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[109 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:23280.wais]
S. Hrg. 109-129
THE ROLE OF EMPLOYER-SPONSORED
RETIREMENT PLANS IN INCREASING NATIONAL SAVINGS
=======================================================================
HEARING
before the
SPECIAL COMMITTEE ON AGING
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
WASHINGTON, DC
__________
APRIL 12, 2005
__________
Serial No. 109-5
Printed for the use of the Special Committee on Aging
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SPECIAL COMMITTEE ON AGING
GORDON SMITH, Oregon, Chairman
RICHARD SHELBY, Alabama HERB KOHL, Wisconsin
SUSAN COLLINS, Maine JAMES M. JEFFORDS, Vermont
JAMES M. TALENT, Missouri RUSSELL D. FEINGOLD, Wisconsin
ELIZABETH DOLE, North Carolina RON WYDEN, Oregon
MEL MARTINEZ, Florida BLANCHE L. LINCOLN, Arkansas
LARRY E. CRAIG, Idaho EVAN BAYH, Indiana
RICK SANTORUM, Pennsylvania THOMAS R. CARPER, Delaware
CONRAD BURNS, Montana BILL NELSON, Florida
LAMAR ALEXANDER, Tennessee HILLARY RODHAM CLINTON, New York
JIM DEMINT, South Carolina
Catherine Finley, Staff Director
Julie Cohen, Ranking Member Staff Director
(ii)
C O N T E N T S
----------
Page
Opening Statement of Senator Gordon Smith........................ 1
Opening Statement of Senator Herb Kohl........................... 3
Opening Statement of Senator James DeMint........................ 8
Opening Statement of Senator Thomas Carper....................... 9
Panel I
Mark J. Warshawsky, assistant secretary for Economic Policy,
Department of the Treasury, Washington, DC..................... 4
J. Mark Iwry, nonresident senior fellow, Economic Studies, The
Brookings Institution, Washington, DC.......................... 25
Eugene Steuerle, senior fellow, The Urban Institute, Washington,
DC............................................................. 80
James A. Klein, president, American Benefits Council, Washington,
DC............................................................. 98
John M. Kimpel, senior vice president and deputy general counsel,
Fidelity Investments, Boston, MA............................... 139
APPENDIX
Testimony submitted by Patricia Cox, chief operating officer,
Schwab Retirement Plan Services, Inc........................... 159
Statement of The Principal Financial Group....................... 168
Information submitted by The Retirement Security Project......... 174
A Report on Corporate Defined Contribution Plans submitted by
Fidelity Investments........................................... 214
(iii)
THE ROLE OF EMPLOYER-SPONSORED RETIREMENT PLANS IN INCREASING NATIONAL
SAVINGS
---------- --
TUESDAY, APRIL 12, 2005
U.S. Senate,
Special Committee on Aging,
Washington, DC.
The committee met, pursuant to notice, at 2:35 p.m., in
room SD-106, Dirksen Senate Office Building, Hon. Gordon H.
Smith (chairman of the committee) presiding.
Present: Senators Smith, DeMint, Kohl, and Carper.
OPENING STATEMENT OF SENATOR GORDON H. SMITH, CHAIRMAN
The Chairman. Ladies and gentlemen, if we can come to
order, we will commence this hearing of the Senate Special
Committee on Aging.
Today's hearing will focus on a very important topic: the
role of employer-sponsored retirement plans in increasing
national savings. We are going to hear from two distinguished
panels of witnesses who will provide us with their insights on
whether the current employer-sponsored retirement plan system
effectively increases national savings and how we can improve
that system.
The average life expectancy of Americans has steadily
increased. For example, the average life expectancy of
Americans born in 1960 was about 70 years. Yet in 2003, life
expectancy was about 77 years. Although Americans are living
longer than ever before, most Americans continue to retire
before age 65.
At the same time, the personal savings rate in the United
States has declined dramatically over the last two decades,
reaching about one percent of personal income in 2004. The
decline in our savings rate is a disturbing trend because, as
the length of retirement grows, Americans must save more, not
less, to ensure a financially secure retirement.
