Module 1: Private Retirement Plans: Background and Context
What alternatives exist for an employer dealing with superannuated employees?
(a) The employer can terminate the employee without any further compensation or retirement benefits once the value of the employee's services drops below the salary being paid. This course of action is seldom taken by employers. (b) The employer can retain the less productive, superannuated employee in his or her current position at the same level of compensation, with the difference between the employee's productivity and salary being absorbed by the employer as a cost of doing business. This approach would be the most expensive method of dealing with less productive, superannuated employees; would engender longer-range indirect costs from the resultant inefficiencies; and would lead to poor morale among productive, active workers. (c) The employer could retain the less productive, superannuated worker and transfer the worker to a less demanding job at the same or a reduced level of compensation. The direct costs in the former case would be similar to alternative (b), but the indirect costs would be reduced because a more capable person would now be staffing the more demanding position. If the employee's salary were reduced, the direct costs of superannuation also would be reduced. A difficulty with this approach is that few firms have a sufficient quantity of these less demanding jobs matching their needs for less productive workers. (d) The employer can establish a formal retirement plan to provide less productive, superannuated employees with an acceptable alternative to continued employment in a humanitarian and nondiscriminatory manner, and the inefficiencies associated with retaining employees beyond their productive years are reduced. The sense of security derived from the knowledge that provision is made for their retirement income needs, at least in part, should increase the morale and productivity of the employees. Also, systematic retirement of older workers keeps the channels of promotion open, thereby offering opportunity and incentive to the younger employees—particularly those aspiring to executive positions. Therefore, a retirement plan should permit an employer to replenish the workforce.
Why have private retirement plans grown so rapidly in the last century?
(a) The increased productivity and morale of the employee group when a formal retirement plan is offered (b) Tax considerations, especially the significant tax advantages associated with qualified retirement plans (c) Wage stabilization programs enacted during World War II that limited higher wages but allowed the establishment of benefit programs, including retirement plans (d) Pressures from unions for additional and expanded employee benefit programs (e) The necessity of business firms to offer employer retirement plans in order to attract and retain qualified human resources in a competitive labor market (f) The desire of employers to reward employees for long periods of service (g) The efficiency of the formal group savings approach in providing economic security for the aged (h) The sales efforts of funding agencies such as insurance companies, bank trust departments, corporate trustees and mutual funds.
What are the forces at work that have restricted the growth of savings in this country?
Advertising, installment credit availability and the media of mass communications encourage individuals to set their sights on a constantly increasing standard of living. This competition from consumption goods for current income dollars results in a lower priority being placed on the accumulation of savings for retirement. Also, the high levels of federal income taxes reduce an income earner's capacity to save. Though tax rates were reduced by the Tax Reform Act of 1986 (TRA '86), they subsequently increased. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) reduced income tax rates once again, although not as dramatically as TRA '86 did. Subsequently, the American Taxpayer Relief Act of 2012, adopted on January 1, 2013, increased rates on taxpayers considered to be high earners. In the not-very-recent past, inflation was an additional deterrent to increased levels of savings. Inflation is a particularly serious threat to the adequacy of savings programs of persons who already are retired. For employed persons, increases in the cost of living may be offset, in part or in whole, by increases in current earnings; however, inflation protection is likely to be less comprehensive for most older persons. Therefore, they are faced with the alternatives of either accepting a lower standard of living or more rapidly liquidating their accumulated savings.
What role did the National Labor Relations Board (NLRB) play in retirement plan development? (Text, pp. 12-13)
An NLRB ruling in 1948 that employers had a legal obligation to bargain over the terms of retirement plans facilitated labor's drive for retirement benefits. Until that time, there were some questions as to whether employee benefit programs fell within the traditional subject areas of collective bargaining, that is, wages, hours and other conditions of employment. The issue was resolved when NLRB held (in the case Inland Steel Company v. United Steelworkers of America) that pension benefits constitute wages and the provisions of these plans affect conditions of employment. Upon appeal, the court upheld the NLRB decision, although it questioned the assumption that such benefits are wages. The result of these decisions was that an employer cannot install, terminate or alter the terms of a retirement plan covering organized workers without the approval of the authorized bargaining agent for those employees. Furthermore, management has this obligation regardless of whether the plan is contributory or noncontributory, or voluntary or compulsory and regardless of whether the plan was established before or after the certification of the bargaining unit.
