[Senate Hearing 109-90]
[From the U.S. Government Printing Office]



                                                         S. Hrg. 109-90
 
  PRIVATE-SECTOR RETIREMENT SAVINGS PLANS: WHAT DOES THE FUTURE HOLD?

=======================================================================

                             JOINT HEARING

                                 OF THE

                    COMMITTEE ON HEALTH, EDUCATION,
                          LABOR, AND PENSIONS

                                AND THE

                          COMMITTEE ON FINANCE
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                                   ON

    EXAMINING A LONG-TERM PERSPECTIVE ON THE FUTURE OF OUR NATION'S 
                 RETIREMENT PLANS IN THE PRIVATE SECTOR

                               __________

                             MARCH 15, 2005

                               __________

 Printed for the use of the Committee on Health, Education, Labor, and 
                                Pensions

                                 ______

                     U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2005
20-164 PDF

For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001




          COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS

                   MICHAEL B. ENZI, Wyoming, Chairman

JUDD GREGG, New Hampshire            EDWARD M. KENNEDY, Massachusetts
BILL FRIST, Tennessee                CHRISTOPHER J. DODD, Connecticut
LAMAR ALEXANDER, Tennessee           TOM HARKIN, Iowa
RICHARD BURR, North Carolina         BARBARA A. MIKULSKI, Maryland
JOHNNY ISAKSON, Georgia              JAMES M. JEFFORDS (I), Vermont
MIKE DeWINE, Ohio                    JEFF BINGAMAN, New Mexico
JOHN ENSIGN, Nevada                  PATTY MURRAY, Washington
ORRIN G. HATCH, Utah                 JACK REED, Rhode Island
JEFF SESSIONS, Alabama               HILLARY RODHAM CLINTON, New York
PAT ROBERTS, Kansas

               Katherine Brunett McGuire, Staff Director

      J. Michael Myers, Minority Staff Director and Chief Counsel



                          COMMITTEE ON FINANCE

                  CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah                 MAX BAUCUS, Montana
TRENT LOTT, Mississippi              JOHN D. ROCKEFELLER IV, West 
OLYMPIA J. SNOWE, Maine              Virginia
JON KYL, Arizona                     KENT CONRAD, North Dakota
CRAIG THOMAS, Wyoming                JAMES M. JEFFORDS (I), Vermont
RICK SANTORUM, Pennsylvania          JEFF BINGAMAN, New Mexico
BILL FRIST, Tennessee                JOHN F. KERRY, Massachusetts
GORDON SMITH, Oregon                 BLANCHE L. LINCOLN, Arkansas
JIM BUNNING, Kentucky                RON WYDEN, Oregon
MIKE CRAPO, Idaho                    CHARLES E. SCHUMER, New York

             Kolan Davis, Staff Director and Chief Counsel

              Russell Sullivan, Democratic Staff Director

                                  (ii)





                            C O N T E N T S

                               __________

                               STATEMENTS

                        TUESDAY, MARCH 15, 2005

                                                                   Page
Enzi, Hon. Michael B., Chairman, Committee on Health, Education, 
  Labor, and Pensions, opening statement.........................     1
Grassley, Hon. Charles E., Chairman, Committee on Finance........     2
    Prepared statement...........................................     3
Baucus, Hon. Max, a U.S. Senator from the State of Montana, 
  prepared statement.............................................     2
Kennedy, Hon. Edward M., a U.S. Senator from the State of 
  Massachusetts, opening statement...............................     4
Certner, David, director, Federal Affairs, AARP..................     6
English, Glenn, CEO, National Rural Electric Cooperative 
  Association....................................................     7
Bowers, Cynthia S., vice president of compensation & benefits, 
  Smurfit-Stone Container Corporation............................     8
    Prepared statement...........................................     8
Gebhardtsbauer, Ron, senior pension fellow, American Academy of 
  Actuaries......................................................    10
Trumka, Richard, secretary-treasurer, AFL-CIO....................    11
    Prepared statement...........................................    12
Kimpel, John, senior vice president and deputy general counsel, 
  Fidelity Investments...........................................    14
Schutz, Pamela, president and ceo, retirement income and 
  investments, Genworth Financial................................    14
    Prepared statement...........................................    15
Friedman, Karen, director of policy strategies, Pension Rights 
  Center.........................................................    18
Covert, Kevin M., vice president and deputy general counsel, 
  Honeywell......................................................    19
Dunbar, Mark K., president, Dunbar, Bender & Zapf, Inc...........    20
Henrikson, C. Robert, president, Metlife.........................    21
    Prepared statement...........................................    22
Garrison, Douglas, manager, Global Benefits Design, Exxon-Mobil..    29
Fuerst, Don, worldwide partner, Mercer Human Resource Consulting.    31
McNabb, William, managing director, Client Relationship Group, 
  Vanguard.......................................................    32
Sperling, Gene, senior fellow, Center for American Progress......    33
Houston, Dan, senior vice president, Principal Financial.........    35
Salisbury, Dallas, president and ceo, Employee Benefits Research 
  Institute......................................................    36

                          ADDITIONAL MATERIAL

Statements, articles, publications, letters, etc.:
    Comments on Ways to Simplify the Rules for Small Employers, 
      by Daniel J. Houston, senior vice president, Principal 
      Financial Group............................................    55
    Weller, Christian E., PhD., prepared statement...............    56
    Additional comments by John Kimpel, senior vice president, 
      FMR Corporation............................................    70
    Thomas, Hon. Craig, a U.S. Senator from the State of Wyoming, 
      prepared statement.........................................    71
        Questions of Senator Thomas..............................    72
    English, Glenn, chief executive officer, National Rural 
      Electric Cooperative Association, prepared statement.......    72
    England, Robert Stowe, Conversation on Coverage, prepared 
      statement..................................................    73
    Conversations and Recommendations of Working Group I, report 
      on.........................................................    76
    Conversations and Recommendations of Working Group II, report 
      on.........................................................   102
    Conversations and Recommendations of Working Group III, 
      report on..................................................   119

                                 (iii)




  PRIVATE-SECTOR RETIREMENT SAVINGS PLANS: WHAT DOES THE FUTURE HOLD?

                              ----------                              


                        TUESDAY, MARCH 15, 2005

                                       U.S. Senate,
  Committee on Health, Education, Labor, and Pensions, and 
                                      Committee on Finance,
                                                    Washington, DC.
    The committees met jointly, pursuant to notice, at 9:30 
a.m., in room SD-G50, Dirksen Senate Office Building, Senator 
Enzi [Chairman of the Committee on Health, Education, Labor, 
and Pensions] presiding.
    Present: Senators Enzi, Hatch, Grassley, Thomas, Burr, 
Kennedy, and Reed.

                   Opening Statement of Senator Enzi

    The Chairman. It is 9:30. We would like to start on time. I 
will call this hearing to order.
    I want to welcome you to this joint forum, conducted by the 
Senate Finance and the Health, Education, Labor, and Pensions 
Committee. I think it is historic. Chairman Grassley and I 
believe that Congress should be proactive on the future of our 
Nation. Today we will be taking a long-term perspective on the 
future of our Nation's retirement plans in the private sector.
    Our Nation is facing a changing workforce that is growing 
older and becoming more adaptable as workers are changing 
careers more frequently, and therefore changing companies more 
frequently. In addition, many companies face global market 
pressure.
    This forum is to address many of these issues, to collect 
as much information as possible in as short a period of time 
from as many experts as possible, so that we can be proactive 
toward helping workers and employers design retirement security 
plans for the future. We do not want just a short-term fix, we 
want to fix it. I believe fervently that we must save defined 
benefit plans so that employers and employees will have this 
valuable option in the future. The HELP and Finance Committees 
are committed to enacting responsible, comprehensive pension 
reforms this year that will stabilize the defined benefit 
system, that will strengthen the PBGC, and that will reduce the 
Agency's deficit.
    We will accomplish these things this year, which means 
there is a long-range future for defined benefit and defined 
contribution plans for us to be discussing here today.
    I also have a particular interest in how we can provide 
more small business employees with retirement benefit coverage 
and how small business owners can provide retirement benefit 
plans.
    I appreciate everybody's attendance, and look forward to 
the roundtable discussion.
    Chairman Grassley.

                 Opening Statement of Senator Grassley

    Senator Grassley. Thank you very much. First of all, 
Senator Baucus will be along in a little while, but in the 
meantime I want to put a statement in the record from Senator 
Baucus.
    [The prepared statement of Senator Baucus follows:]
                  Prepared Statement of Senator Baucus
    Thank you, Chairman Enzi and Chairman Grassley, for holding this 
forum on the future of employer-sponsored retirement plans. I am 
pleased to be here with Senator Kennedy and other members of our two 
committees, to learn from the stakeholders who have joined us today.
    Winston Churchill said: ``It is always wise to look ahead, but 
difficult to look further than you can see.'' Retirement savings is a 
long-term challenge ahead. Today we try to see into that long term, to 
see as far as we can see.
    Two weeks ago, the Finance Committee held a hearing on the 
financial status of the Pension Benefit Guarantee Corporation, and the 
administration's funding proposal for defined benefit plans. It was a 
timely hearing about a difficult subject that we have to address in the 
next few months.
    But today we get to climb above those immediate concerns and lift 
our eyes to the challenges of the future.
    Not the least of these challenges will be accelerating global 
competition. We have to work to create an environment where we can 
compete successfully on the global stage.
    But in doing so, we must remember why success matters. Success 
matters so that American workers can have a good life, so that 
Americans who work hard can share in the success of this country. It is 
thus important to see the future through the lens of benefits for 
workers. And that is why we are here today.
    James Thurber said, ``It is better to know some of the questions 
than all of the answers.'' Then we are on the right track with this 
forum. We have thought-provoking questions to focus our discussion, and 
a diverse group of experienced individuals here to join us in our 
exploration.
    I expect that we will hear different opinions not only of how the 
future will look, but how it should look. In other words, when we leave 
today, I expect that we will have more questions than answers. And that 
will be a good thing.
    I look forward to today's far-sighted discussion. And then I look 
forward to tackling the challenges that we will see.

    Senator Grassley. For my part, I welcome all the 
participants, all of you as experts for your insight on the 
future of private retirement plan systems, and I particularly 
welcome Dan Houston of Principal Financial from my home State 
of Iowa.
    It seems to me that all of you people bring a wealth of 
information and experience and insight to this meeting, a 
perspective on how things operate out there in the real world, 
and you are all here today because of sharing one common goal, 
improving our private retirement system and the retirement 
security of Americans everywhere. So I thank you for 
participating.
    This is a year in which retirement security, thank God, has 
come very much to the forefront of our national dialogue, and 
with the baby boom generation on the cusp of retirement, this 
dialogue could not have been more timely.
    For his part, the President has advanced the dialogue by 
bringing to the forefront ways to strengthen and improve Social 
Security, but we all know that security retirement depends on a 
heck lot more than Social Security, employment based retirement 
plans and private savings, our other two critical legs of our 
three-legged retirement stool. So here today we are going to 
focus attention on those other two legs. We will focus our 
attention not just on where we are today but where we should be 
going.
    Too often here in Congress we find ourselves responding to 
the latest crisis or doing damage control. This is an 
opportunity to be ahead of the curve, and I am pleased also 
that we are holding this hearing jointly with Senator Baucus 
and Senator Kennedy and our two committees, because we have had 
great success in recent years working retirement security in a 
bipartisan way. In the 1990s we passed a series of bipartisan 
pension reforms that brought new life to our private retirement 
system, and we have to work on those successes of the past, and 
so we look forward to this forum being a part of our foundation 
for doing that.
    Thank you, Mr. Chairman.
    [The prepared statement of Senator Grassley follows:]
                 Prepared Statement of Senator Grassley
    Good morning, I want to begin by extending a very warm welcome to 
all of the participants--many of whom have come from far away, 
including Dan Houston [how-stin] from Principal Financial in my home 
State of Iowa--to share their insights on the future of our private 
retirement plan system.
    The people we have in this room really are the experts. They bring 
a wealth of experience and insight. They bring a perspective on how 
things operate in the ``real world'' outside of the beltway. And they 
all are here today because they share one common goal--improving our 
private retirement system and the retirement security of Americans 
everywhere.
    Thank you to all of you for making time to be here today.
    This is a year in which retirement security has taken a central 
place in our national dialogue. With the baby boom generation on the 
cusp of retirement, this dialogue could not be more timely. For his 
part, the President has advanced this dialogue by asking us to look at 
ways to strengthen and modernize Social Security. But we all know that 
a secure retirement depends on more than just Social Security. 
Employment-based retirement plans and private savings are the other two 
critical legs of our three-legged retirement stool.
    Here today, we will focus attention on those other two legs. And we 
will focus our attention not just on where we are today, but where we 
should be going tomorrow. Too often, here in Congress, we find 
ourselves responding to the latest crisis, or trying to do ``damage 
control'' when we become aware that problems exist.
    Today, we have an opportunity to get out of ``reactive mode'' and 
look proactively to the future. I am pleased also to be here today with 
Chairman Enzi and Senator Baucus and Senator Kennedy. We all know that 
the only way to get things done in the United States Senate is to work 
together.
    We've had great success in recent years working on retirement 
security in a bipartisan manner. In the 1990's, we passed a series of 
bipartisan pension reforms that began to breathe new life into our 
private retirement system.
    In the bipartisan 2001 tax relief bill, we enacted a bipartisan and 
far-reaching set of retirement savings reforms. This year, I hope we 
can work together in a bipartisan way to strengthen Social Security. At 
the same time, I hope we can work on a ``next generation'' of 
retirement reforms, including:
     making the 2001 retirement savings reforms permanent;
     protecting workers' retirement plan benefits by making 
sure that pension plans are fully funded and that 401(k) participants 
have the right to diversify out of company stock; and
     expanding savings opportunities for all Americans.
    And as we look farther into the future here today, I hope that we 
can continue to work in a bipartisan spirit on these issues, so that we 
can confront head-on the challenges that we know are sure to lie ahead.

    The Chairman. Thank you.
    Senator Kennedy.

                  Opening Statement of Senator Kennedy

    Senator Kennedy. Thank you very much, Mr. Chairman. I want 
to thank Senator Enzi and Senator Grassley, as well as Senator 
Baucus for bringing us all together.
    We have to let our wonderful witnesses know today that we 
hope you are on your toes because Senator Enzi has filled out 
ERISA forms--[Laughter]-- himself, and he is a trained and 
skilled auditor. So he is at a particular advantage over the 
rest of us here today. He said he just cannot wait to get into 
the facts and figures of the challenge. Well, he will have a 
pleasant day if that is what he is really looking forward to.
    I want to thank all of our great experts and old friends 
who have joined with us for the discussion of the future of 
private pensions.
    Retirement security is a critical issue for all Americans, 
as we all know. The national debate now under way is 
questioning all aspects of our current system which is founded, 
as Senator Grassley has mentioned, on a three-legged stool of 
private pension, Social Security and private savings. The 
private savings rate is at its lowest level in more than 40 
years. We know wages are stagnant, and it is related to 
savings, related to wages.
    The President is proposing to change the structure of 
Social Security. This makes insuring a private pension, I 
believe, all the more important. Despite our efforts in 
Congress over the years to secure retirement from private 
pensions still remains a remote goal for too many Americans.
    The statistics tell the story. Our economy is still weak, 
and compounding the problem, only half of American workers have 
a pension plan at work, a proportion that has failed to improve 
over the past 30 years. Pension coverage is even less adequate 
for women, minorities, and employees in small businesses. As 
the chairman pointed out, the pension system as a whole is 
increasingly shifting to require workers to bear more and more 
risk. Today only 1 in 5 workers have a defined benefit plan, 
and the defined contribution plans and individual retirement 
accounts have an increasing role in our retirement policy.
    In theory, the defined contribution plans and IRAs can 
provide a comfortable retirement, but experience shows this is 
not happening. Half of the workers 55 or older who have a 
retirement account have less than $55,000 in their 401(k)s or 
IRAs, not nearly enough to live on in retirement.
    There are other problems with the defined contribution 
plans. Nearly 30 percent of the employees eligible to 
participate in 401(k) plans do not do so. Many of those who do 
are at risk of over investing in stock of the company that they 
work for. Retirees also bear the risk of outliving their money; 
an unforeseen medical emergency or drop in the stock market can 
be devastating.
    As we look to the future we must also find ways to meet the 
new challenges of a changing economy, workforce and the effects 
of increased globalization on benefits for employers and 
retirees. Manufacturing jobs are being lost to competition 
overseas. Such jobs long provided good wages, good pensions, 
retiree health benefits, but today's low wage jobs, service 
sector jobs, part-time jobs, often do not.
    Other changes also influence our policy. Employees are more 
likely to change jobs or work part time. And increasing numbers 
of women are entering the workforce. These workers should not 
be left behind in earning a pension.
    Overall the Nation's retirement policy needs to better 
reflect our values of fairness and equality. People who have 
worked hard all their lives should not have to live in poverty. 
Surely the janitor who cleans the office tower has as much 
right to retire in dignity as the CEO in the corner office. 
Retirement security for every employee is good policy for our 
society, good policy for our economy as well.
    We have much to do and I look forward to hearing from the 
experts here today the most effective ways to build a strong 
pension system for the future.
    Thank you, chairman.
    The Chairman. Thank you very much.
    Today's forum will proceed in a different manner than 
typical Senate hearings. The primary purpose of this forum is 
to hear from you, the participants, and get your discussion on 
the long-term evolution of the private sector retirement 
benefit plans. Accordingly, today's format will be a 
roundtable. There will be no official oral statements made by 
the participants. However, any of the participants can submit 
statements that will be part of the record if you desire. That 
can even be based on something you may not have gotten to say 
today that you want to turn in to us.
    So if any of you would like to answer a question that is 
being asked by us, or would like to respond to a comment made 
by one of your colleagues, just stand your nameplate on end--I 
am hoping they are sturdy enough to do that--and that will be 
an indication that you want to speak, and I will call on you 
according to your raised nameplate. Occasionally we will vary 
the format to fit the discussion or to pursue something in 
particular.
    Before we begin the discussion, I would like to introduce 
our distinguished panel of participants. I want to thank them 
for their efforts to get here, and then also to change the 
schedule to accommodate our schedule so that we could be doing 
both budget and White House meetings and a number of other 
things.
    First we have Cynthia Bowers, who is the Vice President of 
Compensation & Benefits for Smurfit-Stone Container 
Corporation; David Certner, the Director of the Federal Affairs 
for AARP; Kevin Covert, the Vice President and Deputy General 
Counsel for Honeywell; Mark Dunbar, President of Dunbar, Bender 
& Zapf, Inc.; Glenn English, the CEO of the National Rural 
Electric Cooperative Association; Karen Friedman, the Director 
of Policy Strategies, Pension Rights Center; Don Fuerst, the 
Worldwide Partner of Mercer Human Resource Consulting; Douglas 
Garrison, the Manager of Global Benefits Design of Exxon-Mobil; 
Ron Gebhardtsbauer, Senior Pension Fellow for the American 
Academy of Actuaries, another number person; C. Robert 
Henrikson, the President of MetLife; Dan Houston, the Senior 
Vice President of Principal Financial; John Kimpel, the Senior 
Vice President and Deputy General Counsel of Fidelity 
Investments; William McNabb, the Managing Director of Client 
Relationship Group, Vanguard.
    Dallas Salisbury will be joining us later. He is the 
President and CEO of Employee Benefits Research Institute. The 
change in schedule affected that.
    Pamela Schutz, the President and CEO of Retirement Income 
and Investments, of Genworth Financial. Gene Sperling will--oh, 
he is here, glad you were able to shift your schedule around 
too--Senior Fellow for the Center for American Progress; and 
Richard Trumka, the Secretary-Treasurer of the AFL-CIO.
    We will begin with question No. 1. Our purpose for 
convening this forum today is to find out what the private 
sector initiatives for retirement benefits will look like 20 or 
30 years from now. This will help us in Congress to fashion 
private pension laws accordingly. The three questions that we 
have asked participants to consider are:
    (1) How will private sector retirement savings and pension 
plans evolve 20 years in the future and beyond? Question (2), 
How will our Nation's changing workforce affect the development 
of the retirement benefit plans and to what extent will our 
aging population, the need for portability of plans and the 
adequacy and coverage of plans for workers determine the future 
of private sector retirement savings and pension plans? And 
finally, what role will global competitiveness and U.S. 
companies' ability to compete in the global market, as well as 
to retain workers, determine the development of the private 
sector retirement savings and pensions?
    To start the discussion, I would like to direct everyone's 
attention to Chart No. 10 from the Bureau of Labor Statistics 
Occupational Outlook Handbook. The chart shows that certain 
industries such as the service sector professional and office 
support will increase dramatically in the coming years. Gone 
are the days when a worker stayed at one company for his entire 
life. I have read that today's student will have up to 14 
different occupations, and 10 of those jobs have not even been 
invented yet.
    How will the companies adapt to this changing workforce 
structure?
    Will companies be able to increase participation of workers 
in retirement benefit plans?
    In addition, what structure will retirement plans develop 
to allow for changing careers of future employees?
    That is probably a big enough bite, and there are probably 
some other places you want to go anyway, so we will begin. Does 
anyone want to throw out some answers? We are desperately 
searching for answers.
    Senator Grassley. If you knew how much we got paid per 
minute, you would not waste a minute. [Laughter.]
    The Chairman. Mr. Certner?

  STATEMENT OF DAVID CERTNER, DIRECTOR, FEDERAL AFFAIRS, AARP

    Mr. Certner. I guess I would want to just make one 
beginning comment on this. It seems pretty clear that with the 
changes in the workforce you are going to have a much smaller 
population of younger workers coming on board, and from our 
perspective, we think that part of that gap will need to be 
filled with the increasing number of older workers that we have 
in this country.
    So we think that looking at the future you are going to 
see--and we have already seen this trend in the last few years 
somewhat--and up-tick in the number of older workers who either 
want to remain, employers want them to remain or who choose to 
remain in the workforce, some because they need the money, but 
many because they want to stay active. We think it is going to 
be important that as we look at the benefit structure in the 
future that is very accommodating to making sure that older 
workers want to stay on, and we encourage older workers to stay 
in the workforce because we are going to need those older 
workers in order I think to keep this economy running.
    The Chairman. Mr. English?

   STATEMENT OF GLENN ENGLISH, CEO, NATIONAL RURAL ELECTRIC 
                    COOPERATIVE ASSOCIATION

    Mr. English. Mr. Chairman, I think that we are somewhat 
unique as I understand it in this whole matter in that we are a 
multiple employer group. Electric cooperatives are in 47 States 
across the country. There are some 950 cooperatives who are 
part of our overall program. Our defined benefit program has 
been in existence since 1948; our defined contribution plan has 
been in existence since 1967. Our plan allows all of our 
members to participate even though they are very small electric 
cooperatives, and as such, they are able to pool their 
resources and share the risk, exposure if you would. It also is 
a way in which it gives them portability. They can move between 
cooperatives, move between States and retain this.
    As far as looking to the future and what we might be able 
to contribute, geographically we are in about 83 percent of all 
the counties in the United States. As cooperatives we are 
actually owned by the people who use the electric power that 
are generated by electric cooperatives.
    What we think is a possibility for the future is that we 
may open up our program to every member of the electric 
cooperatives, so you could have small businesses and 83 percent 
of the counties in the United States who would participate in 
this overall benefit plan, multiple employer plan. We think 
that that is a way in which a lot of small businesses in 
particular could offer this kind of a program, a defined 
benefit, defined contribution to their employees, and be able 
to afford it, and be able to share the risk that is involved. 
We have total assets for roughly 60,000 employees right now of 
$7 billion, and as I have mentioned, it has worked extremely 
well for us and is continuing to do so today.
    What we would be troubled by is anything that would 
restrict multiple employers from working together in this kind 
of a plan, and we would hope that in the future it would be 
made easier. There are some contradictions in the law, both 
from a standpoint of ERISA and the IRS that make this more 
difficult. So as throwing out a suggestion, an idea, Mr. 
Chairman, I would suggest that that is one that the committee 
may want to examine, particularly for smaller communities and 
rural areas in this country.
    The Chairman. Thank you. It would be helpful, and you 
probably already have written down those restrictions and ways 
that it can be made easier to share with us.
    Mr. English. We will submit that for the record, Mr. 
Chairman.
    The Chairman. Thank you.
    I believe Ms. Bowers was next. Ms. Bowers.

STATEMENT OF CYNTHIA S. BOWERS, VICE PRESIDENT OF COMPENSATION 
        & BENEFITS, SMURFIT-STONE CONTAINER CORPORATION

    Ms. Bowers. Smurfit-Stone is a leading packing company. We 
employ about 27,000 employees. We have about 400 employees in 
Iowa. We have about 600 employees in Massachusetts, and about 
500 employees in Montana, Missoula, Montana.
    We are a large employer in a lot of small cities, and I am 
really concerned about the future of pensions because I am not 
a benefit actuary, I am not an attorney. I am the person in the 
company that has to justify to our senior management that 
defined benefits are what is good for the company and what is 
good for employees. When you speak about the three-legged 
stool, we really do have a three-legged stool in our country 
for Social Security income, but a couple of those legs are 
getting wobblier and wobblier every year.
    We have 401(k) plans, defined contribution as well as 
defined benefit plans, but in our 401(k) plan our salaried 
employees about two-thirds participate in that. I wish it were 
100 percent but it is only two-thirds. More unfortunate is that 
our hourly workforce, only one-third of our hourly employees 
participate in our 401(k) plan, and that is with significant 
company matches. On our salaried program we match 70 cents on 
the dollar and with 50 cents on a dollar for hourly employees, 
and it is still not enough to entice employees to save on their 
own.
    So if we have an opportunity to strengthen and to make sure 
that defined benefit plans are in place in the future, that is 
what I would like to ensure.
    The problem is, is that what we are encountering today and 
what we see in the future is that the cost of maintaining these 
programs are going to become increasingly overburdensome to our 
company. In the last 4 years we have contributed over $500 
million to our pension trust, and we have a goal of staying at 
a 90 percent funding target, but if we continue to see what is 
happening on the forefront, we believe that our costs will more 
than double. I tell you, I am a pretty good person in trying to 
persuade people, but I do not know if I can persuade my 
management to double our costs, because we are diverting other 
business opportunities that we could be putting that revenue 
toward and putting it toward our pension plan.
    My concern is to how to keep the system viable, healthy and 
there in the long haul.
    [The prepared statement of Ms. Bowers follows:]
                  Prepared Statement of Cynthia Bowers
    Chairman Enzi and Grassley, Ranking Members Kennedy and Baucus, I 
am pleased to provide the Senate Health, Education, Labor, and Pensions 
Committee and the Senate Finance Committee with a formal submission 
summarizing the comments made in the open forum on March 15, 2005. 
These comments are submitted on behalf of my company, Smurfit-Stone 
Container Corporation.
    Smurfit Stone Container Corporation (SSCC) is a leader in the 
packaging industry employing over 35,000 employees throughout North 
America with an $8 billion revenue base. Our company's multiple Single 
Defined Benefit Plans cover approximately 25,000 active U.S. employees, 
16,000 retirees and approximately 9,000 terminated vested employees in 
almost every State, including almost 400 employees in IA, 500 in 
Montana, 600 in Massachusetts. We also have approximately 4,000 in 
union multiemployer trust plans. Both my company's management and 
employees support retaining defined benefit plans as a central 
component to retirement security.
    We cannot look to the future of pension plans without recognizing 
the three major components of any individual's retirement income 
stream. Our employees have the ability to retire with three separate 
income streams: defined benefit plan, 401K savings plan and social 
security. Given the current state of affairs on pension plans and their 
future viability, it is uncertain as to how long companies such as SSCC 
can continue significant contributions into a pension trust under some 
of the proposals before Congress.
    For example, the Administration's proposal for reform of the 
Defined Benefit Plan system could more than double our cost of 
compliance with funding requirements, thus reducing cash flow available 
to continue reinvesting in our business which is required to remain 
competitive in today's global marketplace. As a mature industry with 
long-term defined benefit commitments and capital intensive 
investments, altering the funding rules can have a major impact.
    Over the last 4 years we have invested almost $500 million in our 
pension fund and expect to make a similar investment over the next 4 
years. We have a capital budget of between $225 and $275 million per 
year. The Administration's pension reform provisions will virtually 
eliminate our capital reinvestment capability.
    The fundamental issue is that Americans, on their own don't save 
enough for the future. On a national average savings are trending 
toward depression-era levels around 1 percent of earnings. According to 
American Benefits Council the average person would have to save 7 
percent of earnings over their career in order to amass enough savings 
for a stable retirement. Our company's 401K savings plan reflects the 
general savings trend of the country. For hourly employees only \1/3\ 
contribute, even though they can get company-matching contributions.
    So, if there is no evidence that people are motivated to save on 
their own for retirement, and companies are overly burdened with the 
type of proposals before Congress today, the future looks bleak. In 
time, companies will be forced to cease offering defined plans to an 
even greater extent than already reflected in the last 10 years, as the 
number of pension plans have decreased by 60 percent.
    This situation will inevitably harm Americans as defined benefit 
plans provided a source of income to individuals who may not have 
otherwise saved for retirement. Without this guaranteed income, 
Americans will become more reliant upon Social Security income as a 
primary source, thus further burdening a system that is under duress. 
This loss of income will have a severe impact on the quality of life of 
many Americans.
    Smurfit Stone is a responsible company. Over the last 5 years, we 
have been between 90 percent and 98 percent funded in our pension plan 
and have followed existing law in providing the level of contributions 
in advance of requirements, despite strong market pressures slowing 
industry growth. Any new funding requirements should not be based upon 
the perceived financial strength or weakness of a plan sponsor. Funding 
requirements should be based upon quantitative targets and objectives 
consistently applied to all plan sponsors.
    We are concerned that legitimate efforts to assure long-term 
sustainability and viability of the PBGC may in fact lead to a 
precipitous decline in affordability, reliability and predictability in 
maintaining defined benefit plans. Our 35,000 employees would be 
severely disadvantaged from receiving future benefits if the 
Administration's proposal were to pass as currently constructed.
    Rather than helping secure the future of our defined benefit plan, 
assumptions embedded in the yield curve methodology would create 
unnecessary financial burdens that could lead to reduced future 
reliance on a predictable retirement income. An actuarially-sound 
replacement of the 30-year Treasury rate with a 4-year weighted average 
of the long-term corporate bond rate would address these concerns.
    Utilizing the 4-year weighted average of the long-term corporate 
bond rate with some sort of smoothing would provide more 
predictability. In addition, this option is transparent and provides an 
accurate rate base, it steers a middle course between what is earned 
and what is owed. Imposing a 90-day smoothing concept into a yield 
curve places undue short-term pressures on companies for a long-term 
condition. The reason we encourage 30-year mortgages is to encourage 
purchasing of homes. If home owners had to pay a disproportionate 
amount of the cost up front, rather than over a longer term, fewer 
homes would be affordable. Likewise, we need to allow companies who are 
voluntarily providing long-term benefits to employees to spread a long-
term cost over a longer period of time and not be subject to short-term 
volatility.
    New proposals for funding targets, contribution requirements, 
deduction limits, benefit restrictions and increased premiums will in 
fact jeopardize our company's ability to continue to offer a defined 
benefit plan for new employees. Providing for predictability and 
reducing volatility in funding plans can be achieved with existing 
smoothing mechanisms for assets and interest rates.
    Eliminating tax deductions for over funded plans is a short-term 
revenue benefit to the Treasury at the expense of longer-term 
opportunities to actually enhance the viability of pension funds while 
helping strengthening a company's position in the marketplace.
    I am pleased to present these views and contribute to the debate so 
that we can find a means by which defined benefit plans can continue to 
be offered by companies for their employees with a degree of 
predictability and encouragement rather than penalties for being in a 
growth cycle, recessionary market or specific debt condition. Losing 
our defined benefit plans as a retirement benefit could seriously 
affect our ability to attract the talent necessary to successfully grow 
and prosper as a company.
    Thank you for the consideration of these comments.

    The Chairman. Thank you.
    Mr. Gebhardtsbauer.

    STATEMENT OF RON GEBHARDTSBAUER, SENIOR PENSION FELLOW, 
                 AMERICAN ACADEMY OF ACTUARIES

    Mr. Gebhardtsbauer. Thank you. One of the things we have 
seen is that the future demographics are going to be very 
different than the demographics in the past. In the 1970s we 
have baby boomers coming in, women coming into the workforce. 
So DB plans were developed in the past, and they are going to 
be very different in the future because of different 
demographics. Back then there was so much labor coming in that 
it made sense for a pension plan to have people retiring at 
early ages and incenting people to come in at early ages, and 
retiring at early ages like 55. But in the future the supply of 
the labor is going to shrink a lot after the baby boomers 
leave.
    So as you were talking about, we need ways in which to 
encourage people to continue working. And DB plans are very 
flexible. If the law allows they can just do about anything you 
want, and we have tried all kinds of things in the last 5, 10 
years like cash balance plans, hybrid plans. There is a new 
idea called DBK that would take some of the futures of DB plans 
and bring in the ideas of some 401(k) ideas so that it is 
simpler, the employees can sort of follow it. Another advantage 
of the 401(k) is that the employer actually has to sell it to 
the employees, and the more they sell the lower income 
employees into it, the more the higher income employees can 
participate. So there are all kinds of new ideas that are 
coming along.
    But we cannot do the DBK idea, for instance. People are 
very uncertain about whether they can do this cash balance 
idea. Companies have had it for a long time but now the rules 
are kind of uncertain. So again, a lot of the criticisms that 
people are having of DB plans, for instance, that they do not 
work for a mobile workforce, actually you can modify the 
traditional DB plan into something that does make sense for a 
mobile workforce. For instance, the cash balance idea is 
something that gives the same amount to everybody so that it is 
good for people who are in and out, it is good for women who 
are in and out of the workforce. But it is difficult to come up 
with these new ideas when the rules are kind of tight. In the 
world that we have today where we need to make these changes to 
be able to compete, then the rules need to be flexible enough 
so that we can make some of these changes to our DB plans, and 
either the rules need to be flexible or when a new idea comes 
up we need rules that can change, so that Congress can be 
responsive and quickly change to some of the new ideas.
    So those are some of the things I think would be valuable 
to enable DB plans to change for the workforce of tomorrow.
    The Chairman. Thank you.
    Mr. Trumka.

   STATEMENT OF RICHARD TRUMKA, SECRETARY-TREASURER, AFL-CIO

    Mr. Trumka. Thank you, Mr. Chairman. I think it bears worth 
stating at the beginning that pension and pension security 
cannot be addressed in a vacuum, that all the other policies 
that we are dealing with or all the other challenges that we 
are seeing in the country affect dramatically workers' pension 
plans and savings. And I will refer to things like the budget 
deficit, the trade deficit, outsourcing, the stagnation of 
wages. All of those things affect, one, the ability of 
companies to provide pensions and two, the ability of workers 
to force savings or to have savings.
    Having said that and restating the obvious, I guess I would 
say the following. Unless there is a change in current policies 
and the current business environment, some retirement plan 
trends will continue. The share of private sector workers 
participating in defined benefit plans will continue to decline 
following a quarter century trend. In 1979 we had 39 percent of 
workers who had a defined benefit plan. Today it is only 21 
percent. Retirement plan participation will likely remain flat 
at 50 percent of the workforce as it has over the past 2 
decades, and participation has remained flat even though we 
have seen a shift away from DB plans to DC plans, and it is not 
clear right now that any of the simplification reforms and the 
increases in contribution limits enacted in the mid 1990s will 
have any meaningful effect on the coverage. I think fewer 
workers will be receiving annuities in retirement. Defined 
contribution plans do not offer those annuities, so we will see 
fewer of those happening.
    And as more plans allow workers to take lump sums, I think 
workers will begin to use their retirement savings accounts for 
purposes other than retirement income, all of which are 
dangerous when we are looking for our retirement security.
    I would also point out, Mr. Chairman, that when it came to 
defined benefit plans, a union that I came out of, the United 
Mine Workers, had one of the first if not the first. It was 
signed in 1947. It was a multiemployer plan, and I would just 
like to remind everybody the purpose for that plan. Back then 
many of the mines that the Nation's miners worked in were small 
mines, employing 25, 30, 35 or 40 people. Those mines would 
come into business and go out of business every 2 or 3 years. 
The employers would leave their employees without any 
retirement. As a result of that we needed a mechanism to be 
able to harness that existence of those small entries and exits 
out of the mining industry. The defined benefit plan, 
particularly the multiemployer benefit plan, was the perfect 
vehicle because you had portability and you could take your 
benefits from company to company. As Mr. English said, we need 
to have the flexibility to be able to combine those and to have 
more people join into those plans so that we can share the risk 
even further so that we have professional management of those 
plans in a meaningful way.
    I would also say, Mr. Chairman, that we really do have to 
grapple with a series of touch questions when it comes to 
things like 401(k)s or other forms of savings. What will happen 
to the low and middle income workers? How effective are 
employers' plans at helping workers manager their accounts? 
Will middle income people even have enough retirement?
    Only 50 percent of workers have any kind of a savings 
account, retirement savings accounts, and their average amount, 
as Senator Kennedy said, is about $55,000. If you convert that 
out that comes out to about $230 a month in savings, which is 
not likely to be able to support people very long out into the 
future.
    All of those things are important to us, so when we look at 
things I guess we would say that we really need to protect 
workers' pensions by making funding rules work for single-
employer or multiemployer defined benefit plans. We think we 
have to enact rules that will strengthen pension funding and 
promote employer sponsorship of single-employer defined benefit 
plans, and we have to give multiemployer plan trustees and the 
relevant bargaining parties additional tools to protect their 
pension plans.
    Also one subject I would really like to touch on just 
briefly is to protect workers' 401(k)s when employers file for 
bankruptcy. We just had a lot of talk on the Hill about 
bankruptcy and a bill passed. But while workers' wages get a 
priority, they only get a priority to $4,500. That is a number 
that has not been moved in decades. That low priority cap 
affects how much workers can get back in missed 401 
contributions and in stolen 401(k) money. The other thing that 
we really need to look at in bankruptcy is to make 401(k) 
participant claims for security and pension fraud a priority 
claim in bankruptcy. As it is right now, you do not see that 
happening. They get to the end of the line. This kind of 
problem could be solved in the future by giving 401(k) plans 
and plan participants priority in bankruptcy for fraud and 
breach of fiduciary duty claims arising out of their holdings 
in stock or anything else.
    Those are just a few of the things, Mr. Chairman. I would 
like to submit for you additional items that can be done to 
help retirement security.
    [The prepared statement of Mr. Trumka follows:]
              Supplemental Statement of Richard L. Trumka
    Mr. Chairman and members of the committee, thank you for the 
opportunity to present these additional views on the future of private-
sector retirement plans.

Tax Policy and Retirement Plans

    One roundtable participant suggested that replacing the Federal 
income tax with a consumption tax would have a beneficial impact on 
national saving. While there was no follow-up discussion, it is 
important to note the potentially large negative impact such a shift 
could have on private retirement plans. This issue is particularly 
relevant since President Bush has appointed an Advisory Panel on 
Federal Tax Reform to consider fundamental changes in the tax system 
and submit recommendations for reform by July 31, 2005.
    As a 2001 Congressional Research Service report noted, ``[w]ith 
both defined benefit and defined contribution plans, the typical 
consumption tax eliminates all pecuniary incentives for employer 
sponsored pension plans.'' \1\ Such a fundamental shift in the tax 
system ``could cause a sharp reduction or a wholesale elimination of 
existing pension plans.'' \2\
---------------------------------------------------------------------------
    \1\ Steven Maguire, Congressional Research Service, ``Consumption 
Taxes and the Level and Composition of Saving,'' updated Jan. 11, 2001, 
p. 7.
    \2\ Report of the Working Group on the Impact of Alternative Tax 
Proposals on ERISA Employer-Sponsored Plans, 1996 Advisory Council on 
Employee Welfare and Pension Benefit Plans, U.S. Dept. of Labor, Nov. 
13, 1996.
---------------------------------------------------------------------------
    The elimination of job-based retirement plans clearly would 
undermine the national policy objectives underlying the current job-
based retirement plan system, with particularly negative consequences 
for many low- and middle-income Americans. Current tax code 
nondiscrimination and coverage rules governing employment-based defined 
benefit and defined contribution plans act to increase retirement 
benefits and savings among low- and middle-income workers. Further, as 
was noted by several hearing participants, the payroll deduction 
feature of 401(k)'s and similar retirement savings plans is very 
important, a point strongly supported by comparisons to the very low 
participation rates in Individual Retirement Accounts.
    At a minimum, any discussion of fundamental tax reform must include 
a thorough analysis of its impact on pensions and retirement savings 
plans. Unfortunately, this relationship has been given scant attention 
in the past. As the Department of Labor's Advisory Council on Employee 
Welfare and Pension Benefit Plans concluded in 1996, ``the complex and 
far-reaching implications of fundamental tax reform for the Nation's 
retirement and pension system have not been given adequate attention or 
analysis through existing policy channels, either in Congress or in the 
Executive Branch, especially given the complexity of the issues and 
uncertainty that surrounds them.'' \3\ It remains to be seen whether 
these issues will be given the due they deserve in the upcoming tax 
reform debate.
---------------------------------------------------------------------------
    \3\ Report of the Working Group on the Impact of Alternative Tax 
Proposals on ERISA Employer-Sponsored Plans.
---------------------------------------------------------------------------

Retirement Savings

    One focus of discussion at the hearing was developing effective 
ways to get more Americans to save and to save more for retirement. 
Many people, as I stated at the hearing, simply do not make enough 
money to save much or at all for retirement. In fact, many families 
have trouble paying for basic items and services. For example, the 
Economic Policy Institute (EPI) has found that 3 in 10 (29 percent) 
families with pre-teen children have insufficient incomes to cover a 
basic family budget in their communities, excluding any level of 
savings for retirement, education or even emergencies.\4\ The EPI study 
was based on a budget of necessities, like food, housing, 
transportation, childcare and medical care. In other words, many 
families do not have sufficient income to maintain a safe and decent 
standard of living. For them, the lack of adequate retirement savings 
(or any savings at all) is not a result of consuming too much, the 
favorite explanation of some commentators, but instead a symptom of an 
economy and a labor market that do not provide them with enough to meet 
basic needs.
---------------------------------------------------------------------------
    \4\ Heather Boushey, et al., Economic Policy Institute, Hardships 
in America: The Real Story of Working Families (2001). The report 
focused on families with one or two adults and one to three children 
under 12.
---------------------------------------------------------------------------

Pension Funding

    Although not a focus of the roundtable discussion, I and other 
participants raised serious concerns about the implications of certain 
proposed changes to the pension funding rules for the future of defined 
benefit pension plans. In particular, changes that would result in 
greater volatility in the pension funding requirements--no matter how 
intellectually elegant they may seem to some--are likely to drive many 
employers to freeze or terminate their existing plans, with an ultimate 
negative effect on Americans' pension security.
    Specifically, legislation proposed by President Bush and others 
would eliminate many of the features of the current funding rules 
designed to make funding requirements more predictable by tempering 
interest rate and asset value volatility. Under these approaches, 
liabilities would be measured using market or near-market interest 
rates and assets would be marked to market values. Also, interest rates 
used to measure liabilities would be taken from a yield curve based on 
the duration of the liabilities, increasing the liabilities for 
companies with older participant and beneficiary populations. The 
stated reasons for these changes are protecting the Pension Benefit 
Guaranty Corporation (PBGC) and improving pension security.
    This radically new approach to plan funding likely will have 
effects opposite those intended by its supporters. Volatility in 
required contributions is a major concern to plan sponsors, with three 
out of five employers listing volatility as a top threat to defined 
benefit plans, in one survey. In an environment in which the playing 
field already is tilted significantly in favor of defined contribution 
plans, the shift to a yield curve based on near-market rates likely 
will induce more employers to freeze or terminate their defined benefit 
plans and make it even less likely employers will create new defined 
benefit plans. This outcome will hardly benefit the PBGC, the premium 
payer base of which will be reduced, or workers, whose pension benefits 
will be cut.
    It is the view of the AFL-CIO that pension security can be improved 
without introducing the harmful effects of volatile funding 
requirements. A proposal by Dr. Christian Weller at the Center for 
American Progress illustrates this point. He has shown that funding 
rules based on long-term interest rate averages both decrease funding 
volatility and improve plan funding levels. A key benefit of Dr. 
Weller's approach is that the funding rules become more pro cyclical, 
``lowering the burden during bad economic times and increasing it 
during good economic times, when employers are best able to contribute 
to their pension plans.'' Attached is testimony he recently gave to the 
House Committee on Ways and Means Subcommittee on Select Revenue 
Measures addressing these issues in greater detail. Policymakers should 
seek out these kinds of win-win proposals to build greater retirement 
security.
    On a separate but related matter, policymakers need to give 
multiemployer pension plan trustees and the relevant bargaining parties 
additional tools to protect their pension plans. Current rules do not 
provide the flexibility needed to protect pension plans until it is too 
late.
    The Chairman. Thank you. I appreciate it.
    Mr. Kimpel.

  STATEMENT OF JOHN KIMPEL, SENIOR VICE PRESIDENT AND DEPUTY 
             GENERAL COUNSEL, FIDELITY INVESTMENTS

    Mr. Kimpel. Thank you. I would like to take a slightly 
different tack and talk about what I am most concerned about 
looking at 20 years. It is not the pension system itself, but 
rather the extent to which retirement savings will increasingly 
be eaten up by health care costs. We estimate that a couple 
retiring today will need at least $175,000 to cover that 
couple's out-of-pocket medical expenses. I do not think the 
issue is DB versus DC or annuitization versus nonannuitization. 
Those are important issues, but the real issue, in our 
judgment, is regardless of how much people are saving today, 
they are not saving enough to cover the massive health care 
costs that they will be confronting 20 years out from now, and 
unless and until we focus on that and figure out ways to 
integrate health care savings with retirement savings we will 
not be saving enough.
    The Chairman. Thank you.
    Ms. Schutz.

 STATEMENT OF PAMELA S. SCHUTZ, PRESIDENT AND CEO, RETIREMENT 
           INCOME AND INVESTMENTS, GENWORTH FINANCIAL

    Ms. Schutz. Thank you very much. I represent an insurance 
company, Genworth Financial, and I will come at this from a 
little bit different angle.
    We see the landscape is very much changing, and that the 
burden for guaranteed retirement income shifting more to the 
individual. You see that with the decline in defined benefit 
plans, that guaranteed paycheck for life that people had, and 
exacerbated by the fact that Americans are living longer. The 
defined contribution plans do not offer those guarantees. They 
do not substitute a defined benefit plan. They do not guarantee 
for investment risk and longevity risk.
    So what we see is insurance companies being able to step in 
and fill some of that vacuum and gap to give people peace of 
mind, a paycheck for life, because that is what they do. They 
pool investment and longevity risk. So we see the insured 
defined contribution plan concept and annuitization becoming 
more and more important and valuable as we look ahead in 
retirement savings and security.
    [The prepared statement of Ms. Schutz follows:]

                  Prepared Statement of Pamela Schutz
    Thank you for organizing this important forum and inviting me to 
participate on behalf of Genworth Financial. With 15 million valued 
customers, more than 5,000 skilled professionals, and more than $103 
billion in assets (as of December 31, 2004), we are one of the world's 
largest insurance organizations. We serve three major customer needs: 
protection, retirement income and investments, and mortgage insurance.
                      introduction to the problem
    Helping Americans improve their ability to enjoy a financially 
secure retirement is one of the most challenging domestic issues faced 
by this Congress. Americans are spending a greater portion of their 
lifetimes in retirement than previous generations. Today, more than 
half of all workers retire before their 62nd birthday, and the average 
retiree can expect to spend approximately one-fourth of his or her life 
in retirement. Retirement is also the most difficult financial planning 
exercise that the average individual will face in his or her lifetime 
because the stakes are so high--the potential consequence of making a 
mistake is to live the last years of one's life in poverty.
    A comprehensive retirement income system should be built to deliver 
results on all facets of the ``Three-Legged Stool'': Government Social 
Security, employer sponsored plans, and individual personal savings. As 
the focus of this forum is the trend in employer sponsored plans, it is 
important to recognize the degree to which the burden of assuring an 
adequate retirement income is shifting to the individual, who typically 
has not been given the tools to meet this challenge. This shifting to 
the individual of responsibility for a financially adequate retirement 
will continue as long as the availability of traditional Defined 
Benefit (DB) plans continues to decline. Employees are faced with a 
loss of guaranteed income during retirement and they have limited 
options in replacing that ``paycheck'' for life.
    Further exacerbating the problem of achieving an adequate 
retirement income is the simple fact that Americans are living longer. 
A longer life is something to be thankful for, but it means that we 
each will need income that will match that longer lifespan. Today, 50 
percent of healthy 65-year-old women will live past age 85. In fact, 
one in three will live past age 90 and one in 10 will live past age 95. 
In addition, women spend even more time in retirement than men and are 
less likely to have participated in employer sponsored retirement 
plans. Forty-four percent of female workers lack a pension from any 
employer, compared to 36 percent for male workers. These factors mean 
that both men and women face a difficult challenge in managing their 
savings during retirement years.
               the lack of guarantees for the individual
    At the center of the challenges and concerns individuals have about 
their retirement security is the lack of guarantees, in particular the 
lack of a guaranteed income that will last regardless of how long the 
individual lives and no matter how the stock market performs.
    In their current design, Defined Contribution (DC) plans do not 
replace the guarantees that are associated with a traditional DB plan. 
There is no guaranteed minimum income, there is no guarantee that the 
retirement income will last a lifetime, and there is no guarantee on 
the performance of the individual's overall retirement portfolio. 
Without these guarantees, the employee is faced with having to mitigate 
six key retirement risks on his or her own. These six key risks are:

     long-term rate of return risk (will your assets perform as 
expected),
     inflation risk (will your returns outpace inflation),
     excess withdrawal rate risk (how much can you safely 
withdraw),
     point-in-time risk (can you weather a down market at the 
time of retirement),
     longevity risk (will you outlive your assets), and
     health care risks (will your income stream support rising 
healthcare costs).
                          potential solutions
    Life insurance companies are in a unique position to help employees 
manage these risks by partnering with DC plan sponsors and mutual fund 
companies. Life insurance companies can pool longevity and investment 
risks across a large number of participants--thereby providing 
guarantees at the individual participant level. These guarantees are 
provided by financial institutions that are highly regulated by the 
States to assure that individuals receive the benefits they have been 
promised.
    There is widespread recognition that the purchase of income 
annuities, ``annuitization,'' at the point of retirement would help 
mitigate some of these risks. It is a common practice for life 
insurance companies to:

     convert an account balance into a guaranteed income stream 
that will last a lifetime,
     offer guaranteed payouts over the life of a single 
individual or the life of the individual and his or her spouse,
     increase a fixed payout stream for an expected inflation 
rate,
     guarantee that payments will continue for a minimum period 
whether the individual lives or dies, and
     allow the individual to participate in equity market 
performance.