The need to increase our savings was also emphasized by
Chairman Alan Greenspan of the Board of Governors of the
Federal Reserve System during his testimony before this
committee last month on the economics of retirement. Many refer
to retirement income as a three-legged stool: Social Security,
employer-sponsored retirement plans, and personal savings.
Although there has been a tremendous amount of focus on Social
Security lately, we all know that it takes all three legs of
the stool to keep the whole thing balanced.
Therefore, as pensions are the second largest sources of
income among the elderly, the goal of this hearing is to focus
on ways to increase savings in employer-sponsored retirement
plans and thus improve the stability of America's retirement
system.
Currently, savings and participation rates in employer-
sponsored retirement plans are low. In 2001, only about 58
percent of households with an employed head of the household
under the age of 64 included at least one worker who
participated in an employer-sponsored plan. In addition, about
37 percent, or 28 million, of such households did not own a
retirement savings account of any kind. With respect to the
amount of retirement savings Americans have accumulated among
the 47.8 million households that owned a retirement savings
account of any kind in 2001, the median value of such accounts
was only $27,000.
Besides low savings and participation rates, another
important trend with respect to employer-sponsored retirement
plans is the shift from defined benefit plans to defined
contribution plans, including 401(k) plans. Over the last
several years, the number of defined benefit plans has dropped
dramatically, while at the same time the number of defined
contribution plans has increased. In the context of savings,
this shift is significant because coverage under a defined
contribution plan generally requires employers to take a more
active role in preparing for retirement.
For example, in general, employees must decide whether to
participate in the retirement plan, how much to contribute to
the plan, and how their contributions should be invested.
In response to these trends, I plan to introduce
legislation shortly that is aimed at increasing savings and
participation rates in employer-sponsored retirement plans. For
example, the bill will include a provision intended to
encourage sponsors of 401(k) plans to adopt automatic
enrollment in which a percentage of each employee's salary is
placed in an individual account without requiring the employee
to take any action. Therefore, instead of requiring employees
to actively enroll in a 401(k) plan in order to participate,
under automatic enrollment employees will be automatically
enrolled unless they elect to opt out, as is generally done
under defined benefit plans. Automatic enrollment has been
shown to increase participation rates in 401(k) plans
significantly, especially among low- and middle-income
individuals.
In addition, with increased life expectancies, it is also
important for individuals to preserve their income throughout
their retirement years and not outlive their savings.
Therefore, my bill also will provide incentives to ensure
income preservation throughout one's retirement by encouraging
employers to offer and employees to select distributions from
defined contribution plans and IRAs in the form of lifetime
annuities.
I want to thank all of our witnesses for coming today, and
I look forward to hearing your testimony. I would note that
there is a 3:30 vote scheduled. Perhaps we can hear from
everyone and get all the questions asked in that amount of
time.
I now turn to my colleague, Senator Kohl, for his comments.
OPENING STATEMENT OF SENATOR HERB H. KOHL
Senator Kohl. Thank you, Mr. Chairman.
Mr. Chairman, we have all seen the statistics and the
studies on the amount of money Americans are saving for
retirement, and it is striking that so few are prepared for
their nonworking years. Retirement income has often been
compared to a three-legged stool--as you pointed out--which
includes Social Security, employer-sponsored pensions, and
personal savings. Increasingly, a fourth leg will be wages, as
many older Americans work past traditional retirement age.
Financial planners recommend a retirement income that
replaces 70 percent of pre-retirement earnings. With Social
Security's overall replacement rate of about 45 percent,
clearly other sources of retirement income are critical.
As we continue the Social Security debate, we cannot ignore
the other legs of the stool. Clearly, the pension system needs
improvement. Most workers are not covered by a plan, and only
about half participate in a pension at all. Participation rates
are poor for lower-income workers and small businesses.
Contributions are also low across the board, and too many
workers withdraw money before retirement. The typical balance
for a 401(k) for workers near retirement is only $43,000, and
for workers earning less than $25,000 a year, the typical
balance is only $2,200.
