
Sharing
Only
With
401(k)
Feature
SIMPLE
401(k)
Without
401(k)
Feature
Standard
401(k)
Nonqualified
Deferred
Compensation
§ 408, § 408A
IRAs
Regular
IRAs
Employer IRAs
Roth
IRAs
SEP
IRAs
§ 457(b)
Plans
SIMPLE
IRAs
Executive
Compensation
Arrangements
§ 457(f) Plans
for
Governmental
Tax-Exempt
Employers
Plans of
Other
Employers
3
Pension law has also grown more complex because of
the tax code’s carrot-and-stick treatment of employers.
On the one hand, Congress provides tax incentives to
encourage employers to sponsor plans. On the other
hand, it developed layers of complex rules to inhibit
employers whom it fears will abuse those tax incentives
by providing substantial benefits only to high-paid workers. For example, top-heavy rules, permitted disparity
rules, controlled group rules, leased employee rules, coverage rules, and affiliated service group rules ensure that
employers provide at least some benefits to low-paid
workers as well. In addition, the nondiscrimination rules
themselves (which measure whether employers have
been too generous to high-paid workers) further control
employer discretion but increase the costs of compliance.
Of course, not all blame for the complexity of pension
law belongs to Congress. Lobbyists often seek special
benefits provisions or fight simplification efforts on behalf
of their clients. Benefits practitioners, who rarely take
the lead in promoting simplification proposals, also share
some of the responsibility. Practitioners are not likely to
question a proposed rule’s underlying rationale; instead,
they focus on the legal minutiae required to keep their
clients in compliance. Perhaps simplification seems too
difficult to achieve, or the status quo appears reasonable
enough.
As a result, ERISA is no longer a sensible or practical
statute. The pension system it governs is an uncoordinated jumble of plans, with a labyrinth of rules and regulations. The following are a few of its most frustrating
characteristics from a legal perspective:
Complexity: There are too many rules. Most plans
require, in addition to in-house benefits staff, an army of
outside experts—attorneys, accountants, actuaries, consultants, record-keepers, investment professionals, and
communication specialists—just to keep plans in compliance with existing laws. The rules also change constantly, usually in the direction of greater complexity. Prior
to ERISA, IRC § 401(a), the major tax statute for pension plans, ended with IRC § 401(a)(10). In 1999, it
ended with IRC § 401(a)(34). This averages out to one
fundamental legal requirement added each year since
ERISA was enacted.
Uncertainty: The rules are almost never clear. Even
when statutes appear straightforward, voluminous pages
of regulations are required to explain their application to
various situations. Because benefits law questions are
heavily fact-specific, even those regulations cannot
address all issues. When the law changes, as it often does,
regulatory guidance follows slowly, leading to further
uncertainty. For example, the nondiscrimination rules
for qualified plans were changed by the Tax Reform Act
of 1986 to more quantitative standards. Those changes
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P R O J E C T
affected many other sections of pension law. The new
rules were to become effective as of January 1, 1989.
But because the changes were so extensive, regulatory
interpretation evolved only over a number of years. The
rules were not actually finalized until the early 1990s and
finally became effective only as of January 1, 1994. In
the interim, plans lived in compliance limbo. The pension system is supposed to be a self-regulating system, but
employers often find even substantial compliance to be
difficult given the legal uncertainties created by the sheer
volume of rules.
Inconsistency: There are more exceptions than
rules. Not all rules apply to all employers, contributions,
or plans. Some, though not all, types of contributions are
subject to Social Security taxes. A defined benefit plan
sponsored by a for-profit employer is heavily regulated,
but the identical plan sponsored by a state or local government employer escapes most regulation. The same is
true of employee savings plans. A 401(k) plan, used primarily by corporate employers, must comply with difficult regulations that require complicated annual testing
procedures. This is less true of 403(b) arrangements for
tax-exempt employees and 457 plans for governmental
employees, which are minimally regulated at the
employer level.
Volatility: The rules often flip-flop. For example,
tax-exempt employers could choose to sponsor new
401(k) plans before July 2, 1986, and after December 31,
1996, but not in the interim. Before 1989, taxpayers
who continued to work after age 70½ were not required
to begin taking plan distributions until they actually
retired; however, between 1990 and 1996, they were.
Since 1997, the old rule that no distributions are required
until actual retirement has been reinstated. The Taxpayer Refund and Relief Act of 1999 would have largely
repealed the complicated nondiscrimination regulations
authorized by the Tax Reform Act of 1986 and finalized
just five years ago.
