Mr. Chairman and Members of the Subcommittee:

It is a pleasure to speak with you today regarding pension issues. In accordance with the focus of this hearing, as described in the Subcommittee's announcement, our testimony will address issues relating to pension coverage and participation, particularly for low-income and part-time workers, women, and others who may not be adequately served by current law; ways to improve retirement benefits for workers; portability of pension benefits; and simplification of regulatory requirements. We will also describe the President's proposals to further these goals, strengthen the private pension system, and increase pension security.

The Nation's private pension system has accomplished a great deal for many Americans. Pension benefits have helped millions of people maintain their standard of living in retirement. More than $4 trillion in assets are now held in private retirement accounts. These assets are about 20 times greater than they were when ERISA was enacted in 1974. (Over $2 trillion more are held in plans of state and local governments.) Approximately 47 million workers in the private sector are earning pension benefits in their current jobs, and about two of three families will reach retirement with at least some private pension benefits.

Enhancing pension coverage and security, improving retirement benefits for workers, improving portability, and simplifying the pension laws has been a major focus of the Clinton Administration. Working together in a bipartisan fashion over the past six years, the Administration and Congress have enacted important legislation that has furthered these objectives. We look forward to working with Congress and especially with this Committee to build on these past accomplishments. Before proceeding further, it is worth noting several of these accomplishments.

I. Past legislative accomplishments

In 1993, the Administration submitted legislation that was enacted as the Retirement Protection Act of 1994, to protect the benefits of workers and retirees in traditional pension plans by increasing funding of underfunded defined benefit plans and by enhancing the Pension Benefit Guaranty Corporation's (PBGC) early warning and enforcement powers.

In 1995, the President introduced a package of pension simplification proposals at the White House Conference on Small Business. These proposals were targeted toward expanding coverage, with the particular goal of increasing the number of small businesses that offer retirement plans for their employees, and increasing pension portability. Many of these proposals -- or variations on them -- ultimately were enacted as part of the 1996 Small Business Job Protection Act. These pension provisions, the end product of seven years of bipartisan efforts, represented the most significant changes to the pension laws since the 1986 Tax Reform Act. Among the most important of these changes were

• creation of a new, highly simplified 401(k)-type retirement savings plan for small business (the "SIMPLE"), which is proving to be quite popular with small employers;
  

• simplification of the nondiscrimination testing for 401(k) plans and the development of a design-based safe harbor permitting employers an alternative to 401(k) nondiscrimination testing;
  

• expansion of 401(k) plans to nongovernmental tax-exempt entities;
  

• elimination of the "family aggregation" rules that unduly restricted the ability of family members of small business owners and of other highly compensated employees to save for their own retirement; and
  

• elimination of the section 415(e) combined limits on benefits and contributions applicable to employees who participate in both defined benefit and defined contribution plans.

In 1997, the Taxpayer Relief Act included a number of other provisions that expanded the tax incentives for retirement savings, including

• expansions of individual retirement accounts (IRAs),
  

• repeal of the 15 percent excise tax on very large retirement distributions from qualified plans and IRAs, and
  

• increase in the full funding limitation applicable to defined benefit pension plans.

We can take further steps to promote retirement savings and improve and strengthen our pension system by enacting legislation that will expand the number of people who will have retirement savings (particularly moderate- and lower-income workers not currently covered by employer-sponsored plans), improve workers' retirement benefits, and make pensions more secure and portable. Our focus should be on covering those who are left out of the current system and on improving the level of benefits of those whose current benefits are very modest.

II. Retirement Savings and Tax Policy

Background

Under our pension system, qualified plans are accorded special favorable tax treatment. A sponsoring employer is allowed a current tax deduction for plan contributions, subject to limits, while participating employees do not include contributions and earnings in gross income until they are distributed from the plan. Trust earnings accumulate tax free in the plan.

These important tax preferences for qualified plans are designed to encourage employers to sponsor retirement plans and to encourage participation by moderate- and lower-paid workers. It is often noted that pension coverage reduces the need for public assistance among retirees and reduces pressure on the Social Security system. See, e.g., Joint Committee on Taxation, Overview of Present-Law Tax Rules and Issues Relating to Employer-Sponsored Retirement Plans (JCX-16-99), March 22, 1999.

To ensure that benefits are provided by employers to moderate- and lower-income workers, qualified plans are subject to nondiscrimination rules. Any new pension proposals should be consistent with securing broad retirement coverage and nondiscriminatory benefits in employer-provided plans.

Standards for evaluating retirement savings proposals

It is important that any new or additional tax subsidies for retirement savings satisfy several key principles.

