Plan Types Pensions and Policy Approaches
The federal government has played a major role in the development of employer-sponsored plans through both the provision of favorable tax treatment and direct regulation.
The Internal Revenue Code. The approach of federal pension policy as far back as the 1940s has been to provide tax incentives that will encourage highly paid employees to support the establishment of employer-provided pension plans that provide retirement benefits to the rank and file. The tax incentives arise because under the Internal Revenue Code employer contributions to a pension plan are deductible as a business expense when made, but the employee is not taxed until receipt of pension benefits. In addition, the pension fund is not taxed on its earnings. These two provisions, which permit tax deferral on both employer contributions and the earnings on those contributions, are equivalent to exempting from taxation the earnings on the money that would have been invested after tax, assuming the employee remains in the same tax bracket. This tax provision reduces personal income tax revenues by roughly 10 percent each year.
Because pensions are tax-favored, the tax code limits the amount that can be saved through employer-sponsored plans. In the case of defined benefit plans, the maximum benefit cannot exceed 100 percent of final pay averaged over three years or an indexed amount that is $140,000 for 2001. In the case of defined contribution plans, contributions are limited to the lesser of 25 percent of compensation or a fixed ceiling that rises with inflation (the ceiling is $35,000 in 2001). For the purpose of this calculation, compensation cannot exceed a specified limit, $170,000 in 2001. In addition, employee contributions to 401(k) plans cannot exceed an indexed amount of $10,500 in 2001, and as with defined contribution plans generally, total employee and employer contributions are limited to the lower of $35,000 in 2001 or 25 percent of the participant's compensation.
Because of the favorable tax treatment, the tax code also restricts access to funds contributed to defined contribution plans generally, and to 401(k) plans in particular. Before age fifty-nine and a half, the employee can generally withdraw money without penalty only upon disability or death; otherwise, the employee must pay a 10 percent penalty in addition to income taxes. After fifty-nine and a half, the employee may withdraw funds without penalty. Participants do have limited access to their 401(k) funds without penalty through borrowing provisions that allow individuals to borrow the lesser of 50 percent of their holdings or $50,000.
In addition to contribution and access limits, pension regulations include nondiscrimination provisions stipulating that benefits for highlycompensated employees be given favorable tax treatment only if a high proportion of rank-and-file employees are also covered by the plan. The technical and complex regulations allow considerable leeway, however. They only require that the classification for participation be reasonable and that the level of participation from the highly compensated group be not too much greater than the level of participation from the remainder of the workforce. Employers can exclude from participation those with less than one year of service and those under twenty-one. Employers can also exclude specific groups of workers provided that excluded workers do not exceed 30 percent of the non-highly compensated workforce. In addition, benefits may be forfeited for failure to complete five years of service. Thus, the nondiscrimination requirements do not fully achieve the goal of including all rank-and-file workers.
Employee Retirement Income Security Act (ERISA). The federal government has also sought to protect pension benefits through the direct regulation of these plans, most notably through the Employee Retirement Income Security Act of 1974 (ERISA). ERISA's principle objective was to secure the rights of plan participants so that a greater number of covered workers would receive their promised benefits. It was a response to failings and abuses in defined benefit pension plans, which covered the majority of workers at the time. Before the legislation, some employers imposed such stringent vesting and participation standards that many of their workers reached retirement age only to discover that because of some layoff or merger they were not eligible for a pension. Even workers who satisfied their plans' requirements had no assurance that accumulated pension assets would be adequate to finance benefits. And a few pension plans were administered in a dishonest, incompetent, or irresponsible way. Others engaged in forms of financial manipulation such as concentrating investments in the stock of the plan-sponsoring company, which, while not illegal, also jeopardized the welfare of plan participants. The net effect of these problems was that in the pre-ERISA era plan participants were at the mercy of plan sponsors. ERISA was designed to change the balance of power.
Most observers agree that ERISA has been successful in meeting its stated objective of strengthening workers' claims on benefits. Participation and vesting standards enable workers to establish a legal right to benefits. The implementation of funding and fiduciary standards and the establishment of the Pension Benefit Guaranty Corporation, a mandatory pension insurance program for defined benefit pension plans, ensure that money will be available to pay these benefits. As a result, more workers covered by private sector–defined benefit programs received benefits, and many got larger benefits than they would have in the absence of ERISA.
Although the legislation was successful, its focus was limited. Questions of portability, inflation protection, and coverage were discussed during the deliberations, but they were either not addressed at all or addressed in a very limited fashion in the final legislation. Other issues such as cashing out of lump-sum benefits received almost no attention.
- Plan Types Pensions and Policy Approaches - Major Issues Facing The Pension System
- Plan Types Pensions and Policy Approaches - A Shift To Defined Contribution Plans
- Other Free Encyclopedias
Medicine EncyclopediaAging Healthy - Part 3Plan Types Pensions and Policy Approaches - Coverage Under Private Pension Plans, A Shift To Defined Contribution Plans, Federal Regulation, Major Issues Facing The Pension System