    As a consequence, an emerging market is developing in what Genworth 
calls ``Insured Defined Contribution'' plans. Insurance companies like 
Genworth, MetLife, and others are building new annuity products that 
allow sponsors to offer defined benefit investment options to their 
employees within a 401(k) plan. The importance of an Insured DC option 
is that the individual throughout his or her working career, without 
having to wait until retirement, is able to determine with certainty 
how much guaranteed lifetime income his or her current 401(k) account 
balance will buy at a future retirement date.
    An Insured DC option can be made portable, thereby addressing the 
issues created by an increasingly mobile workforce. In addition, some 
designs can be structured to provide upside potential through equity 
participation in order to offset the risk of inflation. Our consumer 
research into the Insured DC option has indicated significant interest 
on behalf of 401(k) participants. Here are the highlights of our 
findings:

     69 percent of participants age 25-34 would invest in an 
Insured DC offering if given the opportunity, 70 percent of all 
participants would do so.
     23 percent of those who say they would invest in an 
Insured DC option would increase their contributions to their 401(k) 
plan if able to participate in such an option.
     54 percent of the individuals who choose not to 
participate in their employer's 401(k) plan would participate in the 
plan if an Insured DC option was available.
     95 percent of participants found the guaranteed minimum 
income for life feature of an Insured DC option attractive (63 percent 
said very attractive).
     93 percent of participants said portability of the Insured 
DC guarantee was attractive (53 percent said very attractive).
                         the need for education
    A key predicate to successfully managing the risks that Americans 
face in retirement is making sure that they understand those risks. 
Most Americans have not had the opportunity to prepare for the 
responsibility they will face at retirement. Financial planners report 
confusion about retirement planning and many working people do not 
understand how to convert assets into enough income to cover a lifetime 
of non-discretionary expenditures. This conversion of account balance 
into lifetime income at a future retirement date is a very 
sophisticated calculation. In order for Americans to understand the 
dynamics of this retirement reality, we as a country must address the 
significant education gap that exists today.
    The following simple question illustrates the complexity in this 
area: If you were 65 today and were to retire today, would you feel 
wealthier if you had $500,000 in your 401(k) plan or had a pension 
guaranteed to pay you and your spouse $32,500 per year for the rest of 
your lives? It becomes a harder question to answer when given the added 
information that many advisors would say that no more than $20,000 
should be withdrawn annually from a $500,000 balanced fund in order to 
be reasonably assured that the money will last 30 years. However, even 
at this safe withdrawal rate, there is no longevity or investment 
performance guarantee, so it is still possible to outlive this money.
    To help Americans understand the retirement security issues they 
face and the solutions available to them, retirement education needs to 
focus on three components:

     the basics of personal finance, including the discipline 
of saving, starting to save early in your working life, and the value 
of compound interest,
     the conversion of savings into a reliable income stream, 
and
     the value of guaranteed income, a ``paycheck for life,'' 
and the benefit of pooling longevity and investment risk with others.

    While many valuable financial education initiatives have been 
undertaken in recent years by both the public and private sectors, more 
can and should be done.
              the importance of life contingent annuities
    One of the most important, and often least understood, sources of 
financial risk comes from uncertainty about how long one will live. 
According to a 2001 study by the Society of Actuaries, 67 percent of 
retired women and 55 percent of retired men underestimated the average 
life expectancy of a 65-year-old. This uncertainty means that there is 
a real risk of experiencing a reduction in living standard at older 
ages, even if one has tried to prepare for retirement. Saving is not 
enough; one must also be a careful manager of one's savings. 
Individuals should be encouraged to manage their savings during 
retirement in a manner that accommodates their daily needs, but also 
ensures that their savings will not be exhausted when they have more 
years to live. This is why life contingent annuities are so important.
    An annuity that continues to make payments for as long as you live 
(often called a ``life contingent'' annuity) is an affordable, powerful 
retirement tool that allows individuals to manage many of their 
personal retirement risks. The life contingent annuity is a combination 
of investment expertise and insurance that gives individuals the 
ability to insure against the financial risks of retirement by pooling 
their assets, and their financial risks, with a large number of other 
policyholders.
    For many individuals, guaranteed lifetime income payments from an 
annuity may be the most effective way to ensure that retirement savings 
will not be depleted during their life. Outside Social Security and 
employer sponsored DB plans, only an annuity can guarantee that an 
individual will receive regular, guaranteed income payments for as long 
as he or she lives.
    A life contingent annuity is designed specifically to address the 
financial planning problem of guaranteeing that individuals will not 
outlive their income no matter how long they live. The annuity can be 
designed to give consumers the flexibility to transform accumulated 
savings--both savings inside an employer plan and those accumulated 
outside of a plan--into a variety of forms of guaranteed streams of 
retirement income based on each individual's needs.
    Annuities have a variety of features and options that allow 
individuals to provide for their own retirement needs and to provide 
for a spouse or heirs after death The payment stream itself can take a 
variety of forms depending on the individual's needs. It can guarantee 
payments over a person's life (a life contingent annuity), over two 
peoples' lives (called a joint and survivor annuity), over a specified 
period (called a period certain annuity), or over a life or lives with 
a minimum period of payments guaranteed, e.g., 10 years (called a 
certain and life annuity). Annuities that combine life contingencies 
with period certain features are particularly attractive because they 
protect against longevity risk while at the same time providing the 
ability to bequeath amounts to heirs (either in a lump sum or as 
continued periodic payments) upon a death during the period certain.
    Annuity payment streams can be designed to make fixed income 
payments (called a fixed annuity), or can be designed to protect 
against inflation by making payments that increase or decrease with 
market performance (called a variable annuity). Some variable annuity 
products also guarantee minimum income levels while providing the 
upside potential of the equity markets, thereby protecting against 
investment risk in addition to inflation and longevity risk.
    The key point is that life contingent annuities, in whatever flavor 
may best suit a particular individual's circumstances, provide 
individuals with the guarantee of an income stream that will continue 
throughout their retirement years, no matter how long they live.
                               conclusion
    The combination of more and improved retirement education, the 
growth of Insured DC options in employer plans, and encouraging more 
individuals to manage retirement risk through life contingent annuities 
would benefit the Three-Legged Stool: employers would have a 
predictable and stable funding vehicle for the retirement benefits they 
offer and have employees that value and appreciate the benefits 
offered; employees would have an option for guaranteed retirement 
income for life and would be motivated to begin addressing the concern 
earlier in their working lives; and the government would have the other 
two legs of the stool helping to bear the load of retirement security.
    Once again, we appreciate being included in this timely forum and 
look forward to discussing the many different alternatives available to 
resolve some of these critical retirement savings and income issues 
faced by our country.

    The Chairman. Thank you.
    Ms. Friedman.

  STATEMENT OF KAREN FRIEDMAN, DIRECTOR OF POLICY STRATEGIES, 
                     PENSION RIGHTS CENTER

    Ms. Friedman. Hi. Thank you very much for enabling us to be 
here today.
    I wanted to say a few things first from the Pension Rights 
Center's perspective when you are looking 20 years in the 
future. Certainly we need to take into account that there is a 
changing workforce. We want to make sure that while there is a 
shift from defined benefit plans to more individual account 
plans, that we do as much as we can to keep defined benefit 
plans, recognizing that employers have a real role to play in 
providing retirement income to people of all income levels, and 
I want to start with that.
    What I wanted to emphasize today, and many people around 
the table actually know about this, the Pension Rights Center 
has convened a national public policy dialogue over the last 3 
years with several of the people around the room, MetLife, 
AARP, the AFL-CIO, Fidelity, the American Academy of Actuaries, 
are all cosponsors of this initiative called the Conversation 
on Coverage. I know Dallas has been an advisor. We are working 
with Principal. Vanguard has just joined one of our working 
groups.
    The Conversation on Coverage is a forward-thinking forum to 
address the very questions that you are asking today. We have 
been looking at how do we increase coverage for the 50 percent 
of the working population that now has no pensions or savings 
to supplement Social Security. We assume that that challenge is 
going to get even greater in the years forward. The great thing 
about the Conversation--and I can say this because I am just 
the neutral facilitator and am not part of the working groups, 
and John Kimpel is one of our co-chairs right there--the 
Conversation has come up with--and I am not going to go into it 
now, but I would be happy to a little bit later--has come up 
with the kinds of innovative solutions that Ron was talking 
about.
    Working Group 1 looked at how do we increase coverage 
through defined benefit plans, and looked at new forms of 
hybrids, even looked at DBK proposals but also looked at a new 
kind of proposal called a gap, which actually starts with a 
money purchase structure.
    Working Group 2 looked at ways of encouraging savings both 
by making it easier for people to participate in 401(k) plans, 
but also came up with a new structure for a centralized system 
of individual accounts about Social Security.
    Senator Enzi, you talked about the challenges to small 
business. Working Group 3 looked exactly at that challenge and 
came up with what they called a new Model-T plan, which is 
essentially a new kind of multiple employer plan that would be 
marketed through financial institutions to small employers, 
possibly in a small community, and we are going to be looking 
to do a demonstration project on that.
    So I just want to point out that the Conversation on 
Coverage has put out some initial recommendations, and we are 
going to be working to refine those over the next year.
    The Chairman. Thank you.
    Mr. Covert.

STATEMENT OF KEVIN M. COVERT, VICE PRESIDENT AND DEPUTY GENERAL 
                       COUNSEL, HONEYWELL

    Mr. Covert. Thank you, Mr. Chairman. I would like to spend 
a couple minutes coming at this a little less from a policy 
perspective and a little more from a real world employer 
perspective company that actually sponsors these plans. 
Honeywell is a multinational company with 108,000 employees, 
60,000 in the U.S. We provide both defined contribution 401(k) 
plans and defined benefit plans to all of our U.S. employees.
    We actually believe that is the proper mix, to encourage 
both the DC plans giving employees the opportunity to invest 
their own money and share in the largesse of a growing economy 
and good times, but also to provide benefit plans where you 
provide a safety net for employees in their retirement.
    Unfortunately, when we look into our crystal ball we see a 
world of almost exclusively defined contribution plans 20 years 
from now. We already see it with our colleagues in the Fortune 
100 companies, huge companies with large U.S. populations that 
have frozen their plans on the DB side, Tyco, Time-Warner, 
Xerox, Sears, Rockwell, IBM. The list is large and it covers an 
awful lot of employees.
    As an employer we see the reason for that being twofold, 
first the funding issues. What CEOs and CFOs need in this 
global economy is predictability. We cannot survive with our 
competitors either in the U.S. or globally if we have huge 
volatility swings on funding requirements because as you all 
know, we do not plan for 2005 in 2005. We plan for 2005 in the 
year 2000. That is how we manage our cash. That is how we 
manage our capital outlays, research and development and so 
forth.
    Second, we have perverse incentives. In a system whereby we 
ratchet funding requirements and PBGC premiums in lean economic 
times, forcing companies that would rather stay in the system 
out of the system, and yet in good economic times there are all 
types of restrictions to companies being able to put excess 
money, when they have it available, into their plans, so that 
when lean times come their plans are adequately funded.
    The other obstacle we see ongoing is uncertainty. Most 
large employers like Honeywell have hybrid plans of one type or 
another that cover some of their population. Because of the 
District Court decision in Illinois, that has had a very 
detrimental freezing effect on companies in terms of 
willingness to adopt new plans and to maintain their plans. 
That was the reason given by IBM for why they froze their plan. 
They got hit with a huge judgment. They were concerned about 
it, and they could not very well go to their CEO and say, well, 
we are just going to maintain this plan and let that potential 
liability spiral up.
    So we as employers need to know that the plans we sponsor 
are legal. If we do not have that certainty, I as a general 
counsel advising my CEO cannot go to him and say, well, I think 
we should continue to let these plans go, continue to bring new 
employees in, continue to accrue benefits in them with no 
guarantee that we are not going to get hit with a multibillion 
dollar judgment down the road.
    Thank you.
    The Chairman. Thank you.
    Mr. Dunbar.

STATEMENT OF MARK K. DUNBAR, PRESIDENT, DUNBAR, BENDER & ZAPF, 
                              INC.

    Mr Dunbar. My presence here, I think I am one of the few 
that represent small employers. My company is a small plan 
sponsor, and I also do a lot of work with small employers. I am 
actually a pension actuary, so I am one of the few here that 
has that hat on.
    Some of the comments that have been made I think are 
clearly from a large plan perspective. I think with the small 
employer, I think one of the first comments I would make is 
that the small employer needs to have control. So they are 
going to be more interested in a plan design where they have 
the flexibility that they need to be in or out. The ability to 
fund, as Kevin mentioned, is important, to be able to fund in 
good years and not have a huge requirement in bad years. So 
that flexibility is there in both small and large plans.
    I think one of the prior comments was about the DBK 
concept. We have seen interest in the small employers in cash 
balance type arrangements. Obviously, the legal uncertainty is 
of concern. One of the other problems with the cash balance on 
the small employer is the requirement to tag lump sums to GATT 
rates and whipsaw, if any of you are familiar with whipsaw. 
That restricts the interest rate that you can credit on a cash 
balance and that is a deterrent to these types of plans for the 
employees. With the larger employers, they tend to get around 
that by not offering lump sums, but on the small employer that 
is not an option. So that is a big issue.
    If Congress could address the cash balance issues and look 
at the type of designs like the defined benefit (k) 
arrangements, I think that would make the defined benefit area 
more attractive to the small employer.
    When we talk to a lot of our small employers, they are 
willing to commit to a small level fixed contribution, for 
example, safe harbor 401(k)s with a 3 percent fixed 
contribution. Many small employers are willing to agree to 
that, knowing that they can change it in a future year if they 
need to. So they are willing to commit to a low level and then 
put more in if they have a good year. I think that if that 
arrangement was there on the defined benefit side also, it 
would increase the interest in that type of arrangement.
    Other issues, a lot of your small employers, again, you are 
taking dollars away from other sides. If there was incentive 
for them to put plans in, even initially, that would help at 
least not have an expense. I think often with our small 
employers getting hit with document costs over and over again 
as we have to resubmit documents is an issue. From the small 
employer employees, talking about participation rates, you have 
in the code now some saver credit dollars that go to low-paid 
employees. If you could increase those dollar limit numbers to 
hit more employees, I think that would help with getting your 
low-end employees in at the early years. Once employees are 
into a plan they tend to stay in and continue to contribute. It 
is getting those 20- to 30-year-olds in the plans at an early 
age that is difficult. They tend to have other uses for their 
dollars as to ``what am I doing this weekend?'' So if you could 
find a way to give those low-paid employees incentive, it is 
meaningful.
    Thank you.
    The Chairman. Thank you. Do you feel a tremendous burden 
representing 90 percent of the businesses in the United States?
    Mr. Covert. I do. I do. [Laughter.]
    The Chairman. Thank you.
    Mr. Henrikson.

      STATEMENT OF C. ROBERT HENRIKSON, PRESIDENT, METLIFE

    Mr. Henrikson. Yes. First I would like to--it strikes me 
listening to everyone speak that I would like to thank 
everybody for this opportunity because for those of us who have 
been--and most of us have in one way or another--in the pension 
business all our lives, this is a unique opportunity.
    One of the things I think you will notice is that despite 
the fact everyone comes from a little bit different place and a 
position looking at these problems, the language will be very 
similar and I do not think you are going to find a lot of 
disagreements on the major issues.
    One of the things I wanted to mention about the three-
legged stool is that I remember being part of the Council for 
Economic Development back 7 or 8 years ago studying this very 
problem. On my first meeting--and I was going to be good and 
not say anything until the conversation got going--and the 
opening statement was by the chairman at the time, ``One of the 
things we need to have in our opening page is a statement that 
basically says `This generation needs to learn how to save for 
their retirement like we did.' ''
    And I came out of my seat because I think certainly the 
people in that room, no one was living a retirement based on 
what they had saved, I will tell you that, basically a group of 
CEOs. [Laughter.]
    So one of the things about the three-legged stool that I 
would say--and certainly this experience with my parents--the 
most important thing about the three-legged stool is that two 
parts of that stool, two legs of that stool produce an income 
off of which people live. After all, that is what most people 
live off of, income. If you ask them why their status is what 
it is or why they send their kids to the schools they do or 
where they live or what kind of home they buy and whatnot, it 
is based on their income. The three-legged stool, certainly in 
my dad's situation, the day he retired the biggest paycheck he 
got every month was from his defined benefit pension plan. He 
was a middle income person, worked for many years at one 
company. The second biggest payment he got was his Social 
Security check. And then he had his savings which he watched 
like a hawk for the rest of his life because he was worried 
about it. He did not live off of it.
    A few years went by and before you knew it his largest 
paycheck was the Social Security paycheck because it had been 
indexed for upward prices and so forth, then the pension plan, 
and he was still watching his savings, scared to death the 
older he got that he was going to somehow lose that bag of 
cash.
    What we are asking employees to do today, my point is, we 
are asking people to do something that has never been asked of 
people before in the history of the United States. We are 
basically asking them to fund and finance the rest of their 
lives dependent on how much they save, what kind of investment 
decisions they make, and then the big challenge is how do you 
manage that money after you are retired, such that it can 
provide you an income that you can live off of? It is very, 
very difficult.
    The biggest thing that--to tackle what a couple of other 
people have said--the biggest thing lost in terms of security 
when the employers go out of the defined benefit business is a 
mortality pool. That mortality pool makes it possible for 
someone to not have to worry how long they are going to live. 
This is something that cannot be self-insured. It has been 
provided by defined benefit plans for years. It certainly is 
provided by Social Security, and now with a defined 
contribution system, to Pam's point, someone is going to have 
to encourage people to understand what the value of being part 
of the mortality pool is, and that is a very, very big issue.
    In terms of defined benefit plans I would just say we have 
business with many of the Fortune 100 companies in the United 
States. Unfortunately, I think the traditional defined benefit 
plan at the large end of the marketplace the cat is out of the 
bag. The employer has agonized over decisions to get out of the 
defined benefit plan. It was not an easy decision for them to 
make. To think of them reversing that decision at this point, I 
think is very difficult to envision.
    The small plan, the small employer, one of the great things 
about a defined benefit plan is that the employer who has 
worked to build that business and may not have been able to 
afford a retirement plan in the early years, can reach back in 
time to give themselves and their employees past service credit 
on the defined benefit system. And for that reason I think that 
defined benefit plans might grow in the small business 
community.
    [The prepared statement of Mr. Henrikson follows:]

               Prepared Statement of C. Robert Henrikson
    Our Nation is at a retirement crossroads and the next decade will 
prove to be critical for the long term retirement security of 
individuals.
    By now most of us are aware that many Americans have not saved 
enough for retirement. There are other factors at work that are 
compounding the problem. First, we are living longer than at any time 
in our Nation's history. Second, fewer and fewer people will be able to 
rely on the security and guarantee of a fixed level of lifetime income 
afforded by traditional pension plans. We expect that over the coming 
decades, especially as the Baby Boomer generation enters their 
retirement years, these factors will become even more pronounced. The 
convergence of these factors has created the real possibility that many 
retirees will outlive their retirement assets or be forced to adjust 
their lifestyles and standard of living.
    To better understand the magnitude of the problem the country 
faces, a discussion of the demographic and market forces that have led 
us to this point is instructive. Research results that speak to 
people's overall retirement preparedness will be highlighted and we 
will review some of the risks that are unique to retirees. Finally, one 
important solution to the need for lifetime retirement income--
annuities--will be discussed and we will share with you some of the new 
product innovations that allow individuals to convert their nest egg 
into a guaranteed stream of income that they cannot outlive.

The Impending Retirement Crisis

    The looming crisis facing us today is not one that happened 
overnight. We have slowly been evolving to this point over the last 20 
years as the burden of saving for retirement has been steadily shifting 
to the individual. Over that time the number of defined contribution 
plans (DC) has been accelerating rapidly while the number of defined 
benefit programs (DB), with their guarantee of lifetime income, has 
been steadily decreasing. This trend will likely continue over the 
coming decades as defined benefit plans continue to face an uncertain 
future (see Chart 1):


    The Department of Labor, in a Government Accountability Office 
(GAO) study released in July 2003, reported that the percentage of 
workers who participated in a primary defined benefit plan fell by 16 
percentage points while the percentage participating in a primary 
defined contribution rose by 20 percentage points (see Chart 2):


    The PBGC estimated that the number of active employees covered by a 
traditional single employer defined benefit pension plan was 10.5 
million in 2000, down from the peak of 22.2 million in 1988. Of note is 
the fact that half of today's plans allow employees to take their 
distribution in a lump sum rather than as a lifetime monthly paycheck. 
We believe the movement away from traditional pension plans will have a 
significant adverse impact on Baby Boomers' retirement security over 
the next 20 years.
    The shift away from traditional defined benefit plans has put 
increasing pressure on retirement savings plans such as 401(k)s to be 
the primary source of retirement income. With it comes a tremendous 
challenge for our citizens as they are being asked to determine largely 
on their own to how much to save, how to invest that money wisely and 
how to prudently draw down their savings so they are not depleted 
prematurely. Although retirement savings levels are insufficient for 
many workers to enjoy a comfortable retirement, the larger issue is how 
those retirement savings will be managed in retirement so that they 
last a retiree's lifetime.
    So what choices are people making at the point of retirement? In 
its report on private pensions, the GAO analyzed the types of pay-outs 
workers actually received at retirement from defined benefit and 
defined contribution plans. The analysis covered the period 1992-2000. 
They found that retirees in greater numbers are selecting benefits in a 
form other than a guaranteed lifetime payment (i.e., annuities). An 
increasing proportion of more recent retirees chose to directly roll 
over lump sum benefits into an IRA or to leave their assets in the 
plan. From 1992-1994 retirees choosing either of these options 
represented about 32 percent but grew to 47 percent by 1998-2000. 
Clearly, much of this can be explained by the shift toward defined 
contribution plans, less than one-third of which offer an annuity 
option. But the report went on to state that a growing percentage of 
retirees who reported having a choice among benefit pay-out options 
chose pay-outs other than annuities. An analysis conducted by the 
Employee Benefit Research Institute (EBRI) supports the GAO findings. 
All indications are that when given the choice to replicate the benefit 
provided by a traditional pension (i.e., an annuity), few individuals 
are making that choice (see Chart 3):


    There are a number of reasons why people are choosing distribution 
options other than annuities. The two most significant reasons, 
however, are the lack of familiarity with longevity risk and not fully 
understanding how much their retirement savings are worth in terms of 
an income stream.
    Given the clear trend away from traditional pensions, people will 
be relying on programs such as 401(k) plans that do not provide the 
same guarantee of benefits. They will be largely left on their own to 
replicate the security previously provided by defined benefit plans--
security that was created by teams of actuaries, pension experts, 
investment professionals, benefit consultants, accountants, attorneys, 
and by the government through the protection offered by the Pension 
Benefit Guaranty Corporation. Stripped of this expertise and 
protection, employees need our help.

Consumer Preparedness

    Increases in life expectancy, greater responsibility falling to the 
individual and the financial challenges faced by government supported 
programs are creating a period of great risk with regard to retirement 
security. This triple threat is magnified exponentially when you factor 
in that the 36 million Americans over the age of 65 will grow to 72 
million 25 years from now. If that sounds far off, consider that the 
first Baby Boomers will reach the traditional retirement age of 65 in 
just 6 years (see Chart 4):


    So how prepared for retirement are these millions of people? In 
June 2003, MetLife created the Retirement Income IQ test. Twelve 
hundred men and women in the survey between 56 and 65 years of age and 
within 5 years of retiring were asked 15 questions to assess their 
level of retirement preparedness. Ninety-five percent of the 
respondents failed the test and the average score was 33 on a scale of 
100 points. Perhaps most disturbing was the misunderstanding 
surrounding how long people will live. A 65-year-old man has a 50 
percent chance of living beyond his average life expectancy. That's 
what average life expectancy means--about half the population will live 
past that point and the other half won't. Yet when we posed that 
question to 1,200 individuals, the majority of them thought there was 
only a 25 percent or less likelihood of living beyond average life 
expectancy. Only 16 percent of respondents replied correctly that a 65-
year-old couple have a 25 percent chance that one of them will live 
beyond age 97 (see Chart 5):


    Respondents also underestimated how much money experts recommend 
they need for retirement and they overestimated the recommended rate at 
which they can safely withdraw from savings to help make their money 
last throughout their retirement. Over one-third believe they can 
safely withdraw 7 percent from their savings annually, even though 
planning professionals suggest limiting annual withdrawals to no more 
than 4 percent. When you combine underestimating longevity with these 
other findings, the picture becomes very unsettling.
    The results from the Retirement Income IQ are corroborated by many 
other industry studies. EBRI's 2004 Retirement Confidence Survey notes 
that less than one-half of workers have even done a basic retirement 
calculation. Other results of note from this survey include:
     Approximately one-third of respondents are not confident 
of having enough money to live comfortably in retirement.
     One out of six workers said that they were not too or not 
at all confident of having enough money to take care of basic expenses 
in retirement.
     Nearly 4 out of 10 workers believe they will need seventy 
percent or less of their pre-retirement income while retired, a sharp 
contrast to the 90 percent to 100 percent that some financial experts 
estimate individuals will need.
     66 percent of all workers have given little or no thought 
as to how they will manage their money in retirement so that it doesn't 
run out.
    MetLife's 2004 Employee Benefits Trend Study found that nearly half 
of workers rank ``outliving their assets'' as their greatest fear. More 
than half of Baby Boomer employees ages 41 to 60 describe themselves as 
``behind schedule'' in saving for retirement, with 28 percent reporting 
that they are ``significantly behind'' and an additional 27 percent 
described themselves as ``somewhat behind.'' Only 3 percent have 
reportedly reached their goals. Other results of note from the survey 
include:
     Nearly half of all those surveyed report that they manage 
their finances by living paycheck-to-paycheck.
     Young workers between the ages of 21 and 30 are the most 
unprepared, with nearly half lacking retirement goals and/or savings.
    What is the answer? Individuals must receive better retirement 
planning education. It is our belief that the most successful programs 
are those that are made available through the workplace and then 
targeted to employees at various life stages (e.g., singles, 
established families, pre-retirees, and retirees). Beyond that, we 
believe individuals must receive investment advice so they understand 
how to maximize their retirement dollars. We also need to shift the 
conversation from retirement assets to focus on retirement income and 
offer tools to make this happen. Even those who have built a relatively 
large nest egg do not know how much income that nest egg will produce 
throughout their retirement. In short, Americans don't know what their 
savings are really worth.

Risks in Retirement

    Once they reach retirement, there are certain risks people face 
that they did not have to confront during their working years.
    A significant concern for retirees and pre-retirees alike is 
inflation. According to EBRI's 2003 Retirement Risk Study, over half of 
retirees and nearly two-thirds of pre-retirees are very or somewhat 
concerned that they will not be able to maintain the value of their 
savings and investments relative to inflation. In addition, pre-
retirees expressed a greater concern than retirees over the possibility 
of not having enough money to pay for good health care (58 percent of 
pre-retirees are very or somewhat concerned as opposed to 43 percent of 
retirees). Pre-retirees are also more concerned about their ability to 
pay for quality long-term care.
    Market volatility is another risk that can have a unique impact on 
retirees. Recent stock market experience has taught us all how quickly 
and how adversely our savings can be affected when exposed to a bear 
market. But for people who are still saving they have the benefit of 
time on their side and have a reasonable expectation of seeing their 
assets return to or even surpass pre-downturn levels. However, for 
retirees market downturns can have a devastating impact, especially 
early on in their retirement years. Too often people rely on averages 
and base their planning (if any) on the assumption that their account 
will return the average. They research the historical market returns, 
plan to withdraw an amount less than the historical average return and 
then feel confident their money will last them well into their 
retirement years. However, a market downturn in retirement can have a 
much greater impact on a retiree's nest egg if they are taking 
withdrawals than if they are simply saving and still have time to 
recover from any stock market losses. Using average returns while 
planning is dangerous because the market does not earn averages in any 
given year and once you withdraw in a down market, you realize losses 
never to be recovered.
    However, we believe that the biggest risk facing retirees is 
longevity. An earlier graph illustrated the average life expectancies 
for males, females and couples. When we shared these statistics with 
consumers most expressed shock and some even disbelief. But the numbers 
are accurate and, as we continue to make advances in medicine and adopt 
healthier, more active lifestyles, life expectancy will stretch out 
even longer.
    The reason we believe longevity is the greatest retirement risk 
retirees face is because it is the only risk an individual cannot 
manage on his or her own. Market risk can be alleviated somewhat 
through asset allocation and inflation risk can be addressed by 
investing in growth equities or inflation indexed bonds. Not only is 
longevity the one risk individuals cannot manage by themselves, it 
actually exacerbates these other two risks by increasing the length of 
time individuals are exposed to them.

Managing Longevity Risk

    How long one individual will live is extremely uncertain. People 
can take a guess as to how long they are going to live . . . plan so 
that their retirement assets last the right amount of time . . . and 
then hope that they haven't miscalculated their life expectancy. 
Fortunately, there is a better way to manage life expectancy. Join a 
mortality pool and ensure that you will not outlive your retirement 
assets.
    The pooling concept is a powerful one that's at the heart of all 
insurance products and defined benefit plans. Longevity is a small risk 
for the sponsors of large defined benefit pension plans since the ``law 
of large numbers'' permits them to fund for the average life expectancy 
of the entire group of retirees. When a large group of retirees is 
pooled together, the retiree who lives a long time is offset by the 
retiree who dies early.
    By contrast, individuals cannot self-insure the risk of outliving 
their money because they cannot accurately predict how long they will 
live. Whereas an individual can decrease his investment risk by 
changing his investment strategy, there is no way that an individual 
can, on his own, reduce his longevity risk. The only way that an 
individual can manage this risk is by converting his savings to an 
annuity. With annuities, a retiree can manage longevity risk and may 
choose to keep some portion of investment risk (along with its 
potential return) through a variable income annuity. Or a retiree can 
manage both longevity and investment risk with a fixed income annuity. 
An income annuity, also known as an immediate or payout annuity, is an 
insurance product that converts a sum of money into a stream of income 
that is guaranteed to last throughout the lifetime of the policyholder.

The Next Generation of Retirement Income Solutions

    In the coming decades, we believe that annuities will be a critical 
part of the solution to helping people turn their nest egg into 
guaranteed lifetime income in retirement. Market research indicates 
that there is greater receptivity to annuities once their benefits are 
explained. Furthermore, we are beginning to see more innovative product 
designs that are intended to meet the needs of today's--as well as 
future--retirees. Companies such as MetLife are helping to 
revolutionize how employees prepare for the 20, 30 or even 40 years 
that they will live in retirement. The insurance industry has 
introduced some of its most innovative retirement products during the 
past 2 years. This ``new generation'' of income annuities--which are 
supported by a range of educational programs and tools--allow 
individuals to convert their nest egg into guaranteed income that they 
can't outlive. To reflect the needs of today's retirees and the 
retirees of the future, income annuities have become more flexible, 
more affordable and portable, while retaining the product's core value 
of guaranteed lifetime income.
    One recently introduced income annuity is a type of longevity 
insurance--designed to generate income starting at a later age when an 
individual's retirement savings may be running out. The individual may 
elect to receive the monthly income from the product, for example, on 
his or her 85th birthday--the average life expectancy for Americans who 
have reached age 65--or at any point during an individual's retirement. 
Since the individual would typically buy this income annuity between 
the ages of 55 and 65, she is deferring the income start date 20 or 
even 30 years into the future. It allows her to set aside a smaller 
portion of her retirement savings in order to generate a steady stream 
of guaranteed income in the later years when many of us need it most. 
It also allows her to manage her remaining retirement assets to a 
limited time horizon.
    Insurers are also introducing income annuity products that are 
targeted to a younger audience. These new products allow employees to 
create their own ``personal pension.'' Offered as a complement to, or 
as an option within, a 401(k) plan this type of product is unique in 
that--unlike traditional savings vehicles--every contribution an 
individual makes is immediately converted to a specific future income 
benefit that is guaranteed to last a lifetime. This is similar to a 
defined benefit plan. The product is also portable so workers can take 
it with them when they switch jobs. The need for portability is clearly 
important since, as reported in the National Longitudinal Survey of 
Youth, the average Baby Boomer held 10 jobs by the age of 36.
    We are also seeing more income annuity products that offer 
liquidity options that allow purchasers to access money in an emergency 
and inflation options that link benefit increases to changes in the 
CPI. In addition, products are offering features (e.g., more investment 
choices, transfers, and rebalancing) that provide individuals with the 
flexibility and control that they are used to seeing within their 
401(k) plans.
    During the last Congress, the House Ways and Means Committee marked 
up legislation that takes important steps in educating individuals 
about the value of income annuities by including a targeted income tax 
exclusion for retirement plan distributions taken in the form of 
annuity payments. The bill also contained important fiduciary safe 
harbors for employers that offer a specific annuity or IRA at the time 
of distribution, which will encourage employers to offer annuities to 
401(k) plan participants. Finally, a new pension bill to be introduced 
in the near future not only includes these provisions but also 
recognizes the value of longevity insurance by excluding the amount of 
money used to purchase such insurance from the required minimum 
distribution rules.
    We believe that a concentrated effort to educate consumers about 
the benefits of annuities, coupled with legislative proposals, will go 
a long way in helping us meet and overcome the retirement crisis facing 
the country.

    The Chairman. Thank you.
    Mr. Garrison.

STATEMENT OF DOUGLAS GARRISON, MANAGER, GLOBAL BENEFITS DESIGN, 
                          EXXON-MOBIL

    Mr. Garrison. Thank you, Mr. Chairman. I applaud the 
committees for this forum. I think this is, as Mr. Henrikson 
said, it is a very useful opportunity to share ideas among 
ourselves with the different perspectives that we have.
    The point I would like to make would be to rise a little 
bit above some of the details, and my sense is that what we 
fundamentally face is a need for retirement security 20 years 
out. That need is going to be high considering the proportions 
of unprepared baby boomers that we have, the extended life 
spans, the increasing cost of health care, the limits on Social 
Security and the like. I think there is no doubt that the need 
for retirement security is going to be there.
    I would like to point out that I think business objectives 
that are served by retirement plans are still there. Some of us 
in the company that I work for, Exxon-Mobil, has both a DB and 
a DC plan. I am also the chair of the ERISA Industry Committee 
and represent approximately 120 large employers. Many of our 
companies believe that our business objectives are well served 
by retirement plans. We attract and retain people. We enhance 
productivity. We reinforce corporate culture. We reward long 
service. We facilitate the renewal of the workforce. These are 
corporate objectives that are served by retirement plans, and I 
think those corporate objectives will continue to exist 20 
years out.
    In terms of the plans themselves, they are going to be 
shaped, in my opinion, by the business needs, by employee wants 
and desires, what the employees are looking for, by the 
regulatory environment and by the technology and sophistication 
of the industry.
    I would like to point out that I believe there are a number 
of advantages of employment linked plans, primarily the 
discipline in the accumulation phase, as well as in the 
discipline in the spend down phase. In my company, for example, 
we have approximately 96 or 97 percent of our eligible people 
participate in the DC plan. We have designed it really to 
induce participation. You do not get any match if you do not 
put 6 percent of your own contributions in, and folks get 
matched dollar for dollar for that 6 or 7 percent. It is a very 
high cost that you pay if you do not choose to participate.
    There are a number of other very innovative ideas out in 
the marketplace today in terms of automatic participation and 
increasing percentages of contributions as pay goes up, which I 
think the employer can provide some discipline to help promote 
the sense among participants, employees, of the need to set 
aside resources for their retirement.
    I guess the key question for me is the degree to which 
policymakers will facilitate the creation of plans that cover 
more workers while enabling plan sponsors to retain the 
flexibility to stay competitive.
    I think we need, as others have mentioned this morning, 
stable and predictable ground rules. I think we need nationally 
more interest in saving for retirement among workers, and we 
probably need a longer time horizon among plan sponsors and 
investors.
    Thank you.
    The Chairman. Thank you.
    Mr. Fuerst.

   STATEMENT OF DON FUERST, WORLDWIDE PARTNER, MERCER HUMAN 
                      RESOURCE CONSULTING

    Mr. Fuerst. Thank you, Senator. I share the belief of a 
number of people that we need diversified assets to really 
secure retirement. Like an investment portfolio that needs to 
be diversified to provide real security, financial assets in 
retirement need to be diversified. The three-legged stool needs 
three strong legs.
    The problem that we see demonstrated by the chart behind 
you is that one of those legs have been declining for a large 
number of our Americans, and my work as a consultant to large 
companies, helping them design and finance these, I would echo 
the comments that others have made earlier, it is difficult to 
justify to senior management why they are taking on the cost of 
these benefits. An even more challenging situation is to try to 
explain to a company that does not have a defined benefit plan 
why they might want to add one for the benefit of their 
employees.
    They can recognize many of the benefits, that defined 
benefit plans generally provide universal coverage for 
everyone, that they provide a relatively uniform benefit for 
most employees, that there is no leakage from the plan through 
early withdrawals and loans, that they can offer special 
benefits when they have layoffs, window benefits or past 
service benefits as others have mentioned, that the longevity 
pooling resulting from defined benefit plans can create an 
enormous amount of value.
    But they also recognize that they are taking on an enormous 
amount of risk with that plan, and that the risk is not 
justified in many of their viewpoints. The volatility of 
contributions is an enormous problem for financial executives 
today to justify that.
    Many of them were very happy in the 1990s when we had what 
we called funding holidays. In retrospect, those funding 
holidays were very detrimental to the long-term security of the 
plans. We need major revisions in the funding rules of these 
plans that will enhance both the solvency of the plans but also 
the predictability of the contributions. Both of those elements 
are extremely important.
    We need greater certainty about the legality of these 
plans. There are many innovative ideas about how to design new 
pension plans that respond to the needs of a mobile workforce, 
but most of those right now are under an enormous cloud of 
uncertainty about the legal aspects, and companies are not 
willing to implement these new plan designs that would enhance 
portability and the mobile workforce when they see enormous 
legal risk to those plans.
    Finally, there is just very little incentive or even 
appreciation for many employees, particularly young employees 
because of the deferred nature of these benefits. We need more 
incentives for companies to adopt these plans and more 
incentives to make the plans attractive to employees. We have 
had enormous creativity with respect to savings plans and 
defined contribution plans over the past 30 years. Employees 
can put money into these plans on a pretax or after-tax basis. 
They can now even have the flexibility of taking their tax 
benefit when they put the money in or when we take the money 
out. We now have plans that can provide tax-free income in 
retirement.
    We have a lot of creativity in the design of defined 
contribution plans through issues like automatic enrollment or 
investment funds that automatically change asset allocation 
throughout an employee's career, but we cannot make those types 
of innovative changes in pension plans today because of the 
uncertainty under the law. We need more incentives for 
employers to first of all be clear that these are legal and to 
provide a financial incentive.
    I would suggest a couple ideas. For instance, perhaps a tax 
credit for a company that maintained both a defined benefit and 
a defined contribution plan to encourage the diversity of that 
financial security. To employees to make the plans more 
attractive, the ability to get tax-free income from a 
retirement plan. An exemption from taxation of a portion of the 
benefit paid as a lifetime income to an individual would create 
enormous grass roots supports for these plans. Employees would 
be demanding from their employers that they establish a plan 
that would provide that type of income to them. So these are 
the kind of changes that we need to reverse some of the trends 
that we have seen over the past 20 years.
    The Chairman. Thank you.
    Mr. McNabb.

    STATEMENT OF WILLIAM MCNABB, MANAGING DIRECTOR, CLIENT 
                  RELATIONSHIP GROUP, VANGUARD

    Mr. McNabb. Thank you, Mr. Chairman.
    At Vanguard we deal with a huge array of different types of 
investors including IRA investors, defined benefit plan 
sponsors, as well as defined contribution plan sponsors. And as 
we talk to them and due research amongst them in terms of where 
they see the future going and where they would like to see the 
future going, what actually strikes us is the commonality that 
you hear among them even though you are dealing with very 
different constituencies.
    Among the plan sponsors, be they large or small, the two 
common themes we hear, and we have heard this from some of the 
other panel members, are plan sponsors need to know what their 
benefit programs are going to cost, that that need for specific 
knowledge around the cost of the program is very important. The 
advent of 401(k) plans really in the early 1980s when many of 
us began in that business, was that was a big part of it was 
the cost was known. You could predict year from year from year 
what the cost was going to be, and I think that was a lot of 
the attraction to corporate CFOs, and again, you have heard 
that from some of your other members.
    The other issue that rises among plan sponsors, whether 
they are large or small, is this whole mobility of the 
workforce that you referenced in your opening comments, the 
fact that people are going to have 10 or 12 jobs, portability 
becomes a very important concept.
    It is really to that end, when you look at sponsors as well 
as individual investors who may be in IRAs, the themes that 
come across are common. One is portability, the ability to move 
from one kind of plan to another. If you think about our system 
today we have 401(k) plans, 403(b)(7) plans, 457 plans, 401(a) 
plans, SEP IRAs, simple IRAs, simple 401(k), etc, and it is 
very complex. And how you move, what the rules are to move from 
one plan to another are very arcane. So the whole concept of 
portability and simplification is something that really 
resonates with investors, again, whether they are small 
businesses or large corporations.
    The other big theme we keep hearing is we have to do things 
to make it easier for people to invest, and again, people have 
referenced some of these programs, the auto enrollment or the 
auto increase programs that you mentioned in your opening. Auto 
increase, we have some experience with that. We have 200 plan 
sponsors covering about half a million workers today where 
there is an auto increase component in the plan. And we have 
seen among those plans the average savings rate go up in the 
last 12 months about 1\1/2\ percent, so those are the kind of 
programs that seem to work.
    What we hear from sponsors and participants is, what are 
the incentives to do that? It is not necessarily tax credits or 
financial incentives, but it may be--it may take the form of 
fiduciary relief in terms of if we structure a plan a certain 
way, will we have some level of fiduciary protection? I would 
reference on the fiduciary side, several years ago, 404(c), the 
interpretive bulletin came out for 404(c), and I think again 
many of us here worked with that. What that did, for those of 
you not familiar with it, is it gave plan sponsors of defined 
contribution plans a certain level of fiduciary protection.
    If you want to see how positive a legislative change can 
be, you could look at 401(k) plans before 404(c), 401(k) plans 
after, and what you see is a huge increase in participation 
rates and a huge level of increased diversification. We think 
those same kind of principles could apply in terms of 
portability, the auto savings programs and so forth.
    So as we think forward, looking out 20 years, what you 
would hope would happen is rather than building a more and more 
complex system, we would actually strip away some of the legacy 
systems and make a simpler more incentivized system for people 
to save.
    The Chairman. Thank you.
    Mr. Sperling.

STATEMENT OF GENE SPERLING, SENIOR FELLOW, CENTER FOR AMERICAN 
                            PROGRESS

    Mr. Sperling. Thank you very much, Senator. The statistic 
that Senator Kennedy gave at the beginning about the median 
being $50,000 is actually in some ways too optimistic. That is 
for those who have those savings. Over half of people 55 to 59, 
over half have less than $10,000. I mean that is a stunning 
statistic. Over half of all Americans 55-59 have less than 
$10,000 in a 401(k) or IRA, which seems to me pretty clear we 
either have to be or together both increasing the role of 
defined benefits and finding out how that can be more viable.
    But I guess I want to concentrate my comments on how we 
should be making the 401(k) model more targeted to actually 
doing what I consider to be our goals for having incentives, 
which is to increase our private savings rate, to increase 
retirement security among the second and third leg of our 
retirement system.
    Our system today of incentives could not be more upside 
down. We have one system essentially for encouraging savings in 
our country, tax deductibility. When tax deductibility is your 
only incentive for savings, it turns our progressive tax system 
on its head. So when Senator Kennedy talked about the CEO and 
the person who might be cleaning their office, the person 
cleaning their office, if they can somehow manage to save a 
dollar gets a 10 percent deduction. The CEO gets 35 percent 
deduction. Now, what in a sense happens is we have a system in 
which we are giving the least incentive to those who need the 
most help saving and the most incentive to people who need the 
least help.
    What is very clear is that we have incentives now. We spend 
hundreds of billions of dollars over a decade incentivizing 
people to shift savings, well-off people to shift savings from 
nonpreferred savings to tax-preferred savings. We are not doing 
that to increase our private savings rate. And I think that we 
need to take a look at whether this notion of just providing 
incentives through tax deductibility makes sense because what 
is happening now is that it is an upside down system. It is 
funny, if you are a public servant like myself, not that I am a 
well-off person, but you make a little bit more savings you can 
really feel it. When you are really struggling, there is very 
little for you. When you start to make a little you can get a 
SEP IRA, the world comes at you. You get 35 percent deductions. 
You get 401(k) matches. We have a very divided society right 
now, and I see that division as going greater.
    I think we need to think about how we can use what we know 
works best and use public policy to encourage it. What we know 
works well is when people have money automatically dedicated, 
where they have a significant match for them. How significant 
that match might be is important. It may need to be quite a lot 
higher for more low-income people who we now do the least for.
    So the question is how could we do this? My view is that we 
should be moving toward a kind of a universal 401(k), where in 
a sense every single American at all times will essentially 
have the model that the people in the very best or most 
generous plans that we have heard get. In other words, any time 
a person invests a dollar who is middle income, that they could 
get a tax credit for that dollar.
    Now, we had a small step with the saver's credit but it is 
a tiny step. It is not refundable. It does not go up to cover 
that many people. We are trying to do this on the cheap. Were 
we to do a system, were we to give a tax credit, a refundable 
tax credit for low income people that might be 2 to 1 and a 1 
to 1 credit for more moderate or middle income people, we would 
be turning our tax incentive right side up. We would be putting 
the greatest number of incentives to the people who need it 
most.
    I will just very quickly say what that would do. One, it 
would actually leverage private savings to the degree the 
government was giving a dollar in tax incentives, it would only 
be going to the degree it was targeting people who were not 
saving now. Therefore rather than the embarrassing statistic we 
saw in the New York Times, which is that the amount that we 
were giving away in tax incentives was more than our overall 
private savings rate, we would be targeting incentives to 
leveraging additional private savings.
    Second, the automatic 401(k) models are good, but a company 
has to provide it. If you had a generous tax incentive it would 
make it more easy for companies to want to provide a 
deductibility option if they knew their employees were going to 
get a significant match. It would make it easier for private 
sector employees to give an attractive match if the government 
was sharing in that, and they would have an incentive to do 
that to the degree that it helped fix their--made it easier for 
them to meet their nondiscrimination rules.
    For the part-time contingent workforce right now when they 
drop off they have no pension and they have no incentive to 
keep their pension. So one of the things we have not talked 
about is that most people cash out. But if people could roll 
over into a universal 401(k), where even as they worked part 
time or even as they were home for child care, they could still 
get a matching incentive, that would encourage more people to 
do this.
    So I really think we need to think very seriously about our 
incentive system and turning this upside down system around so 
that our tax incentives are targeted to the people who are not 
saving now instead of just encouraging people to shift savings 
from one account to the other.
    The Chairman. Thank you. I want to reiterate that if others 
of you--I am going to take two more people to speak, Mr. 
Houston and Mr. Salisbury, and then we will move on to another 
question. I know a lot of you have some additional comments. 
Hopefully you will share those with us.
    Senator Grassley had to leave to go to the White House and 
have some discussions there that include some retirement, and--
--
    Senator Kennedy. I hope not mine. [Laughter.]
    The Chairman. I think it includes yours. [Laughter.]
    And Senator Kennedy has some obligations on the floor so he 
will have to leave shortly. Senator Reed has already been here. 
Senator Burr is here, Senator Hatch, Senator Thomas. We 
appreciate all of you being here and know that you have staff 
that was here before you came, and there are other members of 
both committees that have staff here that have been collecting 
your comments and that will be doing some additional research. 
We actually do not do all of our own research, and they will 
provide us with some summaries and help us to get through this 
issue.
    We will continue on this question for two more people, and 
then move on to a second question. Mr. Houston.

  STATEMENT OF DAN HOUSTON, SENIOR VICE PRESIDENT, PRINCIPAL 
                           FINANCIAL

    Mr. Houston. First let me just say it is an honor to have 
the opportunity to have an open discussion on these very 
important issues.
    The Principal Financial Group has about 40,000 small- to 
medium-size customers. About 1 out of 11 small employers with 
fewer than 100 employees have their retirement benefits with 
the Principal Financial Group, which is about 3 million 
American workers. This week at the end of the week I will be in 
Tucson with the Inc. 500 group. It is the 500 fastest growing 
companies. And if it is anything like it was last year, what 
they would tell you is top of mind for them is growing their 
businesses; the second is capital formation; third is health 
care like we heard earlier; and the fourth one would be around 
retirement benefits. With these small employers they typically 
will talk about how onerous some of the rules are as it relates 
to compliance and being in compliance as a small employer. So 
again, if the question is, are there things we can do to 
simplify retirement rules and regulations, I think it would be 
well received by small- to medium-size businesses, and again, 
we can submit that, Chairman, for your review, some ideas that 
we have in this area.
    Mr. McNabb spoke at Vanguard about what can happen locally 
to help better increase pension coverage, and again, we have 
similar experience in that when we put salaried employees with 
small- to medium-size group employees with one-on-one meetings 
we can see participation go from 75 percent to 90 percent. We 
can see average deferrals increase by 1\1/2\ to 2 percent. I 
would also tell you that when we can sign them up for auto 
enrollment and step up, they will start at 4 percent and end up 
at 8 percent. And again, I think Mr. Salisbury would comment 
that if we can get American workers to save between 10 and 15 
percent we can reduce pension liability significantly.
    And that really leads me to my last point, and that is I do 
not think we can forget the responsibility the American workers 
have to do a better job. They simply are not saving enough, and 
no matter how much policy we develop, if a young worker is not 
putting away 10 to 15 percent of their salary from the day they 
start employment, they simply will not adequately fund for 
retirement. And again, if they were at that level, they would 
not need the fallback position of a defined benefit program.
    Thank you.
    The Chairman. Thank you.
    Mr. Salisbury.

