1st Session [Bracketed numerals indicate official report page numbers.] PRIVATE PENSION PLAN REFORM AUGUST 21, 1973.-Ordered to be printed Filed under authority of the order of the Senate of August 1, 1973 Mr. LONG, from the Committee on Finance, REPORT together with ADDITIONAL AND SUPPLEMENTAL VIEWS [To accompany S. 1179] The Committee on Finance, to which was referred the bill (S. 1179), having considered the same, reports favorably thereon with amendments and recommends that the bill (as amended) do pass. I. SUMMARY The Comprehensive Private Pension Security Act of 1973 as reported by the committee is designed to make pension profit-sharing, and stock bonus plans more effective in providing retirement income for employees who have spent their careers in useful and socially productive work. It encourages provision for the retirement needs of many millions of individuals. At the same time, the committee recognized that private retirement plans are voluntary on the part of the employer, and, therefore, it has carefully weighed the additional costs to the employer and minimized them to the extent consistent with minimum standards for retirement benefits. In broad outline, the bill is designed (1) to increase the number of individuals participating in retirement plans; (2) to make sure that those who do participate in such plans do not lose their benefits as a result of unduly restrictive forfeiture provisions or failure of the plan to accumulate and retain sufficient funds to meet its obligations; and [2] (3) to make the tax laws relating to such plans fairer by providing greater equality of treatment under such plans for the different taxpaying groups involved. This bill also goes a long way toward equalizing the tax treatment of those in different lines of work. In the case of the self-employed, it makes a threefold increase in the deductible amount which can be set aside for retirement. At the same time, and closely related to this, it provides similar maximum set-asides for those in corporate organizations who are similarly situated to the self-employed. The bill also provides deductions for a modest retirement savings set-aside for those who are not covered by any existing plans. The bill continues to rely primarily on the tax laws to secure needed improvements in pension and related plans. In general, it retains the tax incentives granted under present law for the purpose of encouraging the establishment of plans which contain socially desirable provisions. However, it also improves the effectiveness of these tax incentives by extending or increasing them in certain cases where this is warranted and by pruning them where they have given rise to problems. In addition, the bill provides that plans, in order to qualify for the favorable tax treatment, must meet certain new rules designed to bring about needed improvements. The committee has taken this approach because it believes that properly designed tax provisions are the most effective way of inducing plans to make the improvements that are so urgently needed. At the same time, however, the bill sets up in the Department of Labor a procedure for reviewing employee claims with respect to pension, profit-sharing and other similar plans. The Department of Labor is given the authority to require by court action that pension and similar plans maintain adequate fiduciary standards and that the assets and income of the plans are safeguarded. Present tax treatment of qualified plans Present law encourages employers to establish retirement plans for their employees by granting favorable tax treatment where plans qualify by meeting nondiscrimination and other rules set forth in the Internal Revenue Code. Such qualified plans must cover a specified percentage of employees or cover employees under a classification found by the Internal Revenue Service not to discriminate in favor of employees who are officers, shareholders, supervisory employees, or highly compensated employees. Similarly, the contributions to such plans or the benefits paid out by them cannot discriminate in favor of such employees. The favorable tax treatment granted qualified plans is substantial. Employers, within certain limits, are permitted to deduct contributions made to these plans for covered employees whether or not their interests are vested; earnings on the plan's assets are exempt from tax; and covered employees defer payment of tax on employer contributions made on their behalf until they actually receive the benefits, generally after retirement when their incomes and hence applicable tax rates tend to be lower. The private pension system has shown substantial development under the present tax rules. Private pension plans covered about 30 [3] million employees in 1970 and are expected to cover 42 million employees by 1980 without any change in law. Similarly, in 1970 about $14 billion was contributed to pension plans by employees and employers and 4.7 million beneficiaries received $7.4 billion in pension payments. Moreover, pension plan assets amounted to $150 billion (book value) in 1972 and are expected to reach $225 billion by 1980. Problem areas While the achievements of private retirement plans are substantial, number of serious problems have become apparent. a Inadequate coverage. Despite the rapid growth in pension coverage, one-half of all employees in private nonagricultural employment are still not covered. Pension plans are still relatively rare among small business firms and in agriculture. Moreover, many plans have overly restrictive age and service requirements for participation, resulting in the exclusion of many employees. Inadequate vesting.