Millions More Would Get Pensions Under Tax Plan
Millions of workers would gain retirement benefits under the tax revision plan soon to be considered by the Senate through little-noticed changes aimed at improving the pension system for those who least benefit from it now.
Those aspects of the plan have been overshadowed by the Senate Finance Committee’s controversial proposal to limit individual retirement accounts for workers already covered by pension programs. Nonetheless, many lower- and middle-income workers who do not buy IRAs would benefit from other provisions, according to analysts. By contrast, certain highly paid employees--especially those who plan to retire early--could lose out.
Viewed as a whole, the legislation would be a step back from the increasingly popular “do-it-yourself” approach to retirement that is reflected in IRAs and, to a lesser extent, company-sponsored savings programs known as 401(k) plans.
“The Senate tax bill departs from the save-if-you-can approach that has favored the highly paid employee toward a save-one-save-all approach which ensures that a broad segment of the work force earns the benefits,” maintained Sen. John Heinz (R-Pa.), who is chairman of the Finance Committee’s pension subcommittee. Among other things, the complex plan would:
- Cut the length of time a worker has to stay in a job to be vested (gain ownership of pension benefits); this time now is up to 10 years and would be reduced to five years in many cases. The change would apply to private-sector plans run by a single employer.
- Require that pension programs provide benefits to 80% of a company’s employees or that employers be prepared to justify the fairness of their plans to the Internal Revenue Service. Under current law, employers may cover as few as 56% of their workers. This rule is expected to have the greatest impact on smaller businesses.
- Give a financial break to some lower-paid employees. Now, companies may cut a retiree’s pension benefit by the amount of the retiree’s Social Security benefits. In some cases, the practice virtually wipes out the pension, although the prevalence of this problem is not known. The Senate bill would preserve at least 50% of the pension, regardless of the amount of Social Security benefit.
Curbs on IRAs
- Limit certain retirement savings programs that are most used by highly compensated employees. Workers could still buy IRAs and the earnings would continue to grow tax free. But the tax break for purchasing an IRA would be repealed except for those who are not covered by pension plans. This provision is possibly the most controversial of the entire tax overhaul proposal.
In addition, the yearly ceiling on employee contributions to 401(k) plans would drop to $7,000 from $30,000. At least 90% of participants in such plans would not be affected by the lower ceiling, most analysts estimate. However, the cut would hurt certain well-paid employees who had chosen to put away as much as possible for retirement. If the revision is passed, some pension experts expect an increase in 401(k) participation as those who previously bought IRAs seek alternatives.
Because the changes would be phased in over the next few years, they would have little effect on individuals who are retiring immediately. However, they could significantly alter the pension benefits of many younger workers, especially those who tend to change jobs after several years.
17% Increase
Taken together, the Senate proposals would enable an additional 17% of workers who are in their 30s and 40s today to qualify for pension benefits on retirement, according to projections by ICF Inc., a consultant firm that analyzed the tax plan for the American Assn. of Retired Persons.
The proposals arise at a time of uncertainty within the private pension system, which has grown dramatically in recent decades. Although companies are not required to offer pensions, many seek to do so as a way to aid employees and to reap tax advantages that accrue if the plan follows federal guidelines. Currently, 36.5 million workers--more than half the private work force--are covered by such pension plans, compared to 9.8 million, about 25%, in 1950.
But the nature of pensions is changing. Many employers have moved away from the traditional approach of guaranteeing a prescribed benefit on retirement and have embraced such setups as 401(k) plans, where benefits are affected by the vagaries of interest rates or market conditions.
In addition, the system has been shaken by the decision of many employers in the last several years to take surplus assets out of pension funds and divert the money to other uses. The practice, which has resulted in the removal of more than $9 billion from 856 pension plans, has sparked protests from workers, who feel deprived of their fair share of the money, and questions about whether retirement security is jeopardized.