  STATEMENT OF DALLAS SALISBURY, PRESIDENT AND CEO, EMPLOYEE 
                  BENEFITS RESEARCH INSTITUTE

    Mr. Salisbury. Senator, thank you very much, and I 
appreciate being here.
    Just to build on the comments others have made with a 
slight twist, and the last one is I think that part of what we 
are seeing is if we look at today's retired population, about 
22 percent have pension income from a private defined benefit 
plan, and that is actually lower than it was as recently as 10 
years ago. If we look at that in replacement of those now 
retired, about 21 percent of their income for public and 
private sector retirees comes from an annuity income from a 
pension. That is projected for late boomers, if the system 
simply stays as it is, to decline to 10 percent. If the system 
continues to have employers eliminate new employees from those 
plans, which by our estimates occurred in at least 20 percent 
of defined benefit plans within the last 12 months, then those 
numbers are going to be even lower.
    If we look at what is happening then, the trend lines, as 
Mr. Trumka and others have said, can be expected to continue, 
most Americans, frankly, have always been on their own other 
than Social Security. And if we look at current retirees, 
Social Security is providing 38 percent income replacement, for 
the generation of late boomers it is projected to provide 31 
percent income replacement.
    Savings plans and defined benefit plans, as other speakers 
have noted, but defined benefit plans, importantly, have moved 
away from the traditional annuity provision. Over 25 percent of 
existing plans in the defined benefit realm are now cash 
balance. I am only aware of one that does not offer lump sum 
distributions. In those that do offer them, about 98 percent of 
participants choose a lump sum. Of the other 75 percent of 
existing private defined benefit plans, half now offer lump sum 
distributions, and depending on what survey you look at, 
between 67 and 97 percent choose the lump sum distribution.
    So if there are two things in this realm that Congress 
needs to focus on, I would suggest they did in this last 
legislative round, one is the tremendous importance of 
financial literacy education and getting basic education and 
savings education into our schools early, and doing better, as 
Rob noted, with future generations making the effort to save 
than past generations did. And the data makes clear that past 
generations did not.
    Second, it is longevity education. That has been described 
by people here vis-a-vis annuities, but the sad fact of the 
data is individuals, when given the choice between an annuity 
and a lump sum, do not select annuities. And a large part from 
our retirement confidence survey research that is indicated by 
the fact that most Americans today think they will die far 
sooner than statistically they are likely to live. In other 
words, the general population believes when we use the term 
``life expectancy''--which most in this room know means 
average, 50 percent will live beyond that--most Americans think 
life expectancy means that is the longest I am going to live.
    So my dad, now 91, still getting that defined benefit 
pension check, who thought he would be dead about 20 years ago 
because of childhood diseases and other things, his only income 
beyond Social Security is now that pension check. It was always 
smaller than Social Security. For 25 years it was a fraction of 
income from selling off their primary residence and other 
assets, but now it is the only thing they have. If it had been 
left to my parents at the time they retired, ``Do you want an 
annuity or a lump sum,'' my father tells me, as a former life 
insurance man, he would have selected the lump sum distribution 
because he did not think it would in the long-term mean 
anything to him.
    Second, vis-a-vis the trend line of if we do have 
additional change, two issues that Congress is dealing with or 
has on its table where, as other speakers have noted, it could 
fundamentally change or determine what the world looks like 20 
years from now. One relates to accounting treatment, and in the 
congressional sense last year the Congress dealt with the 
interest rate for funding purposes, and the debate was between 
the yield curve proposals of the administration, which matched 
what the Financial Accounting Standards Board is talking about 
doing, or allowing pension funds, defined benefit plans to 
continue to be funded with so-called smoothing, assuming 
midline for the future. We have historical experience now on 
what this does to the defined benefit system.
    In Great Britain over the last 12 months, 65 percent of 
defined benefit pension plans have been frozen against new 
entrants because of FAS 17 and the move in the United Kingdom 
to mark to market accounting similar to the yield curve. That 
may or may not mean you want to do it. But if that is the 
direction public policy and accounting policy goes, it is 
predictable that most of the remaining defined benefit system 
for future workers will go away.
    The second is cash balance clarity. As has been noted, 
whether one loves them or hates them, wants them or does not 
want them, the effect of an absence of regulatory clarity is 
day in and day out leading to the closing down for future 
workers of cash balance defined benefit plans. So the absence 
of clarity is essentially a decision that one wants them to 
disappear. We do not lobby. We do not take positions. I am not 
saying you should feel one thing or the other.
    I will just emphasize that in terms of whether those late 
boomers manage to get 10 percent replacement from defined 
benefit plans or zero is largely in the hands of the Congress 
today vis-a-vis the combination of the accounting issue and the 
cash balance clarity issue. On stock options and other issues, 
there have been issues of do you tell FASB what to do? This is 
one where if the private regulation takes place, then the fate 
of defined benefit plans, if it follows what it has in the 
United Kingdom, will fundamentally change the trend lines on 
the charts behind you, and defined benefit plans will markedly 
be, if you will, gone 20 years from now.
    Finally, in terms of that long-term trend I just underline 
where I started. The education point, is with longevity 
increases and with individuals needing to contemplate. In my 
case I used the longevity calculators. I have an aunt who is 
105. My father is 91, my mother is 88, and individuals in my 
family have lived into their 80s for over 100 years. The 
calculators tell me 103. I want to find an insurance company to 
take that risk. [Laughter.] But it requires trust, and it is 
the one thing I would underline. One of the reasons individuals 
today take a lump sum instead of an annuity is because of an 
absence of trust that their employer will still be there, an 
absence of trust that their employer will keep the promise. The 
reason they tend, based on research, to not buy annuities is an 
absence of willingness to trust that the offering insurance 
company will be there 40 or 50 or 60 years from now.
    So while we talk about short-term, one of the most 
important issues vis-a-vis education as well, and legislating, 
is trying to figure out how vis-a-vis that 20-year margin to 
bring trust back into the system so that the public will think 
about longevity risk.
    Thank you.
    The Chairman. Thank you very much. I have to cut off 
discussion on that and will reiterate that if any of you want 
to expand on your comments or provide us with information or 
counterpoints that has been brought up, it would be very 
helpful. We have had a truckload of information, and one 
advantage to this format is that we have been able to get 
information from a lot more people than we would be able to do 
in a hearing.
    I am going to switch gears a little bit and go to a 
different question because we do not operate in a vacuum. There 
is little doubt that the global marketplace has a broad effect 
on U.S. companies that are planning for the future. Today many 
companies do have overseas operations. I know one in Cowley, 
Wyoming--anybody here know where Cowley, Wyoming is? The mayor 
there told me that I could say that he lives a half a block 
from downtown and a block and a half from out of town. 
[Laughter.] But he runs a little overseas operation that 
provides lamps, those tubular great lamps that go in the front 
of big office buildings, and he ships those all over the world. 
So all sizes of business have this problem too, and they are in 
competition with companies in other parts of the world. Many of 
the bigger companies have overseas operations, and therefore 
have retirement pension and benefit plans in those countries as 
well.
    How do overseas private sector pension and benefit plans 
and initiatives affect the U.S. companies' decision on 
retirement benefits for their workers? How do we expect this to 
change in the long-term for U.S. workers? What are the 
international implications here? Anybody want to start us off? 
Yes, Mr. Salisbury?
    Mr. Salisbury. I will just add off of the UK experience in 
talking to consultants in companies that because of the changes 
in the United Kingdom have chosen to terminate or freeze their 
defined benefit plans in the UK. That has ended up feeding 
decisions to make changes in their U.S. plans as well, and it 
has basically made it--their choice of words--easier to 
rationalize recent decisions to not make the defined benefit 
plan available here to new hires because it will no longer be 
available in the United Kingdom. The two nations in the world 
with the strongest defined benefit systems up until last year 
were the United Kingdom and the United States.
    So I think as we see change in other countries taking 
place, the International Accounting Standards Board is expected 
to extend FAS 17 to all nations, and with that change, we are 
likely to see a world pressure in that direction of more 
freezings of existing defined benefit plans.
    The Chairman. Before we go to--we will do Mr. English, and 
I think that Senator Hatch has had a question that he wants to 
kind of throw out here too as a result of the discussion.
    Mr. English.
    Mr. English. Thank you, Mr. Chairman. I think--and I am 
following up a little bit on the point that Dallas was making. 
There is a difference, I think, as we look at this issue, 
between those who are offering service, those that are in 
competition and those that are not. That may start having a 
dramatic impact with regard to this entire issue. Ours is a 
service industry. You are not going to go overseas and get 
electric power and bring it in to rural America. We are not 
going to be in competition. A lot of small business in this 
country is not going to be in competition, unlike the example 
that you used, Senator. They are not going to be in competition 
overseas.
    There may be something of a watershed that develops here 
between small business, those who in the service industries 
that do not face competition overseas and those that do. It is 
going to be an interesting reversal if you have greater 
benefits in people living in rural American and small towns and 
in small businesses than you do in some of the largest 
corporations in this country. But I think you could very well 
see that take place.
    Also there is a difference with regard to the employees 
themselves. It is not unusual still in rural America to see 
employees stay with one company throughout their entire history 
as an employee. Certainly with electrical operatives, most of 
our employees do in fact stay with the same electric 
cooperative, live in the same small town throughout their 
history. And this defined benefit program and the defined 
contributions that have been in existence for our employees for 
so long obviously is--we are reaching a point in which they may 
in fact be better off in retirement than many of those who live 
with some of those more generous contributions that are made 
from a wage salary standpoint in some large corporations.
    So it may be that we are seeing a reversal now for those of 
us who come from small towns and rural communities. We see this 
as a wonderful thing that is developing, because if you want to 
live well and you want to have good defined benefits and 
defined contributions over an extended period of time, you 
better move to rural America. Cities cannot give it to you 
anymore because most of their businesses are in competition 
overseas, and they simply cannot afford that particular 
benefit. That may be a bit extreme but you know it is an 
interesting development that may come about as a result of 
this.
    Again, I would make the point that what has stopped people 
in small businesses and particularly those in rural communities 
is they simply have not had the resources to put together a 
defined benefit program, and certainly they cannot maintain it. 
They cannot take care of it. They cannot have that kind of 
expense and certainly do not have that level of sophistication.
    Again, we would strongly urge that you look at the multiple 
employer approach as a way in which you can pool those kinds of 
resources and offer those kinds of benefits to people in small 
business in this country, and particularly those who may not be 
in competition overseas.
    Thank you, Senator.
    The Chairman. Of course we are always tempted to make some 
comments about the comments, but I will withhold.
    We do have the extreme pleasure of having Senator Hatch 
here, who not only serves on the Health, Education, Labor and 
Pensions Committee, but he is also on the Finance Committee. So 
he is the joint person at the joint meeting. And it is kind of 
historic that our two committees are working well together to 
come up with some solutions. And so the man that holds it 
together.
    Senator Hatch. The joint person on the joint committee who 
feels disjointed about this subject. [Laughter.]
    I would just like to ask you what new tools or savings 
plans are needed to get new entrants into the labor force to 
start saving early on in their careers? Somebody may have 
answered this before because I was not here earlier, but I 
would like to have you take a crack at that. What are some of 
the tools that would help us in that area?
    The Chairman. Mr. Henrikson.
    Mr. Henrikson. Yes, I will take it. It has been discussed 
to some degree. I think the strongest statement which also 
tells us a little bit about what is being expected of 
employees, I think is what I would call an automatic enrollment 
approach. In other words, if you can get people to have as the 
default option that they are part of a plan, that would have a 
great effect.
    The problem, however, one of the things that is sort of 
implicit in that is if employees need to have an automatic 
enrollment program to take advantage of something that might 
give them an immediate 50 or 75 percent return on their money, 
we are asking those same employees to make decisions after they 
start to build money, relative to their mix of stocks and bonds 
and so forth and so on, and then at retirement, as if crossing 
65 were sort of crossing a finish line, that is the beginning 
of the most difficult time they are going to have.
    In a syndicated column not too long ago it just struck me. 
Someone said, ``Now that 401(k) plan participants are 
comfortable income averaging in to the marketplace, what they 
really need to do is as markets go up and down, they should 
learn to save more when the stock market declines. They should 
be value averaging in.'' What this says to the retiree, of 
course, is that you ought to learn how to value average out. If 
the market goes down, simply live off of less every month if 
you are taking periodic withdrawals.
    So saving is great. It is great to have increased savings, 
but the question is, are the savings going to turn into a 
secure retirement income?
    Senator Hatch. Thank you. Anybody else?
    The Chairman. Mr. Trumka.
    Mr. Trumka. I want to go back to a point I made at the 
beginning. First of all, none of the pension stuff is done in a 
vacuum, so Mr. Houston said that young people are not saving 
enough money. There is a reason for that. Many of them cannot 
save money and will not ever be able to save money. They have 
stagnant wages. They have health care costs that are going off 
the chart. They have an educational system that they may have 
to pay back school loans. Many of them in industries like steel 
or airlines are living on wages that they were paid in 1980. 
Inflation has gone beyond them. They cannot save. That is why 
defined benefit plans are so absolutely essential in all of 
this.
    And it all ties together because you take the manufacturing 
crisis that we are seeing. We have lost 3,000 manufacturing 
jobs. Most of those jobs were high paying jobs that provided 
pension benefits. They are not there right now. You take a 
trade bill that is not enforced with China. They manipulate 
their currency. They give an employer a 45 percent advantage by 
going offshore and manufacturing in China. They will go 
offshore for 45 percent. The trade bill is not enforced in 
other areas. It gives them another 40 percent because they do 
not enforce their child labor laws, their prison labor laws. 
That gives them another incentive to go offshore, take the jobs 
away that take the pensions and the means to provide those 
pensions with them. You take a tax code that rewards people for 
going offshore. That also affects the ability, and that is how 
globalization has tied into all of this stuff.
    Well, I cannot get past one other thing, Mr. Chairman, we 
have talked about, and I want to come back to this. We have 
talked about clarifying one area of the cash balance plan. We 
would agree with the status of cash balance plan needs to be 
clarified, but because they play a valuable role in retirement 
security under the right conditions, but we also want to 
emphasize that that needs to be accompanied by protections, 
that needs to be accompanied by protections for older, long 
service workers and cash balance conversions because you wake 
up one morning and you think you have a plan that is going to 
give you 30, 40 percent of your retirement income, is going to 
replace that, and you find out that it has not done that. And 
so you end up too late to be able to save more. So they need to 
be protected as well.
    All these things tie together. We believe that defined 
benefit plans are very, very important for young workers and 
old workers because many workers in this country, young, middle 
age and approaching your retirement, cannot save. Let me repeat 
that again. Many workers in this country cannot save. It is not 
a matter of wanting to or not wanting to. They cannot because 
their economic circumstances will not allow them to do that.
    The Chairman. Senator Hatch's question has touched off 
quite a run here. I am going to ask everybody to keep their 
comments under 2 minutes so that we can get more comments and 
perhaps some other questions.
    Mr. Covert.
    Mr. Covert. Thank you, Mr. Chairman.
    First of all, to address Senator Hatch's comments, 
obviously auto enrollment would be helpful. Plan design 
incentives for employers that increase the match, thereby 
drawing more people, incentivizing them to come into the 
system. And also investment education, the ability to provide 
investment education to employees without employers having to 
worry about whether or not they are going to get sued for 
violating ERISA.
    To answer the chairman's question, we have operations in 98 
foreign countries. The pension systems in those 98 foreign 
countries are a patchwork to say the least. Some countries like 
France have mandated social plans like our Social Security 
system, and that is how defined benefit pensions are delivered. 
Other countries like the UK have a similar system to ours. The 
same with Canada.
    The reason why a lot of employers, including Honeywell, 
have frozen their plans in those countries is over regulation. 
You have these perverse rules where if you close a facility or 
consolidate facilities or even do legal tax restructurings of 
your subsidiaries, that can trigger funding obligations on the 
employer on what they call a wind up basis, a termination 
basis, in our parlance, essentially forcing an employer with a 
plan that is already adequately funded to contribute basically 
double what they would ordinarily otherwise have to contribute 
even though nothing in reality has happened to the overall 
solvency of the plan, from Honeywell's perspective.
    So what we do internationally does not really impact what 
we see in the United States. However, I guess what I would say 
is to the extent more and more of our competitors do not have 
the cost associated with maintaining defined benefit plans, 
there is obviously pressure on us because we need to be smarter 
and more competitive with that pension burden that we have. We 
are committed to staying in the system, but that is the types 
of things that we look at, so even though what we do in the UK 
for example does not impact what our thinking is in terms of 
U.S. pension plans, overall it is a global company and we have 
to budget and plan around cash flow, capital investment and so 
forth. A company like Honeywell that provides defined benefit 
plans to its employees is at a disadvantage against companies 
that do not provide defined benefit plans.
    The Chairman. Thank you.
    Mr. Gebhardtsbauer.
    Mr. Gebhardtsbauer. Thank you.
    Senator Hatch asked how can we get more people into these 
retirement plans, and automatic enrollment has been talked 
about, so that you are in unless you elect out. Another way 
that it has been discussed to do all these decisions right at 
your date of hire so that you do not see your big paycheck and 
after you enroll you have a smaller paycheck, so bring them in 
in the beginning, but some of the rules make it difficult to 
bring people in right away because of the participation rates. 
The people at the low end are maybe not as likely to be as 
good.
    One other thought that I have is also in the area of DB 
versus DC. Originally the 401(k) plan was seen as the 
supplement plan, and so it was understandable that not 
everybody would be in the 401(k) plan because was in the DB 
plan, and so the way we have moved in the past 10 years is 
toward less DB plans. In fact, that slide in the middle behind 
Senator Enzi, the green line going up is the 401(k) 
participation rates, so you will see when ERISA was passed in 
the mid 1970s there were really none of them, and now I guess 
it is around 40 percent of the workforce is covered by 401(k)s. 
Whereas DB plans used to be at 40 percent and now they are down 
below 20 percent.
    I happen to know these numbers because I did the slide. 
[Laughter.] My glasses are not this good. [Laughter.] And the 
red line is something called the money purchase plan. That was 
sort of a DC plan, but it is pretty much where everybody was 
involved and was covered in the DC plan. It is a money purchase 
plan. And you will see that it is going down. It is below 10 
percent and it may go away.
    One of the reasons why DB plans and money purchase plans 
are going away is because, as some other people I think, Don, 
mentioned, we have been very creative at improving the rules 
for 401(k) plans so that everybody wants to get into the 401(k) 
plans. And we have not kept the DB rules up. We have not kept 
the money purchase rules up. We have not improved them, and it 
is getting harder and harder to have a DB plan, as Dallas was 
mentioning, for many reasons. These DB plans were the ones that 
covered everybody, and we are moving to a world maybe if there 
is no DBs, maybe there will just be 401(k)s, and so maybe we 
need to tighten up some of the 401(k) rules.
    Right now the rule to encourage more participation in a 
401(k) is done through--if you get 70 percent of your lower 
income employees participating in the 401(k), then 100 percent 
of your higher income employees can participate. So the 
American Academy of Actuaries, where I work, does not actually 
take a position, but one area where you could do, is you could 
change that 70 percent rule. Not everybody is going to like 
that rule, so there will be people pro and con around the table 
maybe on this. But maybe you could raise the 70 percent to 80 
percent, saying you need to have 80 percent of your lower 
income employees participating in order to get 100 percent of 
your higher paid people participating.
    Another area would be in how much the contribution is, so 
you would not only want someone to contribute, but you want 
someone to contribute more, and so if there are ways to change 
the rules so you could get more contributions from the less 
highly compensated people.
    A slightly different topic--I apologize. I will just make 
this really quick because I may be going over my 2 minutes. 
This is a new topic, that whenever Congress wants to do 
something good, the budget rules make it difficult, so Congress 
has actually tied its hands through the budget rules, the cash 
rules. Whenever they create a rule to come up with some of 
these new great ideas that Karen has brought up or I think Mark 
and Don and Gene, in order to get more companies to have 
pension plans, in order to get more people participating, that 
means more deductions today, meaning less tax today. So of 
course that is a negative and so your cash budgeting reflects 
that. But it is not a total escape from taxation because 
eventually this money that went into the pension plan 
eventually comes out, and so it is not escaping tax, it is not 
tax exempt. It is tax deferred, so eventually the government 
gets the taxes back when the distribution is made when you are 
retired.
    So in fact that is actually a good thing because actually 
we need taxes more in the future than we need right now, so one 
way to untie Congress's hands would be to not only have a cash 
budget to score all your changes on a cash rule, but also to 
have some sort of accrual rule accounting, so that you reflect 
the good things that are way out there in the future. More 
people are going to have pensions and more people are going to 
get taxed on their pensions out there in the future, and 
somehow bring that in today. So everybody says that is very 
difficult to do, but actually we have a rule already called the 
Credit Act of 1990 that affects education loans. So the 
government eventually gets the money back 30 years from now, 
and they actually bring that into the budget. So it would be 
great to untie Congress's hands so that it could score things 
like more pension coverage as a good thing, not a bad thing.
    The Chairman. Thank you.
    Mr. Sperling.
    Mr. Sperling. Senator Hatch I will start with an anecdote 
some of us live through. If you go from a campaign into the 
White House, which is campaign young people are probably the 
worst savers. They are a transient group, risk takers. They 
come into the White House or into the government and suddenly 
you have this Thrift Savings Plan. And you get virtually a 
dollar to dollar match on your Thrift account. It is very 
interesting. You watch a lot of people who never thought about 
saving at all, but when they are given the opportunity to have 
it deducted right out of their paycheck and get that 
significant of a match, it is interesting how many turn to 
savers.
    Now, Dallas's charts we would show you, it still does not 
quite work for a lot of the lower income types, people making 
lower incomes. But I think that what you are hearing here is 
there is a lot of studies that first of all say if people were 
automatically put on, or as Ron is saying, even right from day 
one, that people very rarely choose to move out of it.
    Second though, the question is--and I think Mr. Garrison 
talked about with his company--that you really have to give a 
strong incentive to get people to save. So the question is how 
could we replicate this among around the workforce, and I think 
we do have the ability, through our tax code, to do more. I 
mean we give people $1,000 tax credit for having a child, and 
you get it every single year. You could have a refundable 
credit that goes to people, and you can make it quite generous 
in the IDA model at lower incomes, but if you did that, you 
would be doing something. One, you would be encouraging more 
employers to allow automatic deduction if it helped them meet 
the 70 percent rule. So imagine if you have a tax credit that 
encourages employers to allow all their lower and moderate 
income workers to automatically deduct money out--and they are 
telling them, look, if you are lower income, you may get a $2 
to $1 match or dollar to dollar match. That is a fairly 
significant incentive. When the person leaves--young people 
right now, even if they started savings they usually just cash 
out. So the second part of the question really should be how to 
get them to start to save and how not to get them to just cash 
out as soon as they leave their job.
    So I think we are having this whole discussion within the 
Social Security context which is dividing us, but this context 
of how we could use refundable tax credit and incentives to get 
people essentially a universal 401(k) that they feel like they 
can always contribute a dollar and get that match, so it is not 
just the lucky few who find themselves in the TSP, but 
something we could do for all workers, I think really is the 
future and I think it is an area where one could have a lot of 
common ground around a savings and ownership agenda.
    The Chairman. Mr. Houston.
    Mr. Houston. I will keep this under 2 minutes. I think we 
could search for a long time to try to find the silver bullet 
on what we could do, Senator Hatch, to increase participation 
and encourage participation, and I suspect whether it is Chile 
or Australia or Hong Kong, where there is required 
contributions, that is probably where we will need to end up. 
Again, I do not think a required contribution is a bad thing.
    I think one thing you would have to step back from, in 
responding to Mr. Trumka, is whether or not we truly are over 
consuming in this country, of which I am a strong proponent 
that we are. We consume way more than we can afford and the 
resulting factor is we have very little left to save. I do not 
know if we have drifted up too highly, what our standard of 
living is, but in a global workforce, as we continue to move 
these jobs around the world, I think increasingly, whether it 
is for health care expenditures, retirement for DB, DC, wages, 
whatever the case is, we will be head to head in competition 
with a global workforce which will cause us to reconsider 
priorities around consumption versus savings.
    That rural electric angle, I like that one. That has 
potential maybe on job safety. [Laughter.]
    Thank you.
    Senator Hatch. Let me interrupt you on that, because one of 
the questions I have--and it relates to Mr. Trumka's comments 
as well--are defined benefit plans sustainable as they are 
shrinking--which is to say that the average age is rising and 
there are more retirees than there are active workers?
    Mr. Houston. Again, I think it has been hit on from a 
couple of different angles. One is the very large 
multinationals have been able to grind it out and maintain 
their position to still be a sponsor of a defined benefit 
program, although we are making it increasingly challenging to 
do so because of some of the uncertainty around defined benefit 
legislation. For the very small private corporations, who are 
small private practices, there is a real growth, an emerging 
market there. There is a fairly high take up rate among those 
55-year-olds with a half a dozen other employees who would very 
much welcome the opportunity to support a defined benefit plan.
    But if we are talking about small to medium size companies, 
25 employees to a thousand, there is very little appetite to 
take on the liability of the required funding levels for 
defined benefit, and most of them would tell you that something 
that has variable contributions, profit sharing, 401(k), 
discretionary match is the preferred plan design. Again, as I 
mentioned earlier, to the degree we can reduce the burdensome 
compliance nature of the small employers, I think the take-up 
rate would be higher.
    The Chairman. Mr. Kimpel.
    Mr. Kimpel. Thank you. I will be quick. I just want to make 
one point in response to Senator Hatch's first question. I 
fully agree with Mr. Henrikson's remarks about auto enrollment, 
but I do not think auto enrollment in and of itself solves the 
problem. Mr. McNabb earlier made reference to Section 404(c). 
One of the problems with auto enrollment, which the law now 
allows is that if it is automatically enrolled the money 
defaults into a particular investment option under the plan. 
What virtually every employer does today because of 404(c) is 
they default to a money market fund, which in terms of long-
term saving is not the right thing to do.
    What we need is a fairly simple legislative fix that would 
enable employers to match automatic enrollment with a default 
to a life cycle fund, where there would be appropriate 
diversified asset allocation based on the participant's age 
that would change over the course of his or her career.
    The Chairman. Thank you.
    Ms. Schutz.
    Ms. Schutz. Thank you. To your question on what are the 
tools available, education is a real fundamental gap, and I see 
it on really three levels. One is savings and the value of 
compounded interest and earnings, and the lack of awareness and 
literacy around that. The second is the lack of understanding 
of how much in savings is required to create an income stream 
for retirement. I do not think most individuals understand that 
and the math. And the third area is the value of guaranteed 
income sources, annuitization being one of those, in that an 
individual can lay off risk to an insurance company or the 
employer for longevity, for long-term earnings rates, timing 
risk in the market.
    I think that there is really a fundamental education gap 
today that needs to be filled.
    The Chairman. Thank you.
    Ms. Friedman.
    Ms. Friedman. Thank you. I think my remarks are going to 
kind of be an amalgamation of what a lot of people are talking 
about.
    In response to your question, Senator Hatch, certainly the 
kinds of solutions that people are recommending today, 
automatic enrollment and other kind of automatic devices in 
401(k) plans are very important. But I want to reiterate what 
Rich Trumka said, which is for a lot of people, they just 
cannot save. It is great if people could put away 20 percent of 
their income, but people are being asked to save for everything 
now, for their education and their health savings accounts and 
their medical savings accounts, and we have to have something 
that takes some of the risks out of people's investments. And 
that is why we feel strongly that defined benefit plans still 
have to be encouraged.
    You were talking about education, Pamela. One of the things 
that I have been thinking about--and again, I am not sure how 
this is done--but, you know, Dallas is part of ASEC, which is 
the American Savings Education Council, and they have had a 
whole campaign to educate people about the importance of 
individual savings. It seems to me that people in this room 
could work together to do a campaign to educate employers and 
employees about the importance of defined benefit plans as a 
way of addressing those issues.
    There are also--and I said this at the beginning of my 
comments and it has been reflected throughout the day--that 
there is now an exploration of different kinds of hybrid plans 
that take into account the best parts of defined benefit plans 
in terms of the employer puts the money in and assumes the 
risk, and they are guaranteed, with some of the best features 
of 401(k) plans like portability and transparency. I do want to 
say, because I have heard this a lot today and I know that this 
is way beyond the purview of this, but if we are going to 
resolve the cash balance situation we have to do so in a way 
that balances the interests of both employees and employers, 
and particularly takes into account adequate transition 
benefits for older workers in those situations. But we are 
certainly willing to look at interesting new plan designs.
    The Chairman. Thank you.
    Mr. Covert, you had your sign up and you put it down.
    Mr. Covert. I spoke already. Thank you.
    The Chairman. Thank you.
    Ms. Bowers.
    Ms. Bowers. Thank you, Senator.
    Senator Hatch, you are asking two wonderful questions. 
Today the savings rate of the average American, as you are 
hearing, is somewhere between 1 percent and 3 percent. I heard 
3 percent, and then when you factor out the Microsoft dividend 
returns I have heard that it is down to 1 percent on NPR.
    People are not saving. What can we do to encourage them to 
save? There are a lot of techniques that we can do, but in the 
long run what will people have to save to replace defined 
benefit plans should they be removed from an offering in most 
employers? That is a big question and that is going to be a 
difficult area to replace. I think everyone in this room would 
agree that if we can find ways to keep defined benefit plans as 
being something that employers want to offer their employees 
and to continue these plans, that is what we should work 
toward.
    Unfortunately, right now we are getting a lot of pressure. 
We can give you lots of different ways. Through the Treasury 
Department's support of the yield curve, we are finding that 
that creates volatility in the way we have to predict our 
contributions for our plans that a lot of companies will not be 
able to move forward without some type of stable smoothing that 
we have today. So we need to continue the relief that we have 
today.
    We have pressures from companies that are looking at their 
ability to fund their pension plans and also be able to fund 
other business opportunities and having to make some tough 
decisions on where they need to put their moneys. Do they put 
their moneys in trying to grow their business, or do they put 
their moneys in trying to maintain their pension trust? How 
long will it be until we are able to get some kind of stability 
in those contributions?
    I reported earlier this morning, my company, Smurfit-Stone, 
which is a large company throughout the United States with 
27,000 employees and about 60,000 people that participate in 
our defined benefit plan, we are placed under continued 
pressure to make sure we keep our funding at an adequate level. 
And there are some proposals out today that would require us to 
fund at even higher levels. We are funded at about a 90 percent 
funding, and if we were to be required to fund at 100 percent, 
our contributions would be increasing by double what we are 
paying today or even more so over the future.
    So if we want to be able to maintain the ability for 
defined benefit plans, we have got to have some stability in 
those plans, we need to have some relief on how we can project 
what our costs are. And all these benefit programs are looking 
at what happens 10, 20, 30 years into the future. We cannot try 
to solve that problem by taking a snapshot in today's time and 
trying to fix it with short-term limited time basis of fixing 
this problem. This is something that we have to look at over 
the long haul to make sure that we have a solution that people 
can live with, that the average American is not going to be 
compromised. Today the average American is not saving enough to 
replace what will be lost if defined benefit plans are not 
maintained in this country.
    Thank you, Senator.
    The Chairman. Thank you.
    Mr. Fuerst.
    Mr. Fuerst. Thank you, Senator. With regard to increasing 
participation in these plans, there are many innovative 
solutions that have been recommended by several people. All of 
these will help. Frankly, I think we have done a reasonably 
good job. If you look at the chart again behind you, 30 years 
ago we did not have 401(k) plans. We have created enormous 
assets through these plans and IRA plans.
    But over that same time period, where these plans have 
increased enormously, if you look at the net savings of 
Americans, in 1980 it was approximately 10 percent. It was down 
to under 2 percent in 2003 and even lower last year according 
to preliminary reports. We are not saving despite the fact that 
employer sponsored plans are increasing significantly and 
people are contributing to those plans. Yet they are dissaving 
in other areas. At the same time that they might put a 
contribution into a 401(k) plan, they are refinancing their 
house, taking equity out and spending that.
    Consumption has been enormous in the United States, 
consumption growth in the past 10 years. The consumer led the 
economic boom throughout the late 1990s, and through the 
recession it was consumer spending that helped moderate the 
degree of the recession that we had in the early 2000s.
    The problem is not so much participation in employer 
sponsored plans. The tax incentives are there to get people to 
get the tax deduction of pretax contributions to these plans, 
but on the other side there is no incentive for them to save 
overall. There is in fact a--because our tax system is based on 
income rather than consumption, there is an incentive to reduce 
your taxable income but still spend as much as you can. If you 
really wanted to look at a very different approach to the whole 
system--and I know that this has been discussed to some 
extent--a consumption-related tax rather than an income-related 
tax would enormously encourage savings. It would have a lot of 
other impacts also that you certainly have to consider, but it 
would enormously impact savings.
    With regard to the global competitive issue, I think that 
companies that compete on a global market are concerned about 
their total compensation cost, not just their benefit cost or 
their salaries. They make a decision on where to produce goods 
based on their total cost. We may make a decision on how to 
allocate that total cost between benefits and direct 
compensation, but it is the total cost that really drives it. 
If our employees in America want to allocate more toward 
benefits, we can work that out within a total cost 
consideration.
    The real concern though on the global market is being able 
to predict what that is and knowing how volatile your costs are 
going to be. Our problem with respect to pension benefits is 
the volatility of the cost, not the level of the cost. Pensions 
are actually a very efficient way of delivering compensation to 
our employees. It is the volatility that is uncertain.
    That goes also to the comment that was made about is the 
defined benefit system sustainable? It is if we have better 
rules about controlling this volatility. During the late 1990s 
companies had significant benefit cost for pension plans. 
People were accruing more and more benefits each year. Yet we 
were precluded from funding those. In fact, if we put money 
into a pension plan to fund those costs, we would have to pay 
an excise tax when we were at that level. The funding target 
that says if you have assets greater than your liabilities, 
that you cannot make a deductible contribution, really puts 100 
percent funding as a ceiling to the plan, not as a target. And 
if we are going to have volatile markets we have to have 
funding allowable above that level also. If companies were able 
to make a consistent contribution every year, we would not have 
some of the funding problems with these plans that we have 
today.
    Thank you.
    The Chairman. Thank you.
    Mr. Certner.
    Mr. Certner. Thank you. I want to address the question on 
getting more people to save, and I think one of the ways we 
have seen that has been most successful to get people to save 
is through a salary reduction arrangement. I think that shows 
why the Thrift Savings Plans and 401(k) plans, for example, 
have been much better at getting people to save than something 
like an IRA. People just do not have the money, as Mr. Trumka 
and others have said, to save, and certainly if it is not 
coming directly out of their paycheck every 2 weeks, the 
chances of them having a lump sum of money to put in at the end 
of the year are much more nonexistent particularly for people 
at the lower and middle ends. We know that they prefer to save 
by having the money taken directly out of their paycheck. So 
having a 401(k) or a Thrift Savings Plan available for everyone 
would I think essentially be a good goal for this country.
    I mean right now you only have an advantage of being able 
to do that if you are with an employer who has that kind of 
arrangement, and I think if we could make a standard in this 
country that no matter where you worked you would have some 
kind of a salary reduction arrangement, that that money would 
be going somewhere, whether it be an employer plan or even to 
your own individual IRA, you would be able to get more savings.
    You would be able to encourage that by building also on the 
saver's credit that we have right now. We have employer matches 
that encourage to get in, but we also have now the saver's tax 
credit that encourages people at the lower end, and hopefully 
if we can raise that a little bit more to middle income 
earners, so you would have both a salary reduction arrangement 
with a matching contribution. We know that that is at least an 
effective tool to begin to get people in. Others have talked 
about other tools like automatic enrollment. Again, we know 
that boosts participation way up, almost close to 100 percent 
in many circumstances.
    But that only gets us part of the way there. That only just 
gets the money in to people's accounts. We also need to make 
sure we keep that money from coming out. What we see now is a 
significant amount of leakage from the system in the form of 
lump sums or cash-outs pre-retirement. So just getting the 
money in is not going to help if we have the money come right 
out. So you need either auto enrollment, better financial 
literacy, to make sure that people keep that money in the 
retirement income stream and do not just see this as another 
savings pot that they are going to dip in immediately when they 
need a car, need a vacation, or even do things like send their 
kids to college. Those are all useful things if you are going 
to be buying a house and sending your kid to college, but it 
means you are not going to have any money for retirement 
either. We need to make sure that we encourage this money for 
retirement savings not just savings in general.
    Another point on the cash balance arrangements that were 
talked about, we think it would be very important to get 
certainty into this other kind of plan option, and we have said 
for years we needed to have that certainty come along with the 
protections for those, all the workers who were in the old 
system for so many years, and we think that could provide 
another type of plan option, but again, you have that same lump 
sum problem you need to deal with.
    I also want to note--and I think some others have--that we 
do have another problem here with high health care costs in 
this country, and I think you see high health care costs 
squeezing out retirement costs. Health care is a need we have 
now, and both employers and employees need to make those 
payments now, and so the retirement income needs falls behind 
that. So higher and higher health care costs both squeeze out 
the employers' and the employees' ability to contribute money 
for retirement income. So keeping health care costs down I 
think would help very much on the retirement side as well.
    The Chairman. We are also in charge of keeping health care 
costs down, so we will do some other forums on that too. Good 
point.
    Senator Hatch. Not doing too well, however. [Laughter.]
    The Chairman. We have exceeded our allotted time, so I will 
allow Mr. Henrikson, Mr. Garrison and Mr. Dunbar to add their 
comments, and then we will have to close.
    Senator Hatch. Mr. Chairman, I am going to have to leave. I 
apologize for leaving without getting all of these answers, but 
I will pay attention to you. These are big problems, and of 
course I think this has been a very stimulating panel. I just 
want to thank all of you for taking time to be here with us. It 
has been very stimulating to me. I just wish I could have been 
here a little bit earlier. But we are grateful to you, and 
frankly, if you will forgive me, I am going to have to slip 
out. I know the chairman will keep good track of these things.
    The Chairman. Thanks for being here.
    Mr. Henrikson.
    Mr. Henrikson. I have three quick comments to make it 
short. One of the things, mortality pooling, I had mentioned it 
earlier, the other side of mortality pooling which was 
emphasized, someone had said before that defined benefit plans 
are extremely efficient. One of the reasons they are so 
efficient is that mortality gains, that is, when someone dies 
early, are retained in the plan to help pay the benefits for 
people who live a long time. So if you have defined benefit 
plans, not to put a damper on anything--and I have no problem 
with hybrid plans--but when you start adding features to 
defined benefit plans like take the money with you, leave the 
money to your heirs, portability and so forth, the efficiency 
per dollar to benefit is lost to a great degree. So you cannot 
take money out of the system that previously was held in the 
system and not feel the brunt of that.
    To put it another way, for an individual to save and have 
anywhere near, less a high probability that they will be able 
to use that money for the rest of their lives, they would have 
to save probably about 30 percent more to overcome the value of 
mortality gains if they go into a pool. I would make that 
point. I did not mean to sound difficult or convoluted on that. 
But I do not care what kind of a plan it is, whether it is 
Social Security, whether it is a defined benefit plan, take 
mortality gains out of the system and it costs a lot of money.
    The other thing I would say, just in terms of a default 
option on DC, it is kind of odd to us that have been in the 
business for years, DC plans were around a long time before 
there was any option for employees to have different investment 
options. So whether they were profit-sharing plans that said 
zero to 15 percent of covered compensation not to exceed 
profits, that went into your account and then that account was 
managed by the trustees, similar to the way it was in a defined 
benefit plan. So I just would point out that it is sort of odd 
that we then make it hard for people to have a default option 
that is broad based.
    I am sorry Senator Hatch left, but I would just make a 
comment. He asked if plans are sustainable. In some businesses 
it is very difficult. If you look at a company that is in a 
manufacturing business that has 6 or 7 times more retirees than 
actives, and perhaps even more important than that, they are 
not even in the same business that those legacy employees are 
in, and that is going to be very, very difficult. So when you 
are talking about exporting your expertise in the benefits 
arena, for example, across the ocean to another country, you 
probably would not want to replicate that problem.
    The Chairman. Thank you.
    Mr. Garrison.
    Mr. Garrison. Just two quick points, Mr. Chairman. With 
respect to the global issue, we at Exxon-Mobil, look at it in 
terms of a total remuneration package. That is to say some 
portion of the compensation is going to be paid as cash and 
some portion may be put away in terms of a retirement program. 
I think what we are really arguing about here or discussing is 
the proportion that is dedicated to retirement security as 
opposed to current consumption in terms of cash. I think we 
have flexibility. Certainly there are issues associated with 
change from one State to another, but ultimately I think what 
the panel may be recommending is that we need more of an 
emphasis on the retirement savings component of the total 
package and perhaps less on the total consumption or the 
current consumption.
    With respect to Senator Hatch's question, I think an 
additional point, which will not solve all the problems, is 
that we need more of a culture of savings in this country. I 
think in our particular company we preach from day one as new 
employees come in about the three-legged stool and the shared 
financial responsibility, so that it is implicit in the 
employee that he or she is going to help contribute toward 
their retirement, and they understand that is expected of them, 
that is part of the culture of the company, and I guess I would 
say that we make it easy for them to do the right thing by 
having an attractive match that they would forego if they do 
not choose to participate.
    But I do think that the culture and the discipline of 
private employers to incent people and to gently encourage them 
to do what they need to do should not be overstated.
    The Chairman. Thank you.
    And our final word from Mr. Dunbar.
    Mr Dunbar. Just again wanted to hit just the small employer 
perspective on this, but a lot of small employers delay putting 
plans in until they have the resources to put money aside. They 
are going to look at defined contribution plans first. I think 
a lot of the comments around the room have been that your lower 
paid employees cannot afford to defer. I think we see that in 
the small employer, especially if the intent is to try to give 
incentive for the small employer to put plans in and look at 
defined benefit plans as an option. Then the regulatory 
environment has to be cleaned up a little bit so that it is not 
as onerous, because right now it is onerous as far as the 
burdens regulatory wise.
    I think you also need to build some flexibility into 
defined benefit plans so that they can have some flexibility on 
funding. As far as incentives to employers to put plans in and 
incentives for employees to defer, I think those have been 
kicked around.
    Last comment, lump sums. The small employer, they almost 
have to have lump sums built into their plan because when that 
small employer retires that plan is going to disappear, so it 
would be very difficult not to have lump sums built into those 
plans. I think you could restrict possibly the rollover of that 
money so that employees do not have access, you know, maybe 
make it more onerous for people to just take money out for 
different possibilities, but I do think lump sums have to be 
there for small employers.
    Thank you.
    The Chairman. Thank you very much. I want to thank 
everybody for their participation. I know there are other 
comments out there. I am still inviting you to submit those 
along with any other information you think would be helpful to 
the committees. On my global question, one of the things that 
struck me during the discussion is that we in the United States 
expect to be paid the highest and have the highest benefits, 
but we want to buy cheapest. Somehow there seems to be a little 
bit of a conflict there.
    I wish we could go on with this.
    I would want to mention that Mr. Brad Belt, who is the 
Executive Director of the PBGC has spent the morning with us. 
He is over there on the side, and I very much appreciate him 
listening to your comments as well. It is not often that we get 
that kind of participation from somebody directly involved in 
the process, and quite often agencies show up, do their 
testifying and leave. But he has been here the whole time, and 
that is worth mentioning.
    As you can tell from the discussion today the private 
sector initiatives on retirement and security benefits are 
evolving. The defined benefit system is clearly a worthwhile 
retirement security plan for both workers and their companies. 
In addition, the rise of defined contribution plans are 
expected to become an even greater part of the private sector 
retirement security system. As the changing demographics, the 
greater need for portability of retirement plans and the 
globalization of our economy continues, Congress should take 
these into consideration as we draft current and future laws 
affecting the private sector retirement benefit plans. Today 
was just the first of a comprehensive look at the long-term 
future that we are going to need.
    Again, I want to thank all the participants. I know you had 
to rearrange your schedules dramatically to be here and then to 
coincide with our little earlier opening. We will leave the 
hearing record open for 10 days for questions from members as 
well as additional responses you might want to make.
    Thank you very much for being at the hearing, and I 
appreciate the great participation of people watching too.
    [Additional material follows:]

                          Additional Material

                         Principal Financial Group,
                                    Des Moines, Iowa 50392,
                                                    March 25, 2005.
Hon. Michael B. Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
U.S. Senate,
Washington, DC 20510-6300.

    Dear Mr. Chairman: Thank you for the opportunity to appear before 
you and the members of your committee and the Senate Finance Committee 
at the joint forum entitled, ``Private-Sector Retirement Plans: What 
Does the Future Hold?'' I found the exchange of ideas and opinions to 
be stimulating and hope it helps as you and the committee members work 
through the many facets of retirement issues and opportunities.
    At the forum, I was asked to provide comments on ways to simplify 
the rules for small employers. It is my opinion that employers are 
hesitant to sponsor retirement plans because they feel the 
administration and recordkeeping of the plan will be too costly, find 
compliance with pension legislation and regulations too confusing, and 
have concerns about fiduciary liability. They are also concerned with 
the fact that some employees may not be able to save as much as they 
would like because other employees choose not to participate in saving 
for their own retirement. This is especially true for smaller 
employers, i.e. those with less than 100 employees.
    The Principal Financial Group knows the small- to medium-sized 
business market as well as anyone. To help encourage more growing 
employers to sponsor a retirement plan for their employees, Principal 
provides the following plan design suggestions that would simplify the 
administration, fiduciary liability, nondiscrimination, government 
reporting, and plan document requirements of a traditional 401(k) plan 
while at the same time providing meaningful benefits for their 
employees. This design option would only be available for employers 
with less than 100 employees. We offer the following suggestions:

Administration and Nondiscrimination Testing

    Over the last 15-20 years, numerous pension laws have been enacted 
that added overlapping rules in an attempt to raise revenue and limit 
abusive plan situations. These rules merely created more administrative 
complexity and administrative/recordkeeping burdens with only 
incremental assurance rank and file employees are treated fairly. The 
limits include the IRC  402(g) salary deferral limits, IRC  415 
contribution limits, IRC  401(k)/(m) tests, IRC  401(a)(17) 
compensation limit, IRC  401(a)(4) nondiscrimination rules and IRC  
410(b) coverage tests, as well as the top heavy rules added in the 
early 1980s. In addition, there is the overall deduction limit of IRC  
404 that further restricts contributions to employer sponsored plans. 
In place of this myriad of complex and overlapping or redundant rules, 
Principal suggests a very straightforward approach to simplify 401(k) 
plan rules for smaller employers by establishing just two overall 
restrictions to meet:
     Employee salary deferrals will be limited to the current  
402(g) dollar limit, indexed to $14,000 in 2005.
     Any employer match will be capped at one third of the  
402(g) dollar limit or $4,667 in 2005.
    Under these simplified rules, employees would be automatically 
enrolled in the plan 401(k) no later than the start of the second pay 
period after their date of hire. Automatic deferral rates could be set 
by the employer at any reasonable rate between 1-6 percent of pay, with 
reasonable annual automatic increases of 1 percent per year up to 6 
percent of pay maximum. There would be no other entry or coverage 
requirements. Top heavy rules would not apply and all participants 
would be 100 percent vested, further reducing the administration 
burden.
    Contributions will be portable and can be transferred to any other 
401(a), 403(b) or 457 contribution plan.
    If desired, the employer may also decide to make profit sharing 
contributions to the plan participant. The employee would have the 
flexibility to use any of the currently acceptable forms of allocation 
methods (pay-to-pay, integrated, age-weighted and comparability). The 
ability to make these additional contributions will allow employers the 
needed flexibility to design a plan that better meets the needs of all 
their participants but if they do so, any additional contributions 
would be subject to coverage, nondiscrimination, vesting and other 
rules and to restrictions such as compensation and contribution time 
limits.

Fiduciary Rules Under ERISA

    ERISA provides very important protection for plan participants and 
under our simplified plan design approach Principal wants to ensure 
plan sponsors continue to be held to very strict fiduciary standards. 
We offer these suggestions to provide sponsors with minimum fiduciary 
standards that must be followed for plans to remain in compliance with 
ERISA. These include:
     Absent employee direction, the default of all 
contributions to a Lifestyle fund corresponding to an employee's normal 
retirement age of 65 is required.
     All ERISA  404(c) rules must be met for participant-
directed accounts.
     Annual employee statements must be provided in print or 
acceptable electronic means and must include:
      1.Contributions summary
      2. Account balance and projected normal retirement benefit
      3. Access to (print and electronic):
         Fund performance
         Fund performance benchmarks
         Fund summaries/prospectuses
         Fund manager information
         Fund management fees
         Employee education tools such as retirement 
calculators, asset allocation models, deferral calculators, investment 
quizzes and benefit projections
      4. Employee summary plan descriptions must be provided upon entry 
or every 5 years unless the plan is amended more frequently. These may 
be provided in print or acceptable electronic means.

Government Reports

    There would be a simplified government report for this type of 
plan. It would be an annual registration statement similar to the 
current form 5500R filed with the IRS/DOL and would contain the plan 
data of the 5500R as well as basic information on the plan's assets, 
types of investment funds and a summary of contributions made and 
benefits paid for the year.
    Copies of this simplified report must be made available to 
participants upon request.

Plan Documents

    The IRS will provide guidance on required wording for this 
simplified 401(k) plan. In addition, plan documents must be written 
only on a pre-approved IRS prototype.
    Again, thank you for the opportunity to appear and to offer these 
additional comments. If you have further questions, please do not 
hesitate to contact me.
            Sincerely,
                                         Daniel J. Houston,
                                                Sr. Vice President,
                                         Principal Financial Group,
                                Retirement and Investment Services.
                                 ______
                                 
                Statement of Christian E. Weller, Ph.D.
(The following is testimony on the President's Proposal for Single-
Employer Pension Funding Reform before the U.S. House of 
Representatives' Committee on Ways and Means' Subcommittee on Select 
Revenue Measures, March 08, 2005, Securing Retirement Income Security 
Through Sensible Funding Rules.)

    Thank you very much, Chairman Camp and Ranking Member McNulty, for 
inviting me here today to testify on proposed rule changes regarding 
single-employer defined benefit plans. Retirement income security 
occupies much of the public policy debate these days. While most of the 
attention is focused on attempts to privatize Social Security, the 
security of defined benefit pension plans is also in the balance. 
Pensions have received a lot of attention recently since falling 
interest rates and stock prices left DB plans with fewer funds than 
they need to cover all promised benefits. In extreme cases, pension 
plans were terminated, leaving workers with substantially fewer 
benefits than they had expected and resulting in shortfalls at the 
Pension Benefit Guaranty Corporation (PBGC).
    Public policy can address the problems plaguing defined benefit 
pension plans through sensible reforms. In considering these reforms it 
is important to keep the following goals in mind:
    1. Maintain the security of pension benefits;
    2. Promote and sustain sponsorship of defined benefit plans; and
    3. Maintain the ability of the PBGC to support DB plans.
    The administration recently proposed a set of rule changes for 
single employer DB plans. Characteristic of the crucial aspects of this 
proposal is a greater tendency to link pension fund assets and 
liabilities to the market. Such a move would fail the goals for public 
policy reform. By increasing the volatility of pension funding, 
employers would have very strong incentives to terminate their existing 
pension plans, further lowering retirement income security for workers.
    A closer look at pension funding and proposed rule changes shows 
the following:
     Current funding rules are counter-cyclical. Employers are 
required to contribute more to pension plans during bad economic times 
than during good times.
     The administration proposal would exacerbate the counter-
cyclicality of pension funding and increase the uncertainty associated 
with pension plans. Employers would likely terminate their plans 
instead of absorbing the additional costs associated with attempts to 
reduce funding volatility by investing solely in bonds.
     Alternative funding rules could provide for greater leeway 
in averaging fluctuations in pension funding over the course of a 
business cycle and improve the outlook for pensions. This process is 
called ``smoothing.''
     As a result of smoothing, the burden on the PBGC would be 
reduced through better-funded pension plans. Employers would benefit as 
pension funding would become less counter-cyclical, lowering the burden 
during bad economic times and increasing it during good economic times, 
when employers are best able to contribute to their pension plans.