First, tax preferences should create incentives for expanded coverage and new saving, rather than merely encouraging individuals to reduce taxable savings or increase borrowing to finance saving in tax-preferred form. Targeting incentives at getting benefits to moderate- and lower-income people is likely to be more effective at generating new saving. In response to additional tax incentives, higher-income individuals are more likely to shift their savings from one vehicle to another, or offset savings with increased borrowing -- instead of actually saving more. People who save less and have fewer financial resources to shift may be more likely to respond by actually increasing their saving.

Second, any new incentive should be progressive, i.e., it should be targeted toward helping the millions of hardworking moderate- and lower-income Americans for whom saving is most difficult and for whom pension coverage is currently most lacking. Incentives that are targeted toward helping moderate- and lower-income people are consistent with the intent of the pension tax preference and serve the goal of fundamental fairness in the allocation of public funds. The aim of national policy in this area should not be the simple pursuit of more plans, without regard to the resulting distribution of pension and tax benefits and their contribution to retirement security. The object of these tax preferences should not be to deliver the bulk of the benefits to those who need them least.

Third, pension tax policy must take into account the quality of coverage: Which employees benefit and to what extent? Will retirement benefits actually be delivered to all eligible workers, whether or not they individually choose to save by reducing their take-home pay? It is desirable to encourage measures that promote participation by lower- and moderate- income workers, such as employer-funded defined benefit or defined contribution plans, in addition to elective salary reduction arrangements.

Finally, any new or additional tax preferences must not undermine our fiscal discipline.

The President's Proposals

The President has made clear that in this era of surpluses we must save Social Security first. He proposes to commit 62 percent of the unified surplus for the next 15 years to Social Security and an additional 15 percent of the surplus to Medicare to assist retired workers in maintaining their health security.

While protecting the integrity of Social Security is our first priority, it should be possible to take other steps to enhance the retirement security of American workers by promoting new retirement savings for moderate- and lower-income workers many of whom currently lack coverage. The President proposes to devote 12 percent of the unified surplus to establishing a new system of Universal Savings Accounts (USAs) focused especially on those workers.

The President's fiscal year 2000 budget also includes a number of proposals that satisfy the principles outlined earlier and that will promote further expansion of workplace-based savings opportunities, particularly for moderate and lower-income workers not currently covered by employer-sponsored plans. These proposals, which are spelled out in greater detail below, include:

• a small business tax credit for expenses of starting a new retirement plan,
  

• the SMART -- a simplified defined benefit-type plan for small business,
  

• IRA contributions through payroll deduction,
  

• improved portability among different types of plans, and
  

• improvements in the vesting and annuity options to enhance retirement security for women.

The USA account proposal and the pension proposals in the fiscal year 2000 budget reflect the principle that any new tax subsidies for retirement savings should be carefully targeted. To the extent possible, we should avoid providing additional tax subsidies for saving that would occur in any event -- shifting of savings -- which is often the case when the incentives are directed to higher-income individuals.

With this background in mind, I would now like to address the issues identified in the Subcommittee's announcement as the focus of this hearing.

III. Improving Portability of Retirement Savings

Over the years, the Administration and Congress have worked together on a bipartisan basis to greatly improve retirement savings portability for workers. The President's budget clearly reflects the Administration's desire to work with Congress to accomplish even more in this area. We must remember that there are at least two important elements in improving portability: accelerating vesting and making it easier to consolidate retirement savings. We commend Representatives Portman and Cardin and the other co-sponsors of H.R. 1102 for their leadership in promoting improvements in portability.

Accelerated Vesting for Matching Contributions

Currently, employer contributions to a plan, including matching contributions to a 401(k) plan, are required to become vested only after five years (or seven years if vesting is phased in). If an employee switches jobs after four years, all employer matching contributions could be forfeited. Under the President's budget, all employees must be fully vested in the employer's matching contributions after three years of service (or six years if vesting is phased in).

Consolidation of Retirement Savings

Under current law, there are many barriers to consolidating retirement savings. The President's budget takes significant steps toward eliminating these barriers, while balancing the need to prevent increased leakage from the retirement system. Leakage is a serious concern. Two thirds of workers who receive a lump sum distribution from a pension plan do not roll over the distribution to another retirement savings vehicle. Under the President's budget proposals

• A participant with an eligible rollover distribution from a qualified retirement plan would be able to roll the distribution into a section 403(b) tax-sheltered annuity, or vice versa. Under the proposal, such a rollover could occur directly or through an IRA.
  

• Amounts held in a deductible IRA also could be rolled over to an individual's workplace retirement plan. In addition to providing more opportunities to consolidate retirement savings, this proposal would help to simplify the existing "conduit IRA" rules.
  

• A participant in a state or local government section 457 plan would be able to roll a distribution from that plan into an IRA. This proposal would greatly increase payment flexibility for participants in these plans.
  

• A participant with after-tax contributions in a qualified plan would be able to roll those contributions into a new employer's defined contribution plan or into an IRA. Allowing these distributions to be rolled over would increase the chances that these amounts will be retained until needed for retirement.
  

