Working Group on Small Business: How to Enhance and Encourage The Establishment of Pension Plans.
The Small Business Working Group respectfully submits the following report to the 1998 ERISA Advisory Council.
A. Executive Summary.
The 1998 Advisory Council on Employee Welfare and Pension Benefit Plans created a Working Group to study the pension coverage of employees who are employed by small businesses. In choosing this topic, council members expressed concern that pension coverage for many working Americans is eroding. For a large majority who are working for small employers it is nonexistent. This universe of constituents, employers and employees need more education about the pension plan options available and incentives to establish worker retirement savings.
The primary objective of this study is to focus on the small employer community and: (1) evaluate the reasons for such paltry coverage, (2) make recommendations from the information gathered to embellish on what the Department of Labor is already doing in this area, and (3) suggest a methodology to enhance and encourage the education of workers and their employers about the need for more pension coverage. This effort is truly a laudable social and economic goal as we wrestle with the notion of a national retirement policy.
The Department of Labor has had a commitment to the small business community recognizing the need for American workers to be educated as to the importance of retirement planning and saving. The Department’s strategic goal of providing protection of workers’ benefits and the recognition that a secure work force provides economic security for workers and their families represents a strong impetus for the Working Group’s mission.
Achieving financial security for retirement is a complex process that is not getting easier. The need to educate American workers and employers on the importance of planning and saving for a secure, comfortable and dignified retirement is critical. The private voluntary retirement system came into being in the last century and was enhanced following the adoption of legislation of substantive tax incentives after the establishment of the Tax Code in 1913. The growth and development of the organized trade union movement as a powerful advocate of social and economic policy for working Americans in the early 20th century fostered the need of increasing worker security. Two main tenets and perspectives of pension policy early on were working people’s security and preventing tax abuse. ERISA reinforces these principles.
The Working Group heard testimony from eighteen individuals from the public and the private sectors. These individuals have recited from their varied experiences and perspectives why they believe there is a significant gap in pension program coverage for employees of small employers. They have offered comments, statistics, observations and proposed recommendations as to how our Working Group might proceed in offering definitive and specific recommendations to encourage and enhance the establishment of pension plans by the small employer community in order to provide their employees with an opportunity to reach their “golden years” with sufficient financial resources. Private retirement savings may not have the same political “sizzle” as Social Security. However, it is terribly important to make private pension plans for small employers part of the national Social Security debate. Now is the time to re-strengthen all three legs of the proverbial three-legged stool and to make a serious effort to provide a large segment of the working American public with an opportunity to fully participate in a wholesome retirement program. It is important to approach this dilemma with a single- minded focus and a sense of urgency.
All of that said, the Working Group makes the following recommendations that will be elaborated on in the next section. Briefly, those recommendations include:
· Repeal of the Top-Heavy Rules· Eliminate User Fees· Increasing the Limits on Benefits and Contributions· Increasing the Limits on Includable Compensation· Develop a National Retirement Policy· Coalitions· Tax Incentives· Simplified Defined Benefit Plans
A. Repeal of the Top-Heavy Rules.
In 1982, Congress enacted the so-called top-heavy rules because of perceived abuses among plans sponsored by small employers. The top-heavy rules are qualification requirements and have no counterpart under Title I, the Labor Law provisions of ERISA.
A plan is top-heavy if key employees have accumulated 60% or more of the contributions and benefits under the plan. In order to determine whether or not a plan is top-heavy, plans are required to maintain a detail analysis of who is receiving plan benefits. This complex testing is in addition to equally complex testing to determine whether or not the plan satisfies the non- discrimination rules of the tax code. Although similar in purpose, the non-discrimination rules define highly paid and rank and file employees differently and require different tests to determine whether or not a plan satisfies its requirements
In any year in which a plan is determined to be top-heavy, additional qualification requirements apply. First, the plan must provide for more rapid vesting of benefits. Vesting standards were first established by ERISA in 1974. In 1982, when Congress added special rules for top-heavy plans, the more rapid top-heavy vesting schedules significantly increased the likelihood that short tenured employees received pension benefits. Top heavy rules prescribed a 2 to 6 year graded vesting schedule as compared to a then 5 to 15 year graded vesting schedule for non-top heavy plans. In the alternative, the top-heavy rules prescribed a 3-year cliff-vesting schedule as compared to a then 10-year cliff-vesting schedule for non-top heavy plans. Under the top-heavy graded vesting schedule, a participant is 20% vested after 2 years of service and his or her vesting percentage increases by 20% for each additional year. Under top-heavy three-year cliff vesting, participants become fully vested after three years of service.