Plan Sponsorship Linked to Counter-Cyclical Funding Volatility

    Changes in the way pensions are regulated will inevitably affect 
employer behavior. Employers are mainly concerned with unpredictable 
demands for outlays for their pension plans (Hewitt, 2003) This is 
typically more important than other issues, such as simplifications to 
the rules. Changes in funding contributions arise, when the funding 
status of a plan changes. For instance, a deterioration of a plan's 
funding status would increase the financial demands on employers in two 
ways. For one, they would have to make additional contributions to 
their plans, as is discussed below, and second, they may have to pay 
higher insurance premiums to the PBGC. Typically, the size of 
additional contributions can easily dwarf the size of additional 
insurance premiums. The primary focus should thus be on the 
determinants of funding contributions. If changes in funding rules lead 
to more volatility in the funding status of pension plans and thus to 
increased uncertainty about employers' future obligations to their 
plans, employers would become more likely to terminate their plans than 
is currently the case.
    In a defined benefit (DB) pension plan, the employee is guaranteed 
a fixed benefit upon retirement, usually based on years of service, age 
and either final earnings or a benefit multiplier. Accrued benefits for 
private sector DB plans are insured, up to certain limits, by the 
Pension Benefit Guaranty Corporation (PBGC), which is funded by 
insurance premiums from employers with DB pensions as well as 
investment income and assets from terminated pension plans.
    Although DB pension coverage has declined for some time, millions 
of employees and their families still depend on this benefit. The share 
of private sector workers with a DB plan has declined from 39 percent 
in 1975 to 21 percent in 2004 (PWBA, 1998; BLS, 2004). By 2002, the 
last year for which data are available, more than 34 million 
beneficiaries could still expect to receive some benefits from DB 
pensions (PBGC, 2003).
    The funding of a DB plan's liabilities (promised benefits) is 
usually the employer's responsibility. Up until 2000, many employers 
could not contribute more to their plans, as their pensions were well 
funded due to the strong stock market performance and rising interest 
rates. However, after 2000, pension funds faced large shortfalls and 
employers sponsoring them had to contribute large amounts to their 
pension plans. Many large firms with pension plans have faced 
persistent shortfalls. PBGC (2004) estimated that the combined 
shortfall of all single-employer DB plans as of September 2004 was $450 
billion. Consequently, firms had to contribute new money to their 
plans. For instance, 90 percent of DB plans offered by companies 
included in the S&P 500 index showed a loss. When contributions rose, 
corporate earnings were often adversely affected, although some firms 
passed the additional costs on to consumers in the form of higher 
prices (Kristof, 2003). In extreme cases, the demand on employers' 
resources from the weak economy and pension plan underfunding 
contributed to corporate bankruptcies and plan terminations. The PBGC 
took over plans from Bethlehem Steel, LTV Steel, National Steel, TWA, 
U.S. Airways and Polaroid, among others. All of these terminations were 
among the 10 largest since 1974, totaling $8.5 billion in claims and 
covering 263,861 participants (PBGC, 2003).
    Even though the PBGC insures benefits, it does so only within 
limits. By statute, PBGC's insurance is capped, currently at $45,600 
per year for a retiree at age 65 under the agency's single-employer 
pension insurance program. This maximum, though, is reduced for early 
retirement benefits. Other reductions are taken for survivorship and 
disability benefits and recent benefit improvements. Beneficiaries can 
also not accrue further benefits after the plan has been terminated. 
Hence, a plan termination leaves workers with less retirement security 
than expected.
    To discuss the magnitude of recent pension plan shortfalls, it is 
important to understand the mechanics of pension plan funding. A plan's 
funding status depends on how assets compare to current liabilities. 
Current liabilities are the sum of payments to current retirees and of 
benefits that workers have already earned. In earnings-based plans, 
future benefits are forecast given reasonable assumptions about life 
expectancy, inflation and other relevant demographic and economic 
variables. Based on these forecasts, pension plans determine how much 
in assets they need to fund benefits payable in the future. Thus, they 
assume how much interest they expect to earn on their assets. The 
higher this interest rate is, the fewer assets are needed today. It is 
in a plan sponsor's interest to assume a high interest rate since this 
would lower the amount of assets required to be set aside to pay 
benefits. To avoid abuse, regulators set a range of interest rates that 
pension plans can choose from in calculating current liability. Pension 
plans must choose an interest rate that is between 90 percent and 105 
percent of the 4-year weighted average of the 30-year Treasury bond 
yield. \1\
---------------------------------------------------------------------------
    \1\ The Pension Funding Equity Act of 2004 required that plan 
sponsors use a discount rate between 90 percent and 100 percent of a 4-
year weighted average of a blend of investment-grade corporate bond 
yields for plan years beginning after December 31, 2003, and before 
January 1, 2006.
---------------------------------------------------------------------------
    A pension plan's funding status is then determined by looking at 
the ratio of the plan's assets to its liabilities. Plans can choose a 
number of options to value their assets, although many large plans use 
fair market valuation. Assets are evaluated at prices for which the 
assets could be sold on the valuation date.
    By the nature of funding rules, pension plan funding is tied to 
changes in interest rates and stock prices. The main problem is that 
both of these tend to decline around the time of a recession, when 
corporate earnings are also declining.\2\ From 1927 to 2001, there were 
a total of 12 recessions. Only in one recession, from 1973 to 1975, did 
interest rates not decline. The stock market is a forward looking 
indicator. Typically, the stock market peaks about a year before a 
recession starts and continues to decline in a recession. On average, 
stock prices are about 7 percent lower in the year after a business 
cycle peaks than before. That is, pension plans are losing with their 
assets before and during a recession, which brings additional pressures 
due to lower corporate earnings and lower interest rates that translate 
into a higher valuation of a plan's liabilities.
---------------------------------------------------------------------------
    \2\ Interest rates refer to the long-term treasury bond rate and 
total rates of return refer to the year-on-year change in the stock 
market plus the dividend yield. Stock market data are for the S&P500.
---------------------------------------------------------------------------
    The recent recession posed a particular challenge since stock 
prices fell sharply and interest rates stayed lower, and lower longer, 
than in prior recessions (Weller and Baker, 2005). From the start of 
the recession in March 2001 to the end of 2002, the stock market fell 
by 25 percent. From its peak in August of 2000 to its low point in 
February 2003, the stock market lost 44 percent of its value. At the 
same time that the stock market sustained severe losses, interest rates 
declined more and stayed low for a longer period than on average in 
previous recessions (figure 1). In this recession, the treasury rate 
declined by 0.22 percentage points, slightly above the average of 0.19 
percentage points for prior recessions. However, in the first year of a 
recovery, interest rates generally rise by 0.10 percentage points, 
whereas they fell by another 0.34 percentage points in this recovery. 
Thus, in this recovery employers did not see the usual help in funding 
their pensions that would come from rising interest rates.



    The problem of falling asset prices and declining interest rates in 
the recent recession was further exacerbated by the fact that companies 
had not built up more reserves during the prior expansion. This can be 
traced back to two aspects of the current regulatory system. First, if 
a pension plan reaches a certain funding threshold, the employer either 
no longer has to contribute or has to contribute only minimal amounts. 
Second, there are regulatory disincentives to contribute more to a 
pension plan when it is already fully funded. If pension plans are 
fully funded, employers face excise taxes on their contributions to the 
tune of 50 percent. On top of that, they can no longer deduct their 
pension contributions from their tax liabilities. The contribution 
limit beyond which further contributions are discouraged by the tax 
code is 100 percent of current liabilities. Thus, largely due to 
beneficial financial market trends--rising interest rates and higher 
stock prices--the average funding ratio of PBGC insured pension plans 
jumped from 116 percent in 1999 to 145 percent in 2000 (PBGC, 2003). 
However, for many plans, this reserve was insufficient to weather the 
crisis that followed as the stock market bubble burst and the liability 
discount rate sunk to and remained at historically low levels. In 2002, 
74,138 new beneficiaries started receiving payments from PBGC, compared 
to 40,473 new beneficiaries in 2001 and only 11,091 in 2000 (PBGC, 
2003).

Administration Proposal Will Exacerbate Funding Problems

    The administration recently released its own proposal to reform 
funding rules, among other changes to the pension system (DOL, 2005). 
Funding burdens are already counter-cyclical, requiring employers who 
sponsor DB plans to contribute more during bad times than during good 
times. The administration's proposal could exacerbate this volatility 
in addition to the overall costs of some plans. First, the current 
rules require the use of a 4-year weighted average of the 30-year 
Treasury bond rate to determine current liabilities. The administration 
is proposing to eliminate the 4-year weighted average and to replace 
the single treasury rate with a range of bond rates, the so-called 
yield curve. This would mean that liabilities--future benefits--that 
come due at different future dates are discounted by different interest 
rates. For example, a benefit that is due in 10 years will be 
discounted by the interest rate on corporate bonds with 10-year 
maturity; a benefit that is due in 5 years will be discounted by the 5-
year rate, a benefit in 15 years by the 15-year rate and so on. The 
applicable rates would be averaged over 90 days, instead of 4 years. 
Second, the administration proposes that all assets be valued at fair 
market value, thus eliminating the current option to average stock 
price fluctuations over short periods of time. If these changes are 
enacted, plan sponsors worried about the predictability of their future 
contributions would have strong incentives to abandon their plans.
    The administration's proposal would raise the costs of mature plans 
immediately. Employers who have a disproportionate number of older 
workers, e.g. in well established industries, will face rising costs 
from the administration's yield curve proposal. This is because older 
workers are likely to retire sooner than younger workers and their 
benefits will have to be paid out sooner than those for younger 
workers. The discount rate is tied to corporate bonds with shorter 
maturities. Those interest rates are lower than those for corporate 
bonds with longer maturities. A lower discount rate translates into a 
higher liability and higher cost for the employer. According to 
estimates by the Employment Policy Foundation (2005), the liabilities 
for workers 55 and older could increase by 3.5 percent and the 
liabilities for workers between 50 and 54 could rise by 2.0 percent. 
This would particularly hurt the struggling manufacturing sector. That 
is, the administration's proposal would fall short of the first goal to 
secure existing benefits.
    In addition to raising the costs for some plans, the 
administration's proposal on changes to the interest rate would 
exacerbate cyclical fluctuations, just like the use of fair market 
value for assets does, as already discussed.\3\ Employers would become 
more likely to see larger contributions during bad economic times, 
mainly because the smoothing of interest rates over even the minimal 
period of time of 4 years is eliminated. From the 1930s to the present, 
the spot interest rate for long-term Treasury bonds would have declined 
by an average of 0.18 percentage points during recessions. In 
comparison, though, the 4-year weighted average of the long-term 
Treasury bond rate would have risen by 0.47 percentage points. The fact 
that the discount rate is on average 0.65 percentage points higher with 
smoothing than without means that employers face fewer demands on their 
cash flow when they can least afford them. However, it also means that 
they face higher funding obligations during good years, when they can 
actually afford them.
---------------------------------------------------------------------------
    \3\ Employers could theoretically insulate themselves from these 
fluctuations by matching assets to liabilities. However, such a ``bonds 
only'' strategy would substantially raise the costs for employers to 
provide this benefit and thus give another strong disincentive to 
abandon their plans.


    The use of a yield curve, using a variety of interest rates with 
different maturities for separate liabilities, would also exacerbate 
the funding burden during economic downturns, especially for pension 
plans with a more mature workforce. Specifically, the spread between 
short-term and long-term interest rates tends to rise during 
recessions, largely because short-term interest rates tend to fall 
faster than long-term interest rates. Short-term Treasury interest 
rates, in this case for 3-month bills and bonds, have typically 
declined by 1.6 percent during recessions (figure 3). This is an 
increase that is almost eight times as large as the average decline of 
long-term Treasury bond rates during recessions. During a recession, 
employers with an older labor force will see their costs rise much more 
rapidly than employers with a younger workforce.
    The use of a yield curve would increase the volatility of pension 
contributions for employers, thus providing an incentive to terminate 
DB plans. That is, the administration's proposal falls short of the 
second goal to maintain and strengthen future benefit security.


Immunization Not a Viable Alternative

    Fluctuations in liabilities and assets can lead to changes in the 
funding status of pension plans. When interest rates and asset prices 
fall, plans can become underfunded. The administration's proposal would 
increase the volatility of the future funding status of a DB plan. 
Employers could theoretically respond to this surge in volatility by 
matching assets and liabilities by investing in bonds that reflect the 
maturity of a pension plan's liabilities. This process is also referred 
to as immunization.
    To understand how immunization works, consider the way a pension 
plan's liabilities would be calculated under the administration's 
proposal. Future benefit payments would be discounted by the interest 
rates that would apply for treasury bonds with the same maturity as the 
benefit obligation. To finance new obligations, pension plans have to 
purchase additional assets. To avoid fluctuations in funding status 
under the administration's proposal, pension plans could purchase a 
corporate bond with the same maturity and thus the same interest rate 
as the maturity of the benefit obligations (Bodie, 2005). As a result, 
assets would theoretically be matched to the liabilities and the two 
could not move apart over time. Underfunding would thus be reduced.\4\
---------------------------------------------------------------------------
    \4\ Perfect matching would likely not be possible since the 
administration's proposal allows for discount rates to be smoothed over 
90 days.
---------------------------------------------------------------------------
    Although the logic of immunization is appealing, it has one major 
drawback, aside from the potential complexity of implementation, that 
would ultimately hurt pension beneficiaries substantially. Immunization 
would significantly raise the costs of pension plans for plan sponsors. 
Typically plans diversify their assets between different types of 
securities, largely bonds and stocks. By doing so, plans can expect to 
earn a higher rate of return over the long-run than they could by 
merely investing in bonds, while reducing the risks. Through 
immunization, plans would eliminate the added earnings from investing 
in stocks. This loss can be severe. Over 20-year or even 35-year 
periods, the chance of a typical mixed portfolio of a pension plan--60 
percent stocks and 40 percent bonds--is unlikely to perform worse than 
bonds. The chance that a mixed portfolio will on average see a rate of 
return that is at least 1 percentage point higher than a pure corporate 
bond allocation is more than 80 percent (figure 4). The chance of 
seeing a rate of return that is at least 3 percentage points greater is 
50 percent over 20-year periods and 17 percent over 35-year periods. 
These are the potential earnings that pension plans would give up 
through immunization. This loss of earnings would require an offset 
from higher employer contributions to their pension plans.\5\ As costs 
of pension plans would rise, employers would have again a strong 
incentive to abandon their plans.
---------------------------------------------------------------------------
    \5\ Mixed portfolios will not always do better than pure bond 
portfolios. There is a chance that stock market fluctuations are large 
and it takes long periods of time for stocks to recover those losses 
(Weller, 2005).


Notes: Data are based on S&P 500 and corporate bonds (AAA) from 1919 to 
---------------------------------------------------------------------------
2004. Sources are TradeTools.com, Shiller (2000), and BOG (2005).

    However, if pension plans do not immunize, they can face market 
fluctuations from investing in stocks. Uncharacteristically large 
fluctuations in the stock market substantially contributed to the 
decline in pension funding after 2000. This leads to two questions. 
First, who should bear this risk, and second, is there another way to 
handle the risk exposure of pension plans, which does not increase the 
volatility of pension plan funding for employers and thus does not 
raise the specter of plan terminations? The answer to the first 
question is that pension plans are better equipped than individuals to 
handle market risks. The answer to the second question is detailed in 
the next section.
    Pension plans are better equipped than individuals to handle the 
risks associated with investing for retirement. However, if funding 
rule changes provide employers with strong incentives to terminate 
their DB plans, individuals would have to increase their efforts to 
save for retirement through private accounts, such as 401(k)s or IRAs, 
to maintain the same level of retirement income. Even if individuals 
invest prudently, they still face large market fluctuations. Some 
workers would thus retire with substantially less retirement income 
than they were counting on, while others would do better than expected, 
depending on how well the market did during their lifetime (Weller, 
2005). The problem is that individuals can often not wait for the 
market to improve again since many of the reasons for retirement, such 
as deteriorating health, will likely get worse with age. In contrast, 
pension plans are going concerns that can expect additional income as 
they pay out benefits for the foreseeable future. Because pension plans 
generally do not have to liquidate their assets on a given date, they 
can, at least to some degree, wait for markets to improve. After all, 
this is the logic behind using an average interest rate to calculate 
pension plan liabilities. Thus, pension plans are much better equipped 
than individuals to withstand the risks associated with investing in 
stocks.
    As a result of the administration's proposal, pension plans would 
be faced with an unappealing choice. They would either face increased 
volatility in their pension contributions or the costs of funding their 
pension plans would rise substantially. In either case, employers would 
have strong incentives to reduce their commitments to their employees 
through their DB pension plans and shift the risks of saving for 
retirement onto their employees. While pension plans are better 
equipped than individuals to handle long-term fluctuations in the stock 
market, the question still remains whether there are alternative 
funding rules that could help to reduce the volatility of pension 
contributions for employers and lower the incentives to terminate 
pension plans, without jeopardizing the security of pension benefits 
now and in the future. The answer is yes and the details are provided 
in the next section.

More Smoothing Improves Benefit Security

    The problem as described above is that, under current funding 
rules, employers are more likely to have to make contributions to their 
pension plans when times are bad. When times are bad, more employers 
are unable to make payments to their pension plans. Therefore, pension 
terminations spike and the burden on the PBGC grows. The rules proposed 
by the administration would exacerbate this problem, while also raising 
the costs for employers with an older workforce. However, it is 
possible to change the funding rules, so that benefits are protected, 
employers have more certainty associated with the funding of their 
pension plans, and the PBGC will end up with fewer terminations.
    The basic premise underlying these funding rules is that they 
should be more pro-cyclical, allowing employers to contribute more 
during good times and contribute less during bad times, when they can 
least afford it.
    Such an approach is also more consistent with the nature of a 
pension plan than the administration's approach. The proposals laid out 
here give a clearer summary view of how well a pension plan is prepared 
for mastering the challenges of the medium-term future, when it is 
expected to pay benefits. By comparison, the administration's proposal 
to move towards a process of ``marking to market'' provides only a 
snapshot of the pension plan at the time of valuation. This is a 
consistent and accurate view only if it is assumed that the pension 
plan will terminate shortly after valuation. Under all other 
circumstances, the assumptions are too volatile to provide an accurate 
glimpse of the plan's future.
    Three funding rule changes seem especially relevant. First, one way 
to reduce the cyclicality of pension funding is to use a long-term 
average of the benchmark interest rate, e.g., a 20-year average. This 
would substantially reduce the volatility of calculating pension fund 
liabilities and it would de-couple funding requirements from the 
fluctuations of the business cycle, since the period over which the 
interest rate is averaged is longer than any business cycle. A 20-year 
period is also a much closer match to the average duration of pension 
plan liabilities. Moreover, because interest rates have recently been 
so low, the longer-term average would be higher than even the 4-year 
weighted average. Thus, switching to a longer-term average could give 
plan sponsors some funding relief in the immediate future, while also 
improving funding certainty over the long term.\6\
---------------------------------------------------------------------------
    \6\ One of the reasons for changing pension funding rules is that 
the 30-year treasury bond rate is no longer an appropriate bench mark 
because the treasury has stopped issuing these bonds. It appears 
reasonable to use the 10-year Treasury bond rate instead. The benchmark 
rate is supposed to be risk free and reflect the long-term nature of 
pension liabilities. Both the 10-year and the 30-year treasury bond 
reflect the most secure assets. The 10-year treasury bond yield 
reflects the long-term nature of pension liabilities. The Federal 
Government will have outstanding debt that is likely to grow. Its 
financing instrument with the longest maturity is the 10-year Treasury 
bond. Thus, its yield reflects the long-term nature of the Federal 
debt. Further, data on the 10-year Treasury bond rates are available 
since 1953--longer than for the 30-year treasury, which was introduced 
in 1977.


    Second, to mirror the rule change for liabilities, one can also use 
a 20-year smoothing for stock prices (Weller and Baker, 2005).\7\ This 
process essentially assumes that stocks will adjust towards a long-run 
average over a long enough period of time. If stock prices are above 
long-term averages with respect to corporate earnings, they are 
discounted with the assumption that the adjustment process will take 20 
years. The same holds when stocks are too low.
---------------------------------------------------------------------------
    \7\ At the same time that more smoothing is allowed, the current 
practice of credit balances is eliminated.
---------------------------------------------------------------------------
    Lastly, one of the problems associated with the recent funding 
crisis was that pension plans had not built up enough reserves to 
weather the storm that ensued after 2000. The administration has 
recognized this problem and has proposed that employers would be 
permitted to contribute to their plans even after they meet the full 
funding target. However, many employers already could have contributed 
more to their pension plans if they had wanted to during the 1990s 
(Ghilarducci and Sun, 2005). Hence, the lack of a cushion was to some 
degree the unwillingness of employers to increase the funding status of 
their plans, even when times were good. Therefore, a proposal to 
require companies to fund up to 120 percent of liabilities over a 
period of 30 years seems reasonable.\8\
---------------------------------------------------------------------------
    \8\ The baseline assumes normal cost contributions up to 100 
percent.
---------------------------------------------------------------------------
    The effects of these rule changes on a hypothetical plan can be 
simulated.\9\ To evaluate their effect, though, two questions should be 
asked. First, does the contribution pattern become less cyclical? 
Second, does the funding status of a plan weaken because of the rule 
changes? The changes in the funding status are evaluated using the 
ratio of assets at fair market value to current liabilities at the 4-
year weighted average of the long-term Treasury rate. In addition, the 
probability of falling below a funding status of 75 percent is 
calculated.
---------------------------------------------------------------------------
    \9\ The technical details of the simulation from Weller and Baker 
(2005) can be found in the appendix.
---------------------------------------------------------------------------
    The alternative rules would have maintained or reduced the burden 
on plan sponsors compared to the baseline (table 1). That is, on 
average, employers would have had to contribute less, especially during 
bad economic times. Using a smoother discount rate would have resulted 
in contribution holidays from 1998 to 2002 (model (2)); the alternative 
asset valuation method would have resulted in a contribution holiday 
after 1999 until 2002 (model (3)); and the requirement of contributions 
up to 120 percent of current liabilities would have meant no 
contribution holiday during this 5-year period, but contributions would 
have been equal or less compared to the baseline model (model (4)). 
When all three changes are in place, the fund would have enjoyed 
contribution holidays for all 5 years (model (5)), reflecting the 
build-up of sufficient reserves during the preceding good years.\10\
---------------------------------------------------------------------------
    \10\ The easing of the funding burden during the 5 years from 1998 
to 2002 was a result of substantial build-ups in reserves and thus did 
not reduce the funding adequacy and the security of benefits. The 
current liability (CL) funding ratio would have been higher in each 
case than under the baseline (table 1).
---------------------------------------------------------------------------
    To see this, the long-term performance of the alternative funding 
rules is tested, using the past 50 years as an example (table 2). From 
1952 to 2002, average contributions would have been approximately the 
same under all scenarios, or sometimes a little bit less than under the 
baseline.
    However, plans would have built up more reserves due to the funding 
rule changes. In each case, the CL funding ratio would have been higher 
than under the baseline scenario. That is, evaluated at current rules, 
the security of pensions would have improved. Also, in almost all 
cases, the chance of the funding ratio falling below 75 percent is 
reduced compared to the baseline (table 2). This again highlights the 
improved security of pension benefits under the new set of benefits.
    To test whether the proposed rules would make pension funding less 
counter-cyclical, contributions during recessions and non-recessions 
are considered. From 1952 to 2002, only the alternative asset 
assumptions would have lowered the contributions during the recessions 
compared to the baseline model. But for the period from 1980 to 2002, 
all models would have lowered contributions during recessions. Thus, 
during the past 2 decades, employers would have enjoyed more 
predictability in the funding of their pension plans.

                                       Table 1: Funding Status of Model Pension Plan with Different Funding Rules

                                         Baseline model             Model (2)              Model (3)              Model (4)              Model (5)

Discount rate for liabilities......  4-year weighted         20-year average of      4-year weighted        4-year weighted        20-year average of
                                      average of long-term    long-term Treasury      average of long-term   average of long-term   long-term Treasury
                                      Treasury bond yield.    bond yield.             Treasury bond yield.   Treasury bond yield.   bond yield.
Asset assumptions..................  Fair market value.....  Fair market value.....  Adjustments for level  Fair market value....  Adjustments for level
                                                                                      and ROR on stocks,                            and ROR on stocks,
                                                                                      and long-term                                 and long-term
                                                                                      average interest                              average interest
                                                                                      rate for bonds.                               rate for bonds.
Contribution limit.................  100 percent...........  100 percent...........  100 percent..........  120 percent..........  120 percent





                                                           Contribution               Contribution               Contribution               Contribution               Contribution
                                                            as share of   CL funding   as share of   CL funding   as share of   CL funding   as share of   CL funding   as share of   CL funding
                                                              salary        ratio        salary        ratio        salary        ratio        salary        ratio        salary        ratio

1998.....................................................           0.0        100.7           0.0        119.7           8.3        137.1           3.3         97.7           0.0        243.1
1999.....................................................           4.8         98.2           0.0        117.6           6.7        142.2           3.1         97.8           0.0        253.5
2000.....................................................           0.0        101.9           0.0        118.7           0.0        149.7           2.2        100.1           0.0        255.2
2001.....................................................           3.6         87.6           0.0        102.7           0.0        131.0           3.6         87.5           0.0        220.6
2002.....................................................           6.0         76.4           0.0         87.6           0.0        113.2           6.0         76.3           0.0        188.3

Notes: All figures are in percent. Source is Weller and Baker (2005).


                                           Table 2: Summary Measures for Different Funding Rules, 1952 to 2002

                                         Baseline model             Model (2)              Model (3)              Model (4)              Model (5)

Discount rate for liabilities......  4-year weighted         20-year average of      4-year weighted        4-year weighted        20-year average of
                                      average of long-term    long-term treasury      average of long-term   average of long-term   long-term treasury
                                      treasury bond yield.    bond yield.             treasury bond yield.   treasury bond yield.   bond yield

Asset assumptions..................  Fair market value.....  Fair market value.....  Adjustments for level  Fair market value....  Adjustments for level
                                                                                      and ROR on stocks,                            and ROR on stocks,
                                                                                      and long-term                                 and long-term
                                                                                      average interest                              average interest
                                                                                      rate for bonds.                               rate for bonds

Contribution limit.................  100 percent...........  100 percent...........  100 percent..........  120 percent..........  120 percent





                                                             Prob.                         Prob.                                                           Prob.                          Prob.
                                         Avg.       Avg.    of less    Avg.       Avg.    of less    Avg.       Avg.     Prob. of      Avg.       Avg.    of less     Avg.       Avg.    of less
                                       cont. to    fund.      than   cont. to    fund.      than   cont. to    fund.     less than   cont. to    fund.      than    cont. to    fund.      than
                                        salary     Ratio      75%     salary     ratio      75%     salary     ratio        75%       salary     ratio      75%      salary     ratio      75%

1952-2002............................     2.6       98.6        4.1     2.0      116.6        3.4     2.7      101.1        0.7         2.4      109.1        3.0      2.5      137.2        7.7
                                         (2.7)     (13.6)              (2.7)     (28.1)               3.0      (13.9)                  (1.5)     (18.1)               (3.4)     (38.7)
1980-2002............................     3.0      100.3        9.5     0.0      144.4        106     2.8      102.6        0.1         1.7      115.4        4.6      0.0      176.2        0.0
                                         (3.5)     (19.3)               0.0      (16.9)              (3.4)     (18.7)      (1.6)      (23.9)                  0.0    (14.5)

Notes: All figures are in percent. Figures in parentheses are standard deviations.



                                                                   Table 3: Contributions during Recessions and Non-Recessions
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     Baseline model               Model (2)                 Model (3)                 Model (4)                 Model (5)
                                                               ---------------------------------------------------------------------------------------------------------------------------------
                                                                                 Non-                      Non-                      Non-                      Non-                      Non-
                                                                 Recession    recession    Recession    recession    Recession    recession    Recession    recession    Recession    Recession
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1952-2002.....................................................          2.2          2.8          2.5          1.8          1.7          3.2          2.6          2.2          3.4          1.8
1980-2002.....................................................          2.0          3.4          0.0          0.0          0.7          3.8          1.8          1.6          0.0          0.0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: All figures are in percent.

    There are clear benefits from implementing more smoothing in 
pension funding rules. Employers would gain predictability in the 
funding of their pension plans, while the funding status of pension 
plans would generally improve. Thus, employees would enjoy greater 
security of their benefits and the PBGC would ultimately see a 
reduction in the probability of plan terminations.
    This proposal would also introduce funding rules that are more 
consistent with the going concern nature of pension plans. Using long-
term averages assumes that pension funds will buy and sell securities, 
and that these transactions will occur at different interest rates. The 
time frames over which the smoothing occurs are generally consistent 
with the typical duration of pension liabilities. The proposals laid 
out here give a clearer summary view of how well a pension plan is 
prepared for mastering the challenges of the medium-term future, when 
it is expected to pay benefits.
    Numerous proposals, including the administration's, have recognized 
the benefits and the consistency of smoothing in funding rules for the 
future well-being of pension plans. However, such proposals allow for 
more smoothing on the plan contribution side, rather than on the asset 
and liability valuation side (DOL, 2005; Towers Perrin, 2005). This 
still leaves the problem that ``marking to market'' does not provide an 
accurate view of how well the plan is prepared for the future. 
Furthermore, even those who propose more smoothing of contributions 
don't necessarily believe that it will actually work. When introducing 
the administration's plan, Secretary of Labor Elaine Chao was quoted as 
saying in the New York Times on January 30, 2005, that workers will 
``pressure their employer to more adequately fund the underfunded 
pension plans.'' Secretary Chao's comments indicate that the 
administration is counting on the large volatility of pension funding 
that would result from its new funding rules to scare workers into 
demanding more pension contributions from their employers. That is, 
regardless of the funding rules, employers may be forced to increase 
pension contributions to stave off employee dissatisfaction. However, 
this may only be a short-term phenomenon. Because the funding status of 
a pension plan would become more volatile, the contribution demands 
from employees at one point in time may become quickly obsolete as 
asset prices and interest rates change. The result would be frustration 
on the part of employees and large short-term pressures on employers, 
with the likely result that more and more employers would abandon their 
pension plans. Instead, the proposal laid out here would provide 
employees with a more accurate picture of the long-term health of their 
pension plans and stabilize the contribution stream of employers to 
their pension plans.

Conclusion

    After 2000, defined benefit pension plans experienced severe 
underfunding. While the magnitude of the problem was unprecedented, the 
combination of the underlying factors was not. Employers should expect 
a regular recurrence of declining interest rates and asset prices 
during a recession. Current funding rules reflect this regularity and 
the administration's proposal to change these funding rules will not 
make the problem better, but exacerbate the counter-cyclical volatility 
of pension funding. Thus, the administration's proposal falls short of 
the standards laid out in the introduction. It would reduce the chance 
that future benefits will be maintained and it could jeopardize the 
pension security in well established pension plans through higher 
costs.
    Instead of increasing the volatility of pension funding, which 
would drive more employers to terminate their pension plans, there are 
rule changes that would allow for more smoothing of pension liabilities 
and assets and thus stabilize pension funding. Empirical results show 
that this would result in more stable employer contributions to pension 
plans and to higher average funding ratios. Employers would benefit 
from greater certainty about the future of their pension plans, while 
employees and the PBGC would benefit from greater security of pension 
benefits. Thus, these alternatives would meet all three goals of 
sensible funding rule changes. They would secure existing benefits, 
help to maintain benefit security in the future, without unduly 
burdening the PBGC.
    Thank you very much for this opportunity to present my views on 
pension funding rules. I am looking forward to your questions.

References

Board of Governors of the Federal Reserve System (2005). Release H.1 
    Select Interest Rates (Washington, DC: Board of Governors).
Board of Governors of the Federal Reserve System (2003). Release Z.1 
    Flow of Funds Accounts for the United States, March (Washington, 
    DC: Board of Governors).
Bodie, Z. (2005), Less is Less, The Milken Institute Review, First 
    Quarter:38-45.
Bureau of Labor Statistics (2004). Employee Benefits Survey, Percent Of 
    All Workers Participating In Defined Benefit Pension (Washington, 
    DC: BLS).
Employment Policy Foundation (2005). Pension Funding Reform: An 
    Analysis of the Bush Administration's Proposal, EPF Policy 
    Backgrounder (Washington, DC: EPF).
Engen, E.M., Gale, W.G., and Uccello, C.E. (1999). The Adequacy of 
    Household Saving, Brookings Papers on Economic Activity 2, 65-165.
Ghilarducci, T., and Sun, Wei (2005, January). Did ERISA Fail Us 
    Because Firms' Pension Funding Practices are Perverse? Paper 
    presented at the 57th Annual Meetings of the Industrial Relations 
    Research Association (Philadelphia, PA).
Hewitt Associates LLC (2003). Survey Findings: Current Retirement Plan 
    Challenges: Employer Perspectives 2003 (Lincolnshire, IL: Hewitt 
    Associates LLC).
Kristof, K. (2003, April 25). Study Details Pension Plan Shortfalls--
    Nearly 90 percent of S&P 500 Companies with Defined Benefit 
    Programs Were Underfunded Last Year. Los Angeles Times, Business 
    Section, Part 3:4.
Pension and Welfare Benefits Administration (1998). Abstract of 1994 
    Form 5500 Annual Reports. Private Pension Plan Bulletin No. 7 
    (Washington, DC: PWBA).
Pension Benefit Guaranty Corporation (2004). Annual Performance and 
    Accountability Report (Washington, DC: PBGC).
Pension Benefit Guaranty Corporation (2003). Pension Insurance Data 
    Book 2003 (Washington, DC: PBGC).
Shiller, R., 2001, Irrational Exuberance, Princeton, NJ: Princeton 
    University Press.
Tradetools.com, 2005, Weekly Long-Term Financial Market Database 
    (1927), tradetools.com.
Towers Perrin (2005). A Towers Perrin Proposal for Pension Funding 
    Reform. White Paper. Retrieved from www.towersperrin.com.
U.S. Department of Labor (2005). Strengthening Funding for Single-
    Employer Pension Plans (Washington, DC: DOL).
Weller, C., 2005, Social Security Privatization: The Retirement Savings 
    Gamble, CAP Report, February, Washington, D.C.: Center for American 
    Progress.
Weller, C., and Baker, D. (2005). Smoothing the Waves of Pension 
    Funding: Could Changes in Funding Rules Help Avoid Cyclical 
    Underfunding? forthcoming in Journal of Policy Reform.

Appendix: Technical Details of Pension Model

    The basic simulation model referenced here is developed in Weller 
and Baker (2005).
Asset Valuation Method
    First, the difference between market price and trend price is 
calculated for the current period:


    Next, it is assumed that the difference between market price and 
trend price disappears over a period of 20 years, which generates an 
adjustment factor, AF, to the market price of stocks of:


    Since the expected rate of return to stocks is the sum of the rate 
of capital appreciation and the dividend yield--dividends relative to 
market price--the adjustment made to the price also affects the 
expected dividend yield, such that the adjusted dividend yield is equal 
to the ratio of dividends, D, to the adjusted market price, P*.
    We also assume that the difference between the actuarial value and 
fair market value disappears after 20 years, and that assets other than 
stocks earn the same long-term interest rate as for liabilities plus 50 
basis points.
Basic Pension Plan Design
    The number of workers is assumed to have been 10,000 in 1952, 
equally distributed from age 20 to 65, with 80 percent of workers blue 
collar and 20 percent white collar, labor force growth equal to 1 
percent annually, and annual wage growth equal to 3 percent. Assumed 
attrition is 5 percent, equally distributed, and the number of vested 
workers is proportional to that of job leavers. We use the age earnings 
profile for blue- and white-collar workers from Engen et al. (1999).
    Retirement benefits are based on average final pay, with retirement 
benefits equaling 1 percent of the average of the last 5 years of 
earnings for each year of service, with 5 years of vesting, and no 
ancillary benefits. Current liabilities are then calculated using the 
unit credit method. Assets are held in stocks and bonds. From 1952 to 
2002, the pension plan's asset allocation into equities is equal to the 
share of directly held corporate equities out of assets for all pension 
plans (BoG, 2003). The rate of return earned on stocks is set equal to 
the increase in the S&P 500 plus the dividend yield, and the rate of 
return on bonds is equal to the treasury rate plus 50 basis points.
                                 ______
                                 
                                   FMR Corporation,
                                          Boston, MA 02109,
                                                    March 24, 2005.
Hon. Michael B. Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
Washington, DC 20510-6350.
Hon. Edward M. Kennedy,
Ranking Member,
Committee on Health, Education, Labor, and Pensions,
Washington, DC 20510-6350.
Hon. Charles Grassley,
Chairman,
Committee on Finance,
Washington, DC 20510-6350.
Hon. Max Baucus,
Ranking Member,
Committee on Finance,
Washington, DC 20510-6350.

Re: Joint Hearing on Private-Sector Retirement Savings Plans

    Dear Chairman Enzi, Chairman Grassley, Senator Kennedy and Senator 
Baucus: Thank you for the opportunity to participate in the recent 
joint forum, ``Private-Sector Retirement Savings Plans: What Does the 
Future Hold?,'' held by the Senate Committees on Finance and Health, 
Education, Labor and Pensions (HELP). I found the hearing to be quite 
productive and look forward to working with you and your staffs 
regarding the important issues surrounding the need for Americans to 
better prepare for their retirement.
    Three issues raised at the hearing merit additional attention, and 
I would like to offer the enclosed written materials for your review. 
These issues are as follows:
    Savings for Retiree Medical Expenses. As I stated at the hearing, 
Fidelity estimated in 2003 that a couple retiring in 2004 at age 65 
would need to have accumulated at least $175,000 in savings at that 
time to fund out-of-pocket medical expenses in retirement, 
notwithstanding Medicare coverage (including the prescription drug 
benefit) available to retirees at that age. We believe very few 
retirees, even those who have participated in an employer-sponsored 
defined benefit or defined contribution plan, will be adequately 
prepared to pay for these enormous retiree medical costs. We therefore 
believe much more needs to be done to educate workers about these 
expected costs and to offer them appropriate vehicles in which to save 
for these costs while they are still working.
    To provide further information on this issue for the committees, I 
have attached a white paper prepared by Fidelity on the subject titled 
``Retiree Health Care Accounts: The Next Step Toward a Workable 
Solution.''
     Lifecycle Funds. As I stated in the hearing, the current 
Department of Labor regulations under ERISA  404(c) provide no 
fiduciary liability protection for employers with regard to the 
investment option to which accounts are defaulted when participants 
make no affirmative investment election. As a consequence, most 
employers designate a money market fund as the default fund instead of 
a more appropriate lifecycle or similar fund. This problem is 
exacerbated in the case of plans that provide automatic enrollment 
since those plans, by definition, result in a higher number of 
participants being allocated to the default fund. We believe a simple 
solution to this problem would be an amendment to  404(c) that 
provides a shield from fiduciary liability when a properly-designed 
lifecycle or similar fund is designated as the default investment 
option.
    To provide further information on this issue to the committees, I 
have attached two white papers prepared by Fidelity on this topic, 
entitled, ``The Case for Age-Based Lifecycle Investing'' and ``Putting 
Lifecycle Investing Theory into Practice.''
     Longevity Risk and Lifetime Income Planning. Many of the 
participants in the hearing highlighted the importance of the risk in 
retirement income planning and the beneficial consequences of 
annuitization. Fidelity likewise recognizes the importance of longevity 
risk, but we also recognize the importance of other risks in retirement 
income planning with regard to which annuitization may have a less than 
beneficial effect, including inflation risk and issuer risk. To 
encourage retirement planning, Fidelity has developed tools that allow 
retirees to better determine the appropriate level to annuitize their 
retirement income, taking into account all of the relevant risks. We 
therefore urge Congress to proceed cautiously with regard to the issue 
of providing incentives to retirees to annuitize their retirement 
income stream to assure that all of the relevant risks are balanced.
    To provide further information on this issue to the committees, I 
have attached a white paper prepared by Fidelity on this topic entitled 
``Lifetime Income Planning.''
    I would be happy to discuss any of these issues at greater length 
with you or your staffs. Again, thank you for offering me the 
opportunity to participate in the joint hearing.
            Sincerely yours,
                                            John M. Kimpel,
                                          Senior Vice President and
                                            Deputy General Counsel.
                                 ______
                                 
                  Prepared Statement of Senator Thomas
    As public attention has recently been drawn to the subject of 
retirement security and the discussion that has ensued over the 
government's role of providing Social Security benefits, I'm very glad 
that we're taking the time here to address at least some of the role of 
the private sector. While I still believe that ultimately 
responsibility for an individual's retirement lies largely with the 
individual--as illustrated by my introduction of the SAVE initiative 
last week--to the extent that private employers choose to provide 
pension benefits for their workers, those benefits should be reliable. 
In other words, it's extremely important that we have an effective, 
well-regulated--but not overregulated--system. I very much appreciate 
the time each of you has taken to be here today to discuss this 
important issue.
                                 ______
                                 
                       Question of Senator Thomas
    Question. As we look at what makes a good pension system, I think 
we have to remember that private pensions are entirely voluntary and 
that employers can either offer them or not. Hopefully, most will want 
to offer them to attract and retain the best employees. That said, we 
must be careful going forward that we do not hamstring employers that 
try to offer these plans. It is incredibly important that we strike the 
right balance between protecting the employee and keeping employer 
compliance simple and straightforward. What are your suggestions for 
striking and maintaining this delicate balance?
                                 ______
                                 
   National Rural Electric Cooperative Association,
                                                    March 25, 2005.
Hon. Mike Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
Hon. Edward M. Kennedy,
Ranking Member,
Committee on Health, Education, Labor, and Pensions,
Hon. Charles Grassley,
Chairman,
Committee on Finance,
Hon. Max Baucus,
Ranking Member,
Committee on Finance,
U.S. Senate,
Washington, DC 20510-6350.

Re: ``Private-Sector Retirement Savings Plans: What Does the Future 
        Hold?'' Additional Submission for the Record Highlighting 
        Challenges for ``Multiple Employer'' Plans

    Dear Chairman Enzi, Chairman Grassley, Senator Kennedy and Senator 
Baucus: Thank you once again for inviting me to participate in last 
week's Senate Forum dedicated to examining the future of private-sector 
retirement savings plans. We at NRECA appreciate the opportunity to 
continue our strong working relationship with the committees on these 
important issues that impact over 55,000 of our members' employees 
alone.
    As you know, NRECA sponsors both a Defined Benefit (DB) multiple 
employer pension plan, and, a Defined Contribution (DC) multiple 
employer pension plan (401(k) Plan) under  413(c) of the Internal 
Revenue Code (collectively, the ``Plans'') for our members' employees. 
NRECA is the primary source of retirement savings services for the 
Cooperative community, with 77 percent of NRECA's member systems 
offering the DB Plan, 84 percent offering the 401(k) Plan, and 74 
percent offering both plans.
    During the Forum, I stated that while we believe our story is a 
success that should be shared and encouraged, administering and 
participating in a ``multiple employer'' plan does not come without 
significant challenges. Further, I described how the ``multiple 
employer'' plan structure is often overlooked or is an afterthought in 
legislative proposals, resulting in an unclear legal and regulatory 
environment that increases financial risks to both plan sponsors and 
participating employers. The Administration's DB pension proposal to 
determine a plan's funding target or liability based on a company's 
credit rating is the latest example of this--Administration officials 
have publicly admitted that they never considered ``multiple employer'' 
plans in developing their proposal, which simply does not work in that 
context.
    Chairman Enzi asked that I describe some other ``multiple 
employer'' issues for the record as the committees continue to examine 
legislative proposals to preserve and enhance the private retirement 
savings system for the future, and I do so here:
    1. Under current law, the Internal Revenue Service (IRS) has 
established the Employee Plans Compliance Resolution System (EPCRS) to 
enable an employer that maintains a plan that has experienced a problem 
with an applicable Code requirement to correct the problem and 
simultaneously preserve the tax benefits available for employers and 
employees.
    The ECPRS system permits plan sponsors to correct qualification 
failures and thereby continue to provide their employees with 
retirement benefits on a tax-favored basis. One component of the EPCRS 
is the Audit Closing Agreement Program (Audit CAP), which permits a 
plan sponsor to pay a sanction and correct a plan failure while the 
plan is under audit.
    Under Audit CAP, any penalty is a negotiated percentage of the 
amount of taxes that would be owed if the plan were disqualified. For a 
``multiple employer'' plan, this could mean that the penalty would be 
based on the assets of the entire plan, even where for example, an 
operational error relates solely to a plan sponsor's treatment of just 
one participating employer's part of the plan.
    We believe this is a disincentive for small employers to work 
together, to leverage group purchasing power and economies of scale, to 
create ``multiple employer'' pension plan arrangements. While NRECA has 
never been subject to Audit CAP, we believe that the Congress should 
provide clear direction to the IRS that in the ``multiple employer'' 
context, this concept must be refined. That is, in situations where a 
violation is solely attributable to the participation of fewer than all 
participating employers, any negotiated percentage of taxes that would 
be owed if the plan were disqualified should only be based on the 
portion of the plan attributable to those particular employers and 
should not be based on the other parts of the plan attributable to the 
other employers.
    2. Section 4010 of ERISA requires notification to the PBGC for 
plans with unfunded vested benefits that exceed $50 million (the $50 
million section 4010 gateway test). Significant employer 
identification, plan information, and financial information must be 
included in the PBGC filing. While the PBGC notification requirement 
was clearly intended to apply only to large companies, the number of 
plans subject to the 4010 filing has greatly increased in recent years 
due to historically low interest rates.
    The PBGC is interpreting the statute to apply the $50 million 
threshold to a ``multiple employer'' plan in total, even if for each 
individual employer participating in the plan there is no question that 
the value of unfunded vested benefits is well below $50 million. These 
reporting requirements place an unnecessary and unreasonable burden on 
all employers, but particularly small employers participating in a 
``multiple employer'' plan.
    We believe this is a disincentive for small employers to work 
together, to leverage group purchasing power and economies of scale, to 
create ``multiple employer'' pension plan arrangements.
    We hope to continue our work with the committees to address these 
kinds of issues so that ``multiple employer'' plans continue to be a 
viable vehicle for companies committed to doing the right thing--
providing meaningful retirement benefits to their employees. If you 
have any questions, please feel free to have your staff contact me or 
Chris Stephen here in my office at 703-907-6026.
            Sincerely,
                                             Glenn English,
                                           Chief Executive Officer.
                                 ______
                                 
             Prepared Statement of Conversation on Coverage
                              introduction
    The private sector retirement system in the United States is in 
many ways a great success story, providing much-needed benefits in 
addition to basic Social Security benefits for millions of older 
Americans. But millions of others, who will be equally in need of a 
supplement to Social Security, are left out of the system.
    Although there has been tremendous growth in the number of 
workplace retirement plans, the number of people covered by retirement 
plans, and the dollars invested for retirement, the percentage of 
American workers participating in a pension plan has remained at 
roughly 50 percent of private sector workers for the past 2 decades.
    The retirement plan coverage locomotive is stalled and is not 
gaining ground. This is true despite an intensive debate for more than 
a decade on how to improve coverage and the emergence of many 
innovative policy recommendations. Suggestions have been put forward by 
Presidents, Members of Congress, business groups, employee advocates, 
pension specialists, and professors. Some suggestions for simplifying 
rules and establishing new types of retirement plans have been made 
into law. The new plans have prompted some employers who had not 
previously offered plans to do so, while some new rules have prompted 
employers to offer an existing plan to more employees.
    The Conversation on Coverage was envisioned as a vehicle to bring 
together retirement plan experts representing a wide diversity of 
viewpoints in an effort to reach common ground on recommendations to 
increase the rate of retirement plan coverage of American workers.
    There remains a clear need for new ideas to increase coverage, 
especially those aimed at raising coverage rates among low- and 
moderate-income workers.

Background: The Work Place and Retirement Benefits Today

    In 2004, 59 percent of all full-time and part-time private sector 
American workers had access to a pension plan sponsored by the company 
where they worked, according to the Department of Labor. However, only 
about 50 percent of all workers actually participated in these 
corporate pension plans.
    In 2004 total enrollment in the private sector plans was 51.6 
million of the 102.3 million private sector workers, the Department of 
Labor reports.
    Today, as was the case in the early 1980s, higher income workers 
and older employees with job tenure are likely to work at a company 
with a retirement benefit. However, low- to moderate-income people and 
younger employees are less likely to have a retirement benefit. There 
is also a big gap between full-time workers, who have a 53 percent 
coverage rate, and part-time workers, who have an 18 percent coverage 
rate, according to the Department of Labor.
    Companies with more than 500 workers are most likely to have a 
retirement plan. In medium and large companies, a good employee 
benefits package is seen as key to attracting and retaining skilled 
workers.
    Small businesses (with 99 or fewer workers) often face a different 
workforce situation. With a high worker turnover rate, there may be 
less employer or worker interest in benefits with a long-term horizon. 
Smaller companies are where there are the most workers without 
retirement benefits. Among firms with 100 or more workers, the 
participation rate in retirement plans was 65 percent, compared with 35 
percent for employees at small businesses.
    Some of the lower coverage rates among small businesses is due to 
the fact that small businesses are more likely to have part-time 
workers--and part-time workers, as noted, are more likely to be without 
retirement plan coverage. Among the smallest businesses--those with 
less than 10 workers, 41 percent of the workers are part-time, 
according to the U.S. Census Bureau. By comparison, in slightly larger 
companies--those with 10 to 24 workers--the proportion of part-timers 
drops to 33 percent.
    An overall coverage rate of 50 percent at any one time does not 
mean that half the work force never has coverage. The likelihood that a 
single individual will be covered increases with age.

Overview of the Conversation on Coverage's Working Group Reports

    The Conversation on Coverage tackled the issue of expanding 
coverage in its first gathering in July 2001. That event produced a 
number of innovative concepts, and a commitment among the diverse 
constituencies that care about pension issues to find ways to work 
together to improve pension coverage.
    The second phase of the Conversation on Coverage began in early 
2003 with the establishment of a Steering Committee and the creation of 
three Working Groups, each with its own assignment, and each with 
members representing a broad range of views and expertise in retirement 
issues. Members of these groups met for an intensive series of day-long 
meetings during the period from May 2003 through February 2004. The 
groups each had five or six full sessions, numerous subgroup meetings, 
and extensive further communications by telephone and e-mail.
    The 45 experts on the three Working Groups represented a wide 
diversity of viewpoints. They came from businesses large and small, 
from academia, from the legal and employee benefits professions, from 
the union movement, from retiree and women's organizations, and from 
insurance and investment companies. They worked together many hours to 
find common ground. Starting from different points on the ideological 
spectrum, they ultimately came together to reach agreement.
    The starting point for most members of the Working Groups was a 
belief in perpetuating the voluntary private retirement system while 
finding ways to expand it to include more workers. Along the way, some 
members said they preferred new mandates; but, the Working Groups in 
the end reached a consensus on voluntary approaches.
    The private, off-the-record sessions gave the participants a chance 
to explore and debate different concepts without concern that they 
would suggest something that might meet with objection--whether 
practical, political or academic--before it had been more thoroughly 
vetted. It was a chance to let their intellectual hair down, explore 
ideas and share common understandings. Nothing was taken for granted. 
The general theme was to build on the successes of the existing system 
and to look for new ways to make it work better and to reach more 
workers.
    The result of all these efforts is an impressive package of 
proposals that are likely to advance the coverage debate significantly. 
The synthesis of thinking among members of the group is now offered for 
consideration and deliberation by others, including workers, employers, 
Members of Congress and the general public. The Working Groups did not 
attempt to evaluate all retirement plan proposals. Instead, they chose 
to focus on the broad framework of new plans they helped design and 
which they felt had particular merit. Due to the broad diversity in the 
membership of each of the Working Groups, and the considerable time and 
energy devoted to the task, the ideas that have been recommended in 
this report emerge from this process with a stamp of approval that 
increases the odds they can eventually be perfected, piloted and 
adopted.