And, despite increases in coverage, critics argue that millions of workers, many of them women, continue to miss out on pension benefits 12 years after Congress passed landmark pension rights legislation. In part, this is because women have historically stayed out of the long-term career paths sought by men, although this is changing.
Women ‘Big Losers’
“When you look at the pension system, you see that women are the big losers,” said Karen Friedman, education director of the Pension Rights Center, a public interest organization in Washington.
The reason for this is found in the concept of vesting--the real key to benefits. Although 36.5 million workers are covered by private pension programs, only about half, or 18.6 million, have met the length-of-service requirements to guarantee their benefits. Vesting requirements work against those who switch jobs after a few years. If a company requires that a person work for 10 years in order to qualify for a pension, for example, the worker who leaves after nine years gets nothing.
Thus, easier vesting requirements would immediately entitle many more people to eventual benefits. A reduction to five-year vesting in 1985 would have vested about 1.8 million additional workers--1.1 million men and 766,000 women, according to the Employee Benefit Research Institute, a Washington research group supported by private industry. Those figures represent a 10% gain in the number of vested female workers and a 7% gain for males.
Over time, several million workers would be aided by the vesting change alone, although estimates are imprecise, according to a Senate aide who helped write the legislation. As an alternative to five-year vesting, the tax plan would allow a company to require seven years of service. But, under that arrangement, which is expected to be less common, a worker would gain partial benefits after just three years.
‘A Real Big Step’
“If you’re covered and never vest, what good is the pension plan to you?” asked David M. Certner, a lobbyist for the American Assn. of Retired Persons. “I think this is a real big step.”
To be sure, the vested benefit received by workers who quit a job after six or seven years may be modest: lump sum payments varying from hundreds of dollars to several thousand, depending on the person’s age and other factors.
To encourage retirement savings, the bill would continue policies that enable people to escape taxation on cash received from pension funds when they change jobs. It would allow them to escape a 15% tax on the money under certain circumstances--if it is invested in an IRA, for example. In addition, the money would grow tax free under those circumstances.
“We think that the combination of those (tax advantages) will result in a lot of money going into IRA accounts for people that had nothing before,” the Senate staff member said.
For Some, a Leap Backward
But, if the bill represents a step forward for the less-established employees, it may seem like a leap backward to those who are most highly compensated. In addition to losing the IRA tax break and having their 401(k) contributions capped, a small percentage of workers would suffer heavy reductions in early retirement benefits.
The maximum annual benefit of $90,000 allowed under federally approved pension plans would drop to about $65,000 for those who wish to retire at 62, with other reductions affecting retirement as early as age 55, although the government might adopt rules to phase in the cuts.
If such pensions sound extraordinary by today’s standards, they will be more common in the future because of inflation and increases in real wages. And the early retirement limits will ultimately affect a significant number of workers who are now in their 20s, said Mark Ugoretz, executive director of a Washington committee that represents major corporations on pension issues.
“One way to ensure that people will have something at retirement is through employer-based pensions,” added Ugoretz, whose group is unhappy with the early retirement change. “The argument is over what the animal ought to look like.”
Programs Could Be Dropped
The prospect of increased pension expenses for employers--which may vary considerably--along with the need to comply with complex new legal requirements, has led some to speculate that the changes might cause the end of some pension programs. The cost to employers of broadening the pension coverage, primarily for workers who change jobs after several years, would be about $57 a year per employee between 1986 and 1990, rising to $283 a year after 2016, according to the ICF consultants.
Beverly J. Orth, an attorney in Los Angeles with the Mercer-Meidinger benefits consulting firm, warned that the proposed new benefits would backfire on existing participants if employers opt to abandon their pension programs: “What about the ones that would have gotten benefits but now won’t because their plan was terminated?”
But Frank B. McArdle, education and communications director of the Employee Benefit Research Institute, played down such concerns. “There may be situations where an individual employer finds the added costs too much to bear, but, for the pension world as a whole, there won’t be dire effects,” he predicted.
