Changes in Law Hit Traditional Pension Plans
Little-noticed revisions in the pension laws, enacted without public comment in the final hours before Congress adjourned last year, could deliver a strong blow to the traditional pension plans on which 62 million workers have counted for a guaranteed retirement income, pension experts say.
The changes, buried among the scores of provisions in the 1,186-page budget bill, are forcing pension planners and their corporate clients to rethink retirement plans and investment policies.
Frustrated pension specialists say Congress, in its rush to lower the federal budget deficit, may have set back a 15-year drive to put workers’ retirement plans on a more sound footing.
The legislation, critics say, could undermine the future of “defined-benefit” pensions, the traditional plans that promise an assured level of retirement income geared to a worker’s salary and years of service.
“What it did was to fatally wound sound pension policy,” said Louis Kravitz, an Encino actuary whose firm manages pension plans for 800 companies.
Employees of big, established, financially strong companies are unlikely to see any changes in their pension plans on account of the law, experts say. Retirees’ existing benefits are secure.
But for employees of the small and mid-sized firms where most Americans work, many pension specialists say the changes will be dramatic. Even large firms with relatively young work forces may decide they cannot afford to continue their existing pension plans. And employers may be less inclined to enhance retirees’ benefits.
Frustrated by complex and frequently changing rules--and deprived of tax incentives to maintain existing plans--these companies can be expected to abandon traditional pension programs, critics warn. A few won’t replace them. Most will substitute new-style retirement plans that make no promise of a guaranteed retirement income. Some will create hybrid plans with small guaranteed pensions and a non-guaranteed supplementary component.
In all, workers will face more uncertainty in their retirement planning, experts warn.
“What they’ve succeeded in doing in all of these changes is they’ve made defined-benefit plans a luxury that most medium and small employers can no longer afford,” said Phyllis C. Borzi, pension counsel for the House subcommittee on labor-management relations.
The timing of the upheaval in pension rules could not be worse, according to experts critical of the new law.
Other Plans Vulnerable
The October stock market crash, they note, underscored the vulnerability of the alternative, “defined-contribution” plans, which resemble tax-deferred investment accounts and can lose much of their worth if the value of the underlying investments suddenly drops.
“The older person in the work force is better served by a defined-benefit plan generally, not by some relatively short-term defined-contribution program,” said Robert W. Ridley, an employee benefits attorney in Los Angeles.
“That being the case, defined-benefit plans are something . . . that should be encouraged. And frankly, the 1987 changes in the law do just the opposite,” he said. “That’s bad for an aging employee population.”
In fact, some critics warn that the new law may subject even defined-benefit plans to the vagaries of market fluctuations.
Backers of the legislation--including the Reagan Administration and members of the congressional tax-writing committees--predict that the law will achieve its primary objectives of reducing the federal deficit and shoring up the government’s pension insurance system without damaging traditional pension programs.
“By and large, the legislation was good news for responsible employers and appropriate medicine for employers making promises and not funding them adequately,” said Assistant Labor Secretary David M. Walker.
The quarrel focuses on two key provisions of the complicated new law.
First, rules have been tightened to force companies to adequately fund plans for which they have not set aside adequate reserves in the past.
Companies establishing new pension plans will have to quickly make large contributions to cover the years of past service for which they are crediting longtime employees. Those that do not will pay higher premiums to the Pension Benefit Guaranty Corp., the quasi-public insurance company that assumes responsibility for pension benefits when companies cannot meet their obligations.
Big companies with well-funded pension plans favored the changes, in part because they were designed to force companies with weaker plans to act more responsibly, in part because they make it less likely that the guaranty corporation will turn to the financially sound firms for future bailouts.
“I see this as a real strengthening of the defined-benefit pension system,” said Kathleen P. Utgoff, executive director of the pension guaranty corporation, which expects its $2-billion deficit to shrink gradually under the law. “It puts companies that are in trouble on a slow path toward (adequate) funding.”
May Drop Plans
Skeptics say the accelerated funding requirements are more likely to weaken the pension system by forcing some small and mid-sized firms to drop their pension plans altogether, rather than divert funds from other business needs.
“It’s like asking people out of their pockets to suddenly accelerate their mortgage payments,” said Michael S. Gordon, a Washington employee benefits lawyer who, as a congressional aide in the 1970s, helped draft the nation’s basic pension law. “It can’t be done overnight.”
The second key provision limits the tax-deductible contributions that companies can make to well-funded pension plans.