So it is clear that more needs to be done to encourage
saving, but we need to do it right. As we will hear today, the
government now spends more on tax incentives for retirement
saving than Americans actually save. Almost all of these
incentives are worth the most to higher-income workers, who
probably would have saved even without the extra inducement
from the government. Some proposals by the administration, such
as Retirement Savings Accounts and Lifetime Savings Accounts,
instead of reversing this backwards incentive structure, would
go even further in the wrong direction.
Obviously, we need to reorient government policy to
encourage saving and improve retirement security among the
population that most needs to save; our lowest-income workers.
Several policies have the potential to do just that:
encouraging automatic enrollment in 401(k)s; extending and
expanding the saver's credit, which is a matching tax credit
for contributions targeted toward lower-income workers;
improving financial education and investment choice; and
allowing taxpayers to split off a portion of their tax refund
and put it directly into a savings account.
These are promising ideas with the potential to receive
bipartisan support. The time to act is now; the retirement
security of millions of Americans depends on it.
I thank you, Mr. Chairman, and we welcome you all to the
panel.
The Chairman. Thank you, Senator Kohl.
Our only witness on our first panel is Mark J. Warshawsky,
and, Mr. Secretary, we welcome you. He is the assistant
secretary for Economic Policy, Department of the Treasury, and
the microphone is yours.
STATEMENT OF MARK J. WARSHAWSKY, ASSISTANT SECRETARY FOR
ECONOMIC POLICY, DEPARTMENT OF THE TREASURY, WASHINGTON, DC
Mr. Warshawsky. Thank you. Good afternoon, Chairman Smith,
Ranking Member Kohl, and members of the committee. I appreciate
the opportunity to discuss the administration's proposal to
reform and strengthen the single-employer defined benefit
pension system against the backdrop of the larger issue of
promoting national saving.
As far back as 1776, Adam Smith identified capital
accumulation as the key force in promoting growth in the wealth
of nations. Smith also identified the key force in capital
accumulation: increasing national savings. Since Smith's time,
almost all economists have come to understand the vital nature
of national saving, and increasing saving has become a standard
policy prescription for enhancing economic growth and raising
living standards.
We know the U.S. faces a challenge as the economy works
through the implications of the retirement of the baby-boom
generation. With the growth in the workforce set to slow and
the average age of the population rising, maintaining steady
growth in the standard of living will become more difficult.
The Smith prescription shows the way out. Increase our savings,
which will increase our accumulated capital, which will give
each worker more and better tools to work with, which will
raise productivity and secure a growing standard of living.
Despite the fact that this prescription is well known, the
evidence suggests it is exceptionally hard to follow. Net
private saving--which we define as gross private saving less
depreciation on plant, equipment, and housing stock--as a share
of national income averaged about 11 percent from 1955 through
1985, but since then has trended steadily down. Over the past
10 years, it has averaged about 5.5 percent of GDP, or about 5
percentage points below where it was during the decades of the
1950's, 1960's, 1970's, and most of the 1980's.
One reason the saving prescription is difficult to follow
is that incentives work against it. Our tax system, for
example, has for a long time encouraged Americans to spend
first and save second. To reverse this, the Administration has
worked hard to set in place the incentives that encourage
saving. EGTRRA cut the top tax rates which raised the after-tax
rate of return on capital income--encouraging savings. The Jobs
and Growth Tax Relief Reconciliation Act of 2003 cut taxes
specifically on capital income.
But even with these positive changes, the Federal income
tax code still discourages saving. To combat this, the
President has proposed retirement savings accounts, which would
replace the complex array of retirement saving incentives
currently in the tax code, such as IRAs, Roth IRAs, and similar
saving vehicles. The President has also proposed employer
retirement savings accounts, ERSAs, to simplify the saving
opportunities individuals have through their employers. The
President's lifetime savings accounts would, for the first
time, allow individuals to save on a tax-preferred basis for
any purpose. This can be especially important to low-income
individuals and families who need to save but cannot afford to
lock up funds for retirement that may be needed for an
emergency in the near term. The President has also proposed
individual development accounts which would give extra
financial incentive to certain low-income families to set aside
funds for major purchases, such as a first home.