The top heavy vesting schedules' impact have been significantly diluted by subsequent changes in the vesting schedules, which apply, to all plans. Specifically, the Tax Reform Act of 1986 amended ERISA to promote faster vesting for non-top heavy plans. The Tax Reform Act of 1986 vesting schedules provides for 3 to 5 year-graded vesting or 5-year cliff vesting. While there are still marginal differences in top heavy and non-top-heavy vesting schedules, we believe that the number of participants who would not have vested benefits if the top-heavy rules were repealed currently is relatively small.
TEFRA also established minimum benefit and contribution rules for all non-key employees in top-heavy plan, but not for other plans. These rules were enacted because before TEFRA some qualified retirement plans were able to provide rank and file plans’ participants with little or no benefits by coordinating their plans with Social Security benefits. For defined benefit plans, TEFRA required that each non-key employee receive an accrued benefit equal to 2% of the participant’s average compensation for each year of service up to a maximum of 20% of compensation. In a defined contribution plan, non-key employees must receive a contribution equal to 3% of compensation, or the highest percentage contributed to a key employee, if less. For purposes of determining the minimums, integration with social security benefits is disregarded.
The Tax Reform Act of 1986 eliminated methods of coordinating with Social Security that resulted in some rank and file participants receiving little or no benefits. The new so-called “permitted disparity rules” which apply to all plans which coordinate with Social Security modified the types of benefit formula that effectively denied rank and file individuals private pension benefits and required that they provide minimum benefits. In addition, regulations implemented by Treasury after the Tax Reform Act of 1986 generally tightened the non-discrimination requirements, which apply to all qualified retirement plans, assuring that rank and file employees receive greater accrued benefits or contributions. As a result of the changes in the non-discrimination rules, we believe that most plan participants in top-heavy plans are already receiving benefits above the top-heavy minimums.
In 1974, ERISA imposed a combined plan limit on the maximum amount of permitted benefits when an employer maintains both defined benefit and defined contribution plans. In such a case, the sum of a participant’s “defined benefit fraction” and a participant’s “defined contribution fraction” cannot exceed 1.0. Normally, when calculating these fractions, the dollar limits for a defined benefit plan ($130,000 in 1998) and defined contribution plans ($30,000 in 1998) are multiplied by 1.25. Under TEFRA, the dollar limits were multiplied by 1.0 rather than 1.25 for top- heavy plans, which had the effect of reducing the maximum amount of benefits or contributions which key employees in a top heavy plan could receive as compared to highly compensated employees in a non-top-heavy plan. A top-heavy plan could “buy” back the 1.25 fraction by providing addition minimum benefits to non-key employees, unless the plan was “super-top-heavy”, in which case the reduced 1.0 fraction could not be avoided.
In 1996, Congress repealed the combined plan effective in the year 2000 because of its complexity, as part of the Small Business Jobs Protection Act. Congress also repealed the corresponding provisions of the top-heavy rules, which provided for reducing the combined plan limit, also effective in the year 2000.
Although it is possible that plans of larger employers can be top-heavy, as a practical matter, plans of small employers, covering fewer employees, are more likely to be top-heavy. Even if a plan passes the new non-discrimination tests implemented after the Tax Reform Act of 1986, the plan must still be tested for top-heaviness. Calculating whether a plan is top-heavy substantially adds to the burden and complexity of maintaining a qualified retirement plan. Witnesses testifying before the Advisory Council were unanimous in their view that pension laws and regulations are too complex. In addition, a majority thought that current pension law and regulations discourage small employers from establishing qualified retirement plans. Among the requirements most frequently cited as unnecessary and burdensome were the top-heavy rules.
With the changes implemented by the Tax Reform Act of 1986 and the Small Business Job Protection Act of 1996, the top heavy rules, originally enacted in 1982, do little more than add a significant layer of administrative complexity. Whatever the merits of the rules when first enacted in 1982, it is clear that the protections they afford to participants in top-heavy plans have now been applied, by subsequent changes in other pension rules, across the board to participants in all qualified retirement plans.
The top-heavy rules under Internal Revenue Code Section 416 should be repealed. They no longer provide significant protections to rank and file employees. Their effect is largely duplicated by other rules enacted subsequently. Despite their limited utility, all employers must test for top- heaviness. Since most small employers are not capable of performing these tests on their own, they represent an additional and largely unnecessary cost of maintaining a qualified retirement plan. They also create a perception within the small business community that pension laws target small businesses for potential abuses. This too discourages small business from establishing qualified retirement plans for their employees.
B. Eliminate User Fees.
The Internal Revenue Service has for many years had a practice of issuing determination letters to employers opining that their retirement plan conforms in form to the complex rules established under the Internal Revenue Code for qualified retirement plans. Although employers are not required to obtain determination letters, given the adverse tax consequences of a subsequent determination that a plan is not qualified, employers, as a practical matter, generally seek determination letters.
