For years, pension analysts have warned of the unintended consequences of federal pension regulation. In 1996, even President Clinton acknowledged that the growth of regulation over the past 15 years has hurt private pension plans.
Naturally, hopes ran high when pension reform measures were passed by the last Congress. Yet the final legislation was a big disappointment – tantamount to rearranging deck chairs on the sinking Titanic. The next time 'round, Congress should forget about fine-tuning burdensome federal rules and discard most pension regulation altogether.
The problem started in 1982, when Congress began chipping away at tax "loopholes." Tax preferences for pension plans were targeted because well-paid workers were much more likely to be covered by a pension than low-paid workers. The goal of numerous pension law changes was to increase federal revenue while spreading pension coverage more equally across the workforce. The resulting "nondiscrimination" rules tied the contributions and benefits awarded to managerial employees to the level of those received by rank-and-file workers in the same firm.
Employers must perform complicated mathematical tests to ensure that the difference between contributions to, and benefits from, pension plans for both groups falls within an acceptable range. In addition to being hopelessly complex, these mandates restrict the ability of employers to offer higher pension compensation to more valuable workers. Many firms have responded by terminating existing plans. Others forgo creating new plans.
After World War II, pensions had become an important part of worker compensation, and pension coverage increased steadily for more than three decades. By 1979, 54 percent of private employers sponsored a pension plan and 43 percent of all private workers participated in them. However, the increasing overregulation of private pensions since that time has brought their growth to a screeching halt.
Changing labor force demographics and preferences, and escalating global competition account for part of this trend. Although these forces are largely beyond our control, another major factor, government overregulation, is thoroughly within our power to change. Last year's reforms failed to reduce those regulatory burdens significantly. Its pension law "simplifications" were important, but relatively minor. The bill aimed primarily at the nondiscrimination rules by creating a new "model" plan type for small businesses and a "safe harbor" for the 401(k) plans of all businesses.
The new plan type established by Congress, Savings Incentive Match Plans for Employees of Small Employers (SIMPLE), is similar to a 401(k) plan, but it excuses small businesses from some of the nondiscrimination testing—as long as the employer matches 100 percent of all voluntary worker contributions, up to three percent of each employee's salary. The employer may alternatively choose to make a mandatory contribution of two percent of salary for each employee.
The 401(k) safe harbor waives some nondiscrimination tests for those plans if the employer matches 100 percent of worker contributions up to three percent of salary, and 50 percent of additional contributions up to five percent of salary.
Though popular with some businessmen, these new provisions just offer alternative methods for meeting the nondiscrimination rules; they do not eliminate them. Employers are excused from complicated testing, but they are locked in to the new burden of making potentially expensive contributions for all workers. Moreover, the changes essentially ignored much needed deregulation of other plan types.
If Congress wants to get serious about pension reform, two fundamental issues must be addressed. First, the cost and complexity of administering a pension plan has to be reduced. The "simplification" changes passed last summer are a solid start. But real reform entails more than just making the required paperwork easier. Second, Congress must return control of pension design to the firms and workers who pay for them.
Key reforms should include an immediate repeal of the nondiscrimination requirements for contributions and benefits in section 401(a)(4) of the tax code, and the top-heavy rules in section 416. This change would still require firms to offer pension coverage to most rank-and-file workers, but would permit a much broader range of benefit levels. It also would reduce significantly the cost and complexity of pension administration by eliminating the need for testing contribution levels.
Congress may be reluctant to maintain the tax preferences for pension saving if benefits continue to accrue largely to managerial employees, but the current regulatory model cannot last. Despite the enormous disruption in the body of pension law during the 1980s, low-wage workers are now less likely, not more likely, to be covered by a pension. Many firms simply cannot afford to award pension benefits to all employees with the same level of generosity.
Particularly because the future of Social Security is increasingly questionable, Congress must expand opportunities for individuals to save for retirement, even if they are not gold-plated plans. Already this year, eight bills have been introduced to expand access to IRAs, but these alone are not good enough. Employer-sponsored pension plans are valuable forms of retirement saving, and they need to be preserved.
Greg Conko is a policy analyst at the Competitive Enterprise Institute.