-Present law generally does not require an employee plan to give a covered employee vested rights to benefits-that is, the right to receive benefits if he leaves or loses his job before retirement age. Many private pension plans do provide vested rights to benefits before retirement, but a general rule, employees do not acquire vested rights until they have served a fairly long time with the firm and/or are relatively mature. As a result, even employees with substantial periods of service may lose pension benefits upon separation from employment. Inadequate funding.-A significant number of pension plans are not adequately funded-that is, they are not accumulating sufficient assets to pay benefits in the future to covered employees. Under the present minimum funding requirements, contributions to qualified plans must be at least large enough to pay the normal costs (the pension liabilities created in the current year) plus the interest on unfunded accrued liabilities attributable to the past service of the covered employees. However, this minimum funding requirement is not adequate because it does not require the unfunded accrued liabilities for past service to be amortized. Loss of pension benefits due to plan terminations. Even if employees acquire vested rights to pension benefits under a plan which is being funded on what appears to be an adequate contribution schedule, there is no assurance that they will actually receive their benefits when they retire. If, for example, the employer terminates the plan as a result of going out of business, moving, closure of a particular plant, or merger, there may not be sufficient funds accumulated in the plan to pay the full amount of the pension benefits. As a result, employees who have worked for the firm for a long time may be deprived of their pensions with resulting hardship. Misuse of pension funds.-While most pension funds appear to be well managed, there have been instances in which such funds have not been used to the best interest of covered employees. Cases have been noted of extreme misuse of pension funds. In addition, present law permits pension funds to be invested heavily in employers' securities. This frequently is not in the best interest of employees which would be better served by diversifying plan investments. The Internal Revenue Code seeks to prevent abuses in the use of qualified pension funds [4] by prohibiting certain types of transactions which are likely to result in abuse. However, this prohibited transaction provision is not effective both because the present prohibited transactions are limited in nature and because the penalty for noncompliance is the disqualification of the pension plan from tax benefits for a period of time. This penalizes the covered employees who have had no part in any wrongdoing. Discrimination against individuals not covered by pension plans.— Individuals who are outside of qualified pension plans have no opportunity to set aside income for their own retirement under the favorable tax treatment accorded to individuals covered by such plans. These individuals must save for their retirement from income after tax and must pay tax currently on the income earned by their retirement savings. Unjustifiable differences in tax treatment of corporate owner-employees and self-employed individuals under qualified plans.-At present, in practice there is almost no practical limit on the amount of pension contributions that closely held corporations can make to qualified plans on behalf of owner-employees. This has resulted in abuse situations in which extremely large pension benefits have been financed for corporate owner-managers in part at the expense of the general taxpaying public, as a result of the favorable tax treatment that is accorded. The fact that pension contributions on behalf of owner-managers of closely held corporations are in practice not subject to control has also given rise to claims of discrimination on the part of self-employed persons. Pension contributions made by self-employed persons on their own behalf are limited to 10 percent of earned income up to $2,500 a year under present law. It has also had the undesirable effect of inducing many individuals, including professional people, who would normally carry on their activities as sole proprietors or partners, to convert their activities to the corporate form almost entirely to secure the greater tax advantage associated with corporate plans. Provisions of the bill The bill deals with these problems in many different ways. The principal provisions of the bill are summarized below. 1. Participation requirements.-To extend coverage more widely, the bill provides that a qualified plan cannot require an employee to serve longer than one year or attain an age greater than 30 (whichever occurs later) as a condition of eligibility to participate in the plan. This provision is effective immediately for plans adopted after the date of enactment and January 1, 1976, for plans in existence on the date of enactment. However, existing plans which have been determined on the basis of collective bargaining agreements are not subject to the new provision until the expiration of the collective bargaining agreement or January 1, 1981, whichever is sooner. 2. Vesting.-Qualified plans must provide a participant with vested rights to at least 25 percent of his accrued benefits derived from his employer's contributions after 5 years of service. The minimum vesting percentage is required to be increased by 5 percentage points for each of the next 5 years, and by 10 percentage points for each of the |