For many years, the Internal Revenue Service reviewed requests for determination letters without imposing a fee. As part of the Revenue Act of 1987, Congress directed the Internal Revenue Service to collect user fees for determination letters. Budget laws in 1990, 1995 and 1996 extended the IRS’s authority to collect user fees through September 30, 2003. The user fees were imposed at a time when there was significant pressure to generate additional revenue to reduce the budget deficit. Under Revenue Procedure 98-8, the Internal Revenue Service has established a fee schedule taking into account the time and expense of reviewing different types of plans. The fees for determination letters range from $125 to $2,000 depending on the type of plan involved. These fees are in addition to the costs of having plan documents and requests prepared in order to receive a determination letter.
The Internal Revenue Service has a strong interest in encouraging employers to seek determination letters. The IRS review of the plan is likely to reveal any serious drafting errors or incorrect elections, in the case of a master or prototype plan. The frequency with which Congress has changed required provisions for qualified retirement plans increases the potential for inadvertent error. The Internal Revenue Service would prefer that a plan be correctly drafted at the outset rather than go through the complicated, expensive and draconian process of disqualifying a plan.
The imposition of user fees adds another financial obstacle to the adoption of qualified retirement plans by small business. Although user fees apply to all employers—large and small— the cost of establishing a plan is more acutely felt among small employers. User fees do not vary by size of employer. While a $700 user fee for an individually designed qualified plan is an insignificant cost for a Fortune 500 employer, it may well be an insurmountable obstacle for a small employer. The small employers choice may be to not seek a determination letter, with the attendant tax risks, or worse to not establish a qualified retirement plan because the costs are too high.
Now that the budget deficit has become a budget surplus, the economic justification for user fees is much diminished. User fees should be repealed.
C. Increasing the Limits on Benefits and Contributions.
Since ERISA was enacted in 1974, the Internal Revenue Code has provided overall limits on the contributions and benefits under qualified retirement plans. These limits apply to all Section 401(a) qualified retirement plans, Section 403(b) tax deferred annuities and Section 401(k) simplified employee pension plans. There are special rules, which permit a higher defined benefit limit for certain government-sponsored defined benefit plans.
The limits are expressed differently for defined benefit and defined contribution plans. For defined benefit plans, the limit on the annual benefit payable is the lesser of 100% of high three-year average compensation or a dollar amount, which is indexed ($130,000 in 1998). There are special rules that require the benefit to be actuarially reduced for benefits commencing prior to Social Security retirement age (which ranges from age 65 to age 67). There is a minimum benefit of $10,000, which is not indexed, and which can be paid without regard to the normal limits, if the plan participant has at least 10 years of participation and does not also participate in a defined contribution plan.
For defined contribution plans, there is a limit on the maximum annual addition to a defined contribution plan of the lesser of 25% of compensation or a dollar amount, which is indexed ($30,000 in 1998). An annual addition is the sum of employee contributions, employer contributions and reallocated forfeitures.
Both the defined benefit limit and the defined contribution limit apply in the aggregate to all plans of that type sponsored by the same employer.
An additional limit applies if an employee participates in both a defined benefit plan and a defined contribution plan sponsored by the same employer. In such a case, the sum of the participant’s “defined benefit plan fraction” and the participant’s “defined contribution plan fraction” cannot exceed 1.0. Congress repealed this complex rule as part of the Small Business Job Protection Act of 1996 for years after 1999.
The defined benefit and defined contribution plan dollar limit were indexed by ERISA and were originally established in 1974 at $75,000 and $25,000 respectively. From 1976 to 1982, the indexing feature was allowed to operate as intended and the dollar amounts grew to $136, 425 and $45, 475. Under the Tax Equity and Fiscal Responsibility Act of 1982, the dollar limit on defined benefit plans was reduced to $90,000 and the dollar limit on defined contribution plans was reduced to $30,000. Furthermore, the dollar limit on defined contribution plans was frozen at the $30,000 level until the defined benefit dollar limit rose to $120,000 so that the relationship between the dollar limits became 1: 4. For years after 1994, the indexing was modified so that changes in the dollar amounts would be in multiples of $5,000 adjusted downward to the next lowest multiple.
These reductions in the dollar amounts are widely believed to have been revenue driven. These reductions had the net effect of adjusting downward the maximum amount of benefits and contributions that highly-paid employees can receive in relationship to the contributions and benefits of rank and file employees. Witnesses before the Advisory Council testified that these changes have had the perverse effect of “de-linking” retirement benefits of key employees from those of other employees. Key employees looked to non-qualified deferred compensation plans to satisfy their benefit needs rather than establish a qualified retirement plan or enhance an existing qualified retirement plan in which their benefits are significantly reduced.
In order to give key employees the incentive needed to establish qualified retirement plans and expand coverage, we recommend that the $30,000 dollar limit on defined contribution plans be increased to $50,000 which will help partially restore the dollar amount to the level it would have grown to had the indexing continued without alteration since the dollar limit was first established in 1974.
