Retirement Plan May Strip Some Employee Protections

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Retirement Plan May Strip Some Employee Protections

By THEO FRANCIS and ELLEN E. SCHULTZ, Wall Street Journal

February 4, 2003

The new employer-sponsored retirement savings plan unveiled as part of the Bush budget would strip away most of the rules designed to keep employer plans from favoring highly paid employees.

Otherwise, the new Employer Retirement Savings Accounts would be little different from existing 401(k) plans. But by eliminating most of the so-called nondiscrimination tests and modifying others, employers would keep the tax advantages of offering a retirement plan to their workers, while spending less on them.

The administration says the simplified rules will reduce cost and complexity for employers, making them more likely to provide savings plans for workers, which in turn will increase the overall retirement-savings rates.

Together with the other savings proposals, the plans "will provide more savings for Americans," a senior Treasury Department official said.

Particulars of the Bush proposal began to emerge last week.

Critics say employers, who have lobbied for easing the discrimination rules for years, would have fewer reasons to make sure a broad range of employees -- and particularly lower-paid workers -- save for retirement. "It's less retirement savings for lower-income people -- I don't see how you're going to get around that," says Daniel Halperin, a Harvard University law professor who studies pension law and retirement plans.

Currently, in return for special tax treatment of retirement plans, a company must offer the plan to a broad swath of its work force -- not just to owners, officers and top-paid employees -- and, in the process, meet a variety of nondiscrimination tests.

Under current rules, contributions from highly paid workers are tied to contributions from other workers -- the more lower-paid workers contribute, the more managers and other higher-paid workers may contribute. The proposal gives company managers less incentive to provide generous matching contributions or to encourage rank-and-file workers to increase their own contributions to a retirement plan.

Under the proposed plan, lower-paid workers wouldn't have to save as much in order increase the upper limit for how much higher-paid employees could save. For example, if a company's managers want highly compensated workers to be allowed to save 8% of their pretax pay, under current rules management must convince rank-and-file employees to contribute 6% of their pay, on average.

Under the new proposal, rank-and-file workers would only have to contribute 4% to trigger greater allowances for better-paid colleagues. The proposal also would give employers an easier "safe harbor," or a plan design that is considered automatically fair for nondiscrimination testing purposes. Under current safe-harbor rules for 401(k) plans, an employer must match at least 4% of compensation when an employee contributes 5%.

Under the new proposal, employers need only match 3% of compensation when an employee contributes 6%, to pass the test. (Another safe-harbor design, in which employers contribute 3% regardless of employee contributions, would remain unchanged.)

"Net, it's a reduction in benefits," says Mark Iwry, former Treasury benefits tax counsel under President Clinton and now a senior fellow at the Brookings Institution, a nonpartisan think tank in Washington.

The Bush proposal also would eliminate the "top heavy" antidiscrimination rules that mainly affect retirement plans at small employers. These rules hold that if 60% of the retirement-account balances are owned by company officers or owners, then the company must contribute 3% of pay for most workers. Without this requirement, all the assets in the retirement accounts can be owned by the officers and owners.

"Business groups have been trying to get rid of the top-heavy rules for more than two decades," says Karen Ferguson, director of the Pension Rights Center in Washington. "Congress has refused to get rid of them, because they prevent tax-sheltered plans from being honey pots for company owners and officers."

The newly proposed plan does include many of the changes employer groups long have lobbied for, but "it's a bittersweet victory," says Ed Ferrigno, vice president of government affairs for the Profit Sharing/401(k) Council of America, a trade group that represents employers and plan sponsors.

He worries that the president's proposal to create two souped-up kinds of individual retirement accounts, which could allow individuals to save $15,000 a year, will discourage many small-business owners from offering retirement-savings plans for their employees. "Couples can save $30,000 outside [an employer-sponsored] plan -- that's a big, big number for most people," Mr. Ferringo says.

He says, "The little guy, the low-income guy, is going to drop out." Mr. Ferrigno says the solution is more tax breaks for employer-sponsored savings plans. If the distributions were taxed as capital gains and not income, employers would be more likely to set up the plans because that would provide them with an even more-lucrative tax shelter.

Norman Stein, a professor of law at the University of Alabama at Tuscaloosa, is doubtful. "Additional tax breaks won't encourage the formation of new retirement plans," he says. "Most studies show that small businesses don't have retirement plans because they don't have the money to provide them, not because the tax breaks aren't high enough."