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Pension Reform Legislation
Submitted to the
Senate Committee on Finance
Statement of the
Investment Company Institute
June 30, 1999
The Investment Company Institute1 is pleased to submit this statement to the Senate Committee on Finance regarding pension reform legislation issues raised at its June 30 hearing. Most importantly, we would like to take this opportunity to indicate our strong support for many of the provisions of S. 646, the "Retirement Saving Opportunity Act of 1999" and S. 741, the "Pension Coverage and Portability Act." Both bills would make the nation’s retirement plan system significantly more responsive to the retirement savings needs of Americans. Both bills would encourage retirement savings by providing appropriate tax incentives to employers and individuals; and both would eliminate many of the unnecessary limitations that discourage small employers from establishing retirement plans and individuals from trying to save for retirement. The Institute commends the sponsors of S. 646 and S. 741 and other members of this committee for their interest in retirement savings policy.
Retirement savings are of vital importance to our nation’s future. Although members of the "Baby Boom" generation are rapidly approaching their retirement years, studies strongly suggest that as a generation, they have not adequately saved for their retirement.2 Additionally, Americans today are living longer. Taken together, these trends will place an enormous strain on the Social Security program in the near future.3 In order to ensure that individuals have sufficient savings to support themselves in their retirement years, they must increase the portion of their retirement savings received through individual savings vehicles and employer-sponsored plans.
The Institute and mutual fund industry have long supported efforts to enhance the ability of individual Americans to save for retirement in individual-based programs, such as the Individual Retirement Account or IRA, and employer-sponsored plans, such as the popular 401(k) plan. In particular, we have urged that Congress: (1) establish appropriate and effective retirement savings incentives; (2) enact saving proposals that reflect workforce trends and saving patterns; (3) reduce unnecessary and cumbersome regulatory burdens that deter employers—especially small employers—from offering retirement plans; and (4) keep the rules simple and easy to understand.
It is our view that together S. 646 and S. 741 achieve these objectives. The Institute previously expressed its strong support of the provisions contained in S. 646 at the Committee’s hearing on increasing retirement savings on February 24, 1999. Therefore, this written testimony will focus primarily on the pension provisions contained in S. 741.
I. Establish Appropriate and Effective Incentives to Save for Retirement
A. Raise Low Caps That Unnecessarily Limit Retirement Savings
In order to increase retirement savings, Congress must provide working Americans with the incentive to save and the means to achieve adequate retirement security. Current tax law, however, imposes numerous limitations on the amounts that individuals can save in retirement plans. Indeed, under current retirement plan caps, many individuals cannot save as much as they need to. One way to ease these limitations is for Congress to update the rules governing contribution limits to employer-sponsored plans and IRAs. Increasing these limits will facilitate greater retirement savings and help ensure that Americans will have adequate retirement income.
S. 741 contains several provisions that would address this issue, which the Institute strongly supports. Section 402 of the bill would increase 401(k) plan and 403(b) arrangement contribution limits to $12,000 from the current level of $10,000; government-sponsored 457 plan contribution limits would increase to $10,000 from the current level of $8,000. S. 646 would increase the 401(k) contribution limit to $15,000 and the 457 contribution limit to $12,000. Another important provision in both S. 741 and S. 646 would repeal the "25% of compensation" limitation on contributions to defined contribution plans. These limitations can prevent low and moderate-income individuals from saving sufficiently for retirement. (As is noted below, the repeal of these limitations is also necessary in order to enable many individuals to take advantage of the "catch-up" proposal in the bill.)
S. 646 contains an additional proposal that the Institute urges Congress to enact. Specifically, Section 101 of S. 646 would increase the annual IRA and Roth IRA contribution limit to $5,000 and permit future adjustments to account for inflation. Today’s $2,000 contribution limit was set in 1981—almost 20 years ago. If adjusted for inflation, this limit would be at about $5,000 today. IRAs are a critical component of the personal savings tier of the nation’s three-tiered approach to retirement savings. But the current $2,000 contribution limit for IRAs no longer provides sufficient savings opportunities for many Americans in light of its loss of real value to inflation over time, longer anticipated life expectancies and continuing increases in medical costs for our elderly population. Only the IRA is available to all working individuals, including those without access to an employer-sponsored plan. Raising the IRA contribution limit will provide all individuals with expanded retirement savings opportunities.