Backers of the change say many companies took advantage of the flexible limits under the old law to hoard large reserves beyond the reach of the tax man, exacerbating the federal budget deficit. The government expects to reduce the deficit by $800 million annually by imposing strict new limits.
But experts say the nature of the new limit on contributions--150% of the obligations a firm would owe if it terminated a plan--is fraught with problems. Utmost, critics say, the limit makes it impossible for companies to plan ahead for their pension obligations, instead forcing them to contribute on virtually a pay-as-you-go basis.
As a consequence, cushions built up by once well-funded plans gradually will erode, according to pension analysts. And as plans near the limit, they may become more subject to market volatility. One year, good investment performance will mean a plan is overfunded; the next year, a weak stock market could leave the same plan underfunded.
Should the stock market plummet again, the critics warn, traditional pension plans--which weathered the October crash well--may be much more vulnerable.
‘Playing With Fire’
“The next time a Black October or Tuesday or Monday comes around, who knows where (pension plans) will be and who knows what jeopardy that places individuals’ pensions in?” asked Howard C. Weizmann, executive director of the Assn. of Private Pension and Welfare Plans, a business lobbying group in Washington. “They’re playing with fire.”
Critics note too that the tax gains generated by the limit eventually will turn into ever-growing losses for the Treasury. As the work force ages, plan obligations will grow, larger contributions will be allowed under the 150% limit--and the impact on the federal budget will be shoved off onto a later generation.
“We’re eating our children,” Weizmann said.
One company concerned about the changes is Digital Equipment, a Massachusetts computer company that in the past has made substantial pension contributions, even though few members of its relatively young work force are near retirement.
“The constraints this is imposing would put off to future management expenses this management should be absorbing,” complained Edward J. Brady, manager of U.S. employee benefits.
Beyond the disputed provisions, some pension experts are concerned that the mere fact that pension law is undergoing another major revision--the seventh in the last five years--will provoke many smaller firms to abandon their defined-benefit plans. They predict that employers will not want to pay benefits consultants and lawyers as much as $8,000 to administer changes they do not understand.
“A lot of companies are throwing up their hands and saying, ‘Enough--I don’t want any more pension plans,’ ” said Steve Vernon, an actuary with the Sherman Oaks office of the Wyatt Co., a benefits consulting firm. “It’s just one more nail in the coffin.”
Utgoff, of the pension guaranty corporation, insists that the new law will not prove complicated to administer. She noted too that Congress has directed the Treasury Department to issue a report in August on whether aspects of the law need to be revised.
Already, though, the changes are taking their toll--not just on pension plans, but on the people who manage them.
Kravitz says that one of his senior actuaries quit this month out of frustration with the ever-changing rules. Other pension specialists say the extra business created by the legal upheaval no longer seems so attractive.
KEY PROVISIONS OF THE 1987 PENSION PROTECTION ACT
1. Shores up finances of the Pension Benefit Guaranty Corp. The basic insurance premium for all plans increases from $ 8.50 to $16 per employee. Weaker plans must pay an additional premium of up to $34 per employee. The increases will raise $400 million annually for the beleaguered pension insurance program.
2. Requires larger corporate contributions, on a faster schedule, for underfunded pension plans. If a payment of $1 million or more is overdue, the government automatically will impose a lien against the company. Firms are responsible for the obligations of their subsidiaries and affiliates.
3. Limits companies’ tax-deductible contributions to well-funded pension plans. If a plan already holds 150% of the money it needs to pay off its immediate obligations--not counting the additional obligations it will incur as employees earn additional benefits--then the company cannot take a tax deduction for any additional contributions to the plan.
4. Discourages companies from promising benefit enhancements that they cannot afford. Employers must post a bond or other security to cover the cost of improved benefits if they already are 40% or more short of covering their existing pension obligations.
5. Enhances protections for workers in bankruptcies. Payment of pension benefits becomes a higher priority. A bankrupt company cannot terminate its pension plan unless it proves it could not otherwise pay its debts and continue in business.
6. Enhances protections for workers when plans are terminated. Companies must pay full benefits under the plan, not just vested benefits.
SOURCE: U.S. Department of Labor, Pension and Welfare Benefits Administration; Pension Benefit Guaranty Corp. TRADITIONAL PENSION PLANS IN ECLIPSE
“Defined-benefit” pension plans--which provide a guaranteed retirement income based on past salary and years of service--are losing favor. Meanwhile, “defined contribution” plans--in which the retirement benefit depends on the investment results of funds set aside by employers and employees--are gaining in popularity.