For all of its effort to secure the pensions of working people, the Employee Retirement Income Security Act of 1974 has hastened the decline of defined benefit plans. One of its most detrimental effects has been the erosion of the "inspired linkage" our government constructed when tax-qualified, employer-sponsored pensions were young. The inspired linkage comes from government letting employers provide adequate pensions to key executives if they cover a certain percentage of rank-and-file workers under the same plan.
While many forces drove the development of employer-sponsored pension plans, this inspired linkage was a key force. Employers want to provide good pensions for key executives, and linking that to good pensions for the rank and file produced a win-win situation.
However, ERISA placed dollar limits on executive pensions in qualified retirement plans, those plans eligible for tax benefits. These limits have steadily made executive pensions more inadequate in relation to the executives' compensation before retirement. In the 20 years since ERISA, government repeatedly has reduced the dollar amount of total executive pensions allowed within a qualified plan. This limitation, in turn, has led employers to expand non-qualified pension programs, those not qualifying for tax benefits, for their higher paid employees to have adequate pension benefits for them. This move to non-qualified plans has drawn employer interest and attention away from the rank-and-file pension plan and placed increasingly more focus on these supplemental pension plans for key executives.
This trend will continue long into the future and will continue to erode private qualified retirement plans for ordinary workers. I have lobbied members of Congress and both Republican and Democratic administrations on this issue to no avail.
But this erosion of defined benefit plans could be reversed. If it were legal to provide executive pensions within a qualified pension plan at the same proportion of pay as provided for rank-and-file workers, we would see two key positive developments:
-Benefit levels would be higher for ordinary workers, and more of these workers would be covered under employer-sponsored pension plans; and
-The funding of these additional benefits would create more savings in the United States and reduce the cost of capital, in addition to furnishing more adequate old-age income for our growing aging population.
Critics argue that if more money were put into pension plans, the U.S. Treasury would currently lose revenue because those contributions would be tax deductible. (This ignores the fact that when the contributions are distributed in the form of old-age income, they would be taxable income to the recipients. This postponed tax revenue would be a much greater amount than the initial revenue loss, although when converted to a present value basis may be roughly equivalent.)
Another argument is that government policies should not provide tax shelters for highly paid people. This argument misses the point that by allowing adequate pensions for executives, you will increase rank-and-file pensions.
What is the long-range future for private pensions in the United States? There will be no disaster. We have a maturing employer-based system under which the shift from defined benefit plans to defined contribution plans will continue. And we will continue to see the erosion of private sector employer-sponsored pension plans on a tax-qualified basis and a shift to non-qualified plans outside the ambit of governmental regulation.
Within this environment, the aging of America will continue and a relatively small proportion of those reaching 62 to 65 years of age will be able to afford full retirement. More and more will work beyond age 65, although generally not in the same jobs they held earlier. This inadequacy of pensions will be driven by two trends.
For one, typical middle-class people today have little personal savings for retirement other than their employer-sponsored retirement plan.
For the other, defined contribution plans (in contrast to defined benefit plans) inherently base benefits on a person's average pay over a career and do not relate those benefits to their pay near retirement, which is a good indicator of living standard near retirement. Further, defined contribution plans offer repeated opportunities to spend part of the savings through receipt of cash amounts at terminations of employment, through loans that are not repaid, through partial withdrawals while in active employment, among other opportunities. While there will be attempts to raise the retirement age (the increase will be necessary to keep Social Security financially sound), it is unlikely delayed retirement ages actually will extend a worker's career at the same place of employment. Rather, it will be necessary for most to find work in retirement to augment the inadequate combination of Social Security and private pension.
How will the government respond?
Near term, the limits on executive pensions within qualified plans likely will be cut even more, weakening the commitment to employer-sponsored rank-and-file plans.
More income taxes probably will be placed on Social Security benefits for the well-off aged.
Some type of middle-class tax relief to encourage savings might be approved, perhaps in the form of a sort of individual retirement account to be used for education savings or a medical IRA, but in any event the individual will have control.
A plan likely will be proposed for individuals to opt out of either or both Social Security and their employer pension plan, letting them take the money and invest it themselves. Approval, however, seems unlikely.
Adopting a progressive tax on consumed income to encourage savings is a real possibility within the next five years. This could replace part or all of the federal income tax. The concept would be to add up your income annually, subtract your savings, then pay a tax on the balance - your "consumed income." Attention would have to be paid to program design in order to be fair to lower income people.
The issue ahead is clear. We have an aging America that is living longer, a government that has been less than adequate in its support of pensioners, and a greater need for people to build for retirement. The question is, will this country extend the employer-based system to get more workers covered under employer pension plans? So far, it hasn't.
G. David Hurd, who was until his retirement last year chief executive officer and chairman of the board of Principal Mutual Life Insurance Co., parent of The Principal Financial Group, Des Moines, Iowa, continues as a member of its board of directors.