Briefly describe the major effects of ERISA on the design process for private retirement plans.
ERISA effected many of the foundational elements of the private retirement movement. These provisions affected virtually all aspects of corporate and self-employed retirement plans from a legal, tax, investment and actuarial viewpoint. In addition, ERISA established new reporting, disclosure and fiduciary requirements as well as a program of plan termination insurance. Another major feature of ERISA was the establishment of the individual retirement account (IRA) concept, which was initially designed for individuals not covered under a qualified retirement plan.
Describe the merits of private retirement plans as a supplement to Social Security benefits and individual savings programs.
It has been argued that the private retirement system is the lowest cost method of providing economic security for the aged. Besides the administrative efficiency of a group savings approach, it is reasoned that the minor increase in consumer prices that might occur to provide pension benefits is a relatively painless method of meeting the risk. This system spreads the burden of retirement security over a large number of people and over a long period of time. Additionally, the argument is made that private retirement plans increase consumption levels among the aged, which in turn helps to maintain a high level of economic activity. Finally, private retirement plans represent a type of forced savings. This aspect is extremely important, since many people attempt to maintain a relatively high standard of living during their active employment years. Thus it may be argued that it is economically more efficient if at least part of the risk is met through a forced-savings, private retirement approach.
How did wage stabilization during World War II affect private retirement benefits?
One wartime development that encouraged the growth of retirement benefits was the creation of a wage-stabilization program as part of a general price control effort. Employers, in competing for labor, could not offer the inducement of higher wages. Under these conditions, union leaders found it difficult to prove to their membership the merits of unionism. Therefore, the War Labor Board attempted to relieve the pressure on management and labor for higher wage rates by permitting the establishment of employee benefit programs including retirement plans. This policy further stimulated the growth of retirement plans during this period.
What arguments are presented by those opposed to the deferred wage concept?
Opponents of the deferred wage concept argue that some employers that pay the prevailing cash wage rate for the particular industry also provide a retirement benefit. Thus, in these cases, the retirement benefit is offered in addition to, rather than in lieu of, a cash wage increase. Second, the deferred wage concept ignores the possible argument that the employer willingly accepts a lower profit margin to provide a retirement plan for employees. Third, it is sometimes argued that if retirement benefits are a form of wage, then terminated employees should be entitled to the part of the retirement benefit that has been earned to the date of termination. In practice, one finds that only a small number of plans provide for full and immediate vesting of all benefits.
Explain the value of home ownership for the economic security of the aged.
Studies indicate that a substantial proportion of the homes owned by the aged are clear of any mortgage. Since normal maintenance costs and taxes tend to be less when a home is owned than when comparable housing accommodations are rented, home ownership enhances the economic security of the aged. Estimated maintenance costs for an unencumbered home are about 33% to 40% less than the costs of renting a similar home. Also, there is the possibility that the home can be used as an income-producing asset or that a home equity loan can be used to provide additional cash. There is growing interest in reverse annuities. With a reverse annuity, the homeowner receives a lifetime monthly income in exchange for the title to the home at the homeowner's death. The equity in the home and life expectancy of the homeowner will determine the amount of the monthly annuity payment.
Explain the major results of TEFRA on the design process for private retirement plans.
TEFRA reduced the maximum limits of retirement plan benefits and contributions; brought about parity between corporate plans and plans for self-employed persons; introduced special restrictions on plans that are considered "top-heavy," that is, plans that appear to be heavily weighted toward key employees; and provided for federal income tax withholding on retirement and annuity payments.
What were the effects of TRA '86 on the design process for private retirement plans?
TRA '86 represented the most pervasive changes to retirement plans since the passage of ERISA. TRA '86 imposed new coverage tests and accelerated vesting requirements for qualified plans, changed the rules under which qualified plans could be integrated with Social Security, lowered limits for retirement benefits that begin before the age of 65, changed the timing and taxation of plan distributions, and terminated IRA deductions for many qualified plan participants. Substantial changes were also made with respect to employee stock ownership plans and executive compensation.