Key Recommendations of the Working Groups

    Four new promising ideas for new types of retirement plans emerged 
from the Working Groups. They are summarized below.
     The Guaranteed Annuity Plan (GAP) takes an employer-funded 
defined contribution plan, the money purchase plan, and adds new 
twists: the employer guarantees the rate of return on account balances 
of workers. The money purchase plan is a retirement savings plan 
financed by the employer through regular contributions based on a 
percentage of the compensation of each worker. GAP also provides higher 
contribution limits. The normal form of GAP's final benefit is an 
annuity, although employers can offer lump sums. (Working Group I)
     The Plain Old Pension Plan (POPP) is a new variation on 
the traditional defined benefit plan that starts with a modest 
guaranteed benefit that employers can boost in any year and then reduce 
back to the basic benefit in future years. It makes an employer's 
funding obligation more predictable. The normal form of the final 
benefit is an annuity and no lump sums are allowed. (Working Group I)
     The Retirement Investment Account (RIA) Plan proposes the 
creation of a government-authorized, privately-run central 
clearinghouse to accept contributions from all workers at all 
businesses. Employers will not have to administer the plan or take 
fiduciary responsibility for the investment choices of their employees. 
This plan is aimed at providing more individual workers with access to 
a payroll-deduction retirement saving plan through their workplace. 
(Working Group II)
    The Model T Plan is a proposed multiple-employer plan that can be 
offered by financial institutions, such as banks, insurance companies, 
brokerage firms and mutual fund companies. The institutions will 
administer the plans and assume fiduciary liability for a simplified 
array of investment choices in the plan. This plan is likely to expand 
coverage by encouraging more small businesses to offer a plan to their 
workers. (Working Group III)
    These proposals have several common elements. They reduce and/or 
transfer administration costs away from employers and reduce employer 
worries about the costs of funding the plan. They expand the number of 
workers eligible to participate in a plan. They also provide more 
opportunities to provide benefits--and in some instances--increase the 
level of benefits for low- and moderate-income workers. In addition, 
the proposals create approaches that are more appealing to the small 
and medium-sized businesses where coverage is the lowest.
    This report contains a detailed discussion of each of these 
proposals and other recommendations that emerged from the Working 
Groups, preceded by an Executive Summary for each of the Working Group 
reports.

Understanding the Language in the Working Group Reports

    In the individual reports that follow, the reader will come across 
the frequent use of the term ``generally agreed.'' It will help in 
understanding the recommendations that have been made to know how that 
term is defined for purposes of this report. The goal of the group was 
to try to reach consensus. ``Consensus'' did not necessarily mean 
having 100 percent agreement by all parties at all times. There was an 
understanding by the Working Groups that if nearly all members agreed 
on something, then it would be fair to say that the group ``generally 
agreed.'' By that, it is meant that there was only token opposition 
from a few members, usually no more than two.
    Beyond the area of ``general agreement,'' you will also note that 
there are other areas with varying degrees of agreement. It was decided 
from the beginning that there would be no vote per se, as voting was 
seen as working against agreement and could be polarizing. The meetings 
were covered by officially-designated reporters, and the co-chairs 
frequently polled members for their views. The range of views, in fact, 
often did not fall into simple ``for'' or ``against'' categories. As 
people were making compromises, they might be ``for'' with a caveat, or 
``against'' but with some reservation. And sometimes Working Group 
members compromised on one item if they thought it was for the greater 
goal of moving the proposal forward and possibly getting something else 
in return on other ideas. Sometimes, rather than get bogged down in 
contentious issues, the Working Group members agreed to list a range of 
options and to come back later to the issue if there were more time.
    There are times in the report when it helps to know what level of 
agreement existed, since there is a fairly large range of possible 
levels of agreement between no agreement and ``general agreement.'' 
Thus, the reader will encounter such descriptions as ``the majority'' 
favored a given view. Or, ``most'' members supported an approach. When 
views were more evenly divided or diverged in ways that were difficult 
to tally, the text is likely to say that ``the group was divided'' on 
this issue.
    Efforts are made to include minority views, especially when they 
are strongly expressed or held. So, even when there may be ``general 
agreement'' on a point, the reader might find that ``a few'' or 
``some'' members held a different point of view. Sometimes, when there 
was disagreement, the report offers suggestions offered by members for 
addressing the issue at hand.
    It is important to understand the context in which these new 
proposals are being offered. They are not considered finished concepts, 
but initial recommendations. It is hoped that these proposals will 
prompt a host of constructive suggestions for improving them, as well 
as even more new ideas for expanding coverage.
    Lastly, these reports also contain comments and suggestions about 
the recommendations voiced by participants in the Conversation on 
Coverage's July 2004 National Policy Forum.
                                       Robert Stowe England
                                 ______
                                 
   Report on the Conversations and Recommendations of Working Group I
                       working group's assignment
                          answer this question
How do we increase coverage by encouraging incentives for both 
traditional and new forms of defined benefit plans?
                            february 7, 2005
Co-Chairs: Melissa Kahn and Norman Stein

Working Group Members: Phyllis Borzi, Ellen Bruce, David Certner, 
Charles Cole, Patricia Dilley, Lynn Dudley, Ron Gebhardtsbauer, Deene 
Goodlaw, Brian Graff, Nell Hennessy, Mike Johnston, Judy Mazo, Shaun 
O'Brien, and Bob Patrician
                           executive summary
    The Working Group held a series of meetings between May and 
November of 2003 to discuss ways to increase the number of workers in 
the workforce who work at companies that offer a defined benefit plan. 
Such plans typically promise a benefit that provides a guaranteed 
stream of income for life after retirement. Defined benefit plans are 
funded by the employer and the promised benefit level does not depend 
on the actual performance of the plan assets. An increase in workers 
covered by a defined benefit plan can be achieved both by encouraging 
employers that already sponsor defined benefit plans to extend coverage 
to more of their workers and by efforts or policies that prompt more 
employers to offer a defined benefit plan.
    Defined benefit plans have several advantages for employees. Since 
employers fund the plan, employees do not have to determine how much 
they need to save to receive a defined benefit at retirement. Nor do 
they need to make contributions to receive the benefit.\1\ The 
employer, and not the employee, bears the market risk associated with 
investment performance. The employer, and not the employee, decides how 
to invest the income and reallocate assets over time. And, to the 
extent that retirees take their distribution in the form of a lifetime 
annuity, they are relieved of the task of creating a budget for drawing 
down over time the funds in a lump sum, as well as deciding how to 
manage and invest the funds after retirement age.\2\ Further, 
retirement income provided by defined benefit plans is federally 
guaranteed \3\ with coverage provided by the Federal Pension Benefit 
Guaranty Corporation.
    The members of the Working Group reviewed recent proposals for new 
types of defined benefit plans that were designed to appeal to 
employers who currently do not offer a defined benefit plan (See 
Appendices A and B). They looked at traditional plan designs and new 
types of plan designs that contain features of defined benefit plans. 
After reviewing those suggested approaches, the Working Group put 
together the basic outlines of two new proposals--the Guaranteed 
Account Plan (GAP) and the Plain Old Pension Plan (POPP)--aimed at 
employers who may be interested in sponsoring a defined benefit plan 
but who are also wary of the liabilities and burdens associated with 
traditional pension plans.
    Guaranteed Account Plan. The Working Group generally agreed on the 
key design features of this proposed plan, listed below.
     The proposed plan is a new kind of hybrid plan that takes 
the existing money purchase plan and adds a guaranteed account balance. 
The money purchase plan is a retirement savings plan financed by the 
employer through regular contributions based on a percentage of the 
compensation of each worker.
     The account of each participant is credited with an annual 
employer contribution.
     Benefits are funded by the employer, based on standardized 
and conservative funding assumptions; employees could also elect to 
contribute on a pre-tax basis.
     The plan guarantees the annual rate of return on 
participants' account balances.
     The employer invests the plan assets so employees do not 
self-direct the investments.
     The plan offers an annuity as the automatic payment 
option, but participants may also be offered as an alternative a lump 
sum equal to the amount credited to the participant's account.
    With this basic design, GAP transfers from the employee to the 
employer the risks associated with choosing appropriate investments, as 
well as the financial market risk of how well investments perform.
    The Plain Old Pension Plan. The Working Group generally agreed on 
the key design features of this proposed plan, which are listed below.
     The plan is a simple, easy-to-understand traditional 
defined benefit plan that provides a modest basic benefit to allay 
employer concerns about funding the plan.
     The final basic benefit is based on a percentage (as low 
as 1 percent) of an employee's career average pay multiplied by the 
number of years of service.
     The plan would allow employers to fund bonus benefits in 
any given year or years that would raise the final benefit without 
having the bonus benefits become part of the permanent benefit 
structure.
     The plan would permit, but not require, a generous past 
service credit that would be attractive to small business owners.
     All benefits from the plan would be paid in the form of an 
annuity. Lump sum distributions would not be permitted.
    Tax Credit Provisions. The Working Group also supported a number of 
tax credit provisions that would encourage employers to adopt and 
maintain a defined benefit plan, as well as to expand the number of 
workers covered by a defined benefit pension plan.
    Some of the proposals adopted may require changes in public policy 
and some may be pursued through demonstration projects. This will be 
determined in a refinement and implementation stage in 2005.
                              the mission
    The mission of Working Group I was to develop proposals that would 
expand the aggregate number of workers covered by a plan that offers a 
defined benefit. A defined benefit plan is a retirement plan offered by 
an employer who is legally obligated to fund the plan's promise to 
provide a monthly retirement benefit to each eligible employee and 
surviving spouse based on years of service and earnings. (See box on 
plan type definitions page TK for more information on types of plans.) 
The group generally agreed that expanded coverage would include 
providing coverage to employees at firms that previously did not have a 
plan with defined benefits, as well as extending coverage to groups of 
employees at firms with a defined benefit plan that were not previously 
covered by the plan.
    The Working Group also sought to find ways to help prevent further 
erosion of the number of workers currently covered by defined benefit 
plans. To support this goal, the group generally agreed to support 
proposals that would encourage employers who currently sponsor defined 
benefit plans to continue sponsoring such plans. The group also 
generally agreed it should not support proposals that might discourage 
employers who sponsor defined benefit plans from continuing to do so. 
This approach was seen as being similar to physicians who take the 
Hippocratic Oath: ``First, do no harm.''
                               background
    The defined benefit plan is no longer the preeminent and preferred 
method of providing retirement income for employees. The plan's 
dominant position has been eroded in a single generation, as the 
proportion of the private sector workforce covered by a defined benefit 
plan was cut in half from 38 percent in 1978 \4\ to 19 percent in 
1998.\5\
    Meanwhile the proportion of workers with a defined contribution 
plan as their primary retirement plan rose sharply over the same period 
from 7 percent to 27 percent, making the defined contribution plan the 
dominant type of plan in the workforce.\6\ A defined contribution plan 
is an employer-sponsored retirement savings plan that accumulates 
assets from employee contributions and/or employer contributions. There 
is no specific promised benefit at retirement and the investment risk 
falls on each individual employee. In the 401(k) and 403(b) models now 
predominant (both defined contribution plans) employees determine how 
much they should save and often choose how to invest their retirement 
savings. (See box on plan type definitions for more information on plan 
types on page TK.) The employee's retirement income is based on the 
contributions made into the account and the accumulated earnings at 
retirement.
    Federal pension data illustrate the extent of the decline in 
defined benefit plans and employees covered by such plans. The number 
of workers covered has declined and the number of plans has fallen 
sharply. According to a Congressional Research Service paper, the 
number of workers covered fell from 29.3 million in 1983 to just under 
23 million in 1998.\7\ At the same time, the number of plans fell from 
175,000 to 56,400, with most of the loss of plans occurring among small 
businesses (those with 99 or fewer workers). The proportional decline 
has been greatest among small plans. Between 1983 and 1998, for 
example, the number of workers in small plans fell by a disturbing 65 
percent, from 1.86 million to 648,000. That represented a loss of more 
than 1.21 million workers. For the biggest firms, however, there was an 
even greater decline: with only 5.8 million of workers enrolled in 
defined benefit plans. In 1983, the number of active participants in 
defined benefit plans at large companies stood at 28.1 million. By 
1998, it had declined 21 percent to 22.3 million.\8\
    The Pension Benefit Guaranty Corporation provides estimates on the 
number of plans and the number of participants and beneficiaries of 
those plans based on premiums that are paid to the agency. PBGC reports 
that in 2001, there were 22.35 million active workers in plans insured 
by the agency, representing 19.7 percent of the 113.5 million private 
sector wage and salary workers.\9\ This represented a tiny drop in 
workers covered from 22.38 million in 2000.\10\ In 2003, the number of 
single-employer plans fell to 29,512 from 31,229 the previous year. The 
number of multiemployer plans stood at 1,623 in 2003, down from 1,671 
the previous year.\11\
    The data suggest that while the defined contribution plan has 
become a more popular method for providing retirement benefits, it has 
not achieved the success that the defined benefit system enjoyed before 
the rise of the defined contribution plans, particularly 401(k) plans. 
And despite its relative decline, the defined benefit plan remains an 
important part of the employee benefits system, especially at larger 
firms. In 1998, for example, private sector defined benefit plans paid 
out $107.8 billion in benefits, mostly in the form of annuities 
disbursed from plan assets. They also purchased an additional $3.4 
billion in annuities from commercial insurers.\12\ Also, the defined 
benefit plan continues to be the plan of choice for Federal, State and 
local government employees and for workers in the unionized sector of 
the economy.
                the advantages of defined benefit plans
    Defined benefit plans are often seen to have a number of inherent 
advantages for rank and file workers. Significantly, all or almost all 
the contributions are made by the employer. Thus, the burden of 
determining how much to save and how to invest those assets is shifted 
away from the employee to the employer or, in a negotiated plan, to the 
bargaining table.
    Participants in defined benefit plans also enjoy a further 
advantage in that the investment risk is shifted away from the employee 
and the normal form of pension benefit is usually in the form of a 
lifetime annuity in an amount that can be calculated from the formula 
in the plan. More importantly, as recently as 1997, fewer than 25 
percent of participants in defined benefit plans even had an option to 
take benefits in a non-annuity form, such as a lump sum.\13\ In 
addition, the benefits provided by defined benefit plans are federally 
guaranteed with insurance provided by the Pension Benefit Guaranty 
Corporation.
    Providing the retirement income benefit as an annuity eliminates 
the longevity risk for the retiree; that is, the retiree does not have 
to worry about outliving the pension, since the pension is defined as 
an income stream to be provided throughout the retiree's life span. It 
also fully meets the goals of the substantial Federal tax subsidy for 
qualified retirement plans by providing income only during the 
retirement years of the employee and his or her spouse, and cannot be 
dissipated after a pre-retirement termination of employment or 
accumulated as a tax-favored asset for the next generation.
    The benefit of having an automatic annuity in a defined benefit 
plan has, however, been eroded in recent years as more plans have opted 
to offer lump sums as an option and employees have chosen to take lump 
sums instead of annuities. In 2000, for example, 43 percent could take 
their benefit as a full or partial lump sum.\14\
                 problems facing defined benefit plans
    In order to develop new plan designs and fashion new incentives to 
attract employers to the defined benefit form, the group felt it was 
important to understand the reasons for the decline of defined benefit 
plans. Thus, the group explored the reasons why defined benefit plans 
now have less appeal to employers and, in some cases, to employees.
    The Employer's Uncertainty about the Pension Liability. Many 
members of the group agreed that defined benefit plans have become less 
popular because of the unpredictability of the annual contribution 
employers have to make to keep their plans fully funded under Federal 
pension laws. Such contributions are based on a series of actuarial 
calculations that take into consideration the promised benefits for 
workers, the value of assets currently in the plan, the expected rate 
of return that assets in the plan will likely earn in the future, and 
actuarial assumptions such as mortality rates and the rate of employee 
turnover that bear on the cost of benefit liabilities.
    Employers who regularly make required contributions into their 
pension plans to meet future obligations can still fall short of the 
funding goal due to changes in the value of assets in the financial 
markets and due to changes in the prevailing interest rate used to 
evaluate liabilities. Changes in the benchmark interest rates, for 
example, may result in reported funding deficiencies for previously 
well-funded plans.\15\
    In recent years, declining interest rates have required employers 
to contribute larger sums of money. The required contribution was also 
increased because the value of assets in many plans declined 
substantially in 2000, 2001, and 2002. These year-to-year changes can 
make the amount of the funding obligation--the amount the employer 
needs to put aside now to pay benefits later--rise and fall 
dramatically. Thus, swings in interest rates and the market value of 
assets can make the funding obligation volatile. This volatility has 
been a key concern of employers, since it can require companies to 
divert financial resources needed to run the company into the pension 
plan. Requirements for large contributions often come when the company 
may not be profitable and when the failure to invest in the future of 
the company can weaken its prospects for success or even survival. 
Funding shortfalls are not always predictable since they may arise from 
market forces not within the employer's control.
    The volatility in actual funding requirements can cause serious 
cash-flow problems for employers. This volatility also shows up on 
employers' financial statements, as accounting standards require that 
pension assets and liabilities be recorded both on the income statement 
and the balance sheet. That can have a serious impact on employers' 
cost of capital. Proposals under consideration by the accounting 
profession for ``mark-to-market'' reporting would heighten that 
accounting volatility by disallowing the use of some actuarial 
smoothing techniques used to value assets and liabilities for 
accounting purposes.
    Employees Do Not Always Value Defined Benefit Plans. The group 
generally agreed that one of the reasons that employers do not consider 
adopting defined benefit plans is that employees do not ask for them or 
appreciate them. Indeed, younger employees, who may expect to change 
jobs several times, may see a 401(k) or defined contribution plan as 
more valuable, since they know what assets are in their individual 
account and can see the assets grow over time through regular 
statements from the plan. However, the group also generally agreed that 
employees have lately shown more interest in plans that accrue funds at 
a regular pace with a guaranteed rate of return in response to the 
performance of the financial markets from 2000 to early 2003, when many 
employees saw the value of their 401(k) accounts plummet.
    How Much Benefit for the Owners and/or Senior Management? One of 
the concerns about devising new defined benefit plans is not peculiar 
to this type of plan, but applies to all plans. Since most large and 
medium-sized employers have some type of employer-sponsored pension 
plan, most of the expansion that could occur is among small businesses. 
In these businesses, the owner and senior management are likely to be 
part of the plan that is offered, according to several members of the 
working group, and would expect to receive a very large share of the 
pension benefits that would be financed in the plan.
    People who are in the business of selling defined contribution 
plans, such as 401(k) plans, and profit-sharing plans--both popular 
among small and medium-sized employers--report that the owner and/or 
senior management of very small businesses normally expect to receive 
as much as 60 to 70 percent of the benefit. According to those who 
market plans, there is a tipping point for the owner and/or senior 
management when it is easier for the owner to simply take a similar 
amount of money out of the company without any tax deduction at all and 
set it aside for retirement outside of any qualified pension plan. Some 
members of the group felt this reality of the marketplace creates an 
obstacle to expanding coverage. While coverage can be said to be 
increased if more small businesses adopt plans, this may not be 
significant if most of the benefit goes to higher paid workers while 
rank-and-file employees do not receive meaningful benefits.
    Members of the group disagreed on where new plans should set the 
dividing line between the portion of the retirement benefits provided 
to the owners and highly paid managerial employees and benefits for 
regular employees. Some members of the group were concerned that 
potential plan designs that directed too little of the contribution to 
owners and other highly paid employees may not be attractive enough to 
employers to prompt them to sign up for the plan. Others were concerned 
that little would be gained if new plans merely benefit owners and 
senior management with few benefits for the rank and file of the work 
force.
            how the working group went about its assignment
    The members of the Working Group held six meetings and several 
subgroup meetings between May and November, 2003. In the initial 
meetings the group reviewed a number of proposals for new types of 
plans that promised a defined benefit.
    Members were invited to express their opinions about proposals and 
the group sought to reach consensus on as many points as it could. Due 
to the nature of the process of the Conversation on Coverage, members 
of the group often ``took off their advocacy hats'' and often started 
from a position in the ``middle'' in an effort to find places where 
they could generally agree. At times the group was unanimous or nearly-
unanimous in supporting or rejecting a given point. In this instance, 
the group was said to have ``generally agreed'' or ``generally 
disagreed'' on that point. At other times, the group found substantial 
agreement, but not unanimity. Sometimes the opposition was strong. When 
the group disagreed on a point or provision, members were invited to 
offer different options that might address a particular issue. This 
report reflects those differing opinions and varying viewpoints.
    The group began its work by reviewing several defined benefit or 
hybrid plan proposals that were included in a binder that was given to 
all working group members. Hybrid plans have some of the 
characteristics of both a defined contribution and a defined benefit 
plan. (See Definitions of Plan Types at on page TK.) The group 
considered hybrid plans that would, at a minimum, offer a standard 
annual contribution by the employer (which might be waived 
occasionally) and a specified rate of return for the accumulated funds 
in the account that would be guaranteed by the employer or a financial 
institution or company that offers the plan.
    The group devised a set of criteria \16\ for reviewing proposals 
for new types of plans and also for reviewing proposals for tax 
incentives and other ideas to make existing defined benefit plans more 
attractive to employers and employees.
    The group generally agreed that proposals should be attractive to 
employers and employees, make good public policy sense, and be regarded 
as marketable by the financial institutions and consultants who would 
have to sell them to employers.
    For employers, the group generally agreed that the following 
criteria should be considered: reduced regulation, low administrative 
costs, low contribution costs, high benefits for owners and officers, 
attractiveness to prospective employees, designs that are helpful in 
retaining current employees, designs with tax benefits to the company 
and owner, designs with contribution flexibility for the owners.
    For employees, the group generally agreed the following criteria 
should be considered: low costs in terms of contributions and high 
returns on assets in the plan, protection against investment risk, 
employee control over assets, portability of assets, protection against 
longevity risk, protection against inflation, tax benefits, 
psychological benefits of owning assets, simplicity and fairness for 
employees, and the adequacy of benefits provided under the proposal.
    From a public policy standpoint, the members generally agreed that 
proposals should be measured by the effectiveness of the revenue 
dollars spent, and the degree to which savings are preserved for 
retirement rather than withdrawn earlier for other purposes. Proposals 
were also judged on how well they could be sold to Congress, employers 
and employees. They were also judged on how marketable they might be by 
financial institutions and benefits consultants.
    The group generally agreed that the target employer market for the 
proposals they reviewed would be small and medium-sized businesses. 
Some members, however, hoped that some of the proposals that the group 
reviewed and eventually favored would also appeal to large businesses 
that may or may not have a defined benefit plan.
               the group expresses interest in db-k plans
    Early in its conversations the Working Group expressed a preference 
for supporting some type of DB-K plan, with the DB referring to defined 
benefit and the K referring to a 401(k) plan. A DB-K plan would be, 
then, a defined benefit plan with a 401(k) feature. The idea behind 
such plans is to combine two goals into one plan: one side of the plan 
would provide a more secure benefit based on a guaranteed rate of 
return while the other side of the plan, the 401(k), would give 
employees a way to save for retirement through contributions that are 
excluded from taxable income.
    The Working Group identified several potential benefits of a DB-K. 
It would allow employers to offer in one plan a defined benefit based 
on pay and length of service, as well as a retirement savings plan. It 
would provide a ``safe harbor'' for the defined benefit plan where the 
employer provides a minimum benefit formula for all eligible employees, 
such as 1 percent of final average compensation times up to 20 years of 
service. Employers who provide this minimum benefit would be deemed to 
have met the requirements of the nondiscrimination rules, including the 
rules applicable to 401(k) plans--giving them a safe harbor from those 
rules. This would eliminate the need to do costly nondiscrimination 
testing \17\ required by the Internal Revenue Code. It would allow 
employers to imaginatively combine the best features of defined benefit 
plans and 401(k) plans.
    The group generally agreed to support the overall concept of a DB-K 
plan that would have a guaranteed benefit in one arm and a 401(k) 
feature in the other arm. The group, however, did not generally support 
any one of the three plans it reviewed. The three DB-K proposals that 
were discussed are described in Appendix A.
    The Working Group at one point expressed interest in DB-K Proposal 
No. 1, which had one arm that could be either a traditional defined 
benefit plan or a cash balance plan. The Working Group was interested 
in improving on the basic features offered in DB-K Proposal No. 1 to 
make it more attractive for both employers and employees. The group was 
interested, for example, in finding ways to make it less costly for the 
employer by reducing the minimum required contribution.\18\ The Working 
Group generally agreed that employers would be more likely to adopt 
such plans if they were less costly. The group was also interested, for 
example, in allowing for withdrawals at age 59\1/2\ instead of normal 
retirement age to make phased retirement possible at that age, as is 
already possible in 401(k) plans.\19\
    The member who had introduced the original DB-K Proposal No. 3 
suggested that the group replace the cash balance option with a new 
hybrid: the Guaranteed Account Plan, an adaptation of the money 
purchase plan, a defined contribution plan. The money purchase plan is 
a retirement savings plan financed by the employer through regular 
contributions based on a percentage of the compensation of each worker. 
(See definitions of plan types on page TK for more information on money 
purchase plans.)

Working Group Offers Two Plans for Consideration

    After reviewing a number of pre-existing potential designs for new 
types of plans with defined benefits, the Working Group settled on two 
proposals: the Guaranteed Account Plan (GAP) and the Plain Old Pension 
Plan (POPP), whose designs are described below.
    The Working Group members generally supported the broad conceptual 
design of these two proposals. Members also generally agreed on a 
number of key building blocks of design elements for each of the plans 
with reservations on some aspects of the design for the two plans.
    In some key provisions, members could not reach agreement on single 
provisions alone without considering their impact as a whole (see 
section in this report on Working Group I within the discussion of GAP 
titled Four Policy Areas Linked in Discussions). Some members said they 
wanted to be sure that the package of provisions as a whole would 
provide lower paid workers a sufficient share of the benefits in return 
for the greater flexibility and higher benefit the plan would allow 
higher paid employees.
    The Working Group generally supported POPP on a broad conceptual 
level, and there was agreement on some of its potential provisions. 
However, on some provisions there was disagreement. Those areas of 
agreement and disagreement are discussed later in this report. In some 
cases there are options offered for resolving issues and points of 
dispute.
                      the guaranteed account plan
             areas of broad agreement on the design of gap
    The Working Group reached general agreement on some of the key 
design elements of the proposed Guaranteed Account Plan. These elements 
are discussed here as individual building blocks of the overall plan.
    Basic Plan Design of GAP. The group unanimously agreed on the 
following basic design points.
     The proposed plan is a money purchase plan with a 
guaranteed account balance.
     The employer credits the account of each participant with 
an annual contribution.
     Benefits are funded by the employer, based on standardized 
and conservative funding assumptions.
     Employees can also elect to contribute on a pre-tax basis.
     The employer guarantees the annual rate of return on the 
assets in participant accounts.
     The employer invests the plan assets in the accounts and, 
thus, the employees do not self-direct the investments.
     The plan offers an annuity as the automatic payment 
option.
     Participants may also be offered as an alternative to an 
annuity a lump sum equal to the amount credited to the participant's 
account.
    With this basic design, GAP transfers from the employee to the 
employer the risks associated with choosing appropriate investments, as 
well as the financial market risk of how well investments perform and 
annuity purchase rates at any given time. The group did not agree on 
such elements as what the annual guaranteed rate of return should be 
and what limits should be placed on employer and employee contributions 
to control the extent to which highly paid employees might 
disproportionately benefit from the plan.
    One member strongly objected to GAP on the grounds that it was a 
defined contribution plan with a guarantee and not a true defined 
benefit plan and, thus, fell outside the group's mission. Nevertheless, 
there was general agreement among members to support the broad outlines 
of GAP, while views differed on key provisions. Members who supported 
the proposal stated it preserved some of the best elements of defined 
benefit plans and avoided the legal controversies surrounding cash 
balance plans.
    How Some Compromises Were Reached. In the consensus that emerged in 
support of key design features of the GAP, many members of the group 
expressed concern that some of the legislative and regulatory changes 
made over the years have allowed too much leakage of accumulated 
benefits that should be saved for retirement. Some members also 
expressed concerns that Congress and Federal Agencies have been far too 
willing to allow plans to favor higher paid employees in terms of 
contributions and benefits. As a practical compromise, some members 
agreed to retain in proposed new plans, like GAP, many of what they 
considered to be ``bad'' features of current law as a practical 
compromise.
    This was done in response to the contention that if one were to 
tighten existing rules for the new proposed plan, employers would be 
less likely to adopt the proposed plan and might either drop their 
current defined benefit plan in favor of the new proposed plan, or move 
to a defined contribution plan.
    For example, many of the members would have preferred to recommend 
that the GAP disallow any lump sums except for the smallest accounts. 
However, since employers already have a lump sum option in their 
defined benefit plan, it was difficult to support tougher rules for 
GAP. As the point illustrates, the outcome on some key points on which 
agreement was reached was not entirely satisfactory to some concerned 
members. However, they decided as a practical reality they had to 
preserve incentives to keep employers in existing defined benefit 
plans. Thus, even where members supported new various provisions in 
GAP, they made a point of noting that it was not an ideal structure to 
deliver retirement benefits and that, given the constraints of current 
law, it was the best compromise they could make.

With the above caveats, below are the areas where there was general 
agreement:

    How Long Employees Work to Vest in Retirement Benefit. An employee 
is said to be ``vested'' in a pension when the employee becomes 
entitled to the benefits of the plan, including employer contributions 
to a plan and their earnings. The time until a benefit is vested is 
defined under guidelines set forth in Federal pension law.\20\ The 
Working Group generally agreed to propose that GAP would allow 
employers to offer one of two types of vesting for plan participants. 
One choice would be to vest in the entire benefit balance all at once 
after 3 years from the date of employment, an approach called cliff 
vesting. The group also generally agreed to allow for gradual vesting 
over a 6-year period. Under this approach the portion of the benefit in 
the plan that is vested rises each year and reaches 100 percent after 6 
years. The vesting options under GAP are the same as those that apply 
now for 401(k) plans and are more generous than the rules governing 
traditional defined benefit plans. Shortening the vesting requirement 
benefits employees.
    Simplified Funding Rules. Most defined benefit plans have a 
complicated set of rules that govern how much in new funding an 
employer has to contribute each year. When the total assets in a plan 
fall below a level that would make it difficult to meet the future 
benefit obligation, employers are required to close the funding gap. 
There are also limits on the maximum amount that can be contributed in 
a given year. The Working Group sought to simplify the rules in order 
to make GAP more appealing to employers.
    The Working Group generally agreed that the employer be required to 
fund the plan in a manner designed to assure that plan assets are at 
all times adequate to meet current obligations. When the funding level 
of the plan falls below what it will need to meet future obligations, 
the plan has to schedule additional contributions to make up the 
amount. The Working Group generally agreed that when the plan becomes 
underfunded due to market performance of the assets in the plan, the 
gap should be closed over a 5-year period, which is shorter than would 
be required under a traditional defined benefit plan and, thus, seen as 
better protection of workers' earned benefits. The employer would also 
be allowed to make additional contributions above those required that 
could raise the level of assets in the plan to 150 percent of its 
current liability.\21\ This is a higher limit than current law.
    The proposed funding rules for GAP reduce the amount of time the 
employer has to close the funding gap, compared to traditional defined 
benefit plans.\22\ This makes it more likely plans will close their 
underfunding gap after they experience losses. The increase in the 
maximum contribution allows employers to make additional contributions 
in good years when the company can afford those contributions and, 
thus, make it better prepared for lean years, when the employer may 
find it difficult to make required contributions.
    Increased Credit for Past Service. Members stated that plan designs 
that allow for past service credit may be more appealing to older 
employers. This feature would allow employers who have not yet set up a 
defined benefit plan to do so and then make contributions for the years 
employees worked before the plan was set up and, thus, help provide a 
better benefit at retirement. The Working Group generally agreed that 
GAP could provide for up to 7 years of past service credit. The credit 
would be earned 1 year at a time for all the years of prior service 
credit. Thus, it would take 7 years to allow for sufficient employer 
contributions to cover 7 years of past service credit. All employees--
including low and moderate income workers, as well as highly-
compensated employees--would be eligible for the increased credit for 
past service.\23\ Consequently, the grant of past service credit would 
be deemed to satisfy the nondiscrimination requirements. Further, the 
Working Group agreed that when past service credit is allowed, it would 
count toward the vesting requirements of the plan.
    Joint and Survivor Annuity. The Working Group generally agreed that 
the normal benefit offered at retirement would be a joint and survivor 
annuity (or a single-life annuity for unmarried participants), based on 
the value of the participant's account at retirement. That means the 
value of a participant's account would be used to purchase a 
commercially annuity, reasonably priced, that would be issued jointly 
to the plan participant and spouse and that the spouse would continue 
to receive the annuity should the plan participant die. Employers would 
be able to decide whether or not their plans would offer lump sums. 
However, if a participant decided he or she preferred to take a lump 
sum, spousal consent would be required to change the distribution from 
the normal requirement that it be a joint and survivor annuity. Spousal 
consent for a lump sum is currently required for money purchase plans, 
as well as for defined benefit plans.\24\
    A GAP with a 401(k) Feature. The Working Group generally agreed 
that a GAP could also include a 401(k) feature. Employees could, under 
such plans, make elective contributions \25\ to the GAP or the 401(k) 
plan.
    Employer Matching Contributions. The Working Group generally agreed 
that employers could make matching contributions to the GAP when 
employees made contributions to a plan including a 401(k) feature. The 
Working Group agreed this should be allowed in accordance with current 
Tax Code requirements for matching contributions, including safe harbor 
rules.\26\
    Caluclation of Lump Sum. When employees in a defined benefit plan 
leave a company before retirement and they are vested in a defined 
benefit pension plan, they frequently receive a lump sum payment. 
Current pension rules governing defined benefit plans, including cash 
balance plans, require a complicated calculation \27\ to arrive at the 
value of the lump sum. The group generally agreed that rather than 
applying the complicated rules that now affect cash balance plans, that 
individuals would simply receive the balance credited to their 
accounts, using the rules that apply to defined contribution plans. 
Members stated this would be fair to employees and to employers and 
would simplify administration.
        gap design elements with some, but not general agreement
    Rules Governing Terminations of a GAP with Surplus. The Tax Code 
contains provisions that penalize companies when they terminate 
overfunded pension plans. Under the proposed GAP, if employers 
guarantee a specific rate of return, such as 3 percent, and the plan's 
assets experience higher returns, the plan will accumulate surplus 
assets (to the extent the funding method does not fully correct for the 
mismatch). An employer may wish to take a reversion on a portion of 
those assets. A reversion occurs when an employer terminates a plan to 
take out excess pension assets.

There was strong support, but not general agreement, for the following 
suggestions:

     20 Percent Excise Tax on Reversions up to 130 Percent. 
Employers could terminate a GAP and take the surpluses or amounts in 
the plan and pay a 20 percent excise tax for amounts that are up to 30 
percent above the 100 percent level of account balances.
     50 Percent Excise Tax on Reversions Above 130 Percent. If, 
however, the surplus is greater than 130 percent of account balances, 
the employer would have to pay a 50 percent excise tax on the portion 
above 130 percent.

    This feature was thought by members to make GAP more attractive to 
employers who might otherwise wish to avoid taking on the risk of 
guaranteeing the rate of return on account balances. This approach, one 
member said, would be more lenient than current law, but would not give 
employers ``a complete [free] pass.'' Nevertheless, several members 
strongly objected to a reduced excise tax for part of the surplus. They 
argued that without a significant penalty, companies would be tempted 
to take the surpluses and terminate plans.
    Pension Benefit Guaranty Corporation Insurance. Defined benefit 
plans in the private sector are insured by the Pension Benefit Guaranty 
Corporation in Washington, D.C. When underfunded pension plans are 
terminated, the plan assets are transferred to the PBGC and the agency 
takes over the payment of pension benefits. The agency guarantees 
pension benefits at normal retirement age and most early retirement 
benefits.\28\ The agency provides a maximum benefit guarantee, which is 
adjusted every year and is $3,801.17 per month for 2005 for workers who 
retire at age 65.\29\
    Most of the Working Group members supported a suggestion that GAP 
be insured by the PBGC. One member was strongly opposed to the 
guarantee, arguing that PBGC guarantees were inappropriate for a plan 
that was not a true defined benefit plan, but a defined contribution 
plan with a guaranteed rate of return.
    Most of the Working Group also supported charging a lower $5 
premium per member in a GAP. By contrast, the flat rate premium for 
single-employer defined benefit plans is $19 per member per year. (In 
early 2005 PBGC proposed raising the flat-rate premium to $30 as part 
of an effort to strengthen its finances.) Plans that are underfunded 
have to pay an additional adjustable rate premium.\30\ A lower premium 
was recommended to mitigate one of the objections that employers have 
to adopting defined benefit plans; namely, the cost of pension 
insurance premiums. Most, but not all, members of the group believed 
that the lower premium for GAP would not represent risk to the PBGC 
because of the low risk of a GAP benefit default.
    Higher Contribution Limits and Maximum Annual Annuity Benefits. 
Under the Internal Revenue Code, employers can contribute more annually 
for high-paid older employees into defined benefit plans every year 
than they can with defined contribution plans.\31\ The Working Group 
discussed whether or not GAP, which is a hybrid plan, should have the 
contribution limits specified for defined benefit plans or those for 
defined contribution plans.\32\ The contribution limits for defined 
benefit plans are generally more favorable to older workers, which the 
group anticipated would often be business owners and higher-paid 
workers of businesses that adopted a GAP.
    A majority of the group's members agreed that employers should be 
given a choice of whether to use defined benefit or defined 
contribution limits. However, some members strongly objected to this 
provision as providing too much of a potential benefit to owners and 
top executives, who are often older than the average rank-and-file 
worker.
    The Working Group mostly agreed that GAP could use 5.5 percent as 
the interest rate for converting the annuity to a lump sum for purposes 
of the maximum defined benefit limit. The Working Group also mostly 
agreed that if Congress were to change the law to provide a new 
interest rate assumption, the new interest rate assumption would apply 
to GAP.\33\

Four Policy Areas Linked in Discussions About GAP

    As members discussed what provisions to approve for GAP, four key 
issues were frequently tied together in the conversations:

     Minimum guaranteed rate of return on account balances.
     Maximum benefits allowed for higher paid and older 
workers.
     Minimum employer contribution credits for all workers.
     Flexible testing methods for nondiscrimination.\34\

    There were varying levels of agreement on each of these areas. In 
addition, members generally agreed that whatever design the GAP 
proposal would have in the end would depend heavily on the combination 
of these four provisions. Some members suggested that it would not be 
possible to decide what was appropriate for each of these plan design 
elements in isolation without knowing what the other three would be.
    A driving concern for some was a desire to be sure that lower paid 
workers were able to obtain a sufficient share of the benefits in 
return for the greater flexibility and higher benefits the plan would 
allow higher paid employees. For others, the concern was that employers 
be given sufficient flexibility and higher contribution and benefit 
levels in return for minimum contributions to all workers and 
guaranteed rates of return on account balances.
    The four issues revolve around complicated rules of the Tax Code 
governing whether or not retirement plans are ``qualified,'' that is, 
whether plans generate favorable tax benefits for the employer and 
employees. Those benefits, generally, are as follows: immediate tax 
deductions for employer contributions, deferral of income recognition 
for employees until benefits are distributed, and tax exempt status for 
the plan's funding vehicle. The most important of those rules are the 
complex provisions on when plans are considered to discriminate too 
much in favor of highly-paid employees and, thus, invalidate the tax 
qualified status of the plan.
    Minimum Guaranteed Annual Rate of Return on Account Balances. The 
minimum guaranteed rate of return is a key provision since it makes the 
money purchase plan, a defined contribution plan, a hybrid plan with 
defined benefit characteristics.
    The Working Group generally agreed that the rate of return could be 
either a fixed rate or a variable rate, meaning that it is tied to a 
market indicator or index. It was suggested by one advocate for the 
plan that the minimum be set at a 3 percent annual rate of return. That 
would mean that account balances in the account would be credited with 
at least a 3 percent gain each year. The Working Group could not agree 
on an appropriate fixed rate of return. The Working Group, however, 
generally agreed that if the rate of return were variable, it should 
still be the same for all employees at any given time.
    Some members of the Working Group felt that the 3 percent minimum 
return was unreasonably low and does not provide adequate benefits for 
rank and file workers. These members preferred a 5 percent guaranteed 
rate of return. Some members argued that because higher-paid employees 
would be able to contribute more under the higher contribution limits 
and more flexible nondiscrimination tests of the GAP, they would take 
too great a share of the potential benefits under the plan. Other 
members said that if the plan required a 5 percent rate of return, more 
employers who adopted the GAP would probably opt for a variable rate to 
avoid this requirement.
    Larger Contributions for Older Workers in Top Heavy Plans. It was 
proposed to require a contribution minimum of 5 percent of compensation 
for all workers regardless of age, in top heavy plans,\35\ which are 
plans where key employees have amassed benefits greater than 60 percent 
of the entire pool of benefits. Tax Code regulations require top heavy 
plans to make minimum contributions to all employees. Most small 
business retirement plans eventually become top heavy because the 
compensation of key employees is higher and because there is more 
turnover among other employees. This turnover means fewer of them 
accumulate benefits.
    The group also considered a second option for top heavy plans that 
would allow for higher contributions to older workers and lower 
contributions to younger workers. Supporters of this option said it 
would give employers more flexibility in designing plans to meet the 
age demographics of their work forces. The proposed formula was as 
follows: Workers age 30 or under would receive contributions equal to 3 
percent of compensation. Workers age 30 but not over age 50 would 
receive 5 percent of compensation. Workers over age 50 would receive 7 
percent of compensation.
    The Working Group was divided on whether to support the option to 
provide higher contribution minimums for older workers. Some members 
who were opposed said that the low annual rate of return on account 
balances would harm younger workers. Some members who supported higher 
contribution rates for older workers noted that the plan would still be 
subject to nondiscrimination testing.
    Flexible Approaches to Nondiscrimination Testing. Congress requires 
all qualified retirement plans to satisfy nondiscrimination rules, 
which are intended to ensure that such plans do not overly favor 
highly-compensated employees over other employees. The group engaged in 
lively discussions about whether GAP should import the 
nondiscrimination rules applicable to defined contribution plans, 
including complex testing methods known as age-weighting or cross-
testing.\36\
    In a nutshell, cross-tested methodologies allow employers to 
contribute substantially more (as a percentage of pay) to older plan 
participants, without violating the nondiscrimination rules--even if 
most of the older employees are highly compensated.\37\ This 
methodology is based on the premise that a contribution to an older 
plan participant is inherently less valuable than the same contribution 
to a younger plan participant since the latter contribution will have 
more time to accumulate investment returns. Small firms whose owners 
and other favored employees were older than rank-and-file employees 
often used cross-testing methodologies to favor those employees. Recent 
variations on cross-testing methodologies allow some firms to deny the 
benefits of cross-testing to older rank-and-file employees by creating 
subgroups of participants for nondiscrimination testing, provided they 
contribute at least a minimum 5 percent of pay contribution on behalf 
all rank-and-file employees. (Plans that use these methodologies are 
sometimes called new comparability plans.) \38\
    Some members of the group believed that GAP should be able to use 
age-weighting methodologies to prevent GAP from being at a competitive 
marketing disadvantage compared to defined contribution plans. Other 
group members argued that these methodologies were highly technical 
ways of directing benefits to highly compensated employees and should 
either not be permitted in GAP or only permitted if plans using them 
were required to direct additional benefits to lower-paid employees.
    The group had a lively discussion on this issue, with group members 
articulating various views. Most of the members of the group agreed 
that subjecting GAP to more exacting nondiscrimination rules than those 
applicable to defined contribution plans would essentially mean that 
employers would not adopt them. One group member observed that more 
than 75 percent of new defined contribution plans were using cross-
testing and new comparability methodologies. Moreover, the Department 
of Treasury, after lengthy consideration, adopted new regulations that 
provided minimum contribution requirements for many new comparability 
plans. These same rules, including the minimum contribution 
requirements, would apply to GAP. People who expressed this view also 
noted that if policy demanded limiting cross-testing methodologies, 
they should be limited for defined contribution plans as well as GAP 
and that this was an issue that was outside the Conversation on 
Coverage's focus on creating new plans. These group members also 
suggested that there would, in fact, be fewer plans if cross-testing 
methodologies were limited generally.
    A few members of the group argued that GAP's features would attract 
employer interest regardless of whether or not cross-testing 
methodologies are available, particularly given that older highly-paid 
individuals could earn larger benefits in GAP than in a defined 
contribution plans. These members said that since a key objective of 
the Conversation on Coverage is to focus on rank-and-file employees, 
GAP should be designed in a manner that directs meaningful levels of 
benefits to such employees.
    The group generally agreed that the use of cross-testing 
methodologies be conditioned on the employer providing a higher minimum 
benefit than would be provided for a non-cross-tested GAP. For example, 
under current regulation, the minimum contribution for cross-tested 
defined benefit plans is 5 percent. Consequently cross-testing 
methodologies would only be permitted for a GAP if the employer made a 
5 percent minimum gateway contribution for all employees.
    The group also discussed what minimum ``gateway'' contribution 
percentage made to all employees would be appropriate for a safe harbor 
from nondiscrimination rules if the employer wanted to use the higher 
defined benefit plan maximum contribution rules. A majority of the 
group supported allowing cross testing only if the employer contributed 
6 percent of pay gateway contribution for all employees in the plan.
    Some members said they would be willing to support allowing cross-
testing methodologies for the designated minimum gateway contribution 
levels above if the GAP plan also provided that the minimum annual rate 
of return on account balances was higher than 3 percent.
    Minimum Contribution Requirements for Nondiscrimination Safe 
Harbor. The members of the Working Group discussed what minimum level 
of contributions would be required to allow employers to avoid 
nondiscrimination tests.\39\ Several potential arrangements were 
discussed: a minimum contribution for a stand-alone GAP, a minimum for 
a combined GAP with a 401(k) feature, and a minimum for a top-heavy GAP 
either alone or in combination with a 401(k). No agreement was reached 
on this point.
    Converting from an Existing Plan to a GAP. In recent years some 
employers who converted their traditional defined benefit pension plans 
to cash balance plans encountered charges of age discrimination. Some 
employers were criticized for the method they used in calculating how 
the value of the benefit accrued under the traditional plan was 
determined and transferred to an opening balance in the cash balance 
plan.\40\ As a result of strong objections that were raised, cash 
balance plans encountered legal and political obstacles that have yet 
to be resolved. To avoid the problems encountered by cash balance 
plans, the Working Group considered whether or not it should bar an 
employer with a traditional defined benefit plan from converting to a 
GAP.\41\ Several members opposed allowing a conversion to a GAP from a 
traditional plan. Some members warned, however, that if a conversion to 
a GAP is disallowed that employers might instead convert to a defined 
contribution plan, a less desirable outcome than converting to a GAP, 
according to most group members.
    The Working Group also considered whether or not to allow an 
employer to convert a cash balance plan to a GAP. There were some who 
favored allowing such a conversion provided the cash balance plan had 
not previously been converted from a traditional pension plan and 
provided the GAP were not started up by an employer following the 
termination of a converted cash balance plan.
    The Working Group discussed whether or not it should prohibit the 
adoption of a GAP by a company that freezes an existing traditional 
defined benefit plan. There were some who opposed allowing a freeze and 
new GAP, unless the change was part of an agreement negotiated by a 
union. Some members suggested that such a prohibition might lead 
employers to adopt a defined contribution plan after freezing a 
traditional plan.
                       the plain old pension plan

Areas of Broad Agreement on the Design of POPP

    The Plain Old Pension Plan proposal was originally introduced by a 
member of the group and later revised by that member and presented 
again to the group for discussion. In some cases, discussions 
surrounding issues that arose with GAP also proved helpful in 
discussing the provisions of POPP.

    The Working Group generally agreed to the components of the plan as 
spelled out in this section. The basic design elements are as follows:

     The plan is a simple, easy-to-understand traditional 
defined benefit plan that provides a modest basic benefit to allay 
employer concerns about funding the plan.
     The final basic benefit is based on a percentage (as low 
as 1 percent) of an employee's career average pay multiplied by the 
number of years of service.
     The plan would allow employers to fund bonus benefits in 
any given year or years that would raise the final benefit without 
having the bonus benefits become part of the permanent benefit 
structure.
     The plan would permit, but not require, a generous past 
service credit that would be attractive to small business owners.
     All benefits from the plan would be paid in the form of an 
annuity. Lump sum distributions would not be permitted.