B. Simplify IRA Eligibility Rules And Bring Back The Universal Deductible IRA
S. 646 would also simplify IRA eligibility criteria. As we explained in our testimony before this Committee on February 24, 1999, current eligibility rules are so complicated that even individuals eligible to make a deductible IRA contribution are deterred from doing so. When Congress imposed the current income-based eligibility criteria in 1986, IRA participation declined dramatically—even among those who remained eligible for the program. At the IRA’s peak in 1986, contributions totaled approximately $38 billion and about 29% of all families with a head of household under age 65 had IRA accounts. Moreover, 75% of all IRA contributions were from families with annual incomes less than $50,000.4 However, when Congress restricted the deductibility of IRA contributions in the Tax Reform Act of 1986, the level of IRA contributions fell sharply and never recovered—to $15 billion in 1987 and $8.4 billion in 1995.5 Among families retaining eligibility to fully deduct IRA contributions, IRA participation declined on average by 40% between 1986 and 1987, despite the fact that the change in law did not affect them.6 The number of IRA contributors with income of less than $25,000 dropped by 30% in that one year.7 Fund group surveys show that even more than a decade later, individuals did not understand the eligibility criteria.8
Based on these data, the Institute recommends the repeal of the IRA’s complex eligibility rules, as proposed in S. 646. These rules deter lower and moderate income individuals from participating in the program. A return to a "universal" IRA would result in increased savings by middle and lower-income Americans.
II. Enact Savings Proposals That Reflect Workforce Trends and Savings Patterns
A. Make Retirement Account Balances Portable
On average, individuals change jobs once every five years. Current rules restrict the ability of workers to roll over their retirement account from their old employer to their new employer. For example, an employee in a 401(k) plan who changes jobs to work for a state or local government may not currently take his or her 401(k) balance and deposit it into the state or local government’s pension plan. Thus, the Institute strongly supports Sections 301, 302 and 303 of S. 741, which would enhance the ability of American workers to take their retirement plan assets to their new employer when they change jobs by facilitating the portability of benefits among 401(k) plans, 403(b) arrangements, 457 state and local government plans and IRAs. This change in the law would make it easier for individuals to consolidate and manage their retirement savings.
B. Allow Individuals To "Catch-Up" When Able
The laws governing pension plans also must be flexible enough to permit working Americans to make additional retirement contributions when they can afford to do so. Individuals, particularly women, may leave the workforce for extended periods to raise children. In addition, many Americans are able to save for retirement only after they have purchased their home, raised children and paid for their own and their children’s college education. Section 401 of S. 646 would address these concerns by permitting additional salary reduction "catch-up" contributions. The catch-up proposal in S. 646 would permit individuals at age 50 to increase their plan contributions by 50% over the otherwise permitted amounts. The idea is to let individuals who may have been unable to save aggressively during their early working years to "catch up" for lost time during their remaining working years. S. 646 takes the additional step of exempting the catch-up contributions from nondiscrimination testing. We believe this is necessary to maximize the provision’s effectiveness. Repeal of the "25% of compensation" limit, which is proposed in both S. 646 and S. 741, could further enhance the ability of Americans to "catch-up" on their retirement savings.
The "catch-up" is an excellent idea and is a sorely needed, practical response to the work and savings patterns of Americans today. We urge Congress to act on this proposal.
III. Expand Retirement Plan Coverage Among Small Employers
A. Eliminate Unnecessary Regulatory Disincentives To Plan Formation
The current regulatory structure applied to retirement plans contains many complicated and overlapping administrative and testing requirements that serve as a disincentive to employers, especially small employers, to sponsor retirement plans for their workers. Easing these burdens will promote greater retirement plan coverage and result in increased retirement savings.
Meaningful pension reform legislation must focus on the need to increase pension plan coverage among small businesses. Although these businesses employ millions of Americans, less than 20 percent of them provide a retirement plan for their employees. By comparison, about 84 percent of employers with 100 or more employees provide pension plans for their workforce. 9
Unnecessarily complex and burdensome regulation continues to deter many small businesses from establishing and maintaining retirement plans. The "top-heavy rule" is one example of such unnecessary rules. 10 A 1996 U.S. Chamber of Commerce survey found that the top-heavy rule is the most significant regulatory impediment to small businesses establishing a retirement plan.11 The rule imposes significant compliance costs and is particularly costly to small employers, which are more likely to be subject to the rule. It is also unnecessary because other tax code provisions address the same concerns and provide similar protections. While the Institute believes the top-heavy rule should be repealed, Section 104 of S. 741 would make significant changes to the rule, which would diminish its unfair impact on small employers.
B. Provide Incentives To Encourage Small Employers To Establish Plans
In addition to eliminating rules that deter small businesses from establishing retirement plans, such employers also need appropriate tax incentives to encourage plan formation and address their unique economic concerns. There are two proposed tax incentives that we believe would effectively encourage plan formation among small employers.