• A new hire in the Federal government would be able to roll over a distribution from a prior employer's plan to the Federal Thrift Savings Plan. We think it is important for the Federal government to set an example for all retirement plan sponsors in this regard.
  

• An employee of a state or local government would be able to use funds in other retirement plans to purchase service credits in the state or local government's defined benefit plan without a taxable distribution. This provision would be particularly helpful in allowing teachers, who often move between different states and school districts in the course of their careers, to more easily earn a pension reflecting a full career of employment in the state in which they end their career.

We believe these proposals represent a significant step forward in the process of developing bipartisan consensus in the pension area. As noted, these proposals are substantially similar to those included in H.R. 1102 and have benefitted from discussion of these issues in this Subcommittee last year. We look forward to working with members and their staffs to resolve the remaining differences between these proposals.

IV. Improving coverage and participation, particularly for low-income and part-time workers and women

While private pension coverage continues to grow, half of all American workers -- more than 50 million people -- have no pension plan at all. The bulk of the uncovered workers fall into one of three overlapping categories: lower wage workers, employees of small business, and women. The President proposes to address this low rate of coverage with a number of measures that are targeted to these three groups and that satisfy the principles we have identified.

Coverage of lower-wage workers and Universal Savings Accounts

Lower-wage workers are far less likely to be covered by a pension plan than higher income individuals. Over 80 percent of individuals with earnings over $50,000 a year are covered by an employer retirement plan. In marked contrast, fewer than 40 percent of individuals with incomes under $25,000 a year are covered by an employer retirement plan. In addition, the qualified plan rules do not require coverage of many part-time workers.

The President proposes to address these problems by devoting 12 percent of the unified surplus to establishing a new system of Universal Savings Accounts. While the specifics of this proposal are not the subject of this hearing, we expect these accounts to provide a tax credit to millions of lower- and middle-income workers, including many part-time workers, to help them save for their retirement. Millions of workers would receive an automatic contribution. Those who contributed additional amounts also would receive a matching contribution to their USA account. The matching contribution would be more progressive than current tax subsidies for retirement savings -- helping most the workers who most need to increase retirement savings. By creating a retirement savings program for working Americans with individual and government contributions, we will help all Americans to become savers and enjoy a more financially secure retirement.

USA accounts are intended to help provide retirement savings to the millions of workers who are not covered by employer-sponsored pensions. In so doing, we expect USAs to be structured in such a way as to complement and strengthen employer-sponsored plans instead of substitute for them.

Small business tax credit for expenses of starting a new retirement plan

Although businesses with fewer than 100 workers provide 40 million jobs, only 20 percent -- about 8 million of these employees -- have pension coverage from their employer. In comparison, 62 percent of workers in firms with 100 or more employees have pension coverage.

The President's budget provides a three-year tax credit to encourage small businesses to set up retirement programs. The credit would be available to employers that did not employ, in the preceding year, more than 100 employees with compensation in excess of $5,000, but only if the employer did not have a plan or payroll deduction IRA arrangement during any part of 1997. In order for an employer to get the credit, the plan would have to cover two or more individuals.

For the first year of the plan, small businesses would be entitled to a credit, in lieu of a deduction, equal to 50 percent of up to $2,000 in administrative and retirement education expenses associated with a defined benefit plan (including the new SMART plan described below), 401(k), SIMPLE or other pension plan or payroll deduction IRA arrangement. For each of the second and third years, the credit would be 50 percent of up to $1,000 in such costs. The credit covers the expense of retirement education as well as administrative expenses because informed employees save more.

Promoting IRA contributions through payroll deduction

To make it easier for workers to contribute to IRAs, employers would be encouraged to offer payroll deduction. Contributions of up to $2,000 to an IRA through payroll deduction generally would be excluded from an employee's income, and, accordingly, would not be reported as income on the employee's Form W-2. Some employees would be able to use simpler tax forms. As evidenced by the rising participation rates in 401(k) plans, the greater convenience of saving through payroll deduction encourages lower- and moderate-wage earners to save more for retirement. Small businesses establishing such arrangements would be eligible for the new pension program start-up tax credit, provided the arrangement is made available to all employees of the employer who have worked with the employer for at least three months.

he SMART -- a simplified defined benefit-type plan for small business

In 1996, the Administration and Congress created the SIMPLE plan -- an easy-to- administer defined contribution plan for small businesses. However, there is no comparable tax- favored defined benefit pension plan that avoids the need for complex actuarial calculations, with the attendant administrative costs and unpredictability of funding requirements.