Pensions, of course, play a critical role in savings as
well. Accumulating financial assets for future retirement is
indeed one of the main reasons households save any way. If
individuals and households believe they will receive a pension
in retirement, that clearly influences their saving and asset
accumulation behavior. But if, in fact, those promised benefits
are not available because of pension underfunding, then the
household's savings and, when you add up households, the
aggregate national savings is less than it otherwise would have
been had their pension been adequately funded.
Unfortunately, the single-employer pension system's current
serious financial trouble is likely to lead to just such
undersaving and participant benefit losses. Many plans are
badly underfunded, jeopardizing the pensions of millions of
American workers, and the insurance system which protects those
workers in the event that their own plans fail has a
substantial deficit.
The primary goal of any pension reform effort should be to
ensure that retirees and workers receive the pension benefits
they have earned. Clearly, the current funding rules have
failed to meet this goal. As part of its reform proposal, the
administration has designed a new set of funding rules that we
think will ensure that participants receive the benefits they
have earned from their pension plans.
Today I will briefly discuss a few critical issues
pertaining to the funding elements of the proposal and their
likely effects on the economy and national savings. My written
testimony provides a more comprehensive discussion of the
entirety of the proposal.
For any set of funding rules to function well, assets and
liabilities must be measured accurately. The system of
smoothing embodied in current law serves only to mask the true
financial condition of pension plans. Under our proposal,
assets will be marked to market. Liabilities will be measured
using a current spot yield curve that takes into account the
timing of future benefit payments summed across all plan
participants. Discounting future benefit cash-flows using the
rates from the spot yield curve is the most accurate way to
measure a plan's liability. Liabilities computed using the
yield curve match the timing of obligations with discount rates
of appropriate maturities. Proper matching of discount rates
and obligations is, in fact, the most accurate way to measure
today's cost of meeting pension obligations.
The Administration recognizes that the current minimum
funding rules have added to contribution volatility. Particular
problem areas are the so-called deficit reduction contribution
mechanism and the limits on tax deductibility of contributions.
Our proposal is designed to remedy those issues by giving plans
the tools needed to smooth contributions over the business
cycle. These tools include increasing the deductible
contribution limit, and this will give plan contributions an
additional ability to fund up during good times. We also
increase the amortization period for funding deficits to 7
years compared to a period as short as 4 years under current
law. Finally, there is the continued freedom that plan sponsors
already have to choose prudent pension fund investments. Using
all these tools, plan sponsors can limit volatility and
maintain a conservative funding level so that financial market
changes will not result in large increases in minimum
contributions.
We believe these are the appropriate methods for dealing
with risk. We believe it is inappropriate to limit contribution
volatility by permitting plan underfunding that transfers risk
to plan participants and the PBGC.
Under our proposal, plan funding targets for healthy plan
sponsors will be established at a level that reflects the full
value of benefits earned to date under the assumption that plan
participant behavior remains largely consistent with the past
history of an ongoing concern.
Plans sponsored by firms with below investment grade credit
will be required to fund to a higher standard that reflects the
increased risk that these plans will terminate. Pension plans
sponsored by firms with poor credit ratings pose the greatest
risk of default. It is only natural that pension plans with
sponsors that fall into this readily observable, high-risk
category should have more stringent funding standards. Credit
ratings are used throughout the economy and, in fact, in many
Government regulations to measure the risk that a firm will
default on its financial obligations. A prudent system of
pension regulation in insurance would be lacking if we did not
use this information.
Credit balances under current law are created when a plan
makes a contribution that is greater than the required minimum.
Under current law, this credit balance plus an assumed rate of
return can be used to offset future contributions. We see two
significant problems with this system. First, the assets that
underlie the credit balances may lose rather than gain value.
Second, and far more important, credit balances allow plans
that are seriously underfunded to take funding holidays. In our
view, every underfunded plan should make minimum annual
contributions.
So under our proposal, credit balances, as defined under
current law, will be eliminated. Contributions in excess of the
minimum, however, still reduce future minimum contributions.
The value of these contributions is added to the plan's assets
and, all other things equal, reduces the amount of time that
the sponsor must make minimum contributions to the plan. In
combination with the other elements of our proposal, there is
more than adequate incentive for plan sponsors to fund above
the minimum. In fact, we believe there are four other reasons
that employers might choose to contribute more than the
minimum: (1) there is the increased deductibility provisions
that allow sponsors to accumulate on a tax-free basis; (2)
disclosure of funded status to workers will encourage better
funding; (3) a better funded status results in lower PBGC
premiums under our proposal; and, (4) a better funded status
makes benefit restrictions less likely.