First, Congress should provide a tax benefit that would reduce the start-up costs associated with establishing a pension plan. S. 741 proposes a tax credit for small employers of up to 50% of the start-up costs of establishing a plan up to $2,000 for the first credit year and $1,000 for each of the second and third year after the plan is established. S. 646 proposes a tax credit for small employers up to 50% of the start-up costs of establishing a plan up to $1,000 for the first credit year and $500 for each of the second and third year after the plan is established. Such a tax credit would encourage more small employers to establish retirement plans by diminishing initial costs.
Second, Congress should provide assistance to small employers who would like to contribute to a retirement plan for their employees in addition to offering them a salary deferral plan. Because many small employers have cash flow constraints, they are often reluctant to make a commitment to contribute to a retirement plan for their employees. Both S. 741 and S. 646 would grant small employers (those with up to 50 employees) a tax credit for 50 percent of their contributions (up to 3% of employee compensation) to a plan for non-highly compensated employees during the first 5 years of a plan’s operation. This proposal is effectively designed to assure it helps those who need assistance the most—smaller employers and lower-paid individual employees—and would be an excellent way to help small employers deliver a meaningful retirement benefits to lower-paid employees.
C. Expand The Effective SIMPLE Plan Program
The Institute also strongly supports expanding current retirement plans targeted at small employers. Specifically, the Institute supports expansion of the SIMPLE plan program, which was instituted in 1997 and offers small employers a truly simple, easy-to-administer retirement plan.
The SIMPLE program has been very successful. The Institute has found a continued pattern of strong small employer interest in SIMPLE plans over the program’s two-year history. Indeed, new SIMPLE plan formation has continued unabated in the second year of its availability. Based on Institute estimates, mutual funds held in SIMPLE IRAs experienced tremendous growth in 1998, increasing from $0.3 billion to $1.6 billion.
Additionally, information gathered in informal Institute surveys of its members demonstrates just how popular this program is. For instance, one firm alone reported almost 10,000 SIMPLE plans and 47,000 SIMPLE accounts as of December 31, 1997. This increased by about 50 percent over the next quarter to about 14,000 plans and 72,000 accounts. By year-end 1998, the firm had an estimated 23,000 SIMPLE plans and 219,000 accounts. Thus, over one year the number of SIMPLE plans had more than doubled and the number of SIMPLE accounts had more than quadrupled. Other firms for which such data are available demonstrate similar growth rates. An Employee Benefit Research Institute study published in October 1998 similarly demonstrates the effectiveness of the SIMPLE, finding that 12% of small employers with a defined contribution plan report having established a SIMPLE plan over a period of less than 2 years. By comparison, only 9% of small employers surveyed sponsored a SEP, a program that has been available since 1979.12
Moreover, the SIMPLE plan has been especially popular with the nation’s smallest employers. Institute surveys indicate that about 90% of those employers establishing SIMPLE plans had 10 or fewer employees. Employers with 25 or fewer employees constitute nearly the entire market.13
The success of the SIMPLE program is extremely significant, because the lack of retirement plan coverage in the small employer population has been stubbornly nonresponsive to previous policy initiatives and industry efforts. As noted above, under 20 percent of employers with less than 100 employees provide a retirement plan for their employees, as compared to about 84 percent of employers with 100 or more employees.
Despite these successes, Congress can strengthen the SIMPLE program in two ways, each of which the Institute strongly supports. First, S. 741 would raise the SIMPLE plan contribution limits from $6,000 to $8,000 (S. 646 would increase the limit to $10,000). An increase in the SIMPLE plan contribution limit would assure that individuals who work for small employers will have opportunities to accumulate sufficient retirement savings. (As noted above, other provisions of the bills would increase the contribution limits for 401(k), 403(b) and 457 plans.) Second, S. 741 would provide for a salary-reduction-only SIMPLE plan. We believe that this would make the program much more effective for employers of 25-100 employees.
IV. Simplify Unnecessarily Complicated Rules
Simplicity is the key to successful retirement savings programs. This is the lesson of the SIMPLE and IRA programs. S. 741 recognizes the need to keep the rules simple in the case of employer-sponsored plans. As we have noted above, complex and confusing rules diminish retirement plan formation and significantly reduce individual participation in retirement savings programs. We strongly support numerous provisions in S. 741 that would simplify rules. We discuss several of these provisions below.