1.1 Describe the basic economic problems facing the aged
The basic economic problems facing the aged include the following: (a) The desire of aged individuals to maintain, to a high degree, their preretirement standard of living in their retirement years (b) The declining employment opportunities available to the aged (c) The relatively low individual savings of the aged because of higher income taxes, increased consumption patterns, inflation pressures in the recent past and other factors (d) The improvement in longevity experienced during the 20th century.
Identify key changes that EGTRRA made to retirement plans.
The following are among key changes that EGTRRA made to retirement plans: (a) Increased contribution, benefit and deduction limits for all types of retirement savings vehicles (b) Provided business credits for the start-up of retirement plans (c) Provided tax credits to lower income and middle-income employees making contributions to retirement plans (d) Created greater parity among corporate, nonprofit and governmental plans (e) Created greater contribution limits permitted for retirement plan participants who were aged 50 and over (f) Created a new provision to allow certain retirement plans to incorporate a feature called a "qualified Roth contribution program" (g) Allowed greater portability for all types of retirement programs by providing for easier rollover of distributions between various types of plans.
What are some of the provisions of PPA related to defined contribution plans?
The following are some of the PPA provisions related to defined contribution plans: (a) Provided employers with incentives to automatically enroll employees in defined contribution plans and to default automatic enrollees into certain balanced long-term investments or managed accounts (b) Made employer contributions subject to faster vesting schedules (c) Allowed financial service providers to give personal investment advice to 401(k) participants and IRA participants (d) Instituted diversification requirements for certain defined contribution plans holding publicly traded employer stock (not applicable to employee stock ownership plans).
What is meant by business expediency, and how does this concept relate to the growth of early retirement plans? (
The growth of early retirement plans might best be categorized by a single concept: business expediency. The establishment of plans was viewed as a management prerogative, and the primary motivation for the creation of plans was the economic benefit, direct or indirect, that accrued to the employer.
Briefly describe the principal tax advantages of qualified retirement plans.
The principal tax advantages possessed by qualified retirement plans are: (a) Employer contributions (within prescribed limits) can be deducted as a business expense. (b) Investment income earned on retirement plan assets is tax-deferred. (c) There is no current income taxation to the employee on employer contributions to the retirement fund made on the employee's behalf. (d) An employee may be in a lower income tax bracket when distributions are received. (e) Under limited circumstances, distributions from retirement plans may be taxed on a favorable basis.
Explain why there is such a low labor force participation rate among the elderly.
There are many reasons for the withdrawal of the aged from the labor force: (a) Many older workers want to retire and do so voluntarily. (b) Many individuals are physically unable to perform work duties as efficiently as they could at younger ages. (c) Industrial and technological advances operate to the disadvantage of older persons. (d) Though created to alleviate the financial risk associated with excessive longevity, the Old-Age, Survivors and Disability Insurance (OASDI) program and private retirement plans have tended to institutionalize the age of 65 as the "normal retirement age." Note that 1986 amendments to the Age Discrimination in Employment Act (ADEA) banned mandatory retirement (at any age) for most employees.
Is the assumption that the financial needs of an individual decrease after retirement valid? Explain.
This assumption is somewhat valid. The retired individual often does not have dependent children, and a home and its furnishings generally have been acquired by retirement age. The actual decline in the financial needs of a retiree, though, has probably been overstated. An individual's expectations and preferences discourage significant change in one's standard of living upon retirement and, increasingly, retirees remain fairly active, particularly in terms of civic, social, travel and other recreational activities. Also, urbanization, geographic mobility, demographics and changing culture minimize the prospect of retired parents moving in with their children.
Summarize the arguments presented by those opposed to the human depreciation concept.
Those who are opposed to the human depreciation concept argue that the validity of the human depreciation concept of private retirement plans can be challenged on the grounds that the process of aging is physiological and is not attributable to the employment relationship. While certain occupational hazards potentially shorten the life spans of employees, the employer should logically be held responsible only for the increase in the rate of aging caused by those hazards. More importantly, the analogy between humans and machines is inherently unsound. A machine is an asset owned by the employer, and depreciation is merely an accounting technique for allocating the equipment costs to various accounting periods. Employees, on the other hand, are free agents and sell their services to employers for a specified wage rate. An employee, unlike a machine, is free to move from one employer to another. The differences between humans and machines are so great that one must question the value of the analogy as a basis for a rationale of private retirement plans.