The President's budget proposes a simplified defined benefit-type plan for small business, the SMART plan (Secure Money Annuity or Retirement Trust). SMART combines many of the best features of defined benefit and defined contribution plans and provides another easy-to- administer pension option for small businesses. Because the SMART does not involve many employer choices regarding plan design or funding, many of the rules that govern these choices in defined benefit plans will not apply to the SMART. For example, the SMART Plans would not be subject to the nondiscrimination or top-heavy rules applicable to qualified retirement plans. SMART Plans also would not be subject to the limitations on benefits under section 415. Similarly, because SMART Plans do not have complex actuarial calculations, they would be subject to simplified reporting requirements. The minimum guaranteed benefit under the SMART Trust, described below, would be guaranteed by the PBGC with a reduced premium of $5 per participant.

A business would be eligible to adopt a SMART Plan if it employed 100 or fewer employees with W-2 earnings over $5,000 and did not offer (and had not offered during the last five years) a defined benefit or money purchase plan. An employer that maintained a SMART Plan could not maintain additional tax-qualified plans, other than a SIMPLE plan, or a 401(k) plan or 403(b) tax-sheltered annuity plan under which the only contributions that are permitted are elective contributions and matching contributions that are not greater than those provided for under the design-based safe harbor for 401(k) plans.

SMART Plans would provide a fully funded minimum defined benefit, with a possible higher benefit if cumulative investment returns exceed 5 percent. Each year the employee participates, all eligible employees (employees with at least $5,000 in W-2 earnings with the employer in that year and in two preceding consecutive years) would earn a minimum annual benefit at retirement equal to 1 percent or 2 percent of compensation for that year. Moreover, an employer could elect, for each of the first 5 years the SMART Plan is in existence, to provide all employees with a benefit equal to 3 percent of compensation (in lieu of 1 percent or 2 percent of compensation). The maximum compensation that could be taken into account in determining an employee's benefit for a year would be $100,000 (indexed for inflation). Benefits would be fully vested.

Under the SMART, an employer would be required to contribute each year an amount sufficient to provide the annual benefit accrued for that year payable at age 65, using actuarial assumptions specified in the statute (including a five percent annual interest rate). The contributions would be allocated to a separate account to which actual investment returns would be credited for each employee. If a participant's account balance were less than the total of past employer contributions credited with five percent interest per year, the employer would be required to contribute an additional amount for the year to make up for any shortfall. Moreover, the employer would be required to contribute an additional amount for the year to make up for any shortfall between the balance in the employee's account and the purchase price of an annuity paying the minimum guaranteed benefit when an employee retires and takes a life annuity. On the other hand, if the investment returns exceeded the five percent assumption, the employee would be entitled to the larger account balance. If the employee elected to receive an annuity, the larger account balance would translate to a larger annuity.

If an employer did not wish to take on the risk that the cumulative investment return will be less than 5 percent or that the employee will choose an annuity when the insurance market is unfavorable, the employer could choose to purchase a SMART annuity instead. In the case of a SMART Annuity, each year an employer would be required to contribute the amount necessary to purchase an annuity that provides the benefit accrual for that year on a guaranteed basis.

SMART Plans would be subject to the qualified joint and survivor annuity rules that apply to qualified defined benefit pension plans. Lump sum payments also could be made available. No distributions would be allowed from a SMART Plan prior to an employee's attainment of age 65, except in the event of death or disability, or where the account balance of a terminated employee was not more than $5,000. However, an employer could allow a terminated employee who has not yet attained age 65 to directly transfer the individual's account balance from a SMART Trust to either a SMART Annuity or a special individual retirement account ("SMART Account") that is subject to the same distribution restrictions as the SMART Trust.

If a terminated employee's account balance did not exceed $5,000, the SMART Plan would be allowed to make a cashout of the account balance. The employee would be allowed to make a tax-free transfer of any such distribution to a SMART Annuity, a SMART Account, or a regular IRA.

Distributions from SMART Plans would be subject to tax under current rules applicable to the taxation of annuities. A 20 percent additional tax would be imposed for violating the pre- age 65 distribution restrictions under a SMART Annuity or SMART Account.

nhanced retirement security for women

Women receive lower pension benefits than men. Only 30 percent of all women age 65 or older were receiving a pension in 1994 (either worker or survivor benefits), compared to 48 percent of men. Women's pensions are typically smaller than those received by men. Among new private sector pension annuity recipients in 1993-94, the median annual benefit for women was $4,800, or only half of the median benefit of $9,600 received by men.

The President's proposals include a number of provisions that -- while gender neutral -- would have the primary effect of benefitting women. For example, workers who take time off under the Family and Medical Leave Act (FMLA) would be able to count that time toward retirement plan vesting and eligibility requirements. In some cases, counting time taken under FMLA can make the difference between receiving or not receiving credit toward minimum pension vesting requirements.