    Basic Plan Benefit. The basic plan benefit would accrue at 1 
percent a year of the career average income times the number of years 
of service. To make the calculations simpler, plans could rely on 
tables published annually by the Treasury Department or the Pension 
Benefit Guaranty Corporation that would be expressed as a table using 
age and compensation to determine the contribution each year. The 
amounts set forth in the table would be determined by the governmental 
agency using very conservative actuarial assumptions. Employers would 
calculate each year's required contribution by aggregating the 
contributions on the table for each participant. Some members of the 
Working Group suggested that the government publish the actuarial 
tables required in this plan every 5 years instead of annually. The 
actuarial assumptions in the tables would be conservative, to make 
funding shortfalls unlikely.
    Employees Covered. The plan would cover all employees who meet the 
minimum service requirements, including part-time employees. Employers 
would not be required to cover seasonal employees (but could, if they 
wished). Thus, the plan would typically cover a secretary who worked 3 
days a week, but not a college student working for the summer. If the 
employer has separate lines of business, the plan could be adopted for 
one line of business only.
    Vesting. An employee is said to be ``vested'' in a pension when the 
employee becomes entitled to the benefits of the plan, including 
employer contributions to a plan and their earnings. The time until a 
benefit is vested is defined for most plans under guidelines set forth 
in Federal pension law.\42\ As modified, this proposal would allow for 
either 3-year cliff vesting or 2- to 6-year graded vesting. With cliff 
vesting the participant becomes entitled to the benefit balance that 
has accrued all at once after 3 years from the date the participant 
joined the plan. Under graded vesting, the portion of the benefit in 
the plan that is vested rises in equal portions each year until it 
reaches 100 percent after the graded vesting period. Vesting would only 
count service from the date POPP was adopted unless the employer chose 
to count years prior to adoption of POPP.
    Past Service Credit. The plan allows for past service credit for as 
many years as the employer would like. The past service credit would 
have to be amortized; that is, funded in regular installments over a 7-
year period. Likewise, employees would accrue the past service credit 
over a 7-year period.\43\ An employer could give past service credit 
for benefit purposes without giving vesting credit for those years.
    Bonus Benefit. In years when the investments in the plan do very 
well, in years when the company's profits are strong, or at any other 
time, the employer may give a bonus benefit to employees without 
committing to a permanent benefit increase. For example, in good years 
employees could accrue a benefit of 2 percent of compensation instead 
of 1 percent. Or, the employer might increase the benefit by the cost-
of-living, and such COLAs would be treated as a bonus benefit for the 
years they covered.\44\ Past service credit could also be given for a 
bonus benefit.
    Minimum Benefit. There would be no required minimum benefit even if 
the plan is top heavy because the minimum benefit is built into the 
benefit formula, which provides the same level of benefits for all 
employees.
    401(k) Feature. The plan could contain a 401(k) feature. 
Participants could ``buy'' more retirement income through contributions 
using the Government tables to determine the cost. Or, the employer 
could offer a separate 401(k) plan with an employer match for employee 
contributions and profit sharing contributions that would be invested 
in the traditional 401(k) investments.
    Simplified Funding Rules. POPP was designed to simplify the funding 
rules and reduce employer concerns about the plan developing large 
unfunded liabilities that might overwhelm a small business. For this 
reason, the plan will allow for an approach that will smooth changes in 
actuarial assumptions, as well as gains and losses in the assets held 
in the plan. As proposed, the plan would be subject to periodic 
actuarial valuations, primarily to assess investment experience since 
mortality and interest rates would be covered automatically under 
tables. Investment experience would be smoothed by using a 10-year 
rolling average of the asset valuation (or, if less, the number of 
years since the plan was established). Investment shortfalls would be 
funded in installments over 5 years. However, the use of conservative 
actuarial assumptions is likely to significantly reduce the chances 
that plans will have funding shortfalls.
    Joint and Survivor Annuity. The plan was designed to have 
withdrawals from the plan be made only in the form of a qualified joint 
and survivor annuity. Lump sums would not be allowed.
    Terminated Participants. Under the proposed plan design, the 
benefits of terminated participants could be transferred to the Pension 
Benefit Guaranty Corporation, the Federal Agency that insures pension 
benefits--or held in the plan for distribution at retirement age.
    Pension Benefit Guaranty Corporation Insurance. The plan would be 
insured by the PBGC and would pay $5 premiums, lower than those paid by 
traditional pension plans. When plans are terminated, the plan assets 
are transferred to the PBGC and the agency takes over the payment of 
pension benefits.\45\ The agency guarantees pension benefits at normal 
retirement age and most early retirement benefits.\46\ The agency 
provides a maximum benefit guarantee, which is adjusted every year and 
is $3,801.17 per month for 2005 for workers who retire at age 65.\47\ 
By contrast, the flat rate premium for single employer defined benefit 
plans is $19 per member per year. (The PBGC in early 2005 proposed 
raising the flat rate premium to $30 as part of an effort to strengthen 
its finances.) Plans that are underfunded have to pay an additional 
adjustable rate premium.\48\ A lower premium was recommended to 
mitigate one of the objections that employers have to adopt defined 
benefit plans; namely, the cost of pension insurance premiums.
    Plan Termination. If the plan is terminated, there would be no 
reversion of any surplus assets to the employer. Under current law, 
overfunded plans can be terminated and a portion of the surplus can be 
transferred to the employer who sponsored the plan. The process of 
transferring the funds back to the employer is called a reversion. 
Under this provision, the excess would be used to increase benefits of 
current employees to compensate them for the lost opportunity to accrue 
more benefits and could also be used to increase benefits for retirees. 
Some members of the Working Group objected to the proposed reversion 
rules and suggested instead that the plan be governed by existing 
reversion rules.
    Conversion to Traditional Defined Benefit Plan. The plan could be 
amended at any time to become a more traditional defined benefit plan. 
The converted plan would be permitted to use all available 
nondiscrimination testing methodologies available to regular defined 
benefit plans.\49\ After conversion, the employer would adopt its own 
actuarial assumptions and run the converted plan like a traditional 
defined benefit plan, including provide a minimum benefit to all 
workers eligible to participate if the plan is top heavy.\50\
    Tax Credit. As proposed, the plan would allow employers a tax 
credit equal to 5 percent of the contributions made to fund benefits 
for non-highly compensated employees \51\ for a period of 5 years. The 
credit would be recaptured by the Internal Revenue Service if the 
employer terminates the plan within 5 years. This provision would help 
employers cover the costs of providing the benefits to all workers, 
including part-time workers who are not seasonal workers.
    The Working Group generally agreed that the tax credit should be 
higher than 5 percent and should be similar to the level of the Saver 
Credit, which provides a 50 percent credit for contributions up to 
$2,000. Members also said the tax credit for POPP could be similar to a 
temporary tax credit that was offered on contributions to PAYSOPS, 
Payroll Stock Ownership Plans.
    Some members of the Working Group were worried that the tax credit 
might be an incentive for an employer to convert a more generous 
traditional defined benefit plan to a POPP. A member suggested that the 
tax credit be limited to the first 5 years of the plan.
    Required Legislative Changes. The proposed provisions of POPP are 
mostly available under current law. However, legislation would be 
needed to authorize the PBGC to issue contribution tables, to operate 
terminated, sufficient plans, and to act as a clearinghouse for rolled 
over or transferred benefits. Legislation would also be needed to 
permit a 401(k) feature in a defined benefit plan, and enact the tax 
credit for contributions for non-highly compensated employees.
    The Working Group discussed POPP and its proposed provisions and 
generally agreed that the plan had attractive features and that they 
should offer it as a plan to be considered by employers, employees, 
consultants, plan providers and policymakers. The Working Group also 
agreed that the plan would garner more attention from potential 
employers and plan providers if the required legislative changes were 
enacted by Congress.
    Several members expressed doubt that Congress would be interested 
in supporting a new type of defined benefit plan. One member suggested 
that while Congress might not be receptive to the idea of supporting a 
new defined benefit plan, it was helpful nevertheless for the Working 
Group to put forward an idea that the members generally agreed had 
merit. Some members remained skeptical that POPP was sufficiently 
attractive to employers and some questioned whether it would be 
marketed by financial institutions and other prototype plan providers. 
One member said that the proposed benefit based on 1 percent of income 
might be too low to attract the enthusiasm of employees.
                  tax incentives for expanded coverage
    The Working Group submitted ideas for tax incentives that would 
encourage employers to maintain or extend defined benefit plan coverage 
to more employees. These included ideas to reward companies for 
retaining a defined benefit plan, ideas for adopting specific 
provisions that would expand coverage, as well as incentives to start-
up new defined benefit plans.
    The members considered 13 tax credit ideas and adopted some and 
rejected others.

Tax Credits Generally Supported by the Working Group

    Immediate Vesting. The Working Group generally supported giving 
employers a tax credit to provide immediate vesting of benefits.
    100 Percent Coverage of Employees in a Single Line of Business. The 
Working Group generally supported tax credits for this goal.
    Reduction of the 1,000 Hours Requirement for Plan Participation and 
Benefit Accrual/Allocation. The Working Group generally supported the 
idea of reducing the requirement to 500 hours for part-time workers. 
They also agreed that seasonal workers could be excluded from the 500-
hours requirement.

Tax Credits With Some Support by the Working Group

    Establishment and Maintenance of a Defined Benefit Plan. The 
Working Group discussed several options for rewarding employers for 
establishing and maintaining a defined benefit plan. One member 
proposed giving employers a tax credit equal to the cost of PBGC 
premiums every 5th and 10th year. Other members thought this would be 
too expensive.
    Defined Benefit Plans Providing an Annuity Option Only. There was 
support within the Working Group for tax credits for plans that provide 
that benefits be offered only as an annuity, provided there was a 
threshold level for the requirement. Some supported a policy of 
exempting balances of $50,000 from the annuity requirement, while 
others suggested that the group should not set a dollar amount but ask 
the Department of Labor, PBGC, and Treasury to determine a level below 
which there is not a viable annuity market. Members supporting this 
provision said that the PBGC might be encouraged to offer annuities not 
provided by commercial users. One member, however, questioned the 
appropriateness of providing tax credits to employers ``to lock up the 
money'' of employees and recommended instead that employees be given 
the tax credit for taking their benefit as an annuity.
    Plans Not Permitting Pre-Retirement Age Distributions. There was 
support in the Working Group for tax credits for plans that adopted 
this prohibition, with an exception for benefits worth less than 
$5,000. It was seen as supporting the goal of building more assets for 
retirement. One member suggested that rollovers for those who leave a 
company before retirement be made to an IRA that restricted the final 
benefit to an annuity. One member, however, questioned the 
appropriateness of giving tax credits to employers to limit options for 
employees.
    No Use of Permitted Disparity. The Working Group considered a 
suggestion that a tax credit be provided to an employer that did not 
use nondiscrimination testing methods that permit disparity.\52\ The 
group was divided on whether or not to support a tax credit for this 
prohibition.
                         what can be done next
    The Conversation on Coverage in its next phase will consider what 
further steps it can take to promote coverage through adaptations of 
the two major new plan designs--GAP and POPP--to emerge from the 
Working Group. It could consider demonstration projects for an 
adaptation of the proposed two new plan types that would be allowable 
under current law in order to build support for making legislative 
changes to enact statutory changes to provide for a fuller range of 
provisions for the two proposed plans. These demonstration projects 
might help in refining the plans and help build support among potential 
plan providers for marketing the plans.

Definitions of Plan Types

Defined Benefit Plan

    A defined benefit plan is a pension other than an individual 
account plan that provides a regular monthly income after retirement 
that is determined according to a formula. It is not dependent on the 
actual contributions made to the plan or investment performance of the 
plan's assets. Benefits typically are determine based on a fraction 
\53\ of a worker's average earnings (either career earnings or certain 
high earnings years at the end of the worker's tenure) or a flat dollar 
amount multiplied by the number of years worked for the employer. For 
example, a defined benefit plan might offer employees a monthly 
retirement benefit equal to 1 percent of average compensation a year 
multiplied times the number of years worked. In this instance, if a 
worker averaging $40,000 a year worked 20 years, he or she would earn 1 
percent of $40,000 or $400 multiplied by 20 or $800 a month ($9,600 a 
year). In the alternative, a plan might promise a benefit of $40 per 
month times the number of years worked. If a worker put in 20 years of 
service, he or she would also receive $800 a month or $9,600 a year. 
The maximum benefit payable by a defined benefit plan in 2005 is 
$170,000 a year.
    Some newer defined benefit plan designs provide benefits that mimic 
the appearance of defined contribution plans, reporting benefits as a 
lump sum account balance. (See Cash Balance Plans below)
    Private sector defined benefit pension plans must provide 
annuities--either single life annuities for unmarried participants or 
joint and 50 percent survivor annuities for married participants--as 
the default form of benefit. The annuity from a defined benefit plan 
helps retirees (and their surviving spouses) by assuring them of a 
regular income based on a set formula for the rest of their lives.
    Not all retirees receive their defined benefit as a regular monthly 
stream of income, known as an annuity. Instead, some employers allow 
retirees to receive their accumulated benefit as a lump sum (with the 
consent of their spouses). If a retiree elects to take a lump sum where 
it is allowed, that retiree is responsible for deciding how to manage 
and invest those funds, as well as when and how much to pay out as an 
income.
    In a defined benefit plan, the worker does not have to make 
decisions about how to invest assets contributed by the employer into 
the plan. The employer is responsible for determining the amount of 
contributions needed to fund the promised benefits, making those 
contributions each year, investing the assets in such a way they will 
earn a sufficient return to provide for the funds needed to pay the 
promised benefit, and making up for any shortfall in the assets. Most 
benefits provided by defined benefit plans are guaranteed by the 
Federal pension insurance program managed by the Pension Benefit 
Guaranty Corporation. The maximum insured annual benefit for 2005 is 
$45,614.

Defined Contribution Plan

    A defined contribution plan is one that provides workers with an 
individual account and pays out benefits equal to contributions to the 
account and net investment earnings on the contributions. The 401(k) 
plan is the most well-known example of this type of plan. In a 401(k) 
plan, contributions can be made by the employer or the worker and 
employers often ``match'' employee contributions; that is, they provide 
an additional contribution tied to the amount of contribution the 
employee makes. In some defined contribution plans--typically 401(k) 
plans--employees must decide how to allocate all or part of their 
account balances among a set menu of investment options selected by the 
employer (e.g., among various mutual funds and employer stock). In 
other kinds of defined contribution plans--such as profit sharing, 
money purchase, and employee stock ownership plans--contributions are 
made by the employer. In these plans, the employer often invests the 
money in the employees' accounts.
    In most defined contribution plans, workers receive their benefits 
as lump sums when they leave their jobs. They may either roll over the 
account balance to an IRA or a new employer plan or use the money for 
other, nonretirement purposes. Defined contribution plans, other than 
money purchase plans (discussed below) are not required to offer 
annuity payouts and most do not. Upon retirement, an employee has an 
accumulated retirement savings that he or she will have to decide how 
to manage. The retiree has to decide whether to take part or all of the 
assets as an annuity, if that is an option. Or, perhaps the retiree may 
chose to set up a schedule of regular withdrawals. The retiree also has 
to decide how to invest the assets in retirement, including whether to 
change the asset allocation. With the 401(k), there are minimum 
distribution rules, which dictate a minimum withdrawal each year 
beginning at the age of 70\1/2\. Defined contribution plans, unlike 
defined benefit plans, are not insured by the Pension Benefit Guaranty 
Corporation.

Hybrid Plan

    A hybrid plan has characteristics of both defined benefit plans and 
defined contribution plans. The most common hybrid plan is the cash 
balance plan.

Cash Balance Plan

    A cash balance plan is a defined benefit plan that defines the 
benefit as a stated account balance. In a typical cash balance plan, 
each worker is credited on a periodic basis with a pay credit, a 
percentage of one's earnings, and an interest credit, which sets the 
rate of return for the account balance for that year. The interest rate 
can be either a fixed rate or a variable rate. Although cash balance 
benefits are reported as individual account balances, these accounts 
are only hypothetical. Workers' benefit amounts are unrelated to the 
employer's actual cash contributions to the plan and unrelated to the 
actual investment performance of plan assets. The benefit is based on 
the accumulated amount credited to each employee's account.
    As with all defined benefit plans, employers must offer employees 
the option of taking the benefit as an annuity as the default form of 
benefit.

Money Purchase Plan

    The money purchase plan is an employer-sponsored defined 
contribution plan that allows employers to contribute a set percentage 
of compensation for workers into the plan with a maximum annual 
contribution of $42,000 in 2005. This is the maximum for all defined 
contribution plans and, thus, is not a unique design element of the 
money purchase plan. Once an employer establishes a contribution level, 
the amount in subsequent contributions must be maintained until the 
employer makes a formal, prospective pronouncement that the 
contribution will be decreased or discontinued. Thus, contributions are 
made whether or not the business has a profit, which differentiates the 
money purchase plan from a profit-sharing plan, where contributions are 
made to employees' accounts at the discretion of employers, usually 
when there are profits. Unlike other defined contribution plans, money 
purchase plans must provide joint and survivor annuities for married 
participants and single life annuities for unmarried participants.
                               appendix a
                 db-k proposals considered by the group
    Three DB-K proposals were considered by the group, one from the 
American Society of Pension Actuaries (ASPA), one from the American 
Academy of Actuaries (AAA) and one from The Principal Financial Group. 
The proposals share common design features. Each provided both a 
defined benefit formula and the opportunity for workers to make tax-
deductible contributions from their wages and salaries to a defined 
contribution plan. Each plan provided a minimum defined benefit to all 
participants. All of the plans are designed to avoid nondiscrimination 
testing if they promise minimum benefits, and the plans have simplified 
rules for funding the defined benefit portion of the plan.
    DB-K Proposal No. 1. Under this proposed plan \54\ from the 
American Society of Pension Actuaries, there would be a single trust 
established for both the 401(k) and either a traditional defined 
benefit plan or a cash balance plan. However, the trust would have 
strict recordkeeping requirements whereby the assets of each of the 
defined benefit and 401(k) components of the plan would be accounted 
for separately. Accordingly, for example, any excess assets associated 
with the defined benefit portion of the plan could not be used for 
purposes of employer contribution requirements to the 401(k) portion of 
the plan.
    An advocate of this proposal suggested that many employers would 
likely choose a cash balance design over a traditional defined benefit 
plan for the defined benefit portion of the plan. The cash balance plan 
is a hybrid plan in which the employer credits contributions to a 
hypothetical account for each employee and guarantees a rate of return 
on money deemed to be allocated to those hypothetical accounts. (See 
description of plan types on page TK for information on cash balance 
plans.) The accumulated balance is converted to an annuity for payment 
at retirement age, but is typically made available as a lump sum 
payment.
    In order for employers to take full advantage of the concept, the 
ASPA proposal would require under the defined benefit portion of the 
plan a minimum benefit formula for eligible employees of 1 percent of 
final average compensation times up to 20 years of service. The 
proposal would offer employers a cash balance design option instead of 
a traditional defined benefit design. For the cash balance design 
alternative, the proposal contemplates that employers would credit an 
annual contribution for eligible employees to their hypothetical cash 
balance accounts equal to 5 percent of compensation. However, the 
proposal also permits employers to increase contribution levels for 
older workers on a graduated basis so that the plan more closely 
mirrors the increased benefit values for older workers provided under a 
traditional defined benefit plan.\55\ The plan also offered employers 
the choice of making a minimum contribution of 5 percent of pay to both 
the defined benefit and defined contribution side of the plan. The ASPA 
DB-K would also allow for additional accruals to the defined benefit 
arm of the plan based on what portion of income is contributed from 
compensation to the 401(k) side of the plan. In other words, employers 
could match employee contributions to the 401(k) plan by enriching the 
defined benefit side of the plan. There was considerable interest among 
members of the group in the plan, although there was some concern it 
might be an expensive plan, especially the graduated cash balance 
benefit.
    DB-K Proposal No. 2. The Principal DB-K plan was similar to the 
ASPA DB-K plan. However, it offered only a traditional defined benefit 
plan and not a cash balance option. The traditional defined benefit 
portion of the plan was designed to provide a worker who put in 20 
years of service an income equal to 25 percent of career average pay. 
It also offered an option where the benefit could also accrue at a 
higher rate over 10 years.
    DB-K Proposal No. 3. The DB-Plus Plan from the American Academy of 
Actuaries would allow employees to make pre-tax contributions to the 
defined benefit side of the plan. It would also allow for employer 
matches to employee contributions to the defined benefit side of the 
plan. Supporters of the DB-K Plus plan would seek legislative or 
regulatory clarification on current rules that would allow for 
employers who sponsor the plan to offer a higher rate of return for 
funds in the defined benefit side than is currently available under 
Internal Revenue Service rules to solve the so-called ``whipsaw'' 
problem.\56\ The plan would also allow for tax credits for 
contributions on behalf of low-income employees to be deposited into 
the plan.\57\ The plan encourages employers to set up an automatic 
default election that would put new employees into the plan with 
automatic contributions of 1 percent to 6 percent of pay (with 
increases when salaries increased) unless the employee affirmatively 
requests otherwise. The DB-K Plus also allows for distributions 
beginning at age 59\1/2\ even without termination of employment. 
Allowing distributions at age 59\1/2\ would allow members to have a 
phased retirement beginning at that age. The PBGC would insure all of 
the benefits of the DB-K Plus, as long as it was funded appropriately. 
Some members were concerned that because both the defined benefit plan 
and the 401(k) are in a single trust, it could mean that the PBGC would 
be deemed to have guaranteed the 401(k) side of the combination. Others 
raised concerns that the proposal would allow excess assets associated 
with the defined benefit component of the plan to be used to offset the 
cost of employer contributions under the 401(k) component of the plan.
                               appendix b
                 proposals considered and not endorsed
    Risk-Splitting Defined Benefit Plans. After its May 2003 meeting, 
the group formed a subgroup on risk-splitting. Several suggestions to 
share the risk of market performance between the employer and the 
employees were advanced for consideration. A proposal was considered 
for guaranteeing only 75 percent of the final benefit liability. Under 
this approach, the employee would share some of the risk associated 
with the funding obligation for 25 percent of the benefit, while the 
employer still retained responsibility for 75 percent.\58\ The group 
generally did not support any of the risk-splitting proposals. Those 
objecting stated such an approach would put additional burdens on the 
Pension Benefit Guaranty Corporation (PBGC), which insures defined 
benefit plans. The PBGC would face the difficult task of determining 
how much of the benefit should be paid if a plan is terminated and 
taken over by the agency. One member said that Congress would not be 
receptive to the idea of transferring risk to employees.
    Some members suggested that risk-splitting raises a question about 
whether employees should also share in some of the gains if a plan 
over-performs, and also whether employees should have a role in 
selecting investments. One member suggested it would be difficult to 
determine how much of a plan's underfunding was due to poor market 
performance and how much was due to the employer failing to make 
regular, adequate annual contributions. There was also concern about 
the complexity of the risk-splitting proposals before the group. 
Finally, some suggested that risk-splitting could already be 
accomplished by an employer sponsoring both a defined benefit plan and 
a defined contribution plan. While some members of the group believed 
that the concept of risk-splitting had some merit, no one suggested it 
should be listed as a group recommendation.
    SAFE Proposal. SAFE stands for The Secure Assets for Employees 
Plan, which was introduced as legislation in 1997 by Rep. Nancy Johnson 
(R-CT) and Rep. Earl Pomeroy (D-ND).\59\ This plan was designed to 
provide a minimum defined benefit that would be 100 percent funded.\60\ 
It would be funded either by an individual retirement annuity or 
through a trust. SAFE sought to reduce the regulatory burden on 
employers, to reduce uncertainty about potential unfunded liabilities 
and to give employers more flexibility in managing the plan than is 
possible with traditional defined benefit plans.\61\ Members of the 
group discussed the proposal but declined to endorse it.\62\ Members 
suggested that the group should come up with new proposals and not 
revisit previous proposals. Some members, noting the group's greater 
interest in other proposals, cautioned against possibly supporting too 
many proposals. Some group members also expressed concern that SAFE 
permitted designs under which business owners could capture too much of 
the plan's aggregate benefits.
    SMART Proposal. SMART stands for a Secure Money Annuity or 
Retirement Trust Plan, which was introduced by the Clinton 
Administration in February 1998 as a hybrid plan designed for business 
with fewer than 100 employees. Like the SAFE proposal, the SMART would 
offer a minimum guaranteed benefit at retirement \63\ with the 
potential for additional investment return if the assets perform above 
the base 5 percent benchmark.\64\ It would also be funded by an annuity 
or a trust. Members of the group discussed the proposal but declined to 
endorse it.\65\ As with the SAFE, members were in favor of new 
proposals rather than revisiting previous proposals.
    Improved Cash Balance Plans. The group discussed ways to make cash 
balance plans more attractive. Cash balance plans have been criticized 
for discriminating against older workers at some companies that 
switched from a traditional defined benefit plan to a cash balance 
plan. While some members strongly opposed cash balance conversions, 
there was some interest in cash balance plans that are started de novo 
by a company that previously did not have a defined benefit plan. 
Proposals to make cash balance plans more attractive included reduced 
insurance premiums for fully-funded cash balance plans and other 
ideas.\66\ Despite interest in this challenge, the effort to improve 
cash balance plans was eventually set aside, largely because some court 
decisions and regulatory issues had clouded the outlook for such plans 
and strong political opposition had emerged to the plans.
    A List of Incentives to Improve Coverage at Defined Benefit Plans. 
The group decided to create a list of tax incentives that would 
encourage desired behavior with respect to defined benefit plans, 
including such ideas as supporting tax credits for employers who expand 
pension coverage to part-time workers. The ideas the group supported 
are discussed earlier in this report.
    Other Ideas Listed in the Binders. The group also briefly reviewed 
other proposals from a list included in the binder and chose not to 
consider further any of those plans for endorsement. One proposal 
considered was by Ted Groom and John Shoven to eliminate most of the 
Federal rules governing pension plans, including nondiscrimination 
rules, as well as pension insurance and the Pension Benefit Guaranty 
Corporation. It was suggested by Groom and Shoven that more employers 
would offer plans if there were fewer rules governing them. The group 
also briefly discussed, but did not support, a proposal identified as 
the Individual Advantage Plan from Jim Davis of Milliman & Robertson 
that would allow workers the choice of the greater of a cash balance or 
a traditional formula.\67\
    Other Ideas Proposed by Members. The working group also considered 
ideas proposed by its members during its discussions. One member 
proposed eliminating the lump sum option for defined benefit plans. 
Increasingly, workers have chosen to take lump sums instead of an 
annuity, which provides a stream of monthly payments that continue as 
long as the annuitant lives. This idea was seen by some as being beyond 
the scope of the group's mission to expand coverage. The suggestion was 
also criticized because it can be costly for small businesses to 
purchase individual annuities, which might lead some small businesses 
to switch from a defined benefit plan to defined contribution plans. 
One member suggested that lump sums could be deposited into a central 
clearinghouse and, thus, avoid the high costs of purchasing individual 
annuities. There was some support for this approach, with one member 
suggesting that the PBGC could be the clearinghouse. The group, 
however, did not further refine the proposal.
                               appendix c
       contribution calculations for the guaranteed account plan

Case Study Showing Funding Method Over a 7-Year Period

Synopsis of Funding Calculation
    (1) Calculate total of hypothetical contributions for the plan 
year.
    (2) Calculate the value of the assets as of the valuation date, 
before any current contribution is added.
    (3) Calculate the sum of the Guaranteed Account Balances (GABs) as 
of the valuation date (excluding (1)).
    (4) Subtract (3) from (2). If this is a positive number, there has 
been an earnings gain. If this is a negative number, there has been an 
earnings shortfall.
    (5) If (4) is a net loss, calculate the amount that the earnings 
shortfall would be worth in 5 years (including the current year) under 
the plan's guaranteed rate of return (assume current year guarantee if 
the rate can fluctuate).
    (6) Calculate the amount that would be required to be contributed 
as of the valuation date to amortize the amount in (5) over the 5-year 
period.
    (7) Calculate the aggregate GABs as of the valuation date, 
including the amount in (1).
    (8) Subtract the amount in (2) from the amount in (7). This is the 
unfunded portion of the GABs. If (2) is larger than (7), the GABs are 
fully funded, and this amount is zero.
    (9) Minimum funding: The lesser of: (a) the amount in (1) plus the 
amount in (6), or (b) the amount in (8).
    (10) Maximum funding calculation (maximum deduction):
    (a) Calculate 1.5 times the amount in (7).
    (b) Subtract the amount in (2) from the amount in (10)(a). If this 
is a positive number, this is the most the employer can contribute on a 
deductible basis. If this is zero or a negative number, the maximum 
deduction is zero (i.e., the full funding limit).
    (11) Limitations on funding assumptions: pre-retirement discounts 
for turnover and mortality not permitted, no salary scale assumptions.
    (12) Plan is a money purchase plan for IRC  412 purposes, but is 
subject to the special minimum funding requirements stated above. 
Therefore, there would be no quarterly contribution requirement under 
IRC  412(m).
    (13) When calculating the aggregate Guaranteed Account Balances, a 
participant's account must be limited to the maximum lump sum permitted 
under IRC  415(b) if the account were to be distributed as of the 
valuation date.

Case Study

    A GAP is established which promises a 6 percent hypothetical 
contribution, and a 5 percent guaranteed rate of return. Contribution 
is allocable as of the last day of the plan year.
    Year 1: Total participant compensation is $1,000,000.
    Normal cost = $60,000.
    (This is the total compensation times the hypothetical contribution 
rate. There were no prior year contributions, so no guaranteed return 
for the first year.)
    GABs as of valuation date: $60,000.
    No earnings shortfall because the plan does not have any experience 
on the first valuation date.
    Minimum funding: $60,000.
    Maximum funding: $90,000.
    Employer's actual contribution: $60,000.
    Year 2: Total participant compensation is $1,100,000.
    Normal cost = $66,000. This is determined by calculating the 
hypothetical contribution for this year (6% x $1,100,000).
    Actual earnings since last valuation date: $2,392 (about 4%).
    Total value of assets as of the valuation date (before current year 
contribution is made): $62,392.
    The guaranteed return for this valuation period on the GABs from 
the prior valuation date: $3,000.
    GABs as of valuation date (excluding current year's contribution): 
$63,000 (i.e., the GABs as of the prior valuation date plus the 
guaranteed return on those GABs).
    Shortfall: $608 (i.e., assets minus pre-contribution GABs). This 
would be worth $776 in 5 years under the plan's guaranteed rate of 5%.
    Amortization payment for shortfall: $140 (round to nearest $1), 
based on a 5-year amortization period.
    Normal cost plus amortization payment: $66,140.
    Sum of GABs as of valuation date (including current year's 
contribution): $129,000 Shortfall on 100% funding: $66,608 (i.e., 
$129,000 minus $62,392).
    Minimum funding amount: $66,140 (i.e., the lesser of the normal 
cost plus amortization payment or the 100% funding shortfall).
    150% x GABs: $193,500.
    Maximum funding is: $131,108 (i.e., 150% x GABs minus assets as of 
valuation date).
    Employer's actual contribution: $66,500.
    Year 3: Total participant compensation is $1,340,000.
    Normal cost = $80,400. This is determined by calculating the 
hypothetical contribution for this year (6% x $1,340,000).
    Actual earnings since last valuation date: $1,154 (only a 1% rate 
of return).
    Total value of assets as of the valuation date (before current year 
contribution is made): $130,045.
    The guaranteed return for this valuation period on the GABs from 
the prior valuation date: $6,450.
    GABs as of valuation date (excluding current year's contribution): 
$135,450 (i.e., the GABs as of the prior valuation date plus the 
guaranteed return on those GABs).
    Shortfall: $5,405 (i.e., assets minus pre-contribution GABs). This 
would be worth $6,897 in 5 years under the plan's guaranteed rate of 
5%.
    Amortization payment for shortfall: $1,248 (round to nearest $1), 
based on a 5-year amortization period.
    Normal cost plus amortization payment: $81,648.
    Sum of GABs as of valuation date (including current year's 
contribution): $215,850 Shortfall on 100% funding: $85,805 (i.e., 
$215,850 minus $130,045).
    Minimum funding amount: $81,648 (i.e., the lesser of the normal 
cost plus amortization payment or the 100% funding shortfall).
    150% x GABs: $323,775.
    Maximum funding is: $193,730 (i.e., 150% x GABs minus assets as of 
valuation date).
    Employer's actual contribution: $82,000.
    Year 5: Total participant compensation is $1,400,000.
    Normal cost = $84,000. This is determined by calculating the 
hypothetical contribution for this year (6% x $1,400,000).
    Actual earnings since last valuation date: $17,224 (6% rate).
    Total value of assets as of the valuation date (before current year 
contribution is made): $324,362.
    The guaranteed return for this valuation period on the GABs from 
the prior valuation date: $15,832.
    GABs as of valuation date (excluding current year's contribution): 
$332,475 (i.e., the GABs as of the prior valuation date plus the 
guaranteed return on those GABs).
    Shortfall: $8,113 (i.e., assets minus pre-contribution GABs). This 
would be worth $10,355 in 5 years under the plan's guaranteed rate of 
5%.
    Amortization payment for shortfall: $1,874 (round to nearest $1), 
based on a 5-year amortization period.
    Normal cost plus amortization payment: $85,874.
    Sum of GABs as of valuation date (including current year's 
contribution): $416,475 Shortfall on 100% funding: $92,113 (i.e., 
$416,475 minus $324,362).
    Minimum funding amount: $85,874 (i.e., the lesser of the normal 
cost plus amortization payment or the 100% funding shortfall).
    150% x GABs: $624,712.
    Maximum funding is: $300,350 (i.e., 150% x GABs minus assets as of 
valuation date) Employer's actual contribution: $100,000.
    Year 6: Total participant compensation is $1,600,000.
    Normal cost = $96,000. This is determined by calculating the 
hypothetical contribution for this year (6% x $1,400,000).
    Actual earnings since last valuation date: $36,368 (9% rate).
    Total value of assets as of the valuation date (before current year 
contribution is made): $460,729.
    The guaranteed return for this valuation period on the GABs from 
the prior valuation date: $20,824.
    GABs as of valuation date (excluding current year's contribution): 
$437,298 (i.e., the GABs as of the prior valuation date plus the 
guaranteed return on those GABs).
    Shortfall: $0 (the plan is now running at an experience gain).
    Amortization payment for shortfall: $0 (round to nearest $1), based 
on a 5-year amortization period.
    Normal cost plus amortization payment: $96,000.
    Sum of GABs as of valuation date (including current year's 
contribution): $533,298 Shortfall on 100% funding: $72,569 (i.e., 
$533,298 minus $460,729).
    Minimum funding amount: $72,569 (i.e., the lesser of the normal 
cost plus amortization payment or the 100% funding shortfall); the plan 
will have to be brought to full funding this year.
    150% x GABs: $799,948.
    Maximum funding is: $339,219 (i.e., 150% x GABs minus assets as of 
valuation date).
    Employer's actual contribution: $200,000 (Things are going well, 
the employer puts in extra for a rainy day and to get a bigger 
deduction).
    Year 7: Total participant compensation is $2,000,000.
    Normal cost = $120,000. This is determined by calculating the 
hypothetical contribution for this year (6% x $2,000,000).
    Actual earnings since last valuation date: $31,009 (5% rate).
    Total value of assets as of the valuation date (before current year 
contribution is made): $691,738.
    The guaranteed return for this valuation period on the GABs from 
the prior valuation date: $26,665.
    GABs as of valuation date (excluding current year's contribution): 
$559,963 (i.e., the GABs as of the prior valuation date plus the 
guaranteed return on those GABs).
    Shortfall: $0 (the plan is still running at an experience gain).
    Amortization payment for shortfall: $0 (round to nearest $1), based 
on a 5-year amortization period.
    Normal cost plus amortization payment: $120,000.
    Sum of GABs as of valuation date (including current year's 
contribution): $679,963 Shortfall on 100% funding: $0 (i.e., assets 
exceed the GABs).
    Minimum funding amount: $0 (i.e., the lesser of the normal cost 
plus amortization payment or the 100% funding shortfall).
    150% x GABs: $1,019,945.
    Maximum funding is: $328,207 (i.e., 150% x GABs minus assets as of 
valuation date).
    Employer's actual contribution: $0.
                               appendix d

                            Contribution Calculations for the Plain Old Pension Plan
----------------------------------------------------------------------------------------------------------------
                                                                $30,000/     $60,000/    $100,000/    $200,000/
            Compensation  Age                   year         year         year         year
----------------------------------------------------------------------------------------------------------------
30..........................................................         $585       $1,170       $1,950       $3,900
40..........................................................         $960       $1,920       $3,200       $6,400
50..........................................................       $1,584       $3,168       $5,280      $10,560
55..........................................................       $2,043       $4,086       $6,810      $13,620
60..........................................................       $2,666       $5,333       $8,888      $17,776
65..........................................................       $3,537       $7,074      $11,790      $23,580
----------------------------------------------------------------------------------------------------------------

Mortality Assumption: 1994 Group Annuity Mortality table projected to 
2002*
Interest Rate Assumption: 5%
Plan Formula: A lifetime pension = 1 percent times current compensation 
at age 65, payable monthly.
*This is the mortality table required by IRS to calculate minimum lump 
sums from pension plans.

Endnotes

\1\ Traditionally defined benefit plans were designed to provide 
workers with a replacement income that, when combined with Social 
Security, would be sufficient enough to maintain their standard of 
living. However, some defined benefit plans are not designed to provide 
a replacement rate sufficient to maintain a worker's standard of 
living. Instead, they may be designed to provide supplementary income 
with a predictable income stream to add a worker's retirement income. 
For this reason, employees with a defined benefit plan will still need 
assess how much they need in retirement and how determine much they may 
need to save to provide a sufficient replacement income beyond the 
income that will be available from Social Security and a stream of 
income from a defined benefit plan.
\2\ The normal benefit is an annuity, but many defined benefit plans 
offer a lump sum or other payout options. If a retiree does not elect 
an annuity, then the retiree is faced with the task of managing the 
lump sum over one's retirement years. Increasingly, retirees from 
defined benefit plans can also select a lump sum option. In 2000, 45 
percent of full-time private sector employees worked at firms with 
defined benefit plans offered a lump sum option, according to the 
Bureau of Labor Statistics. To the extent that retirees select a lump 
sum option, they must then also devise a plan for managing those assets 
during retirement.
\3\ Private sector pensions insured by the Pension Benefit Guaranty 
Corporation are guaranteed up the statutory limits, now roughly about 
$44,000 if the benefit starts at age 65.
\4\ From Department of Labor data for 2000 and 2001, as reported in 
Constantijn W. A. Panis, ``Annuities and Retirement Satisfaction,'' 
Pension Research Council Working Paper PRC WP 2003-19, The Wharton 
School, University of Pennsylvania, mimeo, 2003, p. 8.
\5\ U.S. Bureau of Labor Statistics, Employee Benefits in State and 
Local Governments, 1998, Bulletin 2531 (Washington, D.C.: U.S. 
Department of Labor, December 2000, Table 1, p.5.
\6\ Panis, p. 8.
\7\ Patrick J. Purcell, ``Pensions and Retirement Savings Plans: 
Sponsorship and Participation,'' (Washington, D.C. Congressional 
Research Service, October 22, 2003), p. 5.
\8\ Ibid.
\9\ Pension Benefit Guaranty Corporation, Pension Insurance Data Book, 
April 2004, Table S-33, p. 57.
\10\ Ibid.
\11\ Ibid, Table S-31, p. 55 and Table M-6 on p. 84.
\12\ U.S. Department of Labor, Pension and Welfare Benefits 
Administration (now the Employee Benefits Security Administration), 
Abstract of 1998 Form 5500 Annual Reports, Private Pension Plan 
Bulletin, Number 11 (Winter 2001-2002).
\13\ U.S. Bureau of Labor Statistics, Employee Benefits in Medium and 
Large Private Establishments, 1997, Bulletin 2517 (Washington, D.C.: 
U.S. Department of Labor, September 1999), Table 133, p. 107.
\14\ U.S. Department of Labor, Bureau of Labor Statistics, National 
Compensation Survey: Employee Benefits in Private Industry in the 
United States, 2000, Bulletin 2555, January 2003, p. 66, Table 78.
\15\ The 30-year treasury rate is used for calculation of the deficit 
reduction contribution and certain other purposes. In recent years 
Congress has provided temporary relief from the 30-year Treasury rate 
as the standard for calculating the benefit obligation. For plan years 
2004 and 2005, employers can use a corporate bond rate.
\16\ For employers, the group generally agreed that the following 
criteria should be considered: reduced regulation, low administrative 
costs, low contribution costs, high benefits for owners and officers, 
attractiveness to prospective employees, designs that are helpful in 
retaining current employees, designs with tax benefits to the company 
and owner, designs with contribution flexibility for the owners. For 
employees, the group generally agreed the following criteria should be 
considered: low costs and high returns, protection against investment 
risk, control over assets, portability of assets, protection against 
longevity risk, protection against inflation, tax benefits, 
psychological benefits of owning assets, simplicity and fairness for 
employees, and the adequacy of benefits provided under the proposal. 
From a public policy standpoint: effectiveness of the revenue dollars 
spent, and the degree to which savings are preserved for retirement 
rather than withdrawn earlier for other purposes. Proposals were also 
judged on how well they could be sold to Congress, employers and 
employees. They were also judged on how marketable they might be by 
financial institutions and benefits consultants.
\17\ Nondiscrimination testing is required under Internal Revenue 
Service rules to ensure that highly compensated employees do not derive 
a much greater benefit from a qualified plan than non-highly 
compensated employees. There are two broad tests. One is Actual 
Deferred Percentage (ADP) Test which measures the rate at which 
employees elect to make contributions. The other is the Actual 
Contribution Percentage (ACP) Test that measures the rate of employer 
matching and after-tax contributions.
\18\ On the contribution issue, the group explored the possibility that 
a combined 3 percent employer contribution for all employees to the 
defined benefit and defined contribution side of the plan would be 
sufficient to avoid nondiscrimination testing and top heavy rules.
\19\ There was also support for providing a joint and survivor annuity 
on the 401(k) side, and for distributions as early as 59\1/2\ years old 
on the defined benefit side to make it easier for workers to engage in 
phased retirement.
\20\ The chief Federal pension law is the Employee Retirement Income 
Security Act of 1974, often referred to as ERISA.
\21\ As explained by the staff of the Joint Economic Committee in 2003 
(See reference at the end), the full funding limit is generally defined 
as the excess, if any, of (1) the lesser of (a) the accrued liability 
under the plan (including normal cost) or (b) 170 percent (for 2003) of 
the plan's current liability (including the current liability normal 
cost), over (2) the lesser of (a) the market value of plan assets or 
(b) the actuarial value of plan assets (i.e., the average fair market 
value over a period of years). However, the full funding limit may not 
be less than the excess, if any, of 90 percent of the plan's current 
liability (including the current liability normal cost) over the 
actuarial value of plan assets. In general, current liability is all 
liabilities to plan participants and beneficiaries accrued to date, 
whereas the accrued liability under the full funding limit may be based 
on projected true benefits including future salary increases. The full 
funding limit based on 170 percent of current liability is repealed for 
plan years beginning in 2004 and thereafter, but is slated to be 
reinstated in plan years beginning in 2010. Thus, in 2004 and 
thereafter, until 2010, the full funding limit is the excess, if any, 
of (1) the accrued liability under the plan (including normal cost), 
over (2) the value of the plan's assets, but in no case less than the 
excess, if any, of 90 percent of the plan's current liability over the 
actuarial value of plan assets, as described above. Reference: 
``Present Law and Background Relating to the Funding Rules For 
Employer-Sponsored Defined Benefit Plans and the Financial Position of 
the Pension Benefit Guaranty Corporation (PBGC),'' Scheduled for a 
Public Hearing Before the Subcommittee on Select Revenue Measures of 
the House Committee on Ways and Means on April 30, 2003, prepared by 
the Staff of the Joint Committee on Taxation, April 29, 2003.
\22\ Traditional pension plans have to make up unfunded balances, 
according to descriptions prepared by the staff of the Joint Committee 
on Taxation in April 29, 2003 (See reference at the end), there are two 
categories of old unfunded liabilities (those that occurred prior to 
the plan year just ended). The employer has to calculate a current 
contribution required to amortize the unfunded liability for each of 
these two categories. The first amount is, in general, the amount 
necessary to amortize the unfunded old liability under the plan in 
equal annual installments until fully amortized over a fixed period of 
18 plan years, beginning with the first plan year that starts after 
December 31, 1987. The second amount is, in general, the amount needed 
to amortize the additional old unfunded liability over a period of 12 
years, beginning with the first plan year that starts after December 
31, 1994. In addition, plans have to make a contribution for any new 
unfunded liability that occurs in the year just ended. If the plan is 
less than 60 percent funded, the employer must contribute 30 percent of 
the new unfunded liability into the plan. The applicable percentage 
decreases by .40 of 1 percentage point for each percentage point by 
which the plan's current liability percentage exceeds 60 percent. 
Reference: ``Present Law and Background Relating to the Funding Rules 
For Employer-Sponsored Defined Benefit Plans and the Financial Position 
of the Pension Benefit Guaranty Corporation (PBGC),'' Scheduled for a 
Public Hearing Before the Subcommittee on Select Revenue Measures of 
the House Committee on Ways and Means on April 30, 2003, prepared by 
the Staff of the Joint Committee on Taxation, April 29, 2003.
\23\ Making the past service credit available to all employees would be 
deemed to satisfy the nondiscrimination requirements.
\24\ However, if the plan is a profit-sharing, 401(k) or stock purchase 
plan, current law states the plan is not required to offer an annuity 
provided the spouse receives 100 percent of the account balance if the 
employee dies while covered by the plan. The law also states that if 
the plan does not offer an annuity and the employee does not die while 
covered by the plan, the employee can withdraw the account balance as a 
lump sum or other non-annuity payment without spousal consent when the 
employee leaves the plan.
\25\ Elective contributions are contributions voluntarily made by 
employees into a retirement savings plan or pension plan.
\26\ Under one safe harbor, the nondiscrimination test would be 
satisfied if the employer contributed 100 percent of an employee's 
contribution up to 3 percent of compensation and 50 percent an 
employee's contribution up to an additional 2 percent of compensation.
\27\ The calculation for lump sums in all defined benefit plans occurs 
through a two-step process. This process presents special issues, 
however, when the plan in question is not a traditional defined benefit 
plan but is, instead, a plan whose benefit is an account balance. 
Several courts have held that the above-described procedure must be 
used to determine lump sum values for cash balance plans. The manner in 
which this is done is to credit interest through an employee's 
retirement age, convert the resulting retirement-age balance to an 
annuity, and then determine the present value of that annuity. 
Generally speaking, if the plan's crediting rate is higher than the 
statutory benchmark interest rate, the lump sum amount will be higher 
than the participant's balance in his account. Thus, a cash balance 
plan is not permitted to pay the account balance in these 
circumstances. This phenomenon has been called whip-saw.
\28\ PBGC guarantees ``basic benefits'' earned before your plan ended, 
which include (1) pension benefits at normal retirement age, (2) most 
early retirement benefits, (3) disability benefits for disabilities 
that occurred before the plan was terminated, and (4) certain benefits 
for survivors of plan participants. PBGC does not guarantee health 
care, vacation pay, or severance pay.
\29\ PBGC's maximum benefit guarantee is set each year under provisions 
of ERISA. For pension plans ending in 2004, the maximum guaranteed 
amount is $3,698.86 per month ($44,386.32 per year) for workers who 
retire at age 65. This guarantee amount is lower if you begin receiving 
payments from PBGC before age 65 or if your pension includes benefits 
for a survivor or other beneficiary. The guarantee amount may be higher 
if you retire after age 65 or if you are over age 65 and receiving 
benefits when the plan terminates.
\30\ Underfunded single-employer plans pay an additional variable-rate 
premium of $9 for every $1,000 (or fraction thereof) of unfunded vested 
benefits. The proposed GAP would have the variable rate premium would 
be phased in for the first 5 years as follows: 20 percent for year 1, 
40 percent for year 2, 60 percent for year 3, 80 percent for year 4 and 
100 percent for year 5.
\31\ The limits for contributions and benefits are within section 415 
of the Internal Revenue Code. For defined contribution plans, the 
current annual contribution limit is currently $41,000 a year for 2004. 
For defined benefit plans, employers can contribute each year toward 
providing a maximum benefit at retirement of $165,000. However, 
employers face maximum tax deduction limits, too, that can limit the 
amount that can be contributed in any given year into defined benefit 
plans.
\32\ The Tax Code sets the rules for converting the maximum allowable 
annuity into a lump sum for purposes of applying the maximum benefit 
limit applicable to defined benefit plans. Under that limit, defined 
benefit plans can pay no more than $165,000 a year as an annual 
retirement benefit. At the time the Working Group was meeting, the Tax 
Code required that plans use the 30-year Treasury rate for converting 
the annuity benefit into a lump sum for this purpose. Treasury has 
discontinued issuing 30-year bonds and the 30-year rate has declined 
considerably in recent years. This has meant that lump sums based on 
the 30-year interest rate assumption have been sharply higher than in 
the past.
\33\ In fact, Congress in April 2004 passed a law to temporarily 
replace the 30-year Treasury rate with a 5.5 percent interest rate for 
2 years (2004 and 2005) for purposes of calculating the maximum defined 
benefit limit.
\34\ Nondiscrimination testing is required under the Tax Code to ensure 
that highly compensated employees do not derive a much greater benefit 
from a qualified plan than non-highly compensated employees. There are 
two broad tests. One is the Actual Deferred Percentage (ADP) Test which 
measures the rate at which employees elect to make contributions. The 
other is the Actual Contribution Percentage (ACP) Test that measures 
the rate of employer matching and after-tax contributions.
\35\ Plans are top heavy when key employees amass benefits greater than 
60 percent of the entire pool of benefits. A key employee is any 
employee who during the plan year was: (1) an officer of the employer 
who received more than $130,000 (adjusted for cost of living) in 
compensation from the employer, (2) a 5 percent owner of the employer, 
or (3) a 1 percent owner who received more than $150,000.
\36\ The name ``cross-testing'' refers to the rationale for these 
rules. The rationale is as follows: the present value of annual 
accruals in traditional defined benefit plans is larger for an older 
employee than a younger employee. For example, if a 25-year old 
employee and a 60-year old employee are each promised an annuity 
benefit of $1 at age 65, the employer must make a larger contribution 
for the older employee than for the younger employee because there will 
be less time for the contribution to earn interest. Treasury 
regulations permit a defined contribution plan to test an allocation to 
an employee's account as if it were a defined benefit with a present 
value equal to the contribution. Thus, the contribution is ``cross-
tested'' as if it were a benefit under a defined benefit plan.
\37\ The maximum contribution, however, is limited to $41,000 annually, 
under section 415 of the Internal Revenue Code.
\38\ Current treasury regulations permit some plans to use new 
comparability testing methods only if they provide a 5 percent 
``gateway'' contribution for all plan participants.
\39\ Nondiscrimination testing is required under Internal Revenue 
Service rules to ensure that highly compensated employees do not derive 
a much greater benefit from a qualified plan than non-highly 
compensated employees. There are two broad tests. One is Actual 
Deferred Percentage (ADP) Test which measures the rate at which 
employees elect to make contributions. The other is the Actual 
Contribution Percentage (ACP) Test that measures the rate of employer 
matching and after-tax contributions.
\40\ In some cases, it required some older workers to work several 
years before the balance in their cash balance account rose from the 
initial balance in the account at the time of the transition. This 
period in which no new benefits were added has been described as a 
period of wear away.
\41\ The Working Group also discussed whether or not an employer should 
be required to wait 2 years after terminating a traditional defined 
benefit plan before being allowed to start a GAP. The members disagreed 
on this suggestion, with some noting that employers might instead 
terminate a defined benefit plan and adopt a defined contribution plan.
\42\ The chief Federal pension law is the Employee Retirement Income 
Security Act of 1974, often referred to as ERISA.
\43\ The past service credit would be calculated by adding \1/7\ of the 
past service career average compensation to the employee's current 
compensation. For example, if an employee has always earned $20,000 per 
year and is entitled to 14 years of past service, the employee will be 
treated as earning $60,000 for the first X years of the plan for 
purposes of calculating the contribution. In this example, the employer 
could decide that only 50 percent past service credit is given, so the 
employee would only be deemed to earn $40,000 for those years. An 
employee who leaves before the full 7-year amortization period will 
only received the accrued past service credit that has vested on 
termination date. The reason for this is that, if pension benefits are 
viewed as deferred wages, the benefits earned after he plan is in 
effect are part of the bargained for package, but past service credit 
would be a windfall. Seven years of service for full accrual would 
encourage employees to give past service credit as a retention device.
\44\ For example, an employer can tell an employee that his or her 
benefit at 65 was increased by 3 percent, which translates into an 
additional accrual on this year's salary equal to, for example, 1 
percent.
\45\ If a POPP were terminated and fully funded, the employer would 
have the option of keeping the plan and paying out benefits when due or 
transferring the benefit obligations and assets to the PBGC. If the 
employer transfers the benefit obligation and assets to the PBGC, 
annuitization would no longer be required, as PBGC would pay the 
benefit guaranteed under its authority, and lump sums would no longer 
be allowed.
\46\ PBGC guarantees ``basic benefits'' earned before your plan ended, 
which include (1) pension benefits at normal retirement age, (2) most 
early retirement benefits, (3) disability benefits for disabilities 
that occurred before the plan was terminated, and (4) certain benefits 
for survivors of plan participants. PBGC does not guarantee health 
care, vacation pay, or severance pay.
\47\ PBGC's maximum benefit guarantee is set each year under provisions 
of ERISA. For pension plans ending in 2004, the maximum guaranteed 
amount is $3,698.86 per month ($44,386.32 per year) for workers who 
retire at age 65. This guarantee amount is lower if you begin receiving 
payments from PBGC before age 65 or if your pension includes benefits 
for a survivor or other beneficiary. The guarantee amount may be higher 
if you retire after age 65 or if you are over age 65 and receiving 
benefits when the plan ends.
\48\ Underfunded single-employer plans pay an additional variable-rate 
premium of $9 for every $1,000 (or fraction thereof) of unfunded vested 
benefits. The proposed POPP would have the variable rate would be 
phased in for the first 5 years as follows: 20 percent for year 1, 40 
percent for year 2, 60 percent for year 3, 80 percent for year 4 and 
100 percent for year 5.
\49\ The plan could use cross-testing, permitted disparity and any 
other formulas permitted under Section 401(a)(4).
\50\ A plan is top heavy when key employees amass benefits greater than 
60 percent of the entire pool of benefits. A key employee is any 
employee who during the plan year was: (1) an officer of the employer 
who received more than $130,000 (adjusted for cost of living) in 
compensation from the employer, (2) a 5 percent owner of the employer, 
or (3) a 1 percent owner who received more than $150,000.
\51\ Highly compensated employees are those who earn at least $90,000 a 
year.
\52\ Under the Tax Code plans that meet the minimum contribution 
requirements of a safe harbor plan to avoid nondiscrimination testing 
must still also fall within the bounds of permitted disparity.
\53\ The accrual rate is the percentage of final salary or final 
average salary which builds up for each year of service or membership 
of a defined benefit plan. For example, the plan may specify a 
retirement benefit of 1.5 percent of final average salary for each year 
of service. The annual accrual rate, therefore, is 1.5 percent (of 
final average salary). Can also be referred to as benefit scale.
\54\ If the DB-K has a cash balance plan instead of a traditional 
defined benefit plan, the plan would require a 2 percent minimum 
contribution for workers under age 30, 4 percent for workers ages 30 to 
40, 6 percent for workers ages 40 to 50, and 8 percent for those over 
age 50. Or, the plan could have a safe harbor if there is a combined 5 
percent of pay contributed to both the defined benefit and defined 
contribution side of the plan.
\55\ This alternative would provide a safe harbor from 
nondiscrimination testing for plans where the employer contributed 2 
percent for employees under age 30, 4 percent for employees age 31 to 
39, 6 percent for employees 40 to 49, and 8 percent for employees 50 
and over.
\56\ It has been suggested that IRS Notice 96-8 makes it difficult to 
provide a rate of return higher than the Treasury rate for employee 
contributions in a defined benefit plan. Since employees can get a 
higher return in their 401(k) plans, they would have little incentive 
to voluntarily contribute to a DB-K plan if the return were going to be 
less. This could be done if policymakers clarified that Section 
411(a)(7)(A)(i) of the Internal Revenue Code would apply to DB-K plans 
and, thus, allow the defined benefit plan to provide a market rate of 
return.
\57\ In the Economic Growth Tax Relief and Reconciliation Act of 2001 
(EGTRRA), Section 25B provides for a tax credit to match contributions 
from low-income employees into a defined contribution plan. The DB-K 
Plus proposal would make these credits available for a tax credit match 
for employee contributions to the defined benefit side of the DB-K Plus 
plan.
\58\ The group also considered an approach that would guarantee only 
those benefits that had been in place for at least 10 years. The group 
also considered an approach that would set higher premiums for 
insurance from the Pension Benefit Guaranty Corporation (PBGC) for 
plans that have higher allocations to equities. Typically equities, 
over time, earn more than bonds; however, earnings can be very 
volatile. Reducing the equity exposure would reduce volatility in the 
pension funding obligation, a key employer concern that was identified 
by the group as impeding the implementation of defined benefit plans.
\59\ The Secure Assets for Employees Plan Act was numbered H.R. 1656 
and introduced in the House of Representatives on May 16, 1997.
\60\ In the case of a SAFE Trust, the employer would be liable for 
additional contributions in years when returns in participant account 
did not earn 5 percent. SAFE plans would not be insured by the Pension 
Benefit Guaranty Corporation.
\61\ Employers would fund the plan with contributions of 1, 2 or 3 
percent of pay for each year they worked. In lean years the corporation 
could scale back the contribution to 1 or 2 percent. Individuals could 
also reap higher benefits than the minimum 5 percent return on funds in 
their accounts of the investments performed better than 5 percent.
\62\ One objection to the SAFE plan was that its past service provision 
made it too rich for an IRA.
\63\ Employees would be credited with either 1 percent or 2 percent of 
their salary for each year they worked, with 3 percent possible for the 
first 5 years of the plan.
\64\ In the case of a SMART Trust, the employer would be liable for 
additional contributions in years when returns in participant accounts 
did not earn 5 percent. The employer who chose the SMART Trust would 
pay reduced premiums to the Pension Benefit Guaranty Corporation, which 
would guaranty the minimum benefit for the Trust. SMART Annuity plans 
would not pay a premium and the benefit would not be guaranteed by 
PBGC.
\65\ One objection to the SMART plan was that it did not relax 
nondiscrimination rules, but simply provided a safe harbor.
\66\ The group was asked to consider ways to solve the age-
discrimination issues and the problems associated with whipsaw, which 
is a situation where an employee can get a benefit after leaving an 
employer that is higher than the employee's account balance.
\67\ The Individual Advantage Plan was developed as a way to deal with 
cash balance conversions, but was also touted as a way for new plans to 
deal with older workers. One member said that he doubted anyone would 
start up a new plan that gave such a choice.
                                 ______
                                 
  Report on the Conversations and Recommendations of Working Group II
                       working group's assignment
                          answer this question
How do we increase coverage and retirement savings by providing new 
incentives to encourage employees to save for themselves, and 
incentives for employers to contribute increased amounts for employees 
in low tax brackets?
                           february 22, 2005
Co-Chairs: Regina Jefferson and Randy Johnson

Working Group Members: Dean Baker, Michael Calabrese, Kenneth Cohen, 
Mark Iwry, Michael Kelso, John Kimpel, Lisa Mensah, Diane Oakley, Eric 
Rodriguez, Eugene Steuerle, and David Wray

Executive Summary

    The proportion of workers who participate in workplace retirement 
plans has remained at or near 50 percent for many years, despite a 
number of efforts by Congress and successive Administrations to adopt 
policies intended to expand coverage. One of the goals of Working Group 
II was to look for ways to expand participation to include 
substantially more of the uncovered half of the workforce and to 
increase the level of saving by those who participate. The group was 
especially focused on low and moderate income workers--those who are 
most likely to lack coverage by a workplace retirement plan.
    The group set out to expand coverage and saving by offering to 
support proposals that are intended to do the following:

     Prompt more employers to offer access to retirement 
savings plans.
     Expand the number of workers who are eligible to 
participate in an existing employer-sponsored retirement plan.
     Increase the overall level of saving by workers in 
workplace retirement savings plans, especially among those who save the 
least--low and moderate income workers.