First, S. 741 would provide a new automatic contribution trust nondiscrimination safe harbor. This safe harbor would simplify plan administration for employers electing to use it, enabling them to avoid costly, complex and burdensome testing procedures. 14 This provision is also an effective way to increase participation rates in 401(k) plans, especially the participation rates of non-highly compensated employees.
Second, the bill also would modify the anticutback rules under section 411(d)(6) of the Internal Revenue Code in order to permit plan sponsors to change the forms of distributions offered in their retirement plans. Specifically, the bill would permit employers to eliminate forms of distribution in a defined contribution plan if a single sum payment is available for the same or greater portion of the account balance as the form of distribution being eliminated. This proposed modification of the anticutback rule would make plan distributions easier to understand, reduce plan administrative costs and continue to adequately protect plan participants. In addition, S. 741 would permit account transfers between defined contribution plans where forms of distributions differ between the plans; this modification of the anticutback rule also would simplify plan administration. It also would enhance benefit portability, which, as noted above, is an important public policy objective.
Finally, S. 741 contains other provisions that would simplify currently burdensome rules and which the Institute supports, including repeal of the multiple use test.
Improving incentives to save by increasing contribution limits to retirement plans and IRAs will provide more opportunities for Americans to save effectively for retirement. Similarly, rules that accommodate the work and savings patterns of today will enable millions of Americans to save toward a secure future in their retirement years. Additionally, providing appropriately structured tax incentives, such as start-up and contribution tax credits for small employers, would increase plan formation. And finally, simplifying the rules applicable to employer-sponsored plans and IRAs would result in a greater number of employer-sponsored plans, a higher rate of worker coverage and increased individual savings. The Institute strongly supports the provisions described above and commends the sponsors of S. 646 and S. 741 for supporting reforms of the pension system that will increase plan coverage and encourage Americans to save for their retirement. We encourage members of this Committee and Congress to enact this legislation this year.
1The Investment Company Institute is the national association of the American investment company industry. Its membership includes 7,576 open-end investment companies ("mutual funds"), 479 closed-end investment companies, and 8 sponsors of unit investment trusts. Its mutual fund members have assets of about $5.860 trillion, accounting for approximately 95% of total industry assets, and have over 73 million individual shareholders.
2For instance, one study concluded that the typical Baby Boomer household will need to save at a rate 3 times greater than current savings to meet its financial needs in retirement. Bernheim, Dr. Douglas B., "The Merrill Lynch Baby Boom Retirement Index" (1996).
3Social Security payroll tax revenues are expected to be exceeded by program expenditures beginning in 2014. By 2034, the Social Security trust funds will be depleted. 1999 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.
8For example, American Century Investments asked 534 survey participants, who were self-described "savers," ten general questions regarding IRAs. One-half of them did not understand the current income limitation rules or the interplay of other retirement vehicles with IRA eligibility. Based on survey results, it was concluded that "changes in eligibility, contribution levels and tax deductibility have left a majority of retirement investors confused." "American Century Discovers IRA Confusion," Investor Business Daily (March 17, 1997). Similarly, even expansive changes in IRA eligibility rules, when approached in piecemeal fashion, require a threshold public education effort and often generate confusion. See, e.g., Crenshaw, Albert B., "A Taxing Set of New Rules Covers IRA Contributions," The Washington Post (March 16, 1997) (describing 1996 legislation enabling non-working spouses to contribute $2,000 to an IRA beginning in tax year 1997).
10The top-heavy rule is set forth at Section 416 of the Internal Revenue Code. The top-heavy rule looks at the total pool of assets in a plan to determine if too high a percentage (more than 60 percent) of those assets represent benefits for "key" employees. If so, the employer is required to (1) increase the benefits paid to non-key employees, and (2) accelerate the plan’s vesting schedule. Small businesses are more likely to have individuals with ownership interests working at the company and in supervisory or officer positions, each of which are considered "key" employees, thereby exacerbating the impact of the rule.
11Federal Regulation and Its Effect on Business—A Survey of Business by the U.S. Chamber of Commerce About Federal Labor, Employee Benefits, Environmental and Natural Resource Regulations, U.S. Chamber of Commerce, June 25, 1996.
12Paul Yakoboski and Pamela Ostuw, "Small Employers and the Challenge of Sponsoring a Retirement Plan: Results of the 1998 Small Employer Retirement Survey," EBRI Issue Brief No. 202 (Employee Benefit Research Institute, October 1998).
14To qualify for the safe harbor, employers would need to make automatic elective contributions on behalf of at least 70% of non-highly compensated employees and match non-highly compensated employee contributions at a rate of 50% of contributions up to 5% or make a 2% contribution on behalf of each eligible employee.