The budget would make a 75 percent (or higher) joint and survivor annuity universally available in plans that are subject to the joint and survivor rules. Having higher survivor annuities could reduce the number of elderly widows living in poverty. Under current law, workers are given the option of a single life annuity, which pays only during the life of the covered employee, or a "joint and survivor annuity" which typically pays a lower pension benefit during the lifetime of the retiree, but continues to pay 50 percent of the amount to a retiree's surviving spouse. Unfortunately, the income a surviving spouse needs to live on is often more than 50 percent of the pension payable while the worker is alive. Many couples may prefer an option that pays a somewhat smaller benefit to the couple while both are alive, but provides a larger benefit -- 75 percent of the joint annuity amount -- to the surviving spouse. In addition, the spouse would be required to receive the same explanation of the worker's choices that the worker receives.

Plan vesting requirements have an especially adverse impact on female employees who tend to have shorter job tenure. As described above, under the President's budget, all employees must be fully vested in the employer's matching contributions after three years of service (or six years if vesting is phased in).

Retirement Savings Education

One key to improving coverage and participation by workers is to address the relative lack of employee demand. Even among workers whose employers offer plans, many fail to take advantage of the retirement savings opportunities available. Nearly 40 percent of employees earning less than $50,000 a year who are eligible to save through a 401(k) plan fail to participate.

Educating workers about the importance of saving for retirement and about investment and financial choices may be quite helpful. A recent study, for example, found that education in the workplace tended to increase participation of workers in 401(k) plans. The role of education in this area and the educational efforts that have been undertaken by the Administration will be addressed by the Department of Labor in its testimony before this Subcommittee today.

V. Improving Benefits for Workers

We share with the Committee the goal of increasing workers' retirement income security. Of course, the nondiscrimination and top-heavy safeguards play an important role in directing adequate benefits to moderate- and lower-income workers under tax-qualified retirement plans, and changes to these rules should be considered only to the extent that this objective is not compromised. We also believe it is important to encourage employers to adopt plans that provide retirement benefits to all covered employees, in addition to salary reduction arrangements (which may not benefit workers who are unable to save). As noted, the President's budget also proposes to improve benefits by accelerating vesting.

Nondiscrimination Rules

The nondiscrimination standards benefit the majority of employees by requiring the employer to provide benefits to them as a condition of receiving tax-favored status for its retirement plans. Higher paid employees are typically very interested in saving for their retirement, and many of them would save even in the absence of an employer plan. On the other hand, many lower-paid employees understandably prefer receiving a larger portion of their total compensation package in the form of current pay, rather than in retirement plan benefits, given scarce resources to meet current expenses. However, it is just these types of lower-paid employees -- who are unable to save on their own -- who need the most help in saving for retirement.

If the nondiscrimination rules were relaxed, some employers could respond by increasing the benefits provided to their higher paid employees without increasing the benefits provided to the rest of their employees. Alternatively, the employer could maintain the current contribution level for the higher paid employees and respond to other employees' desire to shift their compensation package to cash compensation by reducing their retirement benefits. Further reductions in the already low rate of savings for lower-paid employees would have consequences for our entire society.

Top-Heavy Safeguards

The top-heavy safeguards serve as a safety net for lower- and moderate-wage workers, delivering benefits to those workers when the nondiscrimination rules are not adequate to the task. A tax-qualified plan is considered top-heavy whenever 60 percent of the value of the benefits provided under the plan inure to key employees (i.e., certain owners and officers). If a plan is top-heavy, it must provide certain minimum benefits or contributions and must accelerate vesting.

Some pension practitioners have traditionally used their ingenuity to find gaps in the nondiscrimination rules in order to allow plan sponsors to save costs by minimizing the benefits provided to moderate- and lower-paid employees. Some of the more aggressive approaches have resulted in very large disparities in benefits between key and non-key employees. For example, without top-heavy safeguards, some plans could provide as much as $30,000 of annual tax- favored contributions to key employees and as little as one percent of pay to younger non-key employees. The top-heavy rules fill a portion of those gaps by requiring a minimum contribution for all non-key employees that is generally equal to three percent of pay.

As noted, the top-heavy rules apply only when more than 60 percent of the benefits in a plan are concentrated among a limited group of key employees -- often as a result of non-key employees terminating without vesting or because an employer's demographics accommodate a plan design that takes advantage of the permitted disparity in the nondiscrimination rules in order to provide more benefits to higher paid employees. By requiring at least a minimum level of benefits for all employees and accelerating vesting, the top-heavy rules play a very important role in leveling the playing field for workers in these cases.

We do, however, believe that some elements of proposals to simplify the top-heavy rules warrant serious consideration, and we would be pleased to work with this Committee in that regard. However, we have serious concerns about various elements of current top-heavy simplification proposals, particularly provisions that would undermine the ownership attribution rules, which apply not only for purposes of the top-heavy rules, but for purposes of the other pension nondiscrimination rules as well.