Any change, even if relatively insignificant legally,
imposes new costs on plans that must be paid either by
plan sponsors or participants. These costs add to the
already considerable expenses required to keep a plan in
compliance with existing rules every year. Every time a
rule is rewritten, a special exception is provided, or a new
incentive is created, plan documents must be drafted or
redrafted in a form approved by the Internal Revenue
Service. Participant disclosure materials and plan forms
must also be rewritten. Record-keeping, tax reporting,
investment data, and other information processing systems often must be modified.
There are additional costs, not related to taxes, generated by this complexity. Employers, and indirectly
employees, bear the costs of the in-house benefits per-
sonnel required to administer each plan. Other costs are
usually borne more directly by the plan and, ultimately,
plan participants. These costs include Pension Benefit
Guaranty Corporation (PBGC) premiums, in the case of
a defined benefit plan, and the fees of the outside consultants and advisers required to keep the plan in compliance with applicable law. There are, in addition, custody
and trustee costs related to the fiduciary requirements for
holding and investing plan assets. The investments themselves involve investment management fees, transaction
costs, operating expense fees, account maintenance fees
in the case of mutual fund investments, sales charges,
redemption fees, premium taxes, and so on.
The cumulative effect of all these separate costs,
charges, and expenses has been masked in recent years by
the performance of the stock market. However, they
inevitably reduce the rate of return obtained by pension
plan assets and, in the case of defined contribution plans,
the amount of retirement income ultimately payable to
plan participants. The cost of this complexity extends
beyond the pension system to society as a whole. Its true
cost is an expensive and inefficient pension system that
provides insufficient benefits to many workers and no
benefits to many more.
The fact that ERISA is now a partially dysfunctional
statute would generally be of interest only to benefits
practitioners. But ERISA is not an ordinary statute. It
affects virtually every American because it is the prime
mechanism, other than Social Security, through which
people accumulate private resources for retirement. For
this reason, we have great need for it to perform better.
From a societal perspective, one of the most important
issues for the next 25 years will be the aging of the U.S.
population. Due to increases in longevity in the twentieth century, more people are living long enough to retire
and are living longer in retirement. In addition, the
number of retirees is scheduled to increase rapidly once
the baby boomers begin to retire in large numbers.
Already over half of the civilian programmatic spending
in the federal budget goes to the elderly. The long-term
ability of Social Security and Medicare to continue paying the current level of benefits is in question. Government spending on retirees is now growing faster than the
economy.5 Close to one-third of the adult population
will soon be either retired or disabled if current patterns
hold.
Currently, the majority of elderly Americans rely on
Social Security as their primary source of retirement
income and about 40 percent rely on it almost exclusively. Yet Social Security benefits were never intended to
serve as the sole source of retirement income; they were
meant to be supplemented with personal savings and
pension income. However, personal savings rates have
been declining for decades and today many workers are
not preparing for retirement by saving on their own.
Those who do save may not be able to accumulate sufficient assets to maintain their preretirement standard of
living.6 Although the government is now promoting
educational campaigns on the importance of saving for
retirement, it is unlikely that they will have more than
marginal success.
Without additional private resources, the financial
demands created by an aging society will be difficult to
meet, and generating those additional resources will also
be difficult. Through a combination of Social Security,
pension income, and private savings, those in the top half
by income have the capacity to prepare for the 20 or so
years of retirement that is now the norm. Providing those
in the bottom half with the means to accumulate private
resources remains a difficult societal problem.
The pension system has a critical role to play in the
next 25 years. It could mitigate the financial burdens of
an aging society in several important respects. For example, it could provide more incentives for people to retire
later and save more. It could also provide flexible benefits options for older workers. It could promote more
plan funding by employers and expand plan participation
by employees. However, 1999 pension coverage rates
are not much different from those in 1974. At any point
in time, fewer than 50 percent of workers are participating in a retirement or savings plan, a figure that has not
changed since the 1970s (U.S. General Accounting
Office 1997). Although many of these workers will at
some point be covered by a plan, overall participation
rates have been falling in recent years.7 Moreover, aggregate pension benefits are unevenly distributed. Bettereducated, longer-service, full-time, higher-paid
employees at larger companies, especially federal and state
government employees, get the majority of pension benefits.
In one important respect, the pension system in 1999
is unlike its 1974 version and produces a very different
type of retirement income. The number of defined benefit plans that usually provide a guaranteed lifetime
income in retirement has fallen by 60 percent since 1984.
Although the actual number of workers covered by
defined benefit plans has not decreased significantly, the
ratio of active to retired employees covered continues to
decline (Private Pension Plan Bulletin 1999: 2). Few
new defined benefit plans are being established, with the
possible exception of plans for professional corporations
or sole proprietorships covering only a small number of
workers. However, defined contribution plans, which
provide retirement income based on individual account
contributions and their investment earnings, are thriving.