    The group began as a collection of members with a great deal of 
expertise on the key issues before them, but with very diverse and 
strongly-held views. Over the course of more than half a dozen meetings 
of the entire group and additional subgroup meetings, the members 
hammered out a consensus in areas where members held common ground, 
often outstripping the member expectations about the degree to which 
agreement could be reached.

The Retirement Investment Account Plan

    The group's chief accomplishment was to reach general agreement on 
the broad outlines of a new centralized broadly-based savings account 
vehicle, the Retirement Investment Account Plan or MA. This plan is 
targeted at workers at companies that do not currently have a 
retirement plan, as well as workers at firms where there is a 
retirement plan, but where some workers are not eligible to 
participate.
    Members of the group supported the MA because it was believed that 
this approach offers great promise in providing access to retirement 
saving for a substantial portion of uncovered workers. One of the 
reasons the proposed plan will be helpful is because it largely removes 
the administrative burden of sponsoring a plan, a key concern of 
employers who do not now sponsor a plan. By giving employees access to 
a workplace retirement system, it is likely to also dramatically 
increase the chances that workers will contribute toward retirement 
savings.
    As this report will show, much work was put into the details of a 
potential MA plan and much progress was made on many building blocks of 
the system. Even where there was not a general agreement on the 
details, there was often agreement on the framework in which the 
details could be resolved.
    The group generally agreed on the following broad outlines of the 
RIA plan:

     Accounts Will Be Managed By a Central Clearinghouse. The 
RIA plan will be offered through a government-authorized central 
clearinghouse that would be run by the private sector.
     Contributions Can Be Made Through Payroll Deductions. The 
system would be set up to receive contributions from employees through 
payroll deductions by the employer of amounts indicated by employees. 
The system would also be able to receive contributions by employers.
     How the Infrastructure Will Work. The employer will send 
the employee and employer contributions to the U.S. Treasury, and 
Treasury, in turn, will forward contributions to the central 
clearinghouse.
     Participant Contributions Made in a Default Investment. 
Contributions to the RIA plan will be placed in a default investment 
pool that will be a balanced, diversified fund which could also be a 
lifestyle or life cycle fund.
     Participants Can Select From Simplified Investment 
Choices. Participants who wish to choose investments beyond the default 
choice will have a simplified choice of investment options chosen by 
the clearinghouse.

Policies to Expand Coverage in All Retirement Savings Plans

    The members of the group also supported a number of initiatives 
they felt would increase the level of participation and the level of 
retirement saving by and for workers at companies where there is 
already a workplace retirement plan. These include:

     Automatic Enrollment. The group generally supported 
continuing the policy whereby employers voluntarily offer automatic 
enrollment to new hires as a way to prompt workers to contribute 
regularly to their accounts in the plan.
     Automatic Rollovers. The group generally supported 
designating the Thrift Savings Plan--an employer-sponsored saving plan 
for Federal Government employees--as a central national receptacle for 
rollovers for accounts with balances from $1,000 to $5,000 for 
employees who leave a firm. This policy would make it easier for many 
employers to roll over such sums and would likely preserve retirement 
savings for more workers.
     Default Investment Mix. The group generally agreed to 
support a change in Federal pension law to provide a safe harbor to 
allow employers to voluntarily offer employees a default investment 
option that would automatically place their contributions in a balance, 
diversified fund that could be a lifestyle or life cycle fund.
     Saver's Credit. The members generally agreed to support an 
extension and expansion of the Saver's Credit, which provides 10 to 50 
percent government matches for individual contributions of low and 
moderate income workers. The program is slated to sunset in 2007.
     Financial Education. The group generally supported a 
proposal to encourage high schools and colleges to provide basic 
financial education, including education on retirement saving and 
health care finances.

The Mission

    The mission of Working Group II was to review and discuss proposals 
to increase the portion of the work force that participates in a 
workplace retirement saving plan, as well as to increase the level of 
overall retirement savings in plans. The group also was asked to review 
and discuss incentives for employers to contribute increased amounts 
for employees in lower tax brackets.

Principles and Standards

    Members of the Working Group generally agreed on a list of 
principles and standards by which it would evaluate proposals. The 
principles include:

     The effort would be collaborative while inviting diverse 
thinking. It would focus on workers with incomes below the median, 
especially low-income workers, and it would consider the unintended 
consequences of proposals.
     Proposals should be efficient to administer and simple to 
communicate to workers and have a nationally consistent set of rules.
     Proposals should be judged on whether they are 
economically efficient and feasible, both in the short-term and the 
long-term, as well as whether or not they involve minimal interference 
in economic, investment and labor markets.
     Proposals should be judged by whether or not they offer 
flexible terms and rules for both employees and employers.
     Proposals should be politically viable, both in the short-
term and the long-term.
     Proposals should be judged on whether or not they enhance 
retirement income security for all U.S. citizens.
     Proposals, when considered in total, should be equitable 
in their benefits and contributions. They should be equitable 
``horizontally'' (meaning that it affects people the same whether or 
not they have access to an employer-sponsored plan), as well as when 
viewed ``vertically'' (meaning across all income levels).

Background

    The goal of providing a retirement plan for all workers is an 
ambitious one. In 2003, for example, only about 57 percent of American 
workers had access to a retirement plan sponsored by their employer, 
according to the Bureau of Labor Statistics. A majority of these 
workers--about 51 percent--have access to a defined contribution 
retirement savings plan, such as the 401(k) plan.\1\
    Employees participating in a defined contribution plan often save 
by determining what portion of their wages is to be taken from their 
regular pay and contributed to their plan. Employers often match those 
contributions. Workers who participate in defined contribution plans 
usually have the responsibility of determining how much they expect 
they will need to save for retirement and how much they would like to 
contribute out of each pay period. Workers also often are given choices 
to make between several investment options within a plan. When they 
retire, workers with defined contribution plans received lump sum 
distributions and, therefore, have to decide how to manage the 
accumulated savings to provide income across their retirement years.
    Some of the areas where improvements can be made in coverage can be 
found in some of the details of the employer surveys of coverage in 
different segments of the workplace population. Medium and large 
businesses (100 employees or more) had a participation rate of 65 
percent, while small businesses (99 or fewer workers) had a 
participation rate of 35 percent.\2\ Further, the participation rate 
for all full-time workers of all private sector businesses was 58 
percent, significantly higher than the 18 percent for all part-time 
workers.\3\
    Expanding participation in workplace plans is important for other 
reasons. It appears to be the best way to increase retirement saving. 
If one looks at Federal income tax return data, the proportion of 
filers who claim an IRA or Keogh deduction has been both fairly modest 
and steadily declining over time. From a peak of 16.2 percent in 1986, 
it fell to 3.5 percent in 2000 and 2001.\4\ In contrast, the 
participation rate in workplace plans is 66.2 percent of those eligible 
for 401(k) plans (a population of workers that represents 32.6 percent 
of the private sector workforce).\5\
    Increasingly, important decisions that will affect retirement 
income fall on the shoulders of individual workers. If more workers are 
to be able to save for retirement, more of them need to have access to 
and participate in a workplace retirement savings plan. Potential 
opportunities to increase the proportion of the workforce with access 
to a retirement saving and potential opportunities to increase 
participation by those already covered can be created in several ways, 
include the following:

     Employers who have plans can make it easier for more 
workers to participate in those plans.
     Employers who do not have retirement plans, which are 
predominantly in the small business sector, can sponsor plans. (Working 
Group III has focused its efforts on developing a proposal for the 
small business sector).
     Incentives, such as tax credits for employees and/or 
employers, as well as government contributions into accounts, can 
increase the level of overall saving in existing retirement plans.
     Beyond this, the government can create new saving vehicles 
that will be more attractive to smaller employers and self-employed and 
contract workers.
     Employers who do not have retirement plans can facilitate 
access for its employees to new kinds of centralized savings vehicles 
that might be created.
     Government can also devise programs and incentives that 
target lower-income workers.
     Finally, efforts can be made to provide opportunities for 
financial education in high school and college so that more workers 
better understand the need to save for retirement and health care 
expenses and to be better prepared to plan for their future needs.

How the Working Group Went About Its Assignment

    To meet the challenges set out above, Working Group II decided 
initially to focus on ways to increase overall saving in existing 
plans, and ways to expand access to employer-sponsored retirement 
saving plans to more workers. The group also looked at tax-based 
incentives, including tax credits and tax deductions.
    The group looked at the existing Saver Credit program to see how it 
might be expanded and made permanent. It also looked at a range of 
incentives and ideas for improving coverage and saving--including 
automatic enrollment, default investment choices, and financial 
education--and reached agreement on a number of them. This is discussed 
in Section II of this report.
    Working Group II also examined ideas for setting up a new type of 
savings account program that would be patterned after the 401(k) plan, 
but would be more widely available to workers and even non-workers. The 
group devoted considerable time to developing a general agreement on 
the broad outline for a new individual account system named the 
Retirement Investment Account or RIA. The group examined how government 
credits and contributions might play a role in promoting retirement 
saving by low and moderate income workers, especially those who 
presently are not enrolled in an employer-sponsored plan.
    Members were invited to express their opinions about the incentives 
and proposals to increase saving and coverage, as well as the broad 
outline of the RIA. The group sought to reach consensus on as many 
points as they could. At times the group was unanimous or nearly-
unanimous in supporting or rejecting a given point. In this instance, 
the group was said to have ``generally agreed'' or ``generally 
disagreed'' on that point. At other times, the group found substantial 
agreement, while there was minor opposition. At other times, the 
opposition might be strong. When the group disagreed on a point or 
provision, members were invited to offer different options that might 
address that particular issue. Members of the group were assured that 
strong opposition would be noted in the report.
           section i: the retirement investment account plan
    Working Group II's primary accomplishment was its success in 
reaching general agreement on many of the broad outlines of a proposed 
new retirement vehicle, which the group named the Retirement Investment 
Account or RIA.

The Retirement Investment Account Plan at a Glance

    The group generally agreed that the Retirement Investment Account 
would be offered through a new privately-run, centralized 
infrastructure overseen by the Federal Government. The areas of general 
agreement are described below.
    The RIA and the new infrastructure are designed to make it possible 
to have a savings account vehicle potentially available to all workers, 
whether full-time, part-time, self-employed or contingent workers. 
Importantly, the RIA could potentially provide coverage to workers who 
are not now covered by a retirement savings plan. The potential for a 
broadly-based centralized system to boost retirement savings has long 
been a hope for those who would like to see the United States create a 
means whereby all working Americans could participate in a payroll-
withholding retirement scheme.
    In the interest of a harmonious outcome, the majority of the group 
supported making the program voluntary, although a number of members 
strongly favored making it mandatory. There was support also for 
providing a means for workers to contribute directly to the central 
clearinghouse without going through payroll deduction. This could 
include making contributions when filing annual income tax returns.

     Central Clearinghouse. A government-authorized central 
clearinghouse will handle contributions from employees into accounts in 
the RIA plan. The members generally agreed that the government will 
contract some or all of the services provided by the central 
clearinghouse to the private sector.
     Employer Facilitates Contributions. Employers will 
voluntarily help facilitate contributions from employees to the RIA 
plan, but do not have to become involved as plan sponsors; i.e., 
sponsors of the RIA retirement plan. Thus, they do not have to assume 
the responsibilities, fiduciary liabilities, and other burdens of being 
a plan sponsor for the RIA plan.
     Employee Contributions. Employees will indicate the level 
or amount of contributions they would like to have deducted from their 
wages on a regular basis on a revised W-4 form.\6\ The employer will 
transfer to the U.S. Treasury the amount an employee has elected to 
contribute to the RIA plan when the employer submits regular tax 
payments. Treasury, in turn, will forward contributions as soon as 
possible to the clearinghouse.
     Employer Contributions. Employers can also make 
contributions and matches of employee contributions to the RIA. The 
employer contributions, too, are sent along to the U.S. Treasury and 
forwarded as soon as possible to the clearinghouse.
     Default Investment Mix. Contributions to the RIA system 
automatically will be placed into a default investment in a balanced, 
diversified fund which could also be a lifestyle or life cycle fund.
     Investment Choices. For participants who wish to make a 
choice other than the default investment mix, there will be a 
simplified offering of investment options chosen by the clearinghouse.
     Government Credits and Matches. The RIA plan is set up in 
a way that would make it possible to offer government contributions and 
matches of employee contributions, as well as government tax credits. 
The group, however, while supporting government matches and tax credits 
in a general way, did not agree on a specific program.
     Offered in Conjunction With Other Plans. Employers at 
firms that already sponsor 401(k) and other retirement saving plans can 
also offer the workers access to the RIA plans. The target group, 
however, consists of workers who are not covered by or are ineligible 
to participate in an employer-sponsored plan.
     Contribution Limits. The group set limits on participant 
and employer contributions and matches at levels that are designed to 
prevent the RIA plan from undermining the success and appeal of the 
401(k) plan, the SIMPLE,\7\ and other defined contribution plans.

    Members of the group looked at initiatives that members felt would 
be beneficial without consideration for their budgetary impact and 
acknowledge that whatever program that might be proposed would be 
dependent on the Federal budget available at the time.

The Design Elements of the RIA Plan

    The group devoted many hours to discussing the details of how the 
RIA plan would work and how it would fit into the array of existing 
retirement plans without detracting from any of them. The group was 
able to reach some agreement on some of the design elements, but was 
divided on other elements, sometimes strongly divided. Each of the 
broad design elements of the RIA plan are presented below, along with 
the outcome from the group's discussions.

The Infrastructure for the RIA Plan

    The group discussed what type of infrastructure would work best to 
make the RIA plan accessible to employees, while reducing the potential 
burden on employers. The group also examined what would be needed in 
the infrastructure to implement potential government matches and tax 
credits for individuals.
Areas of General Agreement
    The RIA Will Be Run Through a Central Clearinghouse. The group 
generally agreed contributions from employees and employers to the RIA 
plan will flow into a government-authorized central clearinghouse. This 
infrastructure would allow employees to have a portable plan, to the 
extent that a future employer also participates in the RIA plan, and to 
the extent other flexible methods were found for employees to 
contribute directly.
    The Central Clearinghouse Will Be Privately Run. The group 
generally agreed that the government-authorized central clearinghouse 
would be run by the private sector. This approach was taken so that the 
RIA plan would not be seen by critics as creating a big government 
bureaucracy.
    Employees Will Indicate Contributions on W-4 Forms. The group 
generally agreed that employees would indicate what amount of their 
regular pay and compensation would be earmarked as a contribution to 
the RIA plan.
    Employer Will Remit Contributions to U.S. Treasury. The group 
generally agreed that employers will remit the employee-designated 
contributions to the U.S. Treasury. The group generally agreed that the 
employer also will send employer contributions to U.S. Treasury and 
will not remit directly to the clearinghouse.
    The U.S. Treasury Will Transfer Contributions to the Central 
Clearinghouse. The group generally agreed that the U.S. Treasury will 
forward contributions remitted by the employer to the central 
clearinghouse. The group deferred any decisions on how this should be 
done or how quickly it should occur, but generally favored an approach 
that transferred the funds in a timely manner.
    The Clearinghouse Will Credit Contributions Received from the U.S. 
Treasury. The group generally agreed that the clearinghouse will credit 
employee and employer contributions in designated individual accounts 
as funds are sent to it by the U.S. Treasury.
Areas Where Views Differed
    Government Oversight Agency. The group discussed which agency would 
oversee the clearinghouse, but members decided that the proposal for 
the RIA plan should not get into that level of detail.

Who Is Eligible to Participate?

    The group discussed whether or not to include several groups of 
workers: those under the age of 21, part-time workers, contingent 
workers, contract workers, the self-employed, household workers, and 
non-working spouses. Currently, workers from these groups are often 
excluded from required coverage for most retirement savings plans 
sponsored by employers. Excluding them helps employers meet 
nondiscrimination requirements. Self-employed workers do have access to 
existing tax-preferred retirement savings plans, such as the SIMPLE 
IRA.\8\
Areas of General Agreement
    All Wage Earners Eligible to Contribute. The group generally agreed 
that the RIA plan should be open to all Americans who earn an income. 
There were some, however, who did not agree. Some members preferred to 
limit access to the RIA plan to workers earning at least $5,000 a year. 
Some opposed to opening the RIA plan to all workers said they were 
concerned that it might set up a system that would collapse from having 
to administer millions of tiny accounts.
    Self-Employed Can Participate in RIA plan. The group generally 
agreed that the participation of the self-employed would not be 
affected by whether or not employers are required to make the system 
accessible to employees through payroll deductions. The reason is that 
the self-employed could include their contribution into the RIA plan 
when they send the IRS their quarterly income taxes. One member 
suggested that participation of self-employed be limited to those who 
earn at least $1,250 a quarter, which would maintain the $5,000 a year 
limit on participation.
Areas Where Views Differed
    Direct Contributions By Employees. The group discussed how 
individuals might contribute to the RIA plan if they are not able to 
contribute through payroll deductions arranged by their employer. The 
group failed to reach agreement on how this might be done. However, 
there were several suggestions that were offered.
    One member of the group suggested that an alternative method of 
contributing be set up that would allow workers to make contributions 
to the clearinghouse when they file their income taxes every year. 
Another member suggested that workers be allowed to designate a portion 
or all of their refund as a contribution into the RIA plan.
    Non-Working Spouses. The group could not reach general agreement on 
whether or not non-working spouses should be allowed to contribute to a 
RIA plan, as is now allowed with IRA's.
    Some in the group maintained that non-working spouses already have 
access to IRAs and that allowing them to participate in the RIA plan 
would make the system unnecessarily complicated. One member suggested, 
and others agreed, that the proposal remain silent about spouses but 
provide that it will be open to all citizens with earned income, which 
arguably would include what is allowed for contributions to IRA's by 
default. When spouses contribute to IRA's they are deemed to be self-
employed with no reported income. Others in the group contended that 
explicitly offering the RIA to unemployed spouses would assist them in 
preparing for retirement.
                           investment options
    The group discussed whether or not participants could be 
automatically enrolled in the plan, whether there might be a default 
investment choice, and whether there might be additional investment 
options in the plan.
Areas of General Agreement
    Automatic Enrollment. The group generally agreed that employers 
would be allowed to provide automatic enrollment. With this approach, a 
new employee would have to choose not to enroll. Otherwise he or she 
would be enrolled in the RIA plan.
    Automatic Investment in Default Balanced Fund. The group generally 
agreed that if employees do not elect to choose an investment 
option(s), their contributions to the RIA plan would automatically go 
to a balanced,\9\ diversified fund, which could be a lifestyle-oriented 
fund.\10\ A balanced fund is a common name for an investment fund which 
invests significant portions of its assets in each of the major 
investment asset classes: shares or equities, real property, fixed 
interest investments and cash. Lifestyle funds are one type of balanced 
fund that allocates funds between different classes of investments 
based on the participant's age and risk tolerance, and sometimes 
automatically adjusts the allocation as a person ages, becoming more 
conservative over time.
    The group's recommendation regarding the default choice reflects a 
growing trend in the 401(k) system in favor of a default choice of a 
balance fund or lifestyle fund. When a default option is offered, a 
member said, about 75 percent of workers usually accept the default 
investment.
    Clearinghouse Will Select Simplified Investment Options. The group 
generally agreed participants could elect to make a choice among one or 
more of a simplified offering of fund options. The group also generally 
agreed to let the choice of investment options to be determined by the 
clearinghouse.
    One member suggested that the range of choices should be limited to 
the types of choices offered in the Thrift Savings Plan.\11\ Another 
member suggested even fewer options: a balanced fund, an equity fund, 
and a short-term interest fund. One member suggested that some people 
may want a safer investment, such as Treasury bills or bonds. One 
member supported keeping contributions in the default investment in a 
balanced fund until the balance had reached a minimum level, which was 
not specified.

Employee and Employer Contribution Limits

    All defined contribution plans, including the 401(k), have 
contribution limits that affect how much employees and employers can 
contribute. Such limits are put in place partly to reduce the drain on 
government revenues and partly to assure that owners and high wage 
earners do not take too great a portion of the overall tax benefits 
provided to retirement savings plans.
    Over the years Congress has developed a range of simpler defined 
contribution plans with different sets of contribution limits than the 
popular 401(k). As new types of plans have been introduced, lawmakers 
have consciously tried to design them so that they do not work to 
undermine the success of existing plan designs.
Areas of General Agreement
    Why the RIA Has Contribution Limits. The group agreed that the RIA 
plan should have contribution limits for employee and employer 
contributions. The contribution limits would accomplish two things:

     Limits could help assure that higher paid employees and 
business owners do not disproportionally benefit from the MA plan.
     The limits could be kept low enough to prevent the 
proposed RIA plan from prompting employers to terminate their existing 
defined contribution plan, such as a 401(k). Such plans often feature 
employer matching contributions to encourage workers to contribute. 
This, in turn, increases the overall level of saving and encourages 
more workers to save.
    Contribution Limits Should Be Lower Than Those For the 401(k) Plan. 
The group generally agreed that the contribution limits should be set 
lower than those for the 401(k).
    One member explained his support for lower limits as follows: If 
new savings vehicles are set with limits that are too high, it would be 
a disincentive for small business owners to offer an employer-sponsored 
plan. Employers would instead offer workers access to the RIA plan. One 
member said that his business would drop its 401(k) plans ``in a 
heartbeat'' if the RIA plan were created with the same contribution 
limits as a 401(k). The reason is that the employer would no longer 
have to sponsor a retirement plan, educate workers about saving and 
offer matching contributions to get more of the lower paid workers to 
contribute so that the plan could pass nondiscrimination tests.
    Participant contributions to 401(k) plans are called elective 
deferrals in the Tax Code. For 2005, the limit was raised from $13,000 
to $14,000. Similarly, the limit on the salary deferrals \12\ was 
raised from $13,000 to $14,000 for 457 plans of State and local 
governments and tax-exempt. For SIMPLE plans \13\, either SIMPLE IRAs 
or SIMPLE 401(k)s, the limit was increased from $9,000 to $10,000. IRA 
contribution limits for 2005, by comparison, rose from $3,000 to 
$4,000.
    Participant Contribution Limits Set at $5,000 to $6,500. The group 
generally agreed that participant contribution limits should be limited 
to somewhere between $5,000 and $6,500. This contribution limit level 
would position the RIA plan in a niche below the 401(k) plan ($14,000 
limit) and the SIMPLE ($10,000 limits), but above the IRA ($4,000 
limit).
    Employer Contribution Limit Set at $4,000. The group generally 
agreed that voluntary employer contributions could be allowed to the 
RIA plan and that such contributions should be limited to $4,000 a 
year. The RIA contribution limit would position the plan in a niche 
below the 401(k)'s $14,000 limit and also below the SIMPLE's $10,000 
limit.
    Employers Can Choose a Nondiscrimination Safe Harbor for 
Contributions. The group generally agreed to support a 
nondiscrimination safe harbor from having to conduct nondiscrimination 
tests. The safe harbor can be achieved in one of two ways:

     The employer contributes 2 percent of pay into the RIA 
accounts of all workers.
     The employer contributes a match of $1 for each $1 
contributed by an employee into a RIA account for the first 2 percent 
of pay, followed by an employer match of 50 cents for each $1 
contributed by an employee for the next 2 percent of pay.

Withdrawals and Distributions from Accounts in the RIA Plan

    The group discussed when rules should apply for pre-retirement 
withdrawals for either loans or hardship, when changing jobs, when 
withdrawals can begin without penalty, and what rules would govern 
those withdrawals.
Areas of General Agreement
    Plan Allows Hardship Withdrawals, Does Not Allow Pre-Retirement 
Loans. The group generally agreed that the RIA plan would not allow 
loans on balances in the plan, but would allow for hardship withdrawals 
under tight rules. By contrast, in 401(k) plans, participants can take 
out loans against their balances and can have hardship withdrawals.
    Loans were opposed because they would add to the administrative 
burden of the plan for the central clearinghouse. Further, some argued 
that it may be difficult to get the loan prepaid because the RIA plan 
is not an employer-sponsored plan where the employer can arrange for 
payroll deductions to repay the loan. Finally, it was argued that loans 
would add difficult complications to implementing potential government 
tax credits. One member, however, strongly opposed a prohibition 
against loans, stating that the RIA plan should not be inferior to a 
401(k) plan. This member further contended that loans could be repaid 
through payroll deductions.
    Those supporting allowing hardship withdrawals under rules at least 
as stringent as those for 401(k) plans noted that it was important for 
low and moderate income savers to know that they could have access to 
their savings if they had an emergency. Otherwise, some would not 
contribute to the RIA plan or might contribute less if no pre-
retirement hardship withdrawals were allowed.
    No Need to Withdraw Funds When Employees Change Jobs. The group 
generally agreed there was no need for employees to withdraw funds due 
to a plan termination by the employer or because an employee changes 
job, since the RIA plan is associated with a central clearinghouse. 
Even if an employee's new employer does not participate in the RIA 
plan, the funds in the account can continue to enjoy gains from its 
investments. Also, contributions could potentially be continued 
directly to the government when participants file their annual income 
tax return.
    No Early Withdrawals of Government Contributions. The group 
generally agreed that government contributions or matches to accounts 
in the RIA plan could not be withdrawn at all before participants are 
eligible to withdraw employee and employer contributions without 
penalty. This prohibition was supported because it would assure that 
government contributions would go toward supporting participants in 
retirement and not for pre-retirement living expenses.
    Withdrawal Rules Made Consistent for Government, Employer, and 
Employee. The group, while disagreeing on what retirement age should 
be, did agree to make the age uniform for all sources of 
contributions--individual, employer and government--to avoid 
administrative complications if one source of funds faced special age 
restrictions.
    Roll Over Accounts Will Maintain Restrictions on Government 
Contributions. The group generally agreed that the prohibition against 
early withdrawal of government contributions would apply to funds from 
an account in the RIA plan that are rolled over to another retirement 
saving plan.
Areas Where Views Differed
    Age When Withdrawals Can Be Made Without Penalty. The group was 
unable to agree on what age a participant could begin to withdraw funds 
from an account in the MA plan without a penalty for early withdrawal. 
While the group was agreed that the age should be the same for all 
contributions--individual, employer and government--the group was 
divided into two groups about when the retirement age should be set for 
withdrawals. Some members preferred setting the age at 59\1/2\, which 
is the age when participants can begin to withdraw from a 401(k) plan 
without penalty. Other members, however, preferred setting the 
retirement age the same as those for Social Security, where retirees 
can begin to collect a reduced benefit at age 62, and those born in 
1940 can collect the full retirement age benefit at 65 and 6 months in 
2005 (although the age will increase gradually for later birth cohorts 
until it reaches 67 in 2027 for those born in 1960).
    Those who favored withdrawals without penalties at age 59\1/2\ said 
that the RIA plan should not be designed to be inferior to the 401(k) 
plan. The members preferring a later retirement age argued that it 
would preserve the government contribution until retirement age. Group 
members favoring a higher uniform age argued that a higher age for 
withdrawals without penalty could still allow for early withdrawals 
without a penalty due to disability, using the disability rules as 
defined by the Social Security Administration.
    Rollover Rules. The group left unresolved whether or not age 
restrictions set for the RIA plan might apply to funds that were rolled 
over from a RIA plan to another retirement savings plan. While the 
group did support the idea the government funds could not be withdrawn 
until retirement age as defined in the MA plan, it was not decided 
whether or not the age at which funds can be withdrawn without penalty, 
if different, would be transferred to the rollover account in another 
retirement plan.

Government Matches and Tax Credits

    The group discussed three governmental approaches to supporting 
employee contributions to the MA plan:
    1. Direct government contributions to the RIA account (which might 
be characterized as a refundable tax credit, but one that is 
automatically deposited in the account);
    2. A cash (spendable) refundable tax credit and
    3. A nonrefundable tax credit.
    A cash refundable tax credit (No. 2 above) gives the recipient the 
full value of the credit even if the credit exceeds his or her income 
tax liability. As a result, once the credit has eliminated any income 
tax liability the recipient might otherwise have had, any additional 
credit amount is paid to the individual in a check from the Treasury 
that can be used for any purpose.
    A nonrefundable tax credit (No. 3 above) gives the recipient only 
the value of the tax credit up to the recipient's tax liability. For 
example, a nonrefundable tax credit--such as the Saver's Credit under 
current law--would not provide any saving incentive or benefit to a 
worker who pays payroll taxes but has no income tax liability. (The 
group ranked this last among the three approaches.)
    By way of clarification, one member described both the refundable 
and nonrefundable tax credits (Nos. 2 and 3 above) as ``spendable'' tax 
credits to differentiate them from an automatic direct deposit of the 
credit by the government into an RIA account. A ``spendable'' credit is 
not automatically added to the individual's savings. Instead, to the 
extent that it wipes out the individual's income tax liability, it 
frees up other funds that would otherwise have been used to pay that 
tax. Such funds can then be used for any purpose; and to the extent 
that the credit is refundable and results in a check from the Treasury 
to the individual, the individual is, of course, free to use that for 
any purpose as well.
    The group also discussed whether or not the government could 
provide start-up subsidies for the system, as well as tax credits for 
employers who made contributions to accounts above and beyond what 
would be required under nondiscrimination rules.
Areas of General Agreement
    Government Can Offer Matching Contributions to Accounts in RIA 
Plan. The group generally agreed that government could match 
contributions made by employers to the RIA plan.
    Start-Up Subsidy for the System. The group generally supported 
providing a start-up subsidy to get the infrastructure of the RIA plan 
up and running and able to sustain itself.
Areas Where Views Differed
    Government Can Offer Spendable Tax Credits. There was strong 
support, but not general agreement that the government could support 
the RIA plan by offering ``spendable'' tax credits--that is either a 
cash refundable credit or a cash non-refundable credit--as opposed to 
limiting government credits to direct contributions into individual 
accounts in the RIA plan. Supporters noted that allowing spendable tax 
credits gets money into the hands of savers to spend as they wish. One 
member strongly supported a view that spendable tax credits paid to 
individuals are more likely to increase overall saving for retirement. 
However, some members objected to this approach because they felt that 
if government matches went directly into RIA accounts instead of into 
the hands of employees, it would better serve the goal of promoting 
retirement savings.
    Government Credits and Matches Deposited Only in RIA Accounts. 
There was considerable support, but not general agreement, for 
depositing into the RIA plan account all government contributions and 
matches of employee contributions for either the RIA or 401(k). Some of 
those who supported this approach said it would avoid administrative 
complications for the 401(k) system, such as trying to track down a 
former employee a year later when a government contribution arrived. 
Government matches, likely to be based on income levels, could not be 
made until an individual has filed an annual income tax return. Some 
members strongly opposed having government funds go only to the RIA 
plan, claiming it would undermine the 401(k) system. Another member 
favored having government matches be deposited in either the 401(k) or 
the RIA.
    Government Can Offer Matches and Tax Credits. Some members of the 
group supported a policy of both government contributions into 
individual RIAs, as well as government spendable tax credits. The group 
as a whole, however, did not generally agree to support this approach. 
Members supporting an approach that would combine both a match and a 
tax credit also recommended making it more attractive to choose the 
government match to be deposited into a RIA rather than receive a 
spendable credit. For example, a participant could choose between two 
options: (1) the government could deposit $500 into an account for a 
participant who contributed $1,000 to a RIA; or, (2) an employee who 
contributed $1,000 to a RIA could receive a $250 spendable tax credit.
    Can Employers Count Government Contributions for 401(k) 
Nondiscrimination Testing? The group did not support a suggestion to 
allow employers to take into account government contributions to RIAs 
for their employees when they conduct nondiscrimination tests for their 
401(k) Plans. One member who objected to this approach said it would 
lead to fewer employer contributions to 401(k) plans and recommended 
instead a tax credit for employers who make contributions to low-income 
workers that are above the level required under nondiscrimination 
rules.
    Government Seed Money and Super Matches. Most of the members agreed 
that tax incentives, such as small contributions for some or all RIA 
accounts in the system, would be helpful. However, supporters of tax 
incentives could not decide on which incentives to support. Some 
members favored direct contributions to RIAs for workers making less 
than $40,000. Other members favored a super match for initial 
contributions that would benefit lower income workers, such as offering 
a supermatch for the first $5,000 of lifetime savings. Members of the 
group recognized that these types of programs could be relatively 
costly, and acknowledged that whatever program that might be proposed 
would be dependent on the budget available at the time.
    Tax Credits for Employers. There was some support for a suggestion 
to provide tax credits for employers who made contributions or matches 
that are above and beyond levels employers are required to contribute 
to meet nondiscrimination rules and tests. However, the group deferred 
discussion on this point and was unable to address the subject again 
due to time constraints. Similarly, the group failed to reach agreement 
on supporting a tax credit for employers who contributed a higher 
percentage of pay to low paid workers than is contributed on behalf of 
all workers.

Should Employers Be Required to Provide Access to the RIA Plan?

    The working group discussed whether or not to recommend that 
employers be required to transfer contributions from employees who 
wanted to participate in the RIA plan. Members of the group were asked 
whether or not they supported making the MA plan mandatory in any or 
all of the following instances: (1) for workers at companies that do 
not offer employer-sponsored retirement plans, (2) for workers at 
companies that do sponsor plans who are not eligible to participate in 
those plans, and (3) for workers at companies that sponsor plans and 
who are eligible to participate in the plans.
    After discussion, the majority supported making access voluntary on 
the part of the employer to garner business support for the RIA plan. 
However, there were two members who felt strongly that the MA plan 
should be mandatory in all three instances above, while two other 
members supported making it mandatory only for workers who do not now 
have access to a retirement plan. The majority, however, supported 
making access to the MA voluntary on the part of the employer. Some 
members suggested that ways should be found to allow workers to 
contribute directly to the RIA, such as directing tax refunds to be 
deposited in a MA plan account.
    Those who supported a voluntary MA plan gave a range of reasons for 
their views. One member said he was against government mandates because 
they tend to discourage job formation and generally lead employers to 
reclassify workers into contract employees. In addition, the member 
said, mandates place a burden on small businesses. Another member 
argued that the burden of handling contributions would be far more 
onerous than some opponents realized. He noted that in his view it was 
employers, not the government, that do a great deal of the work 
involved with administering the Social Security system. Likewise, 
employers are the ones who will make the MA plan work.
    Those who supported making access to the MA plan required for 
employers felt strongly about the importance of this proposed 
provision. One member said that the need to provide retirement savings 
opportunities to half the workforce without a plan is so great that it 
would justify making access to it mandatory for employers. If it were 
required, the member suggested that the next step would be to launch a 
massive educational program to convince more workers to participate. 
Another member supporting mandatory access said the burden on business 
would be trivial. One member said that if the program was not required, 
it might be better to devote available resources to expanding the 
Saver's Credit to get more workers participating in a retirement 
savings plan.

Next Steps: A Pilot RIA

    Some members of the group supported a program to introduce the MA 
plan on a pilot basis to demonstrate how it can help increase saving 
and how it can work along side existing employer-sponsored plans. The 
experience from a pilot, it was suggested, might demonstrate that the 
RIA plan does not impose an unworkable burden on employers. If this 
were to be demonstrated, it could lead to support for requiring all 
employers to offer access to the MA plan, one member contended. Some 
members questioned whether it was feasible to do a pilot RIA, claiming 
it would be difficult to execute a pilot without new legislation and 
regulatory rules in place. One member was strongly opposed to a pilot, 
claiming that a pilot plan would be expensive to do, negating the low-
cost advantage of the RIA.
      section ii: proposals to increase saving in retirement plans
    The Working Group discussed a number of tax incentives, regulatory 
changes and other approaches designed to increase the number of workers 
covered in an already existing defined contribution plan, as well as to 
increase the amount of money saved and invested through the plan. They 
also looked at ways to increase coverage among low and moderate income 
workers who currently are either not in a plan or who save little 
through the plan in which they are enrolled.

Automatic Enrollment

    When workers are hired, some employers automatically enroll them in 
the 401(k) or other defined contribution plan unless the worker 
specifically requests on government forms that he or she would not wish 
to participate in the plan. The group discussed whether or not this 
should be mandated. The group discussed whether special incentives 
should be provided to encourage more companies to adopt automatic 
enrollment.
    The group discussed whether or not employers who have an automatic 
enrollment program could automatically place employee and employer 
contributions in a balanced fund, including a lifestyle fund. The group 
discussed whether special incentives, such as changes in fiduciary 
rules, should be provided to encourage more companies to place workers 
in a default investment mix. Many employers who have automatic 
enrollment presently allocate by default the funds in the account to a 
money market or other low-risk, fixed income fund. However, some 
employers also already allocate available funds by default to balanced 
funds. Others may be reluctant to allocate by default to balanced funds 
because of concerns about fiduciary liability for the choices of 
participants in the plan in a situation when the participant did not 
chose the investment, except by default.
Areas of General Agreement
    Automatic Enrollment of Workers. The group generally agreed that 
more employers should be encouraged to voluntarily offer automatic 
enrollment but that it should not be mandated by law. Under this 
approach, an employee would have to choose not to enroll; otherwise, he 
or she would be enrolled in the company's retirement saving plan. It 
was suggested that during the implementation phase of the Conversation 
on Coverage that a study be conducted of incentives to encourage 
automatic enrollment.
    Safe Harbor for Default Investment Into A Balanced Fund. The group 
generally agreed that employers should be given a safe harbor from 
fiduciary liability \14\ when they direct the funds of an employee who 
has not made a choice among investment options into a balanced, 
diversified fund, including a lifestyle fund. Some members noted that 
it might be difficult to get Congress and/or regulators to support a 
safe harbor for such an approach, since such safe harbors are based on 
the assumption that the participant chooses the investment.

Automatic Rollovers

    The group discussed whether or not employers should automatically 
place rollover funds of $1,000 to $5,000 from workers who have left the 
company in an investment other than a money market fund or low-return 
investment. When workers leave a company, employers are allowed to pay 
out employee balances up to $5,000. Balances between $1,000 and $5,000, 
if paid from the plans, are automatically rolled over into an 
Individual Retirement Account or IRA unless the employee designates to 
the contrary.\15\ Employees also can elect to take the money out of 
their retirement accounts.\16\
Areas of General Agreement
    Invest Rollovers for Better Earnings. The group generally agreed 
that when employees leave a company and are eligible for payouts of 
sums up to $5,000, it is important that amounts saved be retained for 
retirement purposes and not be spent on current needs.\17\ The group 
also generally agreed that it is important that rollovers of sums 
between $1,000 and $5,000 be invested in a way that will earn the best 
risk-adjusted return for the worker.
    Roll Over Small Balances to the Thrift Savings Plan or IRA. The 
group generally agreed that it would be helpful if there were a single 
national destination for rollovers that any employer could use to 
transfer rollovers. This would make it easier for employers to roll 
over the sums and encourage employees to save the funds for retirement. 
The employers would no longer have to choose an IRA, if they did not 
wish to do so, or if they found it to be a burden.
    The group discussed whether or not to roll over funds to the 
Pension Benefit Guaranty Corporation or to the Thrift Savings Plan \18\ 
which is a retirement savings plan for Federal Government civilian and 
uniformed workers. Some members of Congress have suggested designating 
the PBGC as a recipient for rollover funds. However, the group 
generally agreed that the Thrift Savings Plan would be the preferred 
destination. In addition, the group generally agreed that employers be 
allowed to choose between rolling over small balances to the Thrift 
Savings Plan and rolling them over to an IRA.
    The choice of the TSP as a destination for small balances was seen 
as helping alleviate concerns by the employer about choosing an IRA for 
a departing employee who fails to make a choice for the rollover. Some 
members in the group supported the proposal to roll over small balances 
to the TSP. Other members of the group, however, preferred to keep the 
option of allowing employers to roll over the small balances into an 
IRA. The group reached agreement to allow either one or the other.

Expand Saver's Credit

    Currently, low and moderate income workers can receive a Saver's 
Credit up to $1,000 to encourage saving in a retirement saving plan. 
Enacted into law \19\ in 2001, the Saver's Credit was first available 
in 2002 and is slated to end in 2007. The Saver's Credit can reduce the 
Federal income tax a worker pays dollar for dollar. The amount of 
credit that one can receive is based on one's contributions into an 
IRA, 401(k), and other retirement saving plans.\20\
    The amount of credit available ranges from 10 percent to 50 
percent, depending on adjusted gross income and filing status. Lower 
income workers are eligible for a higher credit.\21\ For married 
couples filing jointly the credit is available on incomes $50,000 and 
under. For single people and married couples filing separately, the 
credit is available on incomes up to $25,000. In practice, most of the 
benefits have been paid out in 10 percent credits for couples filing 
jointly who earn between $35,000 and $50,000.
    The Saver's Credit is not refundable. That is, if someone does not 
owe any taxes, then they can not receive the credit in cash. The credit 
can go only towards reducing an existing tax liability. Although there 
are 57 million workers within the income brackets covered by the 
Saver's Credit, only about 20 percent are eligible to receive any 
benefit.\22\ In this group only about 3.5 million have actually 
received a Saver's Credit by contributing to an eligible savings plan, 
and most have received only a 10 percent or 20 percent match.\23\ 
Contributions are made to a 401(k) and rarely an IRA.\24\ Only about 
\1/10\ of 1 percent received a 50 percent match on a $2,000 
contribution.\25\
    The members discussed whether or not the Saver's Credit had 
increased coverage or saving. Members disagreed on how successful the 
Saver's Credit has been in promoting either goal. One member estimated 
that the program cost $10 billion in tax revenues. Members of the group 
generally agreed that it would be helpful to get detailed information 
on how the program has worked in its initial implementation in order to 
evaluate what changes might improve coverage or saving for retirement.
Areas of General Agreement
    Extend the Saver's Credit Beyond 2007. The group generally agreed 
that the Saver's Credit program should be extended beyond its sunset in 
2007.
    Make the Tax Credit Refundable. The group generally agreed to an 
approach that would make the tax credit refundable and spendable, so 
that more workers could enjoy the benefits. This means that workers who 
do not have a tax liability sufficient to cover the tax credit would be 
eligible to receive a payment for the part not covered by a tax 
liability. Supporters stated that refundable tax credits are desirable 
because they promote greater saving by more workers. Some of those 
supporting a refundable (spendable) credit expressed a preference for 
depositing the refundable (spendable) portion into a retirement savings 
account rather than sending payments to eligible recipients.
    There were some objections, too, to a refundable (spendable) tax 
credit. One member was concerned about compliance issues, such as 
possible fraud. One member stated that refundable tax credits are less 
efficient in promoting saving than government matches. The member noted 
that $1 match would result in $2 of savings. A $1 tax credit might, 
however, only prompt $1 of saving if the tax credit is spent. There was 
also a concern that the government would impose costly complications 
that might be difficult to administer.\26\
Areas Where Views Differed
    Make the Saver's Program Permanent? The group was unable to agree 
on making the Saver's program permanent.
    Raise the Percentage Match and Income Levels. The group discussed a 
variety of ways to raise the percentage of the credit available at 
various income levels, as well as raising income levels eligible for a 
credit. While the group did not generally agree on a new income 
schedule at which different percentage credits would apply, there was 
strong support for raising the tax credit to 75 percent for couples 
filing jointly who earn up to $40,000, with the credit phasing down to 
50 percent for couples earning $50,000, and then phasing down to zero 
for couples earning $60,000. For singles and couples filing separately, 
the income limits would be half the level for couples filing 
jointly.\27\
    Offer a Government Match for Employee Contributions? The group also 
discussed a government match for individual and employer contributions. 
There was support for a government match, but some members were unsure 
about how one would devise a method for determining the match and how 
the funds would be transferred into the plan. The issue is complicated 
by lack of an infrastructure for transferring the funds. It is also 
complicated by the fact that the government match could not be 
transferred into an account until after a worker making a contribution 
filed income taxes, at which time the worker's annual adjusted gross 
income would be known.

Employer Tax Incentives for Matching Contributions By Employers

    Currently, employers are not eligible for tax credits or other tax 
incentives for making matching contributions to employees. The group 
discussed whether or not it was better to offer tax credits to 
employers or employees in order to help increase overall saving. They 
also discussed whether or not tax credits to employers or employees 
would offer the greater net gain in saving. Or, to put it another way, 
which would offer the biggest savings bang for the tax credit buck? The 
group also discussed whether or not tax credits for employers should be 
limited to small businesses and whether credits should be offered only 
for contributions to the accounts of workers below a certain income 
level.
Areas Where Views Differed
    Employer Tax Credit. There was strong support, but not general 
agreement, for a suggestion to provide an employer tax credit that 
rewarded employer contributions or matches, provided it was tightly 
targeted at lower paid workers in both large and small business.
    There were concerns about how a tax credit would work even among 
supporters of tax credits for employers. One member said that 
contributions would have to be ``high quality,'' in the sense that they 
were provided only for employer contributions that were made nearly 
entirely on behalf of the targeted low-income workers.\28\ Some who 
supported a tax credit in principle worried how it might work in 
practice. One member who strongly opposed any type of employer tax 
credit objected said it is not true that this approach gives a greater 
bang for the tax credit buck are not correct. He claimed that if 
employees can get an additional tax credit if the employer matches the 
employee's contribution, it would have a similar affect on net 
retirement savings as providing a tax credit to the employer.
    Members Offer Several Suggestions for Tax Credits. The group 
discussed several options for designing an employer credit without 
deciding to generally support any one of them. One member suggested a 
credit for employer contributions that are above and beyond what was 
needed to satisfy nondiscrimination tests.\29\
    One member suggested a 50 percent tax credit to employers for 
contributions to nonhighly-compensated employees.\30\ One alternative 
was to offer a credit to employers for contributions to workers earning 
up to $40,000 or $50,000.\31\ One member proposed making the employer 
credit a complementary part of the Saver's Credit, which is directed at 
employees. In this instance, the credit would be only for contributions 
above and beyond what an employer makes to the work force 
generally.\32\
    The group discussed whether or not an employer tax credit might be 
limited because the targeted group of small business includes some 
companies without a big tax liability. To reach this group, it was 
suggested that any employer credit also be refundable and 
spendable.\33\

Intelli-Match Proposal to Benefit Low, Moderate Wage Earners

    The group discussed the Intelli-Match proposal \34\ that would 
provide a higher proportionate match or contribution to low and 
moderate income workers than it provides to workers in general.
    Before employers could set up an Intelli-Match proposal, Congress 
would have to pass legislation to grant employers a safe harbor on 
nondiscrimination tests, since some workers would receive matching 
contributions at a higher percentage of pay than others. There are 
existing safe harbors that would allow employers to do this; however, 
they also require immediate vesting, which may be inconsistent with the 
business requirements of some employers. For this reason, the Intelli-
Match proposal had a provision that employers would not have to provide 
for immediate vesting \35\ to the employer match. This would reduce the 
overall cost of an Intelli-Match program for employers.
Areas of General Agreement
    The group generally agreed to support an adjustment in the terms of 
the safe harbor to make defined contribution plans more flexible for 
employers in return for a higher targeted match for workers earning up 
to $50,000.
Areas Where Views Differed
    The group did not agree on the provision in the Intelli-Match 
proposal that would eliminate immediate vesting, although it supported 
the broader concept, as noted above, that the employer would be given 
some additional flexibility in return for a higher match for low and 
moderate income workers.