A fundamental principle underlying the Internal Revenue Code is that tax rules should not be avoided by simply shifting ownership of a business among family members. Proposed changes in the ownership attribution rules would virtually eliminate the obligation to provide fair benefits to non-family member employees in small business retirement plans. For example, under a proposed change, a business run by two spouses who also employed a full-time non- family member would be able to exclude that employee from a retirement plan covering the two spouses as long as the business was legally owned solely by either spouse. Obviously, such a proposal could reduce coverage substantially among workers in small businesses and is inconsistent with our efforts to expand coverage of those workers.

The top-heavy and nondiscrimination protections benefit the American taxpayer and protect the integrity of the pension tax preference by ensuring that the tax preference is utilized by workers throughout the income spectrum and does not serve primarily as a tax shelter for higher-income individuals. Any modifications that might be made to the top-heavy or nondiscrimination protections must not result in moderate- or lower-income workers receiving smaller benefits or in a larger number of short-service workers forfeiting their benefits.

401(k) Safe Harbor

The President's budget proposes to improve the benefits of workers by modifying the rules applicable to the safe harbor 401(k) plan. Under this plan design, an employer is not required to determine the rate at which nonhighly compensated employees are participating in the plan, if the employer provides a specified matching contribution formula. To increase the participation rate of nonhighly compensated employees, the budget would specify a minimum period following the receipt of an explanation of the plan during which employees could choose to participate in the plan for the upcoming year and would require that all employees covered under a safe harbor 401(k) plan receive a small nonelective contribution equal to one percent of pay. Receiving account statements showing this contribution and the tax-free compounding of interest would stimulate the saving habit among current nonsavers and encourage vendors to market savings to those workers and their families.

Effect of Increased Dollar Limits on Moderate- and Lower-Income Workers

We share the concern that percentage-of-pay limitations under defined contribution plans may inappropriately restrict retirement savings opportunities for some moderate- and lower- income workers, including those who have spent an extended period out of the workforce. We would be pleased to work with the Committee on targeted approaches to address these issues. For example, while a wholesale repeal of these limits may not be necessary, a more targeted approach may be to explore whether there is some minimum dollar level of contribution that could address these concerns, similar to the minimum dollar benefit accrual allowed for defined benefit plans. In addition, it is important to ensure that any changes to percentage of pay limitations avoid weakening nondiscrimination tests that are based on employee percentage of pay averages.

Some also suggest increasing maximum dollar limits for tax-qualified plans, on the theory that this would align the interests of decision makers with the rest of the plan participants. They suggest that this would encourage more coverage while the nondiscrimination rules would provide moderate- and lower-paid workers with their fair share. We have several concerns about such an approach, especially if not part of a significantly broader legislative strategy that ensures meaningful benefits for moderate- and lower-income workers. It would need to be demonstrated in each case that the particular proposal would function as an effective incentive for new coverage and new saving, given that a very small percentage of retirement plan participants is affected by the current statutory limits, and the individuals affected tend to be among the wealthiest of Americans. To date, there is no reliable evidence to indicate that these additional tax preferences will result in any appreciable increase in new plan coverage.

Moreover, recent changes in law, such as the repeal of the 15 percent excise tax on very large retirement distributions from qualified plans and IRAs, have already increased the amount that higher-income individuals can save on a tax-favored basis. Some of the 1996 and 1997 provisions have only recently become effective, and the repeal of the combined maximum limits on tax-qualified benefits and contributions -- a major simplification that could increase significantly the ability of higher-income individuals to accumulate tax-qualified benefits -- will not become effective until next year. It is still too early to assess the impact of these expanded tax incentives to establish plans.

In addition, if the nondiscrimination rules (and the limit on considered compensation under section 401(a)(17)) were weakened at the same time maximum dollar limits were increased, the limit increases would be correspondingly less likely to improve coverage or benefits for moderate- and lower-income workers who are currently covered under retirement plans. In fact, an increase in the considered compensation limit from $160,000 to $235,000 increases the relative share of plan benefits that go to higher paid employees. For example, simultaneous increase in the compensation and contribution limits will not require an improvement in a plan contribution formula in order for individuals whose compensation exceeds $160,000 to take advantage of a section 415 contribution limit increase from $30,000 to $45,000. Where the highly paid are satisfied with current benefit levels, an increase in considered compensation may even provide an opportunity to reduce benefit levels for most employees without affecting benefits for the highly paid.

Of course the overall impact of any legislative changes of this particular type would need to be assessed in the context of other provisions that might be enacted at the same time, especially broad initiatives to deliver significant additional retirement savings to lower- and moderate-income workers. I would like to reiterate that we will be happy to work with the Committee on appropriate means of expanding retirement savings opportunities for these workers.