Today, defined benefit plans are commonly found only
ERISA at 50: A New Model for the Private Pension System
5
in large companies while defined contribution plans are
prevalent among companies of all sizes. In 1975, 32 percent of workers with employer plans participated in a
defined contribution plan and 87 percent participated in
a defined benefit plan. By 1995, 81 percent of similar
workers were covered by a defined contribution plan and
51 percent by a defined benefit plan (Private Pension
Plan Bulletin 1999: 3). Defined benefit and defined contribution plans held roughly the same amount of assets in
the aggregate in 1995, but defined contribution plans
received more in contributions ($117 billion for defined
contribution plans and $41 billion for defined benefit
plans) and paid out more in benefits ($98 billion for
defined contribution plans and $85 billion for defined
benefit plans) (Private Pension Plan Bulletin 1999: 3, 8).
While employers now favor defined contribution
plans, the stunning growth of 401(k)-type plans is
employee driven. Although a 401(k) plan is employer
sponsored, its primary attraction is that it allows employees to decide whether, and how much, to save on a pretax basis. In 1984, there were only 17,000 of these plans.
By 1995, they had increased 10-fold to about 200,000,
and there were an estimated 320,000 in 1998. The number of workers participating in them has also increased
exponentially from about 7.5 million employees in 1984
to 34 million in 1998 (Private Pension Plan Bulletin
1999: 86).8 Despite the additional cost of Social Security taxes on contributions by employees to 401(k)-type
plans, employers who sponsor such plans increasingly use
them as their only plans.9 Although employers can and
do contribute to these plans, employees contribute more
in the aggregate than employers to 401(k)-type and other
defined contribution plans (Private Pension Plan Bulletin
1999: 3).10
The popularity of defined contribution−type formats
has had an effect on the structure of defined benefit plans
themselves. Many employers are adopting the increasingly common but controversial practice of converting
their traditional defined benefit plan into a cash balance
plan, a hybrid between a defined benefit plan and a
defined contribution plan. Employers fund cash balance
plans under traditional defined benefit plan rules, but
employees accrue benefits under defined contribution
plan−like rules. In a traditional defined benefit plan,
employees accrue benefits based on years of service and
compensation earned over a specified period. Employees accrue benefits under a cash balance plan through
hypothetical allocations to their accounts each year based
on their compensation and a specified interest credit.
Account accumulations determine the pension benefit
ultimately received. Conversions of traditional defined
benefit plans to cash balance plans have recently become
controversial because many older employees have found
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their expected benefits in the converted plan to be much
less than they would have earned for additional work
under their prior plan. This issue aside, cash balance
plans can be popular with employees because the format
is more appealing, younger workers earn larger benefits,
and benefits are more portable than under the traditional defined benefit plan.
The popularity of defined contribution plans, particularly 401(k)-type plans, and the decline in traditional
defined benefit plans have changed the U.S. pension system. In 1974, employers assumed responsibility for
sponsoring and funding the retirement income of their
employees. Today, individual workers take on much
more of the risk and responsibility for funding their own
retirements. There are several possible reasons for this
shift. For example, employers recognize the costs of providing benefits that replace a high ratio of preretirement
income for extended retirements. In addition, fewer
employees remain with one employer for substantial portions of their work lives, and both employers and
employees are attracted to the flexibility of defined contribution plans. The trend to defined contribution plans
increasingly funded by employees is expected to continue for the foreseeable future.
ERISA AT 50
About 50 bills proposing changes to one or more
aspects of ERISA were introduced in Congress last year,
and many were included in the vetoed Taxpayer Refund
and Relief Act of 1999.11 Most proposals were well
intentioned, but they all suffered from one common
defect: the assumption that the current system is worth
preserving in more or less its current form. They conserved the status quo while tinkering at the edges, changing this rule here and that limit there. They also sought
to add new types of plans and features to a system already
in regulatory gridlock. In short, they failed to demonstrate any broad vision about what ERISA could be.
The vision of ERISA at 50 presented here is predicated on the following observations:
There is a widely held belief that the key to fixing
ERISA is to get more employers to provide a plan,
especially a defined benefit plan, for their employees.
This is wishful thinking.12 It has not happened in the
past 25 years and there is no indication that it will happen in the future in the absence of, and possibly even
with, new or different incentives or true regulatory
simplification.
The primary growth in the pension system will continue to be in defined contribution and defined contribution−like plans, especially those permitting employee
savings but also with employer contributions.