Now, as I have described, the current rules often fail to
ensure adequate plan funding, and recent history has made this
very obvious. Formally, and speaking as an economist, we might
say that the current set of rules has created a partially pay-
as-you-go private pension system by allowing some accrued
liabilities to be unfunded. That is, in general, when plans are
not funded fully, the system basically operates by transferring
contributions associated with younger workers to current
retired workers.
The funding rules proposed by the administration, whereby
sponsors that fall below the accurately measured minimum
funding levels are required to fund up toward their
contribution in a timely manner, and this moved the system in
the direction of being fully funded. In a fully funded system,
the contributions associated with each generation of workers
are invested and fund their own retirements. A basic result in
macroeconomics is that a pay-as-you-go system results in less
savings, a slower rate of capital accumulation, and a lower
steady state capital stock. Therefore, the Administration's
proposal, through the move toward more fully funded private
defined benefit pensions, is consistent and in support of the
administration goal of increases saving and greater capital
accumulation.
Now, let me comment that some analysts recently have
expressed concern that the administration's proposal could have
negative macroeconomic effects. They suggest these effects will
come through depressed business investment by underfunded plan
sponsors, some of whom will, in fact, face higher contributions
under the administration's proposal.
In my opinion, sound economic analysis strong suggests that
there are no short- or long-term macroeconomic risks associated
with reforming pension funding rules. Quite the contrary, the
proposal's long-term economic effects will be positive and in
the direction that we have just described.
Well-functioning capital markets allow companies to finance
attractive investments even if they face short-term demands on
their current cash-flows. For that reason, many economists
believe that there is little link between a company's cash-
flows--including its pension funding requirements--and its
investment decisions. This suggests that as a general matter,
pension contributions are unlikely to cause a reduction in the
plan sponsor's investment pattern.
But even more importantly, it is critical to recognize that
pension contributions finance investment throughout the
economy. They do not just disappear. The monies directed into
pension accounts are invested in stocks and bonds, thereby
deploying these resources throughout the economy. Failure to
recognize this may have led some analysts to mistakenly
attribute negative macroeconomic effects to the
Administration's proposal.
In conclusion, let me say that defined benefit plans are a
vital source of retirement income for millions of Americans.
The Administration is committed to ensuring that these plans
remain a viable retirement option for those firms that wish to
offer them to their employees. The long-run viability of the
system, however, depends on ensuring that it is financially
sound. The Administration's proposal is designed to put the
system on secure financial footing in order to safeguard the
benefits that plan participants have earned and will earn in
the future. We are committed to working with the Members of
Congress to ensure that effective defined benefit pension
reforms that protect workers' pensions are enacted into law.
It has been my pleasure to discuss the proposal, and I look
forward to answering any questions you may have.
The Chairman. Thank you.
We have been joined by two colleagues, Senator DeMint of
South Carolina and Senator Carper of Delaware. If either of you
have an opening statement, we would be happy to take those now.
OPENING STATEMENT OF SENATOR JAMES DeMINT
Senator DeMint. Thank you, Mr. Chairman. I will just make a
couple of comments and maybe ask a question, if we could just
get that started.
Thank you very much for your testimony today. It is a
subject near and dear to my heart. As an employer for many
years, trying to get folks to save was a real challenge. I have
found over the years even matching or putting savings into some
form of pension is very difficult for a small employer with
unpredictable profits. The regulations that require consistent
contributions make it very difficult for a small employer to
participate since year to year we are not sure if we can make a
contribution.
The other frustrating aspect of it was we may have actually
contributed 100 percent of some form of pension or savings, and
only to find that an employee might pull it out with a large
penalty to spend on immediate need.
I think what it comes down to pragmatically is the average-
income American is going to find it very difficult to find any
additional discretionary money to save. That is why I
appreciate the President's recognition that when you take over
12.5 percent of what the average American makes, it is going to
be very difficult for them to find additional money to save.