Second, we recommend that the $90,000 dollar limit on defined benefit plans be increased to $200,000 which will restore the dollar amounts lost through alternations in the dollar amount since 1974, while maintaining the 1:4 ratio established in 1982 as part of TEFRA.
Third, we recommend, that in the future, indexing occur in $1,000, not $5,000, increments which has had the effect of retarding recognition of the effect of inflation.
Fourth, we renew the recommendation of last year’s ERISA Advisory Council that the minimum $10,000 dollar limit on defined benefit plans be increased and indexed. The minimum benefit amount helps increase the benefits of rank and file employees and its value has been badly eroded since 1974. We recommend that the minimum defined benefit dollar amount be increased to $30,000 and be indexed.
Fifth, we recommend that actuarial reductions of the defined benefit plan dollar limit should be required only for benefits commencing prior to age 62. This was the rule originally enacted in 1974 as part of ERISA. It was changed as part of the Tax Reform Act of 1986 and has had the effect of significantly reducing the maximum benefit of participants electing early retirement.
D. Increasing the Limits on Includable Compensation.
Under ERISA, there was no dollar limit on the amount of annual compensation taken into account for purposes of determining plan benefits and contributions. However, as part of the Tax Reform Act of 1986, a qualified retirement plan was required to limit the annual compensation taken into account to $200,000, indexed. The $200,000 limit was adjusted upward through indexing to $235, 843 for 1993. As part of the Omnibus Budget Reconciliation Act of 1993, the limit on includable compensation was further reduced down to $150,000 for years after 1994. Although indexed, adjustments are now made in increments of $10,000, adjusted downward. In 1998, the indexed amount is $160,000.
Witnesses before the Advisory Council testified that these changes, like the reductions in the dollar limits on contributions and benefits, have had the perverse effect of “de-linking” retirement benefits of key employees from those of other employees. As a result, key employees looked to non-qualified deferred compensation plans to satisfy their benefit needs rather than establish a qualified retirement plan or enhance an existing qualified retirement plan. We recommend that the limit on includable compensation be restored to its 1988 level of $235,000 and be indexed in $1,000 increments in the future.
E. Develop a National Retirement Policy
Promote the development of coalitions to offer pooling vehicles for small employers. For multiemployer plans created by collective bargaining an amendment to the Labor Management Relations Act may be needed to allow small employers without a collective-bargaining agreement, to continue to participate in these existing plans. This recommendation deserves further study and consideration.
G. Tax Incentives
Offer tax incentives for employers without a qualified plan to adopt in a plan. Tax credit could be offered to reimburse for the administration of the plan as well as for retirement education costs incurred for the employees.
H. Simplified Defined Benefit Plans
The Working Group restates its support of the recommendation made by 1997 Working Group on Defined Contribution vs. Defined Benefit Plans to create a simplified defined benefit plan.
A. Impact of Demographics on Retirement Security
The combination of social, political and economic factors over several decades contributed to creating a blueprint for retirement security along with the recognition that a vehicle that would provide a modicum of financial security for older Americans, once their work life ended and their retirement began, would do much to thwart the specter of poverty. Over the last four decades America has experienced a demographic tidal wave of a growing and aging population commonly referred to as the “age wave” that has in recent times reinforced and focused national attention on the need to evaluate where we are today and determine how to continue to provide a secure retirement system for older people.
B. Three-Legged Stool of Retirement
Traditionally, the three-legged stool of retirement, Social Security, personal savings and a retirement plan, commonly referred to as the “three cornerstones” of retirement income, has been promoted as the most effective combination to provide a secure retirement.
All three -- Social Security, a pension plan, and personal savings -- can most effectively support and strengthen the three-legged stool. Unfortunately, each of these cornerstones is in various stages of serious threat of erosion in one form or another and has been characterized as America’s looming retirement security crisis. The need for education with regard to savings, pensions and long-term retirement planning is of paramount importance. Our failure to address this crisis portends for serious long-term societal ills.
C. Social Security
For the past two decades various pundits have articulated that we face a crisis and some predict the potential insolvency of the unreliable “pay-as-you-go” Social Security system. They argue that a result of the alleged inadequate funding, and unrealistic investment objectives as well as the impending retirement of the baby boom generation, and the dramatically shifting top heavy demographic landscape in our nation which will place the burden of entitlements onto the younger generation, our Social Security system is seriously threatened.
D. Trends in Personal Savings
The personal savings practices of a large portion of society are also in serious jeopardy. The Commerce Department’s latest national income and product accounts data shows that Americans are saving less than at almost any time since the department began collecting the data in 1929. Its recently-adjusted figures report that Americans saved only 2.1 percent of their disposable income in 1997; in June 1998 the figure hit a staggering 0.2 percent annualized rate. Twenty-five years ago, in 1973 and 1974, the savings rate reached a postwar high of 9.5 percent, and it hovered at about 7 to 8.5 percent well into the 1980’s.