·
·
P R O J E C T
defined benefit plans dominated the pension
· When
system, the rationale for structuring it through
employer-based plans and rules was clear. The
growth in plans where employees save their own
money for retirement, or employers act more as contributors than managers, calls this structure into question, although employers can play an important role in
encouraging employees to participate in these plans.
As employee savings plans become the primary engine
for generating retirement income, the adequacy of
such plans for moderate-income workers must be
addressed.
These observations lead to the following propositions. First, the pension system should be devoting
more of its resources to increasing employee savings.
This means concentrating more of its efforts on defined
contribution and defined contribution−like plans. It also
means rationalizing the means by which employees save
by standardizing the different types of plans now available. Second, while defined benefit plans will continue
to play an important role in generating retirement
income for millions of Americans, it is unlikely that
sponsorship of new defined benefit plans will increase
substantially in the coming years. However, existing
plans could be reformed to remove their disincentives
for employees to work longer. The pension system
should be exploring ways to make these plans more
age-neutral. Third, relying on nondiscrimination rules
to provide adequate benefits for moderate-income
workers is insufficient; new approaches will be
·
required, not only by themselves but in conjunction
with any simplification efforts as well.
Figure 3 illustrates one relatively modest proposal for
how ERISA might look at 50, based on these propositions.
At the heart of the proposal is the creation of a single,
standard form of defined contribution plan. It would
replace the multiple plan types now available as well as
the separate, “simplified” set of plans for small employers.
Such a plan is feasible because contributions to profitsharing plans no longer depend on employer profits,
which was the historical rationale for maintaining separate money purchase, stock bonus, and profit-sharing
plans. The plans continue to differ in terms of formula
(fixed or discretionary), spousal rights, limits on
deductible contributions, and benefits distribution (cash
or stock). Because these are not difficult design issues, it
should be relatively easy to compromise on a standard
form with sufficient flexibility to be attractive to small
and large employers alike.
The standard plan would also provide a simplified
option for employee savings. The current plans—401(k)
for corporate employers, 403(b) for certain tax-exempt
employers, and 457 for governmental employers—are
very similar in terms of the amounts employees are permitted to save. However, they operate under very different regulatory regimes designed for different types of
employers. Linking employees’ opportunities to save
with the tax attributes of their employer no longer seems
reasonable, in light of the need to increase personal savings for retirement.
FIGURE 3.
ERISA at 50
ERISA at 50
Defined Contribution Plans
Defined Benefit Plans
·
··
·
··
·
Coordinate normal retirement age (NRA)
with Social Security retirement age (SSRA)
Reduce early retirement subsidies
Reduce late retirement penalties
Provide incentives for part-time work and
phased retirement for older workers
Reduce disincentives for post-NRA work
Provide a minimum portable benefit for
short-term workers
Permit employees to purchase a larger
benefit or additional years of service
··
··
·
·
Single plan for all types of employers
Single eligibility standard
Same rules on withdrawals
Same rules on portability
Same deductible limit on contributions
by employees and employers
Same FICA-tax treatment for employee
and employer contributions
Government Matching
Contributions for Low- and
Moderate-Income Workers
Individual
Retirement
Accounts
Coordinated Limit on
Employee
Contributions
ERISA at 50: A New Model for the Private Pension System
7
The proposal also enhances the role played by IRAs.
Although IRAs were initially created to provide workers
without an employer plan with some means of taxdeferred savings for retirement, they have never really
developed their potential. While they are a popular
vehicle for rollover contributions, they remain a marginal, underperforming producer of new defined contribution savings. Under this proposal, IRAs achieve parity
with employer plans through a coordinated individual
savings limit. All workers, except perhaps the highestincome workers, without an employer plan would be
permitted the same level of deductible contributions as
workers covered by a standard plan. Thus, we retain a
simplified “discrimination” rule, but one based on total
employee plus employer contributions. Contributions
made to the standard plan would reduce the deductible
limit under the IRA and vice versa. Canada, for example, has had a similar arrangement for many years with its
IRA-equivalent Registered Retirement Savings Program
(RRSP). Canadian tax law establishes an individual taxdeferred savings limit similar to the IRC § 415(c) limit.
This limit is coordinated between contributions to an
RRSP and any employer plan. Using this model in the
United States would enable millions of Americans without an employer plan to increase substantially their savings for retirement.
Defined benefit plans raise a different set of issues.
