May 30, 2009


Management objectives are one major factor in pension design; the other is the government regulatory structure. This section discusses the development of the government's role in this area.

Most employees covered under an employer-sponsored retirement plan are covered under what is known as a qualified retirement plan. A qualified plan is one that receives certain valuable federal tax benefits, but its design, funding, and administration must meet an extraordinarily complex set of federal statutory and regulatory requirements. Most federal regulation in this area specifically preempts state and local regulation. The tax benefits from such plans to both employer and employee are generally (though not always) adequate to justify the inconvenience of this severe regulatory regime. A nonqualified plan is any other retirement or deferred compensation plan. Nonqualified plans are subject to much simpler federal regulation, along with less favorable tax treatment. Nonqualified plans are used primarily for executive compensation arrangements that replace or supplement qualified plan coverage for a selected group of highly compensated executives.

The government's role in the retirement income area has been dictated primarily by historical factors. Beginning in the late 19th century, the economy of the United States changed fairly rapidly from predominantly agricultural to predominantly industrial and service oriented. Coinciding with this change—and probably in response to it—the large, supportive extended family of the agricultural economy was largely replaced by smaller, more fragmented family units. The shift away from agriculture reduced the amount of economically useful work available to older people, and family structural changes reduced the amount of family support for the aged.

Because of these economic and social trends, people generally must make specific plans for their retirement. This is a difficult matter for most individual employees to do alone and, consequently, employer-sponsored pension plans have become increasingly important.

In the 20th century, federal government involvement in retirement plans for the aged also greatly expanded. The federal government's involvement is twofold. For most people, the most obvious federal government program in this area is the Social Security system adopted in the 1930s to provide direct benefit payments to the aged. But even before the Social Security system was adopted, the federal government became involved in a more traditional way by measures designed to encourage the private pension system.

Governments tend to be reluctant to adopt direct payment arrangements for dependent individuals, particularly in the United States—a reflection of the generally conservative social values of the American public. Historically, governments have tended to look first at private organizations to act in this area. This is one reason why charitable institutions, such as orphanages and hospitals, have for centuries been granted various forms of tax exemption.

In the tradition of encouraging private initiatives, in the 1920s the federal government began encouraging private, employer-sponsored retirement plans by providing two kinds of tax benefits. First, pension funds were made tax exempt under the Revenue Acts of 1921 and 1926. Then, in the Revenue Act of 1928, employer contributions to plan funds were made currently deductible by the employer, even though benefits were not paid to employees until later years. These basic provisions still apply and form the basis for today's vast federal regulatory scheme for qualified plans.

The embryonic private pension system of the 1920s declined significantly during the depression of the 1930s. This was one reason for the adoption of the Social Security system. However, since the 1940s, private pension plans have revived to an enormous degree. Assets in private pension plans now amount to more than three trillion dollars, which constitutes a very substantial portion of the nation's entire capital.

Because of the large sums involved, any tax benefits provided to qualified plans cost the government a great deal in lost tax revenues; the government estimate is well over $75 billion annually. This large "tax expenditure" is often given as a primary justification for the exhaustive scheme of government regulation that now applies to qualified pension plans. Fundamentally, the argument is that the large tax expenditure is designed to help prevent individuals from becoming dependent on the government in retirement. Consequently, the government attempts to make sure that plan benefits go where they are most needed so that this tax expenditure is cost effective. Much pension regulation is aimed at discouraging plans that primarily benefit highly-compensated employees who have other sources of retirement income. Other rules are intended to assure that the large sums set aside for plan benefits are managed in the exclusive interest of plan participants and beneficiaries.

In practice, the government frequently adopts new or modified statutes and regulations relating to pensions without clear or articulated long-range policy objectives. The absence of a coherent federal retirement policy is currently a critical federal policy issue. Current issues in pension regulation include those covered in the following sections.

Tax Revenue Loss

At times, revenue-raising needs outweigh retirement policy issues in Congress. The tax benefits for qualified plans cause a substantial apparent decrease in tax revenues. The criticism is also frequently made that too much of the tax benefit goes to high-income individuals who don't need government help. Whatever the merits of this argument, it is indisputable that "fine tuning" the rules to reduce tax benefits for certain plan participants can increase tax revenues in the short run, without the political pain of visibly "raising taxes." The need to raise revenue has motivated many recent changes in the qualified plan law, and it probably will be a factor in future legislation. Changes of this type are often enormously complex as a result of the need to carefully target the group whose benefits are to be reduced, typically the owner-employees of closely held businesses. Revenue-motivated changes are often criticized as resulting in bad retirement policy.

Discrimination in Favor of Highly Compensated Employees

Although a major thrust of virtually all qualified plan legislation since the 1940s has been to discourage employers from discriminating in their plans in favor of highly compensated employees, a considerable amount of such discrimination is still possible, as discussed throughout this text. Because of this, much qualified plan legislation has been designed to reduce the "tax shelter" aspects of qualified plans, particularly those for smaller businesses whose owner-employees receive substantial benefits. Many of the most complex and awkward provisions of the law, such as the top-heavy rules, were designed in this vein.

Seemingly, it would be easy to eliminate the discrimination problem by simple, appropriate benefit or contribution limits. However there is a counter-vailing policy consideration. Small businesses, collectively, employ a large and increasing segment of the work force. Owners of these businesses may not be interested in maintaining a qualified plan for their employees unless the plan provides substantial, and possibly disproportionate, benefits for the owners themselves. This policy issue, therefore, involves tension between tax-benefit equity and efficiency on the one hand, and the need to encourage small business retirement plans on the other. No simple resolution of this is likely in the near future, and complex legislative compromises on this issue will probably continue to emerge from Congress.

Encouraging Private Saving

Surprisingly, in view of the trillions invested in pension plans, relatively little policy emphasis has been given to the role of the qualified plan rules in encouraging private savings. One problem is that policy makers agree neither on the appropriate level for private savings nor on whether government policy should encourage savings rather than allowing the free market to set the level. Another factor is that economists are divided about the efficacy of the qualified plan provisions in encouraging savings. Some economists argue that these plans merely displace private saving that would take place in any event. Nevertheless, the savings issue is an ongoing factor in the policy debate.

Interest-Group Pressures

As the foregoing discussion indicates, retirement policy poses difficult problems even if viewed from a neutral intellectual viewpoint. The actual political climate, of course, is not neutral. The qualified plan business is large and involves many firms and individuals. Most of these organizations eagerly and frequently convey their views to Congress in great technical detail. This complicates the resolution of issues and makes change more difficult.

Mandatory Retirement Plan Coverage

A presidential commission formed in the late 1970s to study pension policy recommended the establishment of a Minimum Universal Pension System (MUPS) for all workers, to be funded by employers at an initial rate of at least 3 percent of payroll. The MUPS benefit would be completely portable from job to job. In general, the MUPS approach is not popular with employers and benefit plan designers, who prefer the flexibility of current rules; at the present time, Congress is not considering it seriously.

Age and Sex Discrimination

Age and sex discrimination have not been addressed by Congress specifically as retirement plan issues. However, recent federal legislative and regulatory activity related to employment discrimination in general has affected retirement plans


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