According to a study done last year by the non-profit research organization Public Agenda and underwritten by Fidelity Investments, 46 percent of Americans said they have saved less than $10,000 for retirement, including money saved in their retirement plans.
Consumers account for 62% of the Gross National Product in the United States today. According to Juliet Schor in her book “The Overspent American”, the majority of Americans are intent on “Competitive Consumerism”. They try to acquire the trappings of the rich by acquiring the most and latest toys. Schor flogs the American way of life for its excesses, its materialism and its dangerously pervasive messages that “you are what you own”.
Americans want to keep up with the Joneses, but cannot – too many of the Joneses have become millionaires. The diabolical marketing by corporations of the capitalist conspiracy keeps American consumers buying beyond their income. Life has become a see -- want -- borrow -- and buy bummer. Americans spend more than they realize, hold more debt than they admit, and ignore many of the moral conflicts surrounding acquisitions. It seems a paradox: despite a booming economy reflecting eight years of substantial growth, more than a million Americans file for bankruptcy each year. Consumer bankruptcy filings shot up 29% from 1995 to 1996. Last year, in 1997, they jumped another 20% to a record high of 1.4 million. In 1985 only 350 thousand individuals filed for bankruptcy.
The flood of credit card offers in mailboxes has helped propel consumer debt to record levels. Some experts say the spike in bankruptcies has come from ease of filing for bankruptcy and the loss of the stigma that bankruptcy once brought. One could easily observe that we have created a system to consume and accrue debt when, in reality, we should be asking the question “what are society’s goals” with respect to savings and debt and offering an approach as to how to address them.
Recently, in Philadelphia, a couple earning a combined income of $75,000, who were sending their children to private school at a combined cost of $7,500 a year and renting a Mercedes, filed for bankruptcy. The bankruptcy judge found that the couple did not abuse the law, commenting that “The debtors are persons who became accustomed to living with the amenities of the upper middle class and have been unable to completely adjust themselves to a somewhat altered financial depression.”
Congress is currently grappling with this vexing problem. The result may be the tightening of the bankruptcy code denying individuals the benefits now enjoyed. The result could have a profound effect on the quality of life.
History is a great teacher -- often repeating itself – for many reasons. Why, might we ask? People have not changed much over the course of modern civilization. History sets precedents and gives people ideas. In this age of extremes and the new world order, the ability to meet the needs of a modern, rapidly changing globalized economy rests more and more on the shoulders of the individual. This means that for consumers the future is in their hands.
We have had the luxury of living in an era, especially, over the last fifteen years of one of the most scintillating periods in U.S. economic history. The complexity and speed with which innovation has revolutionized the world of finance have reached a proportion where it is difficult to comprehend all of the dynamics of this fast-paced change from moment to moment. In the American economic “miracle” everything should be up has gone up – GDP, capital spending, incomes, the stock market, employment, exports, consumer and business confidence. Everything that should be down is down – unemployment, inflation, interest rates. This litany of America’s economic success may sound tinny to those who feel their lives are buffeted by forces over which they have virtually no control. People are working harder than ever before. The gap between the well to do and the poor has been growing. The options for unskilled workers keep shrinking, as does the “safety net” that is supposed to protect them if they fall out of the economy altogether. The natural American tendency to feed a national optimism and sense of renewal that rides over the potholes of politics and defies predictions of calamity must be held in check.
When the Clinton Administration introduced the notion of health care reform early in the first term our national conscience was awakened to the fact that over 35 million working Americans were without health care coverage and that number has increased to 43 million in 1998. Today, with prescription drug costs skyrocketing, it is shocking that 145 million Americans are not covered by a prescription drug plan. As we face the most profound demographic change in the history of our nation – the “age wave” – many American consumers are ill-prepared for retirement.
E. Lack of Retirement Planning by Workers
We are in what Arthur Levitt, Chairman of the Securities and Exchange Commission, recently characterized as a “financial literacy crisis”. One out of two Americans has no pension coverage. Three out of four Americans do not know how much they will need to retire. Three out of four Americans do not know the difference between a stock and a bond. One out of three workers who is offered a 401(k) plan does not participate. One out of five has saved nothing for retirement. A recent poll showed that people fell into these various categories:
21% are planners15% are impulsive19% are deniers (believing they won’t live long enough)26% are strugglers (and need help)
With people living longer lives, the period of retirement will be almost as long as the period of working. Institutions shunting more responsibility onto the shoulders of the individual mandates the necessity for individual knowledge and individual action. The individual cannot go it alone. With mergers and acquisitions, downsizings, restructuring and re-engineering, the world of workers is riddled with tragedy and high anxiety.