Although it is unlikely that defined benefit plans will
achieve renewed popularity, they will continue to exist,
largely within larger corporations and the public retirement system. It is important to preserve as many of these
plans as possible because they can provide important
incentives to encourage people to work longer. The task
here is not so much to simplify the law but to make it
more flexible. The following changes are suggested: (1)
coordinate normal retirement age under tax law with
Social Security retirement age to gradually increase the
age of normal retirement; and (2) reduce or eliminate
early retirement incentives. It is also possible to adopt
flexible or phased retirement rules that would enable
workers to make a gradual transition into retirement with
wages from part-time work supplemented by pension
payments. This would require liberalizing the in-service
distribution rules for pension plans, which is not a difficult task. At the same time, disincentives to work past
normal retirement age could be reduced by eliminating
suspension-of-benefits provisions and restructuring benefit formulas for more actuarial fairness by age. The public sector is experimenting with new arrangements such
as delayed/deferred retirement option plans (DROPs),
which, if successful in providing additional flexibility for
employees without increasing costs for employers, could
serve as models for the private sector as well.
8
T H E
R E T I R E M E N T
P R O J E C T
Defined benefit plans could also be made more attractive to mobile workers by adding portability features such
as a minimum benefit provision with cash-out features
for shorter-term employees. It might also be worth
exploring whether defined benefit plans could induce
additional worker savings by providing an opportunity
for older but shorter-service employees to purchase additional years of service for a larger benefit. The United
Kingdom, for example, permits employees to make additional voluntary contributions to defined benefit plans
with a formula based on final salary to purchase a larger
benefit. Many government defined benefit plans in the
United States currently have similar provisions, but private employer plans do not.
Two additional and interrelated issues merit discussion:
nondiscrimination rules and the adequacy of retirement
benefits available to moderate-income workers. The
nondiscrimination rules attempt to prevent employers
from skewing plan benefits to high-income employees.
These rules even apply to employee savings in, for example, a 401(k) plan where the amount high-income
employees can save depends on how much low-income
employees, on average, have saved. While serving a
noble purpose, these rules are responsible for much of the
complexity of contemporary benefits law. They are
mostly effective in limiting the benefits of high-income
workers in qualified plans who generally have access to
nonqualified deferred compensation plans that replace
benefits lost due to these rules.
Perhaps other direct approaches to providing an adequate retirement income for moderate-income workers
should be considered, even if they generate additional
complexity. Despite the nondiscrimination rules, these
workers do not thrive in a pension system dominated by
defined contribution plans. For many, employer contributions based on a percentage of pay do not create
account accumulations sufficient to fund adequate retirement income. In addition, many cannot or do not contribute to employee savings plans on their own. Defined
benefit−type arrangements often provide more valuable
benefits for these workers, although few get those benefits either. Creating incentives for employers to provide
additional benefits in either type of plan for these workers may be a useful trade-off for relaxing or eliminating
the nondiscrimination rules.
In the end, these workers may need further help from
the federal government to save for retirement. Several
proposals to provide government contributions to stimulate retirement savings by moderate-income workers
are currently being discussed in Congress. For example,
the Clinton administration once advocated creating
USA Accounts for this purpose, and two Social Security reform proposals, the Bipartisan Social Security
Reform Act of 1999 (S. 1383) and the 21st Century
Retirement Act (H.R. 1793), have similar features.
Each of these plans provides federal dollars through a
basic saving contribution as well as matching contributions for low- and moderate-income workers. Currently, none of these plans work well administratively (Perun
1999). In addition, it is questionable whether a new federal entitlement program on the magnitude of the USA
Accounts proposal is necessary or how much federal
funds should be spent in any of these programs to
encourage retirement savings by young people or those
with only temporarily low incomes. However, integrating some federal contribution into IRAs and
employee savings plans could provide valuable incentives for additional retirement savings by moderateincome workers. For example, federal dollars could be
used to provide matching grants for savings within plans
that meet some minimum standard of portable benefits.
For low-income workers, some defined benefit features
in Social Security to provide a minimum retirement
income will still be required.
CODA: RETIRE ERISA AT 65
Of course, there’s no need to stop with ERISA at 50.
Let’s look just another 15 years into the future. By that
time, there will be just a few defined benefit plans left in
America, and they will largely cover retirees. The plan
to simplify defined contribution plans and to give defined
benefit plans more defined contribution−like features has
been such a success that even more drastic simplification
is possible. It is now time to retire the ERISA-at-50
framework and think about what ERISA at 65 could
look like (figure 4).
In just 15 short years, it’s finally become apparent that
a defined contribution plan is just a collection of individual retirement accounts. It’s also become obvious that
individual defined contribution accounts are the perfectly simple retirement savings vehicle for the post-ERISA
era. Defined contribution plans have become obsolete.
