[10] base for computing deductible plan contributions on behalf of such proprietary-employees is limited to the first $100,000 of their earned income. 9. Lump-sum distributions. The committee bill provides a new method of taxing lump-sum distributions from employee plans which is equitable and relatively simpler than the 7-year averaging procedure provided by the 1969 Act. Under the new provision, that portion of the distribution (other than the employees' own contributions) representing pre-1974 value receives capital gains treatment; the balance of this lump-sum distribution is to be taxed as ordinary income under a separate tax schedule (the tax schedule applicable to single people) generally without reductions, exclusions, or consideration of the taxpayer's other income. However, to insure that the tax paid by lower income individuals on their lump-sum distributions will generally not be more than under present law, a special minimum distribution allowance is provided under the separate tax rate schedule. In addition, averaging relief is provided for the portion of the lump-sum distribution which is taxed as ordinary income under the separate tax rate schedule by providing 15-year averaging for such income (i.e., the tax is generally computed on one-fifteenth of such income and the result is then multiplied by 15). II. REASONS FOR THE BILL One of the most important matters of public policy facing the nation today is how to assure that individuals who have spent their careers in useful and socially productive work will have adequate incomes to meet their needs when they retire. This legislation-The Comprehensive Private Pension Security Act of 1973-is concerned with improving the effectiveness of qualified retirement plans in their vital role of providing retirement income. In broad outline, the objective is to increase the number of individuals participating in employerfinanced plans; to make sure to the greatest extent possible that those who do participate in such plans actually receive benefits and do not lose their benefits as a result of unduly restrictive forfeiture provisions or failure of the pension plan to accumulate and retain sufficient funds to meet its obligations; and to make the tax laws relating to qualified retirement plans fairer by providing greater equality of treatment under such plans for the different taxpayer groups concerned. Essentially, the committee bill represents a significant improvement in the tax treatment now applicable with respect to qualified retirement plans. The committee regards the present legislation as part of an evolutionary process which keeps this basic framework but which builds on it new provisions which experience indicates are necessary for the proper functioning of these plans. A fundamental aspect of present law, which the committee bill continues, is reliance on voluntary action by employers (and employees under contributory plans) for the establishment of qualified retirement plans. The committee bill also continues the approach in [11] present law of encouraging the establishment of retirement plans which contain socially desirable provisions through the granting of tax inducements. In other words, under the new legislation as under the present law, no one is compelled to establish a retirement plan. However, if a retirement plan is to qualify for the favorable tax treatment, it will be required to comply with specified new requirements which are designed to improve the retirement system. Since the favorable tax treatment is quite substantial, presently involving a revenue loss of over $4 billion a year, it is anticipated that plans will have a strong inducement to comply with the new qualification rules and thereby become more effective in fulfilling their objective of providing retirement income. The tax advantages associated with qualification under the Internal Revenue Code are substantial. Employers, within certain limits, are permitted to deduct contributions made to such plans on behalf of covered employees, whether or not the interests of covered employees 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 ENCOURAGEMENT OF NONDISCRIMINATORY PLANS UNDER As already indicated, our tax laws now provide substantial tax incentives for the establishment of nondiscriminatory retirement plans. In order to qualify as nondiscriminatory, a retirement plan 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, either the contributions to the plan or the benefits paid out by the plan must not discriminate in favor of officers, etc. In adopting this legislation, the Finance Committee is aware of the achievements of the private pension system under the 1942 legislation. The private retirement system has grown rapidly over the past three decades. About 30 million employees were covered by private retirement plans in 1970 compared to 4 million in 1940 and 9.8 million in 1950. (See Table 1.) By 1980, these retirement plans are expected to cover 42 million employees." 1 To qualify on this basis, the plan must cover 70 percent or more of all the employees, or 80 percent or more of all employees who are eligible to benefit under the plan if 70 percent or more of all the employees are so eligible, excluding in each case employees who have been employed not more than a minimum period prescribed by the plan, not exceeding 5 years, employees whose customary employment is for not ore than 20 hours in any 1 week, and employees whose customary employment is for not more than 5 months in any calendar year (sec. 401 (a) (3) (A)). 2 See Public Policy and Private Pension Programs. A Report to the President on Private Employee Retirement Plans by the President's Committee on Corporate Pension Funds and Other Private Retirement and Welfare Programs, January 1965, p. vi. [12] ¡Coverage 1 Employer TABLE 1.