F. Shift to Defined Contribution Plans
Much has happened to change the private pension plan system as well as the methodology for delivering benefits. Since the 1970’s, qualified defined contribution plans, participants, and contributions have grown as a percentage of the employment based retirement system. According to the findings from the Form 5500 series report filed with the Department of Labor for 1994 the count of private pension plans filing was about 690, 350, a 2% decrease from 1993. The number of defined benefit plans decreased by 11% to 74,400, while the number of defined contribution plans has decreased by less than .5% to 615,900. The number of defined benefit plans has decreased each year since 1986. The 1994 count is only 43% of the peak total of 175,000 plans in 1983.
The long-term patterns of decreases in the defined benefit plan active participants and increases in defined contribution plan active participants continued in 1994. Defined benefit plan active participants decreased by 2% to 24.6 million. Defined contribution plan active participants increased by 2% to 40.4 million.
We have witnessed during the last two decades some serious trends that could best be characterized as the “deinstitutionalization” of retirement benefit coverage as evidenced by the statistics recited above. Many employers have shifted the responsibility for providing for retirement income from their shoulders to the shoulders of the worker as witnessed by the precipitous decline of defined benefit plans and the increasing proliferation of defined contribution plans where tomorrow’s retirees’ income security will likely depend increasingly on his or her life-long money management skills and decisions.
What would normally have been considered an issue that most people would readily rally around and support, namely, the creation of a pension plan for employees, has become a debate about who is responsible for the employee’s long-term retirement income goals. Perhaps the shift of pension coverage or, more importantly, the lack thereof, has become more noticeable and profound for employees of small employers.
A major portion of small employers do not offer retirement benefit programs to their employees because of various obstacles including the tax laws, regulatory issues, administrative costs, fear and a misperception as to what employees want in a compensation package. As a result, it was determined to undertake a much-needed examination of the issues that confront small businesses and their employees in the area of pension programs and retirement planning.
Who cares? Over two-thirds of small business employees are not covered by a retirement plan largely because companies’ revenues are uncertain or employees prefer high wages or other benefits. Therein lies the charge to this Working Group as to how to enhance and encourage the establishment of pension plans offered by the small employer community.
Retiring workers with a pension plan will be able to supplement their Social Security benefits with their retirement income. Those workers with low incomes who do not have the ability to save and are not covered by a pension plan will be at risk at an extremely vulnerable period of their lives. The burden of this responsibility cannot be placed with the children of those retiring baby boomers who themselves are facing dramatic changes in the world of work as we move through this modern industrial transition known as the “new world global economic order” into the 21st century. This new era is not a forgiving one. It is dominated by instant communications; the accelerated flow of capital, and global interdependence and interconnectedness as evidenced by the economic shock waves occurring in other countries that rocked the American financial markets during the summer of 1998.
H. Impact of Globalization
With the onset of accelerating and widespread globalization over the past two decades, global competition among many American employers has skyrocketed. Global capitalism is being unleashed with an intensity and scale we have not witnessed before in economic history, in a world where national governments are wrestling with the reality that they are becoming progressively less able to protect businesses, investors, and individuals from the evolving and sometimes brutal free market forces. When you assimilate and crunch this down to the ground where most of us function, these changes will drive household decisions on jobs, savings, buying houses, education, and the ability to provide a comfortable and financially secure retirement. This intensity will continue. Many organizations will increasingly deal with uncertain profit margins. Certainly the flexibility to quickly divest a business venture or to terminate a business with the least obligation can be a competitive advantage for an organization competing globally. Defined contribution plans were perceived by some businesses to be more preferable to defined benefits plans when they were unsure of their organizations’ stability, viability, and profits. During periods of stock market turmoil small business’ financing strategy can stall and for some their financing efforts can go into a tailspin. Small firms have fewer resources and financing alternatives when the wealth of people who provide the seed money is in jeopardy.
I. Difference in Coverage Between Large and Small Employers
The private voluntary retirement system has been relatively successful for individuals employed by large companies. We have been less successful in promoting and providing coverage among employees of small companies. In the small employer community there are an array of reasons why pension plans are not offered to their employees. In a world were the predominant concern is “will today’s workers be able to maintain their pre-retirement standard of living” and, it appears that most of the retirement debate centers on whether to privatize Social Security or at least invest some of its funds in the stock market, the Working Group has struggled and wrestled with the challenge as to how to promote the recognition of the need to create retirement programs for a large segment of the working population, some 32 million as estimated by the Department of Labor, that are without coverage.
J. Summit on Retirement Savings
In 1997 Congress passed and the President signed into law the Savings Are Vital to Everyone’s Retirement Act (SAVER). The Act called for an initial Summit on Retirement Savings to be held on June 4th and 5th of 1998. The mission of the Summit was to determine how best to raise awareness of the need for pension and individual savings so that working Americans and their families may enjoy a comfortable and secure retirement. This is an issue that must capture the attention of government, employers, employees, the media, community organizations, schools and families to work towards communicating the need to build retirement security and in a more pervasive way, a national retirement policy.