Individual retirement savings vehicles have become a
garden variety financial services industry product. Even
today, the financial services industry provides almost all
the services required by most employer-based defined
contribution plans: off-the-shelf prototype plans, custodial services, investment options, employee communication, distribution functions, accounting, and tax
reporting. Practically speaking, the employer is often just
the conduit of contributions to the individual accounts
held in the plan. Removing the superstructure of a plan
has simplified benefits law. Individual defined contribution accounts work as well, if not better, in delivering
retirement benefits to workers as the old employer plan.
Of course, the tax code continues to have rules for
how much employers and employees can and must contribute to these individual accounts. Employers will still
have incentives to contribute on behalf of their employees and to encourage their employees to save for retirement. Some nondiscrimination rules will still be satisfied.
In addition, there will be rules about appropriate investments and permissible distributions. The main distinction is that employers are happy. They no longer have
to supervise or assume fiduciary responsibility for their
employees’ retirement funds. The administrative burden
and expense of maintaining a plan no longer exist.
Employers spend more of their employee benefit dollars
directly on their employees and less on the plan compliance industry. They need only send their contributions
to workers’ accounts through their payroll system.
FIGURE 4.
ERISA at 65
ERISA at 65
The Last Defined Benefit
Plans
Employer Contributions
Individual Defined Contribution
Accounts
Employee Contributions
Government Contributions
for Low- and ModerateIncome Workers
ERISA at 50: A New Model for the Private Pension System
9
Employees are happy, too. Their own contributions go
directly to a centralized retirement account that they
manage as they wish. They have administrative and
investment control over their retirement assets, no matter who their employer is or how many employers they
have—although these managed accounts will still have
restrictions on withdrawals and maximum contributions
eligible for various tax benefits. Saving for retirement has
become almost as easy as opening up a bank account.
This is how it should be.
Retirement Savings, 1999, Washington, D.C.: U.S. Department of
Labor, available at http://www.dol.gov/dol/pwba.
7. For example, the Employee Benefit Research Institute reports,
based on Bureau of Labor Statistics data, that 91 percent of all fulltime workers in medium and large establishments were covered by a
plan (either defined benefit or defined contribution) in 1986 but only
78 percent in 1993. Parallel figures in small private establishments
were 47 percent in 1992 and 42 percent in 1994. Participation rates
for state and local government employees have, however, remained
relatively stable. See EBRI Databook on Employee Benefits, 1997,
Washington, D.C.: Employee Benefit Research Institute.
8. See also the Profit Sharing Council of America at www.psca.org.
It should be noted that the definition of 401(k)-type plans used in
the Department of Labor report includes more plans than the traditional 401(k)-type plans such as 401(k), 403(b), and 457(b) plans.
ENDNOTES
1. This paper was prepared for the ALI-ABA pension policy conference, “ERISA after 25 Years,” Washington, D.C., October 1, 1999.
We are grateful to Rudolph G. Penner for his comments.
2. For example, see Theodore R. Groom and John B. Shoven, 1999,
“How the Pension System Should Be Reformed,” and Daniel I.
Halperin and Alicia H. Munnell, 1999, “How the Pension System
Should Be Reformed,” papers presented at the Brookings Institution/SIEPR/TIAA-CREF conference, “ERISA after 25 Years: A
Framework for Evaluating Pension Reform,” Washington, D.C.,
September 17. The papers present almost diametrically opposed
reform proposals.
3. ERISA refers generically to the U.S. pension system, both public
and private. The authors recognize that the statute does not cover all
plans and employers in the system. ERISA also covers certain nonretirement plans, such as health and welfare plans, which will not be
discussed here.
9. About 87 percent of 401(k)-type plans are the only plan sponsored
by the employer. This statistic, however, includes more plans than
the traditional 401(k)-type plan under the definition used in this
report.
10. Contributions by participants to defined contribution plans have
been increasing over the past 10 years and in 1995 were 6 percent
higher than employer contributions.
11. Information about these bills can be found at
http://thomas.loc.gov.
12. See The 1999 Small Employer Retirement Survey: Building a Better
Mousetrap Is Not Enough, 1999, Issue Brief No. 212, Washington,
D.C.: Employee Benefit Research Institute.
REFERENCES
4. A full discussion of past amendments to ERISA is beyond the
scope of this paper. For a good history of pension legislation since
1974, see EBRI Databook on Employee Benefits, 1997, Washington,
D.C.: Employee Benefit Research Institute, Appendix E.
5. See, for example Rudolph G. Penner, 1999, “The Coming Collapse of the U.S. Economy?” The Retirement Project, Brief No. 4,
Washington, D.C.: The Urban Institute; and C. Eugene Steuerle and
Christopher Spiro, 1999, “Can Spending on the Elderly Always
Grow Faster Than the Economy? Should It?” The Retirement Project, Straight Talk on Social Security and Retirement Policy, No. 3,
Washington, D.C.: The Urban Institute.