Payroll Deduction IRAs

    The group discussed ways to expand the availability of payroll 
deduction IRAs, including requiring employers to offer them at firms 
that do not have a retirement savings plan, as well as requiring 
employers who have a retirement plan to offer the payroll deduction IRA 
to workers who are not eligible to participate in that plan.
    Under current law \36\ employers are allowed to provide employees 
with the opportunity for making contributions to an IRA through payroll 
deductions. In 2005 employees are able to contribute up to $4,000 a 
year to a payroll deduction IRA, while workers over 50 can contribute 
an additional $500 directly to the bank.
Areas of General Agreement
    The group generally agreed that it would be desirable to expand 
payroll deduction IRAs.
Areas Where Views Differed
    The group was divided on this issue and did not agree to require 
employers to offer the payroll deduction IRA. As an alternative, some 
members suggested that workers be allowed to contribute part or all of 
their refund to an IRA when they file their annual tax returns.

Reducing the Risk in Defined Contribution Plans

    The group considered several proposals that were designed to reduce 
the market risk than may occur when investment returns perform below 
historic averages for an extended period. A period of low returns can 
be of special concern if this occurs when workers are nearing 
retirement.
Areas of General Agreement
    Government-Issued Retirement Bonds. The Group generally supported 
encouraging employers to offer inflation-adjusted retirement savings 
bonds as an investment option in their plans. The group identified 
Treasury Inflation-Indexed Securities (TIPS) as a potential candidate 
for this option.
Areas Where Views Differed
    Government Insurance for Defined Contribution Plans. It was 
proposed that the government insure the difference between a career 
average return on investments and the actual return on investment in a 
worker's account at the time of their retirement, death or disability. 
The group did not endorse any form of government insurance for 
contributions or investments in defined contribution plans.
    Combination Defined Contribution/Cash Balance Offset Plan. The 
group decided against considering a proposal with a defined benefit 
component, as it was seen to be within the scope of Working Group I on 
defined benefit \37\ plans and not within the scope of the assignment 
set for Working Group II. A proposal had been submitted to recommend 
adding a cash balance plan to a 401(k) in order to assure that a 
portion of the retirement saving would have a guaranteed return no 
matter what happens to the markets.

Raising the 70 Percent Coverage Requirement

    Under tax law, 70 percent of employees must participate in a 
retirement plan in order for the plan to qualify as 
nondiscriminatory.\38\ In addition, plans can exclude from this 
calculation employees who work less than 1,000 hours a year. Some 
members suggested that it might be possible to increase the required 
level of coverage to some level above 70 percent of workers. The group 
also considered whether or not to recommend that employers be required 
to include more part-time and contingent workers to the standard 
required to be nondiscriminatory.
Areas of General Agreement
    The group generally agreed there should be more study of the impact 
of raising coverage above 70 percent and increasing part-time coverage.
Areas Where Views Differed
    The group was unable to reach agreement agree on supporting either 
raising the 70 percent level or increasing the number of part-time and 
contingent workers. There was strong disagreement over the proposal to 
increase the number of part-time and contingent workers. Some members 
said that the group needed data to demonstrate the impact of both 
approaches to determine which would be more effective, while others 
were willing to support these approaches with more data.

Other Proposals

Areas of General Agreement
    Improving Financial Education and Literacy. The group generally 
agreed to support instruction on financial literacy for high school and 
college students. However, the group did not recommend making it a 
requirement for graduation, as one member had suggested.
    Tightening Coverage Rules. While not making any specific 
recommendations, the group generally supported the proposition that 
coverage rules should be tightened. However, the group also generally 
agreed that more studies are needed to measure the impact of various 
proposals before endorsing them.

Endnotes

\1\ U.S. Department of Labor Bureau of Labor Statistics, National 
Compensation Survey: Employee Benefits in Private Industry in the 
United States, March 2003 (Washington, D.C.: Department of Labor, April 
2004), Table 1, p. 3.
\2\ U.S. Bureau of Labor Statistics, ``Employee Benefits in the United 
States, 2003,'' News, UDSL: 03-489, September 17, 2003, Table 1, p. 3. 
From the web site at http://www.bis.gov/news.release/pdf/ebs2.pdf.
\3\ Ibid.
\4\ U.S. Department of the Treasury, Internal Revenue Service, 
Statistics of Income Bulletin, (Winter 1984-1985, Winter 1986-1987, 
Winter 1990-1991, Winter 1993-1994, Winter Fall 1995, Winter Spring 
1996, Fall 2001, and Winter 2002-2003).
\5\ Craig Copeland, ``Retirement Plan Participation and Features, and 
the Standard of Living of Americans 55 or Older,'' EBRI Issue Brief 
Number 248 (Washington, D.C.: Employee Benefit Research Institute, 
August 2002), Figure 2, p. 8.
\6\ The W-4 is the form the IRS requires to be filled out by new 
employees for tracking payroll taxes and deductions.
\7\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business with 
less than 100 employees, as well as self-employed people. SIMPLE stands 
for Savings Incentive Match Plan for Employees.
\8\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business with 
less than 100 employees, as well as self-employed people. SIMPLE stands 
for Savings Incentive Match Plan for Employees.
\9\ A balanced fund aims to produce high rates of return over the 
medium to long term. In terms of risk levels, a balanced fund usually 
occupies a middle position. It is more volatile than a fund with 
primarily cash and fixed interest investments. It is less volatile than 
a fund which invests only in equities and real property.
\10\ In a Lifestyle Fund, the choices about how much to put into 
equities, bonds and cash are based on the risk tolerance of the 
investors and the investor's goals. Lifestyle Funds allow an investor 
to put all the assets in a single fund and not have to review or revise 
those investments. The fund periodically adjusts the allocation and 
gradually becomes increasingly more conservative as the investor moves 
toward retirement age.
\11\ The Thrift Savings Plan offers only a handful of few investment 
options, which is generally seen to make it easier for participants to 
use and make decisions about investing. The TSP offers, for example, 
the following five choices: a Government Securities Investment (G) 
Fund, a Fixed Income Index Investment (F) Fund, a Common Stock Index 
Investment (C) Fund, a Small Capitalization Stock Index Investment (S) 
Fund, and an International Stock Index Investment (I) Fund.
\12\ Some pension plans refer to the contribution made into the plan as 
a salary deferral because it reduces the amount of income that is 
counted for taxation purposes, while deferring taxes on that income 
until it is withdrawn later.
\13\ SIMPLE IRAs and SIMPLE 401(k)s are available to small business 
with less than 100 employees, as well as self-employed people. SIMPLE 
stands for Savings Incentive Match Plan for Employees.
\14\ Internal Revenue Code 404(c) requires a participant to make a 
choice in order to give employers a safe harbor from fiduciary 
liability for the participant's choice.
\15\ Congress required employers to rollover sums for departing 
employees who do not make a choice in the Economic Growth and Tax 
Relief Reconciliation Act of 2001. Implementation of the policy cannot 
begin until Treasury issues regulations affecting the rollovers.
\16\ If employees withdraw their money from a 401(k) account after 
leaving a job and do not deposit into an IRA or another 401(k) at their 
next job, they will owe taxes on the withdrawal, including a 10 percent 
penalty tax on amounts withdrawn before age 55.
\17\ Congress required employers to rollover sums for departing 
employees who do not make a choice in the Economic Growth and Tax 
Relief Reconciliation Act of 2001. Implementation of the policy can not 
begin until Treasury issues regulations affecting the rollovers.
\18\ The Thrift Savings Plan offers only a handful of few investment 
options, which is generally seen to make it easier for participants to 
use and make decisions about investing. The TSP offers, for example, 
the following five choices: a Government Securities Investment (G) 
Fund, a Fixed Income Index Investment (F) Fund, a Common Stock Index 
Investment (C) Fund, a Small Capitalization Stock Index Investment (S) 
Fund, and an International Stock Index Investment (I) Fund.
\19\ The Saver's Credit was part of the Economic Growth and Tax Relief 
Reconciliation Act of 2001.
\20\ Saver's Credit also available for contributions to 403(b) plans, 
457 governmental plans, SIMPLE 401(k) plans or SIMPLE IRA's.
\21\ For married couples filing jointly, workers with income up to 
$30,000 are eligible for a 50 percent Saver's Credit for their 
contributions into a saving plan. Married couples earning $30,001 to 
$32,500 are eligible for a 20 percent credit, and married couples 
filing jointly earning $32,501 to $50,000 are eligible for a 10 percent 
credit. Those earning over $50,000 are not eligible for a credit. For 
single people or married people filing separately, the Saver's Credit 
is available for 50 percent of contributions for workers with incomes 
up to $15,000. Workers with incomes $15,001 and $16,250 can obtain a 20 
percent Saver's Credit. Single workers and married people filing 
separately who earn between $16,251 and $25,000 can receive a 10 
percent Saver's Credit on contributions. Slightly different earnings 
levels qualify a head of household: (50 percent for incomes up to 
$22,500; 20 percent for incomes $22,501 to $24,375; and 10 percent of 
incomes $24,376 to $37,500).
\22\ Data provided by former Treasury official Mark Iwry.
\23\ Ibid.
\24\ Ibid.
\25\ Ibid.
\26\ A proposal to make the refundable amounts made available by a 
special savings bond payable on retirement and not through a tax credit 
has been made by Senator Jeff Bingaman (D-New Mexico).
\27\ For singles and couples filing separately, there was support for 
raising the credit to 75 percent for those earning up to $20,000. The 
credit would be gradually phased down to 50 percent for those earning 
$25,000. It would then be gradually phased out to zero for those 
earning $30,000.
\28\ The member who proposed this suggestion said the definition of 
``high quality'' would have to be further refined.
\29\ Nondiscrimination testing is required under Internal Revenue 
Service rules to ensure that highly compensated employees do not derive 
a much greater benefit from a qualified plan than non-highly 
compensated employees. There are two broad tests. One is Actual 
Deferred Percentage (ADP) Test which measures the rate at which 
employees elect to make contributions. The other is the Actual 
Contribution Percentage (ACP) Test that measures the rate of employer 
matching and after-tax contributions.
\30\ Non-highly-paid employees are those who earn less than $90,000. 
Highly compensated employees earn $90,000 or more.
\31\ In this proposal, employer contributions would have to meet ``a 
certain quality of coverage'' standard in order to qualify for the 50 
percent tax credit, such as requiring that the first dollar of coverage 
awarded by employers would reach the target population within a given 
range. Companies would not qualify if they integrated their benefits 
into Social Security or if they engaged in cross testing to meet 
nondiscrimination testing requirements. Credit would be made for 
matching and automatic contributions. On matching contributions, 
employers had to provide at least a 20 percent match. On automatic 
contributions, the level would have to be 1 percent or 2 percent of 
pay. The credit was capped at 3 percent of pay for the employer 
contribution. It could also be provided for a 1 percent non-elective, 2 
percent match. The target was low-income people, not just small 
business workers.
\32\ The employer credit would be allowed made for employer 
contributions to workers earning less than $30,000, and be applied to 
contributions 1 percent or 2 percent of wages above the percentage 
contribution levels the employer was providing to all employees.
\33\ One member described both the refundable and nonrefundable tax 
credits as ``spendable'' tax credits to differentiate them from 
contributions deposited into an account by the government.
\34\ One possible Intelli-Match approach would be to provide a 100 
percent match for employee contributions up to $2,000 or 4 percent, 
whichever is greater. A worker earning $100,000 could contribute up to 
$4,000 and receive a $4,000 match. A worker earning $20,000, however, 
might contribute $2,000 even though that would represent 10 percent of 
the worker's salary. Even so, the worker would still get a $2,000 
match. The proposal would also provide a tax credit to the employer for 
the amount of employer match contributed to people making less than 
$50,000 that is above the percentage match give to owners and highly-
compensated employees.
\35\ An employee is said to be ``vested'' in a pension when the 
employee becomes entitled to the benefits of the plan, including 
employer contributions to a plan and their earnings.
\36\ In 1975 the Department of Labor issued a regulation describing the 
circumstances under which the use of an employer payroll deduction 
program for forwarding employee monies to an individual retirement 
account (IRA) will not constitute an employee pension benefit plan 
subject to Title I of the Employee Retirement Income Security Act 
(ERISA) of 1974. Further, as part of the conference report on the 
Taxpayer Relief Act of 1997, Congress expressed its view that 
``employers that choose not to sponsor a retirement plan should be 
encouraged to set up a payroll deduction system to help employees save 
for retirement by making payroll deduction contributions to their 
IRAs.'' (H.R. Rep. No. 220, 10th Congress, 1st Session at 755, 1997).
\37\ Defined benefit type plans are retirement plans offered by 
employers who promise to fund and provide a monthly retirement benefit 
to each eligible employee based on years of service and earnings.
\38\ Internal Revenue Code Section 410(b).
                                 ______
                                 
  Report on the Conversations and Recommendations of Working Group III
                       working group's assignment
                          answer this question
How do we increase coverage and retirement savings through new 
institutions and structures?
                           february 10, 2005
Co-Chairs: Ian Lanoff and Pamela Perun

Working Group Members: John Ameriks, Chris Bone, Doug Ell, Cathy Heron, 
Pat Humphlett, Leslie Kramerich, Robert Nagle, Carol Sears, Javier 
Silva, Dick Wartman, Christian Weller, and Janice Winston
                           executive summary
    Despite years of efforts to address the challenge, more than half 
the private sector work force does not participate in a retirement 
saving plan. Thus, employees are unlikely to accumulate any significant 
savings for their retirement years, which are likely to be very long as 
Americans continue to live longer. The workers who might be the most 
likely to experience poverty in old age are the same workers who are 
most likely to be without access to a retirement saving plan today.
    Working Group III set out to do something about this uncovered 
group that needs the most attention. Its mission was to look for ways 
to enroll various financial institutions in new efforts to target the 
most important segment lacking coverage: small businesses. In this 
segment only 35 percent of employees participate in a workplace 
retirement savings plan. The group also wanted to reach part-time 
workers. This group represents an even greater area of need since only 
18 percent of part-time workers participate in a workplace retirement 
savings plan.
    The group also recognized that workers are much more likely to save 
if they have a way to save through their employer. When such plans are 
offered, participation rates are high across the board, even if there 
is no employer match. One reason is that savings can be regularly 
deducted from a worker's pay check.
    After reviewing a range of proposals aimed at reaching the target 
group, the Working Group decided to take the bold step of offering its 
own clean-slate proposal to reach the masses of uncovered workers. 
Taking a leaf from Henry Ford's highly successful strategy of designing 
a car for the masses, the group decided to name its plan the Model T. 
The new Henry Ford's would be executives at regulated financial 
institutions: banks, insurance companies, brokerage firms, and mutual 
funds.

     All employees--full-time, part-time, contingent workers 
and even independent contractors \1\ --would be eligible to participate 
if an employer agreed to be part of a plan. This is a striking 
departure from existing rules that allow employers to limit which 
employees might be eligible for such plans as the 401(k).
     Regulated financial institutions could be authorized to 
offer a simplified plan to groups of employers.

    This multiple employer plan could be targeted to a specific region. 
For example, a bank in Peoria, Illinois could offer the plan to 
businesses in the Peoria area. The plan could also be targeted toward 
business categories, such as a Mississippi insurance company offering a 
plan for Mississippi construction and building trade groups.

     The group generally agreed that there should be only three 
to five investment options and that they would include model portfolios 
that would be conservative, moderate and aggressive.
     Employers would also be able to automatically enroll 
workers.
     If workers make no choice among investments, the employer 
could designate that their contributions be invested in a mix of 
options that would be appropriate for their age and expected date of 
retirement.

    Small businesses would be more likely to offer such plans because 
two of the chief reasons they say they currently avoid plans would be 
eliminated. The plan would be administered by the financial institution 
that provides it and the employer would no longer be potentially liable 
as a fiduciary for the investment choices of employees.
    Employers would be allowed to contribute to the plan, but would not 
be required to contribute. This, too, would address a concern by small 
businesses whose managers and owners worry that the business is too 
precarious and profits too uncertain to commit to employer 
contributions.
    While tax credits for employer and employee contributions were seen 
as helpful, they were not deemed to be essential for the plan.

Mission

    The broad mandate of Working Group III was to find new institutions 
and structures to increase the portion of the workforce covered by a 
retirement saving plan and to raise the level of retirement savings. 
The members of the group looked at the role that financial institutions 
could play in providing new approaches that target workers employed by 
small businesses, where coverage and saving are much lower than in mid-
sized and large businesses.
    The group generally agreed they should try to develop broad 
outlines for a new plan they named the Model T plan, which would be a 
simplified, low-cost group retirement savings plan that could be 
sponsored by financial institutions, such as banks, insurance 
companies, mutual fund companies, and brokerage firms. The group set 
out to design the elements of the plan and how it might work to attract 
plan providers and employers. In working on the design elements of the 
plan, the group sought to find agreement on as many areas as possible 
and, where a consensus could not be developed, to identify areas where 
more work needed to be done.

Background

    The goal of providing a retirement plan for all workers is an 
ambitious one. In 2003, for example, only about 57 percent of American 
workers had access to a retirement plan sponsored by their employer, 
according to Bureau of Labor Statistics. Of that group 20 percent have 
access to a defined benefit plan; that is, a plan that is generally 
funded by the employer and which usually provides a stream of income 
for life.\2\
    The number of workers who actually participate in those plans is 
somewhat lower. Among all private sectors workers, 49 percent of full-
time and part-time workers participated in an employer-sponsored 
retirement plan. That represented 50.5 million in a total private 
sector work force of 103.5 million in March 2003.\3\
    The employer survey found that different segments of the workplace 
population have widely differing participation rates. The participation 
rate is 65 percent among the 45.9 million employed last year in medium 
and large businesses (100 employees or more). However, the 
participation rate was only 35 percent among the 59.6 million employed 
last year by small businesses (99 or fewer workers).\4\ There is an 
ever sharper divide in participation rates between full-time (58 
percent) and part-time workers (18 percent).\5\
    Getting small business owners to sponsor plans is difficult, but 
not impossible. According to the 2003 Small Employer Retirement Survey 
(SERS) by the Employee Benefit Research Institute, 29 percent said they 
were likely to start a plan in the next 2 years.\6\ At the same time, 
68 percent said they were not likely to start a plan.\7\ This 
represents a sharp decline in the number of small businesses that are 
likely to start a retirement plan in recent years. In 1998, for 
example, 42 percent of small business owners said they were likely to 
start a plan in the next 2 years, while 56 percent reported they were 
not likely.
    The survey looked at a number of factors that could improve the 
chances that small businesses would offer a plan. It found that 73 
percent of small businesses were more likely to start a plan if it did 
not require employer contributions, 67 percent were more likely to 
start a plan if the employer could get tax credits for start-up costs, 
57 percent were more likely to start a plan if the plan had reduced 
administrative requirements, and 55 percent were more likely to start a 
plan if it offered easy-to-understand information about the plan.\8\ 
Fiduciary responsibility is another stumbling block to employers 
sponsoring plans.
    These data suggest that a plan that has discretionary contributions 
on the part of the employer, is easy to administer, reduces fiduciary 
liability for the choices of employees, provides tax credits for start-
up costs, and is easy to understand, would likely prompt a good deal of 
interest among small business employers.
    Employer-sponsored pension plans still appear to be the best way to 
motivate workers to save for retirement. The Federal income tax return 
data indicate that the proportion of filers who claim an IRA or Keogh 
deduction has been both fairly modest and steadily declining over time. 
From a peak of 16.2 percent in 1986, it fell to 3.5 percent in 2000 and 
2001.\9\ By contrast, the participation rate in workplace plans is 66.2 
percent of those eligible for 401(k) plans (a population of workers 
that represents 32.6 percent of the private sector workforce).\10\

How the Working Group Went About Its Assignment

    Working Group III first examined a range of existing proposals 
aimed at employees of small businesses. Instead of recommending any of 
those proposals, the group instead decided to start with a clean slate 
and design the broad outlines of a new proposal for a simplified 
multiple employer \11\ or group plan that would be offered to small 
businesses by financial institutions.
    In taking this approach, the group was also responding to a 
recommendation from the first Conversation on Coverage in 2001 to 
examine new types of model group pension plans that would enable groups 
of unrelated small employers to pool resources, thereby reducing 
administrative costs and fiduciary liability.\12\
    Taking a leaf from Henry Ford's Model T, which became the symbol of 
affordable transportation for the masses, the group named its new plan 
the Model T multiple employer plan. It was the group's hope that it 
could be an inexpensive and accessible savings vehicle that could 
provide pensions to tens of thousands of workers in small companies.
    Under the Model T plan approach the plan providers--banks, 
insurance companies, brokerage companies, and mutual fund companies--
would assume fiduciary liability for the investment choices in the plan 
and would shoulder administration duties for the plans. The transfer of 
these two responsibilities from the employer to the plan provider was 
seen by the group as a means of addressing these two of the key 
objections by small businesses to starting a new defined contribution 
plan. In addition, the simplicity of the proposal was seen as 
addressing another key concern of both small business employers and 
employees.
                      the model t plan at a glance
    The group generally agreed on the following broad outlines of the 
Model T plan.

     Multiple-Employer Plan. It will be a multiple-employer 
defined contribution group or pooled plan and not an aggregation of 
individual retirement accounts.
     Workplace Plan. The Model T will be offered by an employer 
to employees and independent contractors of the firm.
     Administration by Third Party Provider. The administration 
of the plan would be the responsibility of the plan provider--a 
financial institution--and not the employer.
     Financial Institutions Would Offer the Plan. Regulated 
financial institutions--banks, insurance companies, brokerage firms and 
mutual fund companies--would be authorized to offer the Model T plan, 
in much the same way the Internal Revenue Code now authorizes certain 
types of financial institutions and corporations to offer IRAs. The 
authorized institutions would market the plan to employers.
     Limited Investment Choices. The group generally agreed 
that Model T plans would be required to offer a limited choice of three 
to five options that would consist of model portfolios and/or lifestyle 
funds, with the possibility of a guaranteed return investment option. 
The choices would be designed to make them easy for the employer and 
employee to understand.
     Fiduciary Liability Transferred to Third Party Provider. 
The fiduciary responsibility for the investment choices will be 
transferred from the employer to the plan provider.
     Default Investment Mix Option. Plan providers will have 
the option of offering participants in the plan the option of choosing 
a default mix of investments based on a lifestyle fund or a model 
portfolio.\13\
     Employee and Employer Contributions. Once an employer 
signs up with a plan provider, both the employer and employees will be 
able to contribute to the plan.
     Securities and Exchange Commission Is Lead Regulator. 
While the Internal Revenue Service and the Department of Labor would 
play an important role in the regulation of the Model T plan, the 
Securities and Exchange Commission would take a leading role in the 
regulation and oversight of fiduciary and investment matters.
                the building blocks of the model t plan
    The group discussed in detail how the plan might be structured and 
what policies would govern the various elements of the plan. In many 
cases, the group was able to reach a consensus, but in others there 
were varying opinions, or dissenting opinions. The outcome of the 
discussions of the various elements is presented below.
Building Block No. 1

Plan Providers

    The group discussed potential plan providers to offer the plan to 
employers. This included banks, insurance companies, mutual fund 
companies, brokerage firms, and various financial intermediaries.
Areas of Agreement
    Regulated Financial Institutions Can Offer the Plan. The group 
generally agreed the regulated financial institutions can sponsor the 
Model T plan. This would include banks, insurance companies, brokerage 
firms and mutual fund companies. A number of members indicated they 
thought that a simplified Model T plan might be attractive to banks, 
which have not been as active in offering retirement plans as other 
financial institutions.
    Plans Can Target Regions and Groups. The group generally agreed 
that plan providers could offer plans that are targeted to employers in 
a specific geographical or regional area or targeted at employers in 
specific categories of business and industry.
    Authorized Providers. The group generally agreed to support a 
regulatory approach that is similar to the Internal Revenue Code 
provisions governing who can offer IRAs \14\ when designing regulations 
for designating which financial institutions would be authorized to 
provide the plan to employers. They also generally agreed that the 
process would be open to eligible financial institutions already 
regulated by a Federal or State Agency. This would include banks, 
insurance companies, brokerage firms, and mutual fund companies.
    Brokers and Intermediaries. The group discussed whether or not 
brokers or intermediaries could pool contributions from self-employed 
individuals and forward them to a regulated financial institution plan 
provider. The discussion included such potential intermediaries as 
organizations representing freelance workers. It was generally agreed 
that an organization could be allowed to facilitate signing up its 
members in a plan offered by a financial institution.
Areas Where Views Differed
    Authorization Dependent on Target Participation by Low-Income 
Workers. There was a proposal by one member that the authority of 
financial institutions to offer the Model T be dependent on the ability 
of the plan provider to market the plan in such a way that a designated 
portion of the workers covered by the plan--perhaps 20 percent--would 
be low-income workers. This would follow the approach taken in the 
Community Reinvestment Act (CRA) toward regulating depository 
institutions. The group was divided on whether or not to support a CRA-
type approach to licensing. One member who objected said it would 
increase the cost of the plan by increasing the level of detail in 
administering it. One member supported the use of the CRA-type approach 
by institutions offering the Model T but did not want to make it part 
of the eligibility requirements for a financial institution seeking to 
offer a plan. One member suggested that a study be made of 529 college 
saving plans \15\ with CRA-type requirements to see if something could 
be adapted to suit the eligibility requirements for the Model T plan.
    Commissions for Brokers and Intermediaries. The group also 
discussed whether organizations or even brokerage firms could pool 
contributions from a group of workers or small employers for a 
commission. The group could not agree, however, on whether 
organizations could earn fees for their work as facilitators.
    Professional Employment Organizations. One member suggested that 
professional employment organizations or PEOs that lease out employees 
be authorized to offer the Model T to the employees they lease out to 
businesses. However, the group did not generally agree to support 
allowing PEOs to be plan sponsors.
Building Block No. 2

Employee Participation in the Plan

    The group discussed which of a given company's employees would be 
eligible to participate in the plan and whether or not employers should 
be allowed to automatically enroll workers when they are hired.
Areas of Agreement
    All Employees Eligible to Contribute. The group generally agreed 
that once an employer agrees to participate in a Model T plan offered 
by a financial institution, then all employees will be eligible to 
contribute to the plan. This will include full-time workers, part-time 
workers, contingent workers and independent contractors. As noted 
above, there was interest in having organizations facilitate 
contributions from various groups of workers, including the self-
employed.
    Automatic Enrollment. The group generally agreed that an employer 
participating in a Model T plan could adopt the option of automatically 
enrolling a new hire into the plan unless the employee indicated 
otherwise.
Areas Where Views Differed
    Limits on Employee Contributions. The group deferred discussion on 
setting contribution limits for employees and/or employers to the next 
phase of the Conversation on Coverage, with the assumption that the 
limits would be in keeping with the limits for other defined 
contribution plans.
Building Block No. 3

Employer Contributions to the Plan

    The group discussed whether or not employers could contribute to 
the Model T plan and whether, in fact, employers might be required to 
contribute.
Areas of Agreement
    Employer Contributions Allowed. The group generally agreed the 
employers would be able to contribute to the Model T plan.
Areas Where Views Differed
    Mandatory or Voluntary Contributions. The group discussed whether 
or not employer contributions would be made mandatory, but remained 
divided on this issue. There was strong opposition to mandatory 
contributions. One member said that if employer contributions were made 
mandatory, then it would create a barrier for signing up employers to 
be part of the Model T plan. Another member noted studies--such as the 
annual Small Employer Retirement Survey (SERS) by the Employee Benefit 
Research Institute--that have found that small business employers would 
be more likely to offer a retirement saving plan if employer 
contributions were entirely discretionary.\16\
    Some members were strongly in favor of mandating employer 
contributions. One member who supported a mandate said that if there is 
no mandate for the Model T plan, he did not see how it would differ 
very much from an IRA. A member who opposed mandatory contributions 
said that the Model T would still be a different plan because it would 
allow for employer contributions to the plan. One member suggested as a 
compromise a flexible policy rule in which employers would be required 
to contribute in x years out of five, depending on whether or not there 
are profits. Another member suggested requiring the employer to 
contribute 1 percent of compensation if the employee puts in 4 percent 
of compensation. One member suggested that the Model T allow for 
reverse match contributions, where the employer contributes first and 
the employee matches the employer contributions.
Building Block No. 4

Investment Options in the Plan

    The group discussed how many investment options and what types of 
investments should be included in the Model T plan.
Areas of Agreement
    Simplified Investment Options. The group generally agreed that the 
plan should offer at least three investment options, but no more than 
five options. The members also generally agreed that the choices should 
include at least three model portfolios or lifestyle funds: 
conservative, moderate, and aggressive.
    Default Investment Mix. The group generally agreed that when 
employees fail to make choices on their own, plan providers should be 
allowed to offer participants at firms that join the plan a default mix 
of investment options based on lifestyle or life cycle funds--or model 
portfolios representing the basic asset classes.
Areas Where Views Differed
    Additional Investment Options. The group discussed including an 
investment option that would provide a guaranteed rate of return. 
Although several in the group strongly supported such an option as key 
to encouraging low-income workers to participate, the group did not 
reach agreement that this should be a required investment option.
    Government Definitions of Investment Options. The group discussed 
having the government define exactly what should be in an investment 
option, but could not reach agreement on this point.
    Two Tiers or One? The group discussed whether or not financial 
institutions might have two models or tiers to offer employers: (1) a 
simplified incubator model plus (2) a full-fledged plan with more 
investment options. Those who supported the concept of two-tiered plans 
argued that employers could begin with the simplified incubator plan 
and then move on to a traditional qualified plan offered by the 
institution offering the incubator plan--or any other institution--when 
they were ready. The suggestion was made out of concern that the 
simplified plan might not be profitable for plan providers and, thus, 
might fail to enlist their enthusiastic marketing of the plan. Members 
explained that the Model T might not be as profitable in the beginning 
because it would consist of a lot of accounts, each with very small 
balances.
    The group was divided on this proposal. Some supported an approach 
with two plan options, a simplified incubator and a full-fledged plan, 
while others supported a single, simplified Model T plan. Members 
supporting a single Model T plan argued that while the Model T might 
not prove to be as profitable initially as the financial institution 
might wish, account balances would grow over time, increasing the 
plan's profitability. Further, employers could mature into one of the 
whole range of existing single employer plans when they are ready for 
more investment options and more bells and whistles in their plan.
    Government Sponsored Start-Up Plan. The group discussed whether or 
not the government should sponsor a Model T plan for those employers 
with many small accounts, clients whose business would not be 
profitable for financial institutions that provide Model T plans. The 
group was divided on whether or not there should be a government start-
up plan. A member who opposed a government plan said it would be 
difficult for the government to start up a plan. Further, it was 
suggested that the financial institutions that were interested in 
sponsoring Model T plans would be opposed to it. Members supporting a 
government start-up plan, however, continued to strongly support this 
approach. One asked why financial institutions would be opposed, since 
the government plan would be only for unprofitable accounts. A member 
opposing a government plan said it would ``get tricky'' to devise a way 
for employers to move from the government plan to a private sector 
plan.
Building Block No. 5

Regulation and Oversight

    Since the Model T plan would transfer administration and fiduciary 
liability from the employer to the plan provider, it raised a number of 
questions about what regulatory regime would work best to keep the plan 
costs low while protecting participants. The group also looked at the 
question of who would have fiduciary liability for the investment 
choices in the plan and for any malfeasance and fraud that might occur. 
The group generally agreed that the employer would be relieved of 
fiduciary liability for the choice of investment options in the plan.
Areas of Agreement
    SEC is the Lead Regulator. The group discussed what regulatory 
roles would be played by the Department of Labor, the Internal Revenue 
Service, and the Securities and Exchange Commission. The group 
discussed whether the SEC should enhance its role as fiduciary 
regulator over Model T plans above the level of scrutiny it applies for 
the non-pension related oversight that constitutes its regulatory 
focus. They also discussed whether or not the SEC should be the lead 
fiduciary regulator instead of the Department of Labor or IRS. The 
group generally agreed that the SEC should take the lead role in 
fiduciary regulation for the Model T. They also agreed that at the same 
time the IRS should be the guardian for tax rules while the Department 
of Labor would regulate the employer/employee relationship. The exact 
nature of the DoL's regulatory role was deferred for future 
consideration.
    SEC Will Regulate Model T Plans Offered By Banks and Insurance 
Companies. The group discussed whether or not the SEC oversight would 
apply beyond brokerage firms and mutual funds to include banks and 
insurance companies, which are chiefly regulated by Federal banking 
authorities, as well as State banking and insurance authorities. One 
member noted that the SEC currently already regulates mutual funds 
offered by banks and variable annuities offered by insurance companies. 
Thus, the member explained, it is not a departure for the SEC to also 
regulate Model T retirement saving plans provided by banks and 
insurance companies. The group generally agreed that the SEC could be 
the fiduciary regulator for all providers of Model T plans.
    Paying for Plan Administration Costs. The group discussed how 
administration costs would be paid. The group generally agreed that the 
sponsoring financial institutions could charge a fee for administration 
(in addition to the fee for investment management). They also generally 
agreed that the fee could optionally be borne by participants as a 
charge against earnings.
    Fees Should Be Low. The group generally agreed that internal fees 
charged to manage funds, as well as administrative fees to manage the 
plan, should be low. Many in the group supported an approach that would 
keep fees below 100 basis points.\17\
Areas Where Views Differed
    SEC Will Regulate Fees. Many in the group supported the view that 
the SEC would be responsible for regulating fees and determining what a 
reasonable fee might be. The SEC would also be responsible for 
determining whether or not there should be a cap on fees. This approach 
would expand the powers of the SEC, which currently oversees mutual 
funds, but does not regulate fees in mutual funds. However, the group 
did not generally agree to this approach. One member strongly objected 
to having the SEC set rates or caps for funds, stating that putting 
this in the proposal would ``seriously derail'' any effort to get 
support for the Model T plan. The member objecting also noted that if 
the Model T plan had caps, it would reduce the number of players in the 
market, while removing the cap would increase competition, which, in 
turn, would act to keep fees lower.
    Enhanced SEC Fiduciary Authority. The group was divided over 
whether or not the SEC should enhance its fiduciary oversight for Model 
T plans. Some favored the current level of fiduciary scrutiny applied 
to brokerage firms and mutual funds as a way of streamlining regulation 
and keeping down costs. Others, however, felt that since the SEC was 
the lead regulator, it would have to take on some of the duties 
associated with the Department of Labor and some of the more extensive 
list of prohibited transaction rules under ERISA.\18\
    Study to Address Unresolved Fiduciary Issues. The group generally 
agreed that a study should be undertaken to develop an outline for a 
regulatory regime for the Model T. For starters, the study could flesh 
out the duties of the various regulatory bodies, and address what 
enhanced fiduciary regulatory authority the SEC might have over Model T 
plans.
    Among the unresolved issues is a question of whether or not any 
fiduciary liability would remain with the employer. Some suggested that 
the employer would retain fiduciary liability for choosing a Model T 
provider, even if it transfers to the plan provider the fiduciary 
liability for the investment choices offered in the plan. Some 
suggested that employers should face restrictions on who they might 
choose so ``they could not hire their brother-in-law down the street,'' 
as one member put it.
    There was also discussion about whether or not the plan provider 
might escape fiduciary liability for the choices in the plan, if it 
follows the required list of investment offerings. The group, however, 
did not reach agreement on a suggestion to remove fiduciary liability 
for plan providers who chose the recommended investment options. One 
member explained that a plan provider could simply offer the investment 
options of a business colleague or a relative rather than provide 
investment options that were managed for the sole interest of the plan 
participants.
Building Block No. 6

Withdrawals and Distributions

    The group discussed under what terms and conditions employees could 
make pre-retirement withdrawals for hardship or as a loan. They also 
discussed the rules that would apply when employees leave an employer 
and the rules that would govern distributions of assets when a 
participant reaches retirement age.
Areas of Agreement
    Hardship Withdrawals Not Allowed. The group generally agreed to 
disallow hardship withdrawals. This approach was taken partly because 
it would be difficult for plan providers to be able to determine if 
there was a genuine hardship. In addition, barring hardship withdrawals 
was seen as simplifying the plans, making them less expensive, and also 
encouraging workers to retain their accumulated balances until they are 
old enough to be eligible to take distributions.
    Loans Allowed Up to 50 Percent of Assets. The group generally 
agreed that participants would be able to withdraw loans from their 
accumulated balances for amounts up to 50 percent of the value of the 
assets in their plan. They also generally agreed that if a participant 
defaulted, the loan would be treated as income and taxed. This approach 
was taken to provide some type of pre-retirement access to the assets 
in the plan. This approach was taken on the assumption that workers 
tend to contribute more and save more if they know they can withdraw 
some of the funds for an emergency. Loans were seen as preferable to 
hardship withdrawals, for the reasons noted above.
    Lump Sum Withdrawals at Age 59\1/2\. The group generally agreed 
that participants could withdraw up to 50 percent of the value of the 
assets in the Model T plan beginning at age 59\1/2\, conforming to the 
age set for defined contribution plans generally, including 401(k) 
plans. If a participant has taken out loans and not repaid them, these 
loans would count toward the 50 percent maximum limit that could be 
withdrawn as a lump sum.
    Required Annuity on 50 Percent of Account Balance. The group 
generally agreed that at least 50 percent of the account balance in the 
plan should be converted to an annuity or be subject to the current 
joint and survivor annuity rules. In addition, employees could elect at 
retirement to take out the entire balance as an annuity, with spousal 
consent.
    Rollover Rules. The group generally agreed that a participant who 
leaves an employer can withdraw up to 50 percent of the balance or roll 
over the account into another Model T plan where he or she is eligible 
to contribute. A participant who leaves a company can also leave the 
remaining 50 percent in the account until age 59\1/2\. A participant 
would have to either leave the 50 percent balance designated for a 
future annuity in the plan or roll it over to a new Model T plan.
    No Maximum Age or Minimum Withdrawals. The group generally agreed 
that there would be no maximum age at which time withdrawals would have 
to begin and no schedule of minimum annual withdrawals after that 
designated age. In 401(k) plans, for example, withdrawals must begin by 
age 70\1/2\ unless the employee is still working. If retired, annual 
withdrawals beginning at age 70\1/2\ are based on the life expectancy 
\19\ of the participant--or the participant and his or her spouse, if 
married.
    Joint and Survivor Annuities. The group generally agreed to apply 
existing law governing joint and survivor benefits to the Model T plan. 
That means the annuity would be issued jointly to the plan participant 
and spouse and that the spouse would continue to receive the annuity 
should the plan participant die. Plans would be able to decide whether 
or not they would allow the individual to take up to one-half of the 
balance at age 59\1/2\. If a participant decided he or she wanted to 
take 50 percent of the accumulated balance as a lump sum when it is 
offered, current law governing joint and survivor annuities would apply 
to the remaining amount in the plan.\20\
Areas Where Views Differed
    Other Types of Payment Schedules. Some members suggested that 
participants be allowed to set up a regular withdrawal schedule timed 
to life expectancy for the annuity half of the benefit. Participants 
could, however, outlive the assumed time span for a schedule of 
payments, while annuities would make regular payments as long as a 
participant or surviving spouse lived, in the case of joint and 
survivor annuities.
    Government Managed Annuities. One member suggested that balances 
dedicated to annuities be transferred to the Social Security 
Administration and that SSA could then issue the annuities. Or, 
alternatively, the Pension Benefit Guaranty Corporation could assume 
control of the balances dedicated to annuities and pay out the 
annuities beginning at retirement age. The group, however, declined to 
support this approach.
Building Block No. 7

Tax Incentives and Provisions

    The group discussed whether or not there should be tax credits for 
employers, employees and plan providers, as well as tax subsidies for 
employers and providers. The group also discussed how contributions, 
gains and distributions would be treated for tax purposes.
Areas of Agreement
    Special Tax Treatment Not Essential. The group generally agreed 
that while special additional tax benefits for contributions by 
employees and employers might be helpful, it was not essential for the 
Model T plan.
    Current Tax Preferences Favored. The group generally agreed that 
the Model T should follow existing tax policy in key issues affecting 
contributions, earnings, capital gains, and distributions. Employee 
contributions would be excluded from income and, thus, income taxes. 
Employer contributions would be considered an expense against corporate 
income. Earnings, dividends and capital gains within the Model T plan 
would accumulate tax-free. Distributions and withdrawals from the plan 
would be taxed as part of ordinary income. Distributions upon 
separation from service upon termination of employment would be subject 
to the current withholding rules and a possible penalty if not rolled 
over to an IRA or another plan. Distributions that result from failure 
to repay a loan could be subject to the current early withdrawal 
penalty if made before age 59\1/2\.
    No Tax Subsidy for Plan Providers. The group generally agreed that 
the Model T plan should not provide a start-up tax credit or subsidy 
for financial institutions that offer the plan to employers.
Areas Where Views Differed
    Tax Credits for Employer Contributions. The group also discussed 
whether or not there should be tax credits for employers as an 
incentive for them to contribute to the plan or match employee 
contributions. While members generally agreed the tax credits for 
employers would be helpful, the group did not reach agreement on what 
types of credits would be appropriate. One member said it would be more 
difficult to get Congress to enact a law to set up the Model T, if it 
included tax credits for employer contributions. Another member, 
however, said that the plan should call for a tax credit, noting that 
one could not get a subsidy if one did not ask. The member also 
suggested allowing third parties to offer to match employee 
contributions for low-income workers.
    Super Deductions for Employers. The group discussed a suggestion to 
give employers a super deduction, such as 110 percent, for 
contributions to the Model T plan. While some members supported this 
approach, the group did not reach general agreement on recommending 
this policy.
    Start-Up Tax Credit for Employer. The group discussed whether or 
not small businesses should get tax credits for costs associated with 
starting up the plan, but could not agree on a recommended policy. Some 
members noted that the plan was provided by a third party, so start-up 
costs would be minimal. Other members noted, however, there would be 
some costs associated with setting up the plan and some members 
supported a credit for the first few years of the plan as an inducement 
to get small businesses to sign up with a plan provider. One member 
suggested a limited start-up credit.
    Tax Credits for Employees. The group discussed whether or not to 
recommend refundable tax credits for employees to encourage 
contributions, expanding on the nonrefundable tax credits available 
through the Saver's Credit.\21\ The group, however, did not generally 
agree to support this approach, although some members strongly favored 
it.
Building Block No. 8

Marketing Considerations

    The group discussed how the plan might be marketed to assure that 
more small businesses would decide to participate.
Areas of Agreement
    Description of How the Model T Plan Differs. The group generally 
supported providing a description of how the Model T differs from other 
retirement and saving plan types as a way to interest and eventually 
enlist financial institutions to provide the plan, as well as serving 
as a way to draw attention to the plan for employers who might wish to 
offer it to their employees.
    Demonstration Project. The group generally supported exploring the 
possibility of a demonstration project to generate interest in the 
Model T plan. Such an effort could be modeled after such successful 
campaigns as ``Cleveland Saves,'' which enlisted the Mayor and local 
banks in a public education campaign that included ``personal 
trainers'' who called up people and asked if they had saved anything 
that day. The Model T demonstration project could market a 
demonstration plan to small businesses and their employees in a given 
community.
Areas Where Views Differed
    Government Education Campaign. There was discussion of having the 
government mount a public education campaign on the Model T plan so 
that financial institutions that offer them will not have to advertise 
them. Instead, individuals and small businesses would approach 
potential providers. This was seen as a way to reduce the cost of the 
plans and prompt financial institutions to offer them. The group, 
however, did not reach general agreement on supporting this approach.

Endnotes

\1\ Independent contractors in this context refers to contract 
employees and freelancers, but does not include the employees of 
professional firms, such as lawyers and accountants, who advise or take 
on specific projects for companies.
\2\ U.S. Department of Labor Bureau of Labor Statistics, National 
Compensation Survey: Employee Benefits in Private Industry in the 
United States, March 2003 (Washington, D.C.: Department of Labor, April 
2004), Table 1, p. 3.
\3\ U.S. Bureau of Labor Statistics. National Compensation Survey: 
Employee Benefits in Private Industry in the United States, 2000, 
Bulletin 2555 (Washington, D.C.: U.S. Department of Labor, January 
2003), Table 1, p. 4. The 2000 survey of businesses represents an 
employed population of 107,538,277, 85,939,757 full-time and 21,598,520 
part-time. The survey does not include workers employed by State and 
local governments, the Federal Government or the military.
\4\ U.S. Bureau of Labor Statistics, ``Employee Benefits in the United 
States, 2003,'' News, UDSL: 03-489, September 17, 2003, Table 1, p. 3. 
From the web site at http://www.bis.gov/news.release/pdf/ebs2/pdf.
\5\ Ibid.
\6\ Small businesses reported as follows: 7 percent were very likely to 
start a plan in the next 2 years, while 22 percent were somewhat 
likely. Source: Employee Benefit Research Institute, ``The 2003 Small 
Employer Retirement Survey (SERS) Summary of Findings'' (Washington, 
D.C.: EBRI, June, 2003), p. 2.
\7\ Small businesses reported as follows: 25 percent were not too 
likely to start a plan in the next 2 years, while 43 percent were not 
at all likely. Source: Ibid.
\8\ Ibid.
\9\ U.S. Department of the Treasury, Internal Revenue Service, 
Statistics of Income Bulletin, (Winter 1984-1985, Winter 1986-1987, 
Winter 1990-1991, Winter 1993-1994, Winter Fall 1995, Winter Spring 
1996, Fall 2001, and Winter 2002-2003).
\10\ Craig Copeland, ``Retirement Plan Participation and Features, and 
the Standard of Living of Americans 55 or Older,'' EBRI Issue Brief 
Number 248 (Washington, D.C.: Employee Benefit Research Institute, 
August 2002), Figure 2, p. 8.
\11\ Multiple employer plans (MEPPs) are controlled by a single plan 
document (for this reason they are technically classified as a type of 
single employer plan) and do not involve a collective bargaining 
agreement. The employers usually have some kind of connection short of 
common ownership (``controlled group'' status), and the (typically 
employer) contributions are pooled in a single trust. Fiona Wright, 
``Working Paper on Pooled Multiple Employer Pension Plans'', mimeo, May 
2003.
\12\ Leslie B. Kramerich, ``Confronting the Pension Coverage 
Challenge,'' A Report on the Conversation on Coverage Convened by the 
Pension Rights Center, July 24-25, 2001, p. 42. From the web site at 
http://www.pensioncoverage.net/pdfs/whitepaper.pdf. The report 
discussed recommendations for pooled arrangements noting that these 
would be appealing to small businesses while also being a good vehicle 
for covering part-time and contingency workers.
\13\ Lifestyle or life cycle funds allocate funds across the three main 
asset classes: equities, bonds and cash. For participants who wish to 
make a choice, there will be a simplified offering of fund options to 
be determined by the clearinghouse.
\14\ The Internal Revenue Code's Section 408(a)(2) designates what 
institutions can offer an IRA (banks, credit unions and State 
corporations chartered by the commissioner of banking, and 401(n) 
defines what a bank is. Some non-bank financial organizations that 
offer IRA's often have affiliates that meet the definition of a bank. 
In addition, the trustee of an IRA can also be ``a person other than a 
bank,'' but such a person or entity has to apply to the Commissioner of 
the Internal Revenue Service to demonstrate that it can ``act within 
the acceptable rules of fiduciary conduct.'' The particulars for this 
requirements are spelled out in Treasury Regulations  1.408-2(e)(6).
\15\ So-called 529 plans are college savings programs established and 
administered by the States. They are named 529 Plans after the IRS code 
section that outlines the details of the plans.
\16\ The 2003 Small Employer Retirement Survey found that 73 percent of 
small business would be more likely to start a plan if it did not 
require employer contributions.
\17\ A basis point is one one-hundredth of a percentage point. Thus, 
100 basis points equal 1 percentage point.
\18\ The group did not explore in any detail what sort of prohibited 
transactions might be required in a fiduciary regime. The Employee 
Retirement Income Security Act (ERISA) of 1974, for example, sets forth 
a list of prohibited transactions to which employee benefit plans are 
subject. The Investment Company Act, which governs mutual funds and 
brokerage firms, also has a list of prohibited transactions, but not as 
extensive as ERISA.
\19\ Withdrawals at age 70\1/2\ are based on life expectancy under a 
uniform IRS table or the joint life expectancy of the participant and 
his or her spouse if the spouse is more than 10 years younger than the 
participant.
\20\ Since the Model T is a defined contribution plan, it follows 
current law applicable to such plans, but only on the portion that can 
be withdrawn as a lump sum, and only then if the plan does not offer an 
annuity on that portion. This policy is based on that fact that defined 
contribution plans are not required to offer an annuity provided the 
spouse receives 100 percent of the account balance if the employee dies 
while covered by the plan. However, current law also states that if the 
plan does not offer an annuity and the employee does not die while 
covered by the plan, the employee can withdraw the account balance as a 
lump sum or other non-annuity payment without spousal consent when the 
employee leaves the plan. Thus, if the plan offered an annuity on only 
50 percent of the balance, then the lump sum could be taken out without 
spousal consent. However, if the plan offered an annuity on the entire 
balance, with the option of a lump sum on 50 percent, it would require 
spousal consent to take the benefit as a lump sum. Some members 
suggested that the process of obtaining consent for the annuity portion 
should be streamlined to reduce administrative costs, while others 
insisted that the current form of consent--a signature on paper--must 
be obtained to protect spousal rights.
\21\ Enacted into law in 2001, the Saver's Credit was first available 
in 2002 and is slated to end in 2007. The Saver's Credit can reduce the 
Federal income tax a worker pays dollar for dollar. The amount of 
credit that one can receive is based on one's contributions into an 
IRA, 401(k), and other retirement saving plans. The Saver's Credit is 
part of the Economic Growth and Tax Relief Reconciliation Act of 2001. 
The Saver's Credit is also available for contributions to 403(b) plans, 
457 governmental plans, SIMPLE 401(k) plans or SIMPLE IRA's. The 
Saver's Credit works as follows: For married couples filing jointly, 
workers with income up to $30,000 are eligible for a 50 percent Saver's 
Credit for their contributions into a saving plan. Married couples 
earning $30,001 to $32,500 are eligible for a 20 percent credit, and 
married couples filing jointly earning $32,501 to $50,000 are eligible 
for a 10 percent credit. Those earning over $50,000 are not eligible 
for a credit. For single people or married people filing separately, 
the Saver's Credit is available for 50 percent of contributions for 
workers with incomes up to $15,000. Workers with incomes between 
$15,001 and $16,250 can obtain a 20 percent Saver's Credit. Single 
workers and married people filing separately who earn between $16,251 
and $25,000 can receive a 10 percent Saver's Credit on contributions. 
Slightly different earnings levels qualify a head of household: (50 
percent for incomes up to $22,500; 20 percent for incomes $22,501 to 
$24,375; and 10 percent of incomes $24,376 to $37,500).

    [Whereupon, at 11:44 a.m., the joint committee forum was 
adjourned.]