Delegates to the Summit represented the leadership from political parties, large corporations, small businesses, labor organizations, and numerous trade groups dealing with employee benefits, personal finance and retirement issues. Of large concern were the barriers that Americans face when saving for retirement and the challenges and obstacles employers’ face when providing retirement plans. Clearly, the mantra for retirement security is the need to educate all to its importance.
This fact was reinforced by three surveys that were released around the time of the Summit. The surveys showed that Americans are worried about saving enough for retirement. They also feel that they need more education to properly plan for it and believe they will keep working part-time after they retire in order to make ends meet.
Just one in four respondents to the 1998 Retirement Confidence Survey of the Employee Benefit Research Institute (EBRI) said they believe they would have enough money to live on after they retire. The survey polled 1,500 individuals aged 25 and older. Their average age was 43. The survey found confidence hadn’t budged in six years, despite a booming stock market and sharp rise in mutual fund retirement investing.
K. How To Motivate Americans To Save
What can motivate American workers to save for their retirement? The study found fear that was a factor for nearly half of those respondents who were saving. Some 48% said watching retirees struggle motivated them. Some 37% cited “time running out” as a motivator.
A second study by the same group, EBRI, showed employees of small businesses need help from their employers to both motivate and educate them on the value of retirement planning. A telephone survey of 601 small companies, those with 100 or fewer employees, found only about a third of workers were covered by retirement plans. Few workers at these companies even inquired about retirement planning, according to the survey. When there were plans, the most popular was the 401(k) plan.
In those companies with plans, only about half offered retirement education to workers and consequently, the study concluded, only about one employee in five participated. In large companies, eight out of ten employees participated, due largely to educational efforts.
Still another survey conducted and released by the American Association of Retired Persons found baby boomers willing to work well into their retirement years. Eight out of ten polled said they wanted to work at least part-time jobs after they retire, mostly to maintain what they admitted was an indulgent lifestyle. But a fourth said they believed they would have to work from necessity. Today, just 12% of those over 65 now are working.
In March 1998 the Securities and Exchange Commission initiated a campaign that aimed to motivate individuals to learn how to save and invest wisely. The “Facts on Saving and Investing Campaign” is a response to the need for heightened money management and investment skills among Americans. Financial knowledge, skill and awareness are particularly important given the increased individual responsibility Americans face for funding their retirements.
As recited above, Americans need to save more and invest wisely because they can expect to live longer and many do not expect Social Security and Medicare to provide benefits comparable to those that beneficiaries receive today.
L. Contingent Workforce And Small Employers Plan Sponsorship
The globalization of the economy has forced companies to restructure, re-engineer, merge with and acquire other businesses in order to heighten their competitiveness. The growing cost of running a business, especially a smaller one, has increased the practice of leasing or hiring contingent employees. For those small employers that do not lease employees workers’ compensation rates have gone through the roof. Despite an increasingly tight labor market, fewer small businesses are offering health care and retirement benefits. This would seem to defy conventional wisdom that employers are being forced to offer better perks to attract employees as the unemployment rate has dropped to levels not seen since the 1960’s.
Small employers are hiring independent contractors, temps, part-time and younger, less- experienced people who may believe that they have less need for pension benefits but instead seek higher salaries.
For those small employers who might give thought to providing retirement benefits they are confronted by the apparent complexities associated with creating pension plans. Part of the confusion may also be attributed to the number of plans or options in existence.
The Department of Labor, through various offices, has done a great deal in its outreach effort to promote the awareness for the need to create retirement vehicles for employees of small employers. This group became a target group in 1995 when the department recognized that it had to be a catalyst to promote a national campaign to educate Americans on the need to save for retirement. Other groups targeted were women and minorities.
Brochures have been created and disseminated through organizations, at public appearances of the Secretary and Assistant Secretary and through partnerships developed with private sector groups such as the National Association of Women Business Owners.
Work groups and task forces have been developed as well as coalitions with business and community-based organizations like the Chamber of Commerce, the Small Business Council of America, the Small Business Association, the Hispanic Radio Network and African-American publications. An interactive web site (///) has been established and the department maintains an 800 number (800-998-7542) where inquiries can be made and information can be obtained.
Small employers who have a plan find that their ability to hire and retain good employees is enhanced. Also, a pension plan can have an impact on employee attitude and performance and certainly facilitate an employee’s ability to prepare more substantively for retirement.
Those small employers who do not have a pension plan who were surveyed recited three main reasons why (1) they see their employees’ preferences for wages and other benefits; (2) the cost of set up and administration as well as government regulations; and (3) their uncertain revenue stream makes it difficult to commit to a plan.
When asked what changes would lead to serious consideration to establish a plan the following responses were given: (1) an increase in profits; (2) providing a business tax credit for starting a plan; (3) an increase in demand from their employees; and (4) allowing key executives to save more in a plan (i.e., eliminate the non-discrimination requirements).