6. A more detailed discussion of these issues can be found in a number of recently issued reports and white papers. See, for example,
Policy Challenges Posed by the Aging of America, 1998, a discussion
briefing dated May 29, Washington, D.C.: The Urban Institute,
available at www.urban.org; Who Will Pay for Your Retirement? The
Looming Crisis, 1995, Washington, D.C.: Committee for Economic
Development; Financing the Retirement of Future Generations: The Problem and Options for Change, 1998, Public Policy Monograph No. 1,
Washington, D.C.: American Academy of Actuaries; The 21st Century Retirement Plan, 1999, Washington, D.C.: The Center for Strategic
and International Studies; William G. Gale, 1998, Are Americans
Saving Enough for Retirement? New York: The Twentieth Century
Fund Foundation; and the Final Report on the National Summit on
10
T H E
R E T I R E M E N T
P R O J E C T
Perun, Pamela. 1999. “Matching Private Savings with
Federal Dollars: USA Account and Other Subsidies for
Saving.” Washington, D.C.: The Urban Institute. The
Retirement Project, Brief No. 8.
Private Pension Plan Bulletin. 1999. Abstract of 1995
Form 5500 Annual Reports, Number 8. Washington,
D.C.: U.S. Department of Labor, Pension and Welfare
Benefits Administration.
U.S. General Accounting Office (GAO). 1997. Retirement Income: Implications of Demographic Trends for Social
Security and Pension Reform. GAO/HEHS-97-81. Washington, D.C.: GAO.
Appendix
SUMMARY OF SELECTED RULES
CIRCA 2000
12
Appendix. Summary of Selected Rules circa 2000: Part 1
T H E
IRC § 403
Arrangements
IRC § 401(a) Plans
R E T I R E M E N T
Defined Benefit
Eligible
employer
Money
Purchase
Any employer
Profit Sharing
or Stock Bonus
& Standard
401(k)
Profit Sharing or
Stock Bonus &
SIMPLE 401(k)
Other Profit
Sharing or
Stock Bonus
without 401(k)
Employee Stock
Ownership Plan
IRC § 403(b)
Any employer
except state and
local
governments
401(k)-eligible
employer with <100
employees and no
other plan
Any employer
Corporate employer
IRC § 501(c)(3)
organizations and
public schools
P R O J E C T
Lesser of $30,000 or
Annual benefit
25% of pay or
limit = lesser of
exclusion
allowance
$135,000 or 100% Per person annual limit = lesser of Per person annual
Per person annual limit = lesser of $30,000
Overall limits
1
1
$30,000
or
25%
of
pay
limit
=
401(k)
+
match
or
25%
of
pay
(20%
of
pay
× years of
× high 3 years’ pay
service – employer
(not governmental
contribution)1
plans)
Pay limit
$170,000
Normal cost + past
service liability
Match up to 3% or
Amount required
Annual funding amortization over
NA
fixed 2% of pay
NA, usually
by plan formula
10 years or 155%
contribution required
of current liability
Employee
limits
NA
NA
$10,500
$6,000
Employer
deduction limits
Based on funding
requirement
Based on
funding
requirement
15% of taxable
pay
Greater of 15% of
taxable pay or
required contribution
Exclusion from
SS tax
Yes,
Yes, contributions contributions
and distributions and distributions
10% early
withdrawal tax
Sometimes
Yes
No 401(k), yes
No 401(k), yes other
other
contributions and
contributions
distributions
and distributions
Yes
Yes
NA
NA
25% leveraged/15%
15% of taxable nonleveraged of taxable
pay
pay + dividends paid out +
interest on loan
$10,500
NA
Yes
Yes
No deferrals, yes
employer contributions
and distributions
Yes
Yes
Yes
IRC § 403
Arrangements
IRC § 401(a) Plans
Defined Benefit
In-service
withdrawals
ERISA at 50: A New Model for the Private Pension System
Nondiscrimination
rules (not
governmental
plans)
Integrated with
Social Security
Money
Purchase
3
General rule
May be
Spousal protection
Survival annuity, consent and death
benefit rights
Vesting
Deferred
Special
requirements
Profit Sharing or
Stock Bonus &
SIMPLE 401(k)
Financial hardship,2 minimum 2-year holding
period (employer), loans
Not allowed
May be
Profit Sharing or
Stock Bonus &
Standard 401(k)
PBGC guarantee and Minimum funding
premium of $19 per
required in full
participant
each year
ADP, ACP, safe
harbors and general
rule4
NA
May be (employer)
No
Other Profit
Sharing or Stock
Bonus without
401(k)
Employee Stock
Ownership Plan
Minimum 2-year holding period, loans
Financial hardship,2
loans
ACP for match,
availability test for
deferrals and general
rule4
3
General rule
May be
IRC § 403(b)
No
May be
Only death benefit usually5
401(k) immediate;
others deferred
Immediate
None
Deferred
Deferrals immediate;
others deferred
Forfeitures/interest raise
annual limit if ≤ 1/3
Catch-up contributions
contributions for HCEs.
permitted with 15+
100% employer securities years of service. May
allowed. Diversification
also be a DB plan.
optional at 55. Put
option/voting rights.