-PRIVATE PENSION AND DEFERRED PROFIT-SHARING PLANS: ESTIMATED COVERAGE, CONTRIBUTIONS, BENEFICIARIES, BENEFIT PAYMENTS, AND RESERVES, 1950, 1955, 1960-70 Non Non Year Total Insured insured Total Insured insured 1 Includes pay-as-you-go, multi-employer, and union-administered plans, those of nonprofit orga- 2 Excludes annuitants; employees under both insured and noninsured plans are included only once under the insured plans. * Includes refunds to employees and their survivors and lump-sums paid under deferred profitsharing plans. Source: Compiled by the Office of the Actuary, Social Security Administration, from data furnished primarily by the Institute of Life Insurance and the Securities and Exchange Commission. [13] The growth which has occurred is also evidenced in other ways. Between 1950 and 1970, total annual contributions made to retirement plans by employees and employers rose from about $2.1 billion to about $14 billion. In 1950, 450,000 beneficiaries received $370 million from retirement plans; in 1970, 4.7 million beneficiaries received $7.4 billion in pension payments. Moreover, retirement plan assets soared from $12.1 billion in 1940 to $150 billion in 1972 (book value) and are expected to reach $225 billion by 1980.* PROBLEM AREAS Despite the substantial achievements of retirement plans, it has become apparent that a number of problems have arisen which prevent many of these plans from achieving their full potential as a source for retirement income. These problem areas are outlined below. Inadequate coverage.-Despite the rapid growth in retirement plan coverage in recent years to its 1970 level of about 30 million employees, one-half of all employees in private, nonagricultural employment are still not covered by retirement plans. Retirement plans are still relatively rare among small business firms and in agriculture. Moreover, even where employees work for a firm with a retirement plan, the age and service requirements for participation in the plan may be overly restrictive, excluding many employees. Discrimination against the self-employed and employees not covered by retirement plans.-Another problem area is that present law discriminates against employees not covered by retirement plans and against the self-employed. This is primarily because the personal retirement savings of individuals not covered by pension plans must be made out of after-tax income, while those covered by retirement plans are permitted to defer tax on their employer's retirement contributions. In addition, the earnings on the retirement savings of noncovered persons are subject to tax as earned, while the tax on earnings of pension funds is deferred until paid out as a retirement benefit. Self-employed people also frequently maintain that they are discriminated against as compared with corporate executives and ownermanagers of corporations in regard to the tax treatment of retirement savings. At present, there is no comprehensive limit on the amounts the employer can contribute on behalf of corporate executives and owner-managers of corporations; similarly, there is no statutory limit on the amount of pension benefits that the latter can receive-so long as those contributions or benefits do not discriminate in favor of employees who are shareholders, officers, supervisors, or highly paid and do not constitute unreasonable compensation. As a result of legislation enacted in 1962 and amended in subsequent years, self-employed people can establish retirement plans for themselves and their employees but their deductible contributions to such plans on their own behalf are limited to 10 percent of earned income up to $2,500 a year. Some self-employed people, including professional people, have been successful in securing the tax advantages associated with corporate Table 1 and Securities and Exchange Commission, Private Noninsured Pension Funds, 1972 (Preliminary). [14] retirement plans by forming professional corporations. In many cases these are one-man corporations. Although the Service for a long time. refused to recognize the validity of such corporations for Federal tax purposes, the courts sided with the taxpayers, and the Internal Revenue Service has agreed to generally recognize such corporations.5 Inadequate vesting.-Present law generally does not require a retirement plan to give a covered employee vested rights to benefitsthat is, the right to receive benefits even if he leaves or loses his job before retirement age. Over two-thirds of the private retirement plans provide vested rights to retirement benefits before retirement. However, as a general rule, employees do not acquire vested rights until they have accumulated a fairly long period of service with the firm and/or are relatively mature. At present, only one of every three employees participating in employer-financed plans has a 50 percent or greater vested right to his accrued retirement benefits. Moreover, 58 percent of covered employees between the ages of fifty and sixty and 54 percent of covered employees 60 years of age and over do not have a qualified vested right to even 50 percent of their accrued retirement benefits.' As a result, even employees with substantial periods of service may lose retirement benefits on separation from employment. Extreme cases have been noted in which employees have lost retirement rights at advanced ages as a result of being discharged shortly before they would be eligible to retire. In addition, failure to vest more rapidly is charged with interfering with the mobility of labor, to the detriment of the economy. Inadequate funding.-Another problem area is that a significant portion of present pension plans are not adequately funded that is they are not accumulating sufficient assets to pay benefits in the future to covered employees. As a result, there is concern that many employees now covered by pension plans may not actually receive pensions when they retire because the funds will not be available to pay for those pensions. In general, pension plans that are qualified under the Internal Revenue Code must meet certain minimum funding requirements by 5 However, the 1969 Tax Reform Act made contributions on behalf of shareholderemployees who own more than 5 percent of an electing small business (subchapter S) corporation's stock subject to the same 10 percent-$2,500 limitations as apply to retirement contribution deductions on behalf of self-employed people. However, as noted below, vesting is required for employees under so-called H.R. 10 plans for owner-employees and may also be required in other cases to prevent the plan from having a discriminatory effect in operation, or upon plan termination or complete discontinuance of contributions. U.S. Treasury Department-Fact Sheet. Pension Reform Program, as reprinted in Material Relating to Administration Proposal Entitled the "Retirement Benefits Tax Act", Committee on Ways and Means, 93d Cong., 1st sess., p. 37, Table B. |