Increases in IRA and Salary Reduction Contribution Limits

We share the goal of increasing retirement savings. At the same time, proposed increases in contribution limits for IRAs and for SIMPLE, 401(k), and other salary reduction plans must be scrutinized carefully to assess their effect on sound pension policy. We should examine the efficiency of such proposals in terms of increasing retirement savings, and their effect on coverage for moderate- and lower-income workers. For example, increases in the 401(k) contribution limit would benefit a relatively small number of taxpayers who have the ability to set aside these amounts in a 401(k) plan, and who may well only shift existing savings to their 401(k) plan.

Increases in IRA limits are likely to attract additional deposits by higher-income taxpayers who are already saving for retirement, and who may merely shift their additional IRA contributions from other savings. Currently, a small business owner who wants to save $5,000 or more for retirement on a tax-favored basis generally would choose to adopt an employer plan. However, if the IRA limit were raised to $5,000, the owner could save that amount -- or jointly with the owner's spouse, $10,000 -- on a tax-preferred basis without adopting a plan for employees. Therefore, higher IRA limits could reduce interest in employer retirement plans, particularly among owners of small businesses. If this happens, higher IRA limits would work at cross purposes with other proposals that attempt to increase coverage among employees of small business.

Similarly, if the owner wants to save, say, $15,000 a year in a qualified plan (as opposed to the $10,000 that can currently be saved via 401(k) salary reduction), the owner has an incentive to adopt a plan that provides employer contributions to employees. The limit on 401(k) contributions and the resulting pressure to provide employer contributions serves a useful purpose in our system. Increasing the 401(k) limit may prompt employers to substitute expanded voluntary salary reduction opportunities for employer contributions. While 401(k) plans are highly desirable, defined benefit and employer-funded defined contribution plans play -- and should continue to play -- a central role in our pension system. These plans provide benefits to lower-paid workers regardless of whether they individually choose to save by reducing their take- home pay. Fewer employer-funded benefits and contributions may mean less retirement savings by the lower- and moderate-income workers who have the greatest difficulty saving for retirement.

Some may respond to this concern by contending that employers will not reduce employer-funded contributions in favor of IRAs or voluntary salary reduction elective arrangements if maximum dollar limits for employer-funded plans are also increased when limits are increased for IRA and 401(k) contributions. However, whatever the relative levels of permissible tax-favored contributions might be among different types of plans, the absolute amount of IRA plus salary reduction contributions that would be permitted if both of those limits were increased [combination of higher IRA contribution limits and higher salary reduction contribution limits] may be enough to satisfy the desire for tax-favored retirement savings on the part of many decision-makers, including many small business owners.

Similar concerns are raised by proposals for a $5,000 SIMPLE plan that provides for no employer contributions. Surveys suggest that the popularity of SIMPLE plans with small businesses is already exceeding expectations in the two years since SIMPLEs became available. The SIMPLE plan requires only a modest, but important, employer matching or automatic contribution. A proposal that allows $5,000 of employee pretax contributions without either nondiscrimination testing or employer contributions would certainly undermine the SIMPLE plan. Furthermore, in combination with a $5,000 IRA contribution limit proposal, there could be substantial displacement of not only SIMPLE plans but also 401(k) plans (which have nondiscrimination standards or safe harbor employer contributions) and other employer plans. The Administration's payroll deduction IRA proposal, which is based on current law IRA limits, is a better approach to addressing small businesses' concerns about financial commitment, without undermining the success of SIMPLE plans.

Similar considerations apply to proposals to add Roth-IRA type "designated plus accounts" to 401(k) plans and 403(b) annuities. Treating pre-tax contributions as "designated plus contributions" would effectively increase the limit on 401(k) and 403(b) pre-tax contributions. They would eliminate or relax the income and contribution limits for Roth IRAs, and would have other serious consequences.

Catch-up Contributions

We are sympathetic to concerns that those who have spent extended periods out of the workforce may encounter obstacles to "catching up" on retirement savings needs. Obviously, the most important obstacle in this regard is an individual's own financial ability to increase savings. With respect to the employer plan system, evidence suggests that nonstatutory limits imposed by plans or employers (e.g., limiting salary reduction contributions to ten percent of pay) are a significantly greater barrier to catch-up contributions than the statutory $10,000 401(k) contribution limit. In fact, only a small percentage of participants over the age of 50 are actually affected by the $10,000 contribution limit, and those tend to be among the highest-income individuals.

We think it is worth exploring ways to address barriers to increasing savings, particularly for those over the age of 50. In so doing, it may be more appropriate to focus on percentage-of- pay limitations, particularly as applied to lower-income workers, as discussed earlier.

VI. Simplifying Regulatory Requirements

Another area of bipartisan accomplishment has been pension simplification, particularly as part of the 1996 Small Business Job Protection Act. Further improvements can be made to promote simplification, provided that there is an appropriate balance between simplifying rules and protecting workers, so that moderate- and lower-income workers receive a fair share of retirement benefits.