1. The $30,000 overall dollar limit is a cumulative limit for employers and employees across all qualified plans.
2. Financial hardship is an immediate and heavy financial need, even if foreseeable or voluntarily incurred, not satisfiable by other resources.
3. No HCE may receive a contribution or benefit of a higher percentage of pay than any NHCE.
4. Both the Actual Deferral Percentage (ADP) test for 401(k) contributions and the Average Contribution Percentage (ACP) test for matching and after-tax
contributions are designed to limit contributions for HCEs (highly compensated employees) based on the average contributions for NHCEs (non–highly
compensated employees).
5. The surviving spouse receives the account balance as a death benefit, usually in a lump sum.
13
14
T H E
Appendix. Summary of Selected Rules circa 2000: Part 2
R E T I R E M E N T
IRC § 408, 408A IRAs
Traditional IRA
Roth IRA
Nonqualified Deferred Compensation Plans
SEP-IRA
Earnings less than
$110,000 for
Employees of all
individuals and
employers
$160,000 for couples
SIMPLE
IRA
Eligible 457(b) plans
Executive
Arrangements
Employees of
Employees of state and local
Select group of officers
employers with no
government and officers of tax-exempt or highly compensated
other plan and
organizations
employees
<100 employees
P R O J E C T
Eligibility
Anyone
Dollar limit
$2,000 for all IRAs,
deductible if no employer
plan or income less than
$42,000 for individuals and
$62,000 for couples
$2,000 for all IRAs
$30,000
NA
$8,000 − contributions to 403(b),
SIMPLE, and 401(k) plans
None
Maximum % of
pay
100%
100%
15%
NA
33 1/3%
NA
Employer
limits
NA
NA
Lesser of
$30,000 or 15%
of pay
Match of up to 3%
or fixed 2% of pay
Lesser of $8,000
as reduced above or 33 1/3%
None
$2,000
$2,000
NA
$6,000
Lesser of $8,000 as reduced above
or 33 1/3%
None
NA
NA
15% of aggregate
pay
None
NA
None
Yes on
contribution and
distribution
No on employee;
yes on employer
contribution and
distribution
No on employee contribution; yes on
distribution
No (except after
vesting)
Yes, increased to
25% in first 2 years
No
No (unless annuity
purchased)
Employee
limits
Employer
deduction limits
Exclusion from
SS tax
10% early
withdrawal tax
No on contribution; yes on distribution
Yes
Maybe
Yes
IRC § 408, 408A IRAs
Traditional IRA
Penalty tax
exceptions
Withdrawals
Roth IRA
Medical, first home
purchase and higher
education expenses,
health insurance
payments for
unemployed
Yes
SEP-IRA
First home purchase
Same as
(up to $10,000)
traditional IRA
5-year waiting period
Loans available
ERISA at 50: A New Model for the Private Pension System 15
Nondiscrimination
rules
Nonqualified Deferred Compensation Plans
Yes
SIMPLE
IRA
Eligible 457(b) plans
Same as
traditional IRA
NA
Yes
Unforeseeable emergency only
while employed
Yes
Unclear
Yes
Can favor HCEs
None
No
None
None
Uniform
percent of pay
contribution
Required match
or contribution
None (unless
annuity purchased)
Pay limit
See above
$170,000
$170,000 for 2%
contribution
NA
Integrated with
Social Security
NA
May be
No
NA
Spousal
protection
None
Vesting
Special
restrictions and
benefits
Executive
Arrangements
Immediate
None
After-tax
contributions only
Employer does
not have to
contribute
every year
Employees
generally
responsible for
investments
Immediate for
employee;
deferred
Immediate usually
for employer
$15,000 catch-up limit for 3 years Taxed when paid or
before retirement. Unfunded plan made available (or
but trust requirement for public- when vested for taxsector plans. May also be a DB
exempts).
plan.
May be DC or DB.
Note: All dollar values are indexed, and the given figures are as of 2000.
Sources: Harry Conaway, William M. Mercer and C. Eugene Steuerle, Andrea Barnett and Pamela Perun, the Urban Institute.
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