The notion of employers having the ability to pool resources and participate in a coalition or multiemployer-like vehicle might enhance the willingness to establish plans. Multiemployer plans as a retirement delivery system offer: (1) economies of scale; (2) no regulatory compliance obligations; (3) the requirement to pay the contribution; (4) a pooling of actuarial costs; (5) security from investment risk and volatile fund fluctuations; (6) access to professionals - attorneys, accountants, actuaries, investment managers and investment consultants; and, (7) portability for employees.
The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for pension plans in private industry. For example, if your employer maintains a pension plan, ERISA specifies when you must be allowed to become a participant, how long you have to work before you have a nonforfeitable interest in your pension, how long you can be away from your job before it might affect your benefits, and whether your spouse has a right to part of your pension in the event of your death. Most of the provisions of ERISA are effective for plan years beginning or after January 1, 1975.
ERISA does not require any employer to establish a pension plan. It only requires that those who establish plans must meet certain minimum standards. The law generally does not specify how much money a participant must be paid as a benefit.
ERISA does the following:
ERISA also creates standards welfare benefit plans, but those plans are not discussed in this booklet.
Generally speaking, there are two types of pension plans: defined benefit plans and defined contribution plans. A defined benefit plan promises you a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service -- for example, 1 percent of your average salary for the last 5 years of employment for every year of service with your employer.
A defined contribution plan, on the other hand, does not promise you a specific amount of benefits at retirement. In these plans, you or your employer (or both) contribute to your individual account under the plan, sometimes at a set rate, such as 5 percent of your earnings annually. These contributions generally are invested on your behalf. You will ultimately receive the balance in your account, which is based on contributions plus or minus investment gains or losses. The value of your account will fluctuate due to the changes in the value of your investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. The general rules of ERISA apply to each of these types of plans, bust some special rules also apply. To determine what type of plan your employer provides, check with your plan administrator or reach your summary plan description (see p.13).
A money purchase pension plan is a plan that requires fixed annual contributions from your employer to your individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.
Your employer may sponsor a simplified employee pension plan or SEP. SEPs are relatively uncomplicated retirement savings vehicles. A SEP allows employees to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements.
Under a SEP, you as the employee must set up an IRA to accept your employer s contributions. As a general rule, your employer can contribute up to 15 percent of your pay into a SEP each year, up to a maximum of $30,000.
If you work for a company employing 25 or fewer people, your employer may establish a salary reduction SEP. If your employer has such a plan, in addition to any employer contributions to your SEP, you may also elect to have SEP contributions made on your behalf from your salary on a before-tax basis, up to the lesser of 15 percent of your pay or $9,240 in 1995. Your deferral contributions are added to any employer contributions to determine the annual limit ($30,000 or 15% of your pay). Other limits may apply to the amount that may be contributed on your behalf. State and local governments and tax-exempt organizations are not eligible to establish salary reduction SEPs.
A profit sharing or stock bonus plan is a defined contribution under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit sharing plan or stock bonus plan include a 401(k) plan.
Your employer may establish a defined contribution plan that is a cash or deferred arrangement, usually called a 401(k) plan. You can elect to defer receiving a portion of your salary which is instead contributed on your behalf, before taxes, to the 401(k) plan. Sometimes the employer may match your contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount you may elect to defer each year. The dollar limit on the amount you elect to defer each year. The dollar limit in 1995 is $9,240. The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living. Other limits may apply to the amount that may be contributed on your behalf. For example, if you are highly compensated, you may be limited depending on the extent to which rank and file employees participate in the plan. Your employer must advise you of any limits that may apply to you.
Although a 401(k) plan is a retirement plan, you may be permitted access to funds in the plan before retirement. For example, if you are an active employee, your plan may allow you to borrow from the plan. Also, your plan may permit you to make a withdrawal on account of hardship, generally from your funds you contributed. The sponsor may want to encourage participation in the plan, but it cannot make your elective deferrals a condition for the receipt of other benefits, except for matching contributions.
The adoption of 401(k) plans by a state or local government or a tax-exempt organization is limited by law.
Employee stock ownership plans (ESOPs) are a form of defined contribution plan in which the investments are primarily in employer stock. Congress authorized the creation of ESOPs as one method of encouraging employee participation in corporate ownership.
The Department of Labor enforces Title I of ERISA, which, in part, establishes participants rights and fiduciaries' duties. However, certain plans are not covered by the protections of Title I. They are:
The Labor Department's Pension and Welfare Benefits Administration is the agency charged with enforcing the rules governing the conduct of plan managers, investment of plan money, reporting and disclosure of plan information, enforcement of the fiduciary provisions of the law, and workers benefit rights. But other agencies also are involved in pension law monitoring and enforcement. They are:
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