For example, the President's budget includes a proposal to simplify the definition of a highly compensated employee. The definition would be modified to eliminate the complex option to treat all employees earning below the 80th percentile in an employer's workforce as nonhighly compensated employees. This will ensure that all employees earning over $80,000 are classified as highly compensated employees for qualified plan nondiscrimination testing purposes. This would not only make the law simpler, it would also make it more fair. Under current law, an executive or professional earning hundreds of thousands of dollars can be classified as a nonhighly compensated employee for nondiscrimination testing if the individual is below the 80th percentile (which can occur in a small firm with several highly paid executives or professionals) unless the person is a five-percent owner of the business.

Some have proposed allowing employers a deduction for dividends paid to an employee stock ownership plan (ESOP) when employees elect to leave the dividends in the ESOP. Current law allows employers to deduct ESOP dividends if they are distributed from the plan or used to pay certain ESOP indebtedness. Proponents argue that this proposal would simplify administration by making it unnecessary for a participant to make an offsetting 401(k) plan election if the participant prefers to defer tax on income equal to the amount of the dividend. However, the proposal would need to be modified to treat the employee's election to leave dividends in the ESOP in the same manner as any other cash or deferred election. Otherwise the provision would allow ESOP participants 401(k)-type cash-or-deferred elections that are not subject to the $10,000 limit and that are not subject to nondiscrimination standards. Further, unless the election is subject to the 401(k) rules, the proposal might make it easier for C corporations that are substantially owned by ESOP participants to effectively avoid federal taxes on all corporate earnings.

Simplicity Versus Flexibility

Complexity of pension rules is often attributable to employers' desire for certainty while at the same time accommodating a wide range of plan designs and practices to satisfy various corporate objectives. Accordingly, major simplification of the pension rules is likely to come only at the price of curtailing the extensive flexibility employers currently enjoy.

The pension nondiscrimination regulations reflect the effort to combine certainty with flexibility. These regulations, which were finalized in 1993, were the product of an unprecedented amount of dialogue between the government and plan sponsors, following multiple rounds of comment, discussion, and revision. Plans have long since been amended to reflect the regulations.

These regulations address the complexity issue by providing a set of safe harbors that allow employers to avoid nondiscrimination testing by retaining or adopting straightforward plan designs that provide uniform benefits to participants. These plans pass the nondiscrimination tests regardless of the characteristics of the employer's workforce. Today, well over 90 percent of qualified plans use these safe harbor designs.

Compliance Programs

Another example of easing regulatory burdens without weakening worker protections may be found in the compliance programs maintained by the Internal Revenue Service. Since 1990, the Service has maintained a number of compliance programs to enable correction of retirement plans that fail to meet tax-qualification requirements. These programs have evolved over the years in response to taxpayer suggestions, and there has been widespread appreciation for how successful the programs have been.

Some legislative proposals would effectively undermine these programs and would adversely affect compliance. The programs reflect the principle that plan sponsors need a carefully graduated series of stages in the process to make sure that the sponsor always has the incentive to avoid delaying correction to a later date -- especially an incentive to correct shortly after the error has occurred when correction is easy and before participants have been harmed. The incentive structure should also ensure that if the error has not been corrected within a specified time, the sponsor will have a further incentive to correct at the next stage in the process.

Pending legislative proposals would restrict the flexibility that is currently essential to the administrative compliance programs. Some proposals, for example, would fail to require full correction of qualification errors, even in the case of significant violations. For instance, if a plan discovered it had failed to pay 401(k) benefits to 20 retired participants, the current programs would encourage prompt correction after discovery of the failure. By contrast, under legislative proposals, the sponsor would not be required to take any corrective action unless and until the audit notice cycle began, and then would be required to correct only for most of the participants. These proposals would not allow the IRS to require that benefits ever be paid to the remaining participants, even if the plan could easily pay the benefits and even after audit. These legislative proposals also would dramatically revise the tax consequences for disqualification, removing the primary compliance incentive for plans that cover predominantly nonhighly compensated employees, such as multi-employer plans or plans of businesses in financial distress for which loss of an income tax deduction or a tax on trust earnings is not important. Such changes could undermine the IRS administrative compliance and correction programs, which have been widely recognized as improving plan compliance.

To protect participants while lessening regulatory burdens, we need to continue developing and improving flexible programs, such as the Employee Plans Compliance Resolution System, that create appropriate incentives, as opposed to enacting legislation that might impede innovation and flexibility. The productive administrative process that has developed and expanded these compliance programs requires maximum flexibility, feedback, and adaptation. These favorable results can best be achieved through the kind of administrative approach involving the pension community that has been undertaken in recent years.

The Treasury Department appreciates the opportunity to discuss these important issues with Members of this Subcommittee, and we would be pleased to explore these issues further.

Mr. Chairman, this concludes my formal statement. I will be pleased to answer any questions you or other Members may wish to ask.