That is why I believe it is so important that we as a
Government figure out how we can start saving part of that 12.5
percent that people are already putting into their Social
Security plan.
The average American family now contributes over $5,000 a
year in Social Security taxes, if you include the employer's
side of that. That makes it very difficult for an employee to
add to. So as we look at total savings, we do see that is a key
problem in America because, as you know, when there is not
savings from a large percent of the population, the wealth gap
continues to grow. We have half of Americans who own something
and the other half who don't, half who benefit from the growth
in the economy and nearly another half that don't.
So I appreciate the President's proposal. I would be very
supportive of expanding particularly the idea of IDAs, which at
least somewhat control how the money could be spent, expanding
those in some ways. But I think I would just like your comments
on realistically can we expect the Americans who need to save
the most to actually come up with additional funds as well as
the employers who have the most difficult time of creating
these plans coming up with plans under new regulations that
might make it more difficult for them to be consistent with
them, if you could just make a few comments, I would appreciate
it.
Mr. Warshawsky. One reason to particularly focus on defined
benefit plans is that under current law the rules have become
extraordinarily complex. I am sure that is a strong
disincentive, particularly for small employers, for sponsoring
defined benefit plans. Defined benefit plans do have certain
advantages for employees and employers, and in particular they
are, if you will, a forced saving vehicle. Everyone
participates and the money is put in by the employer, and
sometimes by employees as well.
Under our proposal, we basically have a significant
simplification of the rules; this is hard to appreciate without
knowing how complicated the current rules are. But I think it
is fair to say that we have a much simpler system, and that
perhaps could have the impact down the road of encouraging
smaller plan sponsors to enter the system.
Another aspect of our proposal is that by allowing
companies to fund during good times, that enables them to
manage their cash-flow better than under current law, which is
very restrictive of additional contributions because of the
full funding limitations.
Senator DeMint. Thank you.
The Chairman. Senator Carper.
OPENING STATEMENT OF SENATOR THOMAS CARPER
Senator Carper. I have got a couple of questions I want to
ask our witness. I am going to wait until just a little bit
later. But this is certainly a timely hearing and a timely
issue, and we appreciate your input, and I look forward to
asking a couple of questions.
Thank you.
The Chairman. Did I detect in your statement an expression
that defined contribution or defined benefit plans do more to
add to national saving, one versus the other?
Mr. Warshawsky. Not necessarily. I think the import of my
statement is that underfunded defined benefit plans do detract
from national savings because employees think they are going to
get the benefits that are promised to them and, therefore, they
save less. But in point of fact, the realization may be other
than what they are promised because the plan is poorly funded.
So, therefore, one way of increasing national savings in the
context of defined benefit pensions is to be sure that these
plans are adequately funded. That is really what I was getting
at in my testimony.
The Chairman. Many defined contribution plans occurs
essentially through a payroll deduction, and then it is there
and they own it and they watch it grow, they participate, their
knowledge increases, I assume, in what they have.
Mr. Warshawsky. I think that is an aspect of a defined
contribution plan. That is right.
The Chairman. How much simpler are 401(k) plans versus
defined benefit plans in terms of--you spoke to Senator DeMint
about the complexity being a significant deterrent to small
companies offering defined benefit plans. How much simpler are
defined contribution?
Mr. Warshawsky. There have been studies in the past that
actually try to quantify the administrative costs of defined
benefit versus defined contribution plans, and depending on the
size of the plan sponsor, because there are economies of scale,
defined contribution plans are easier and less costly to
administer. Therefore, because defined benefit plans have had
layer upon layer upon layer of regulation and rules that have
been established for them, particularly in the funding area,
one point of our proposal is to simplify that system.
The Chairman. How about the administrative cost? Is one
more costly to administer versus another?
Mr. Warshawsky. I believe for many employers, defined
benefit plans are more costly to administer.
The Chairman. How often is it that there is malfeasance on
the part of the corporation or the pension fund manager where
workers are utterly cheated out of their retirement? I ask that
because of a terrible case that occurred in my State whereby
not only were some pensions underfunded, but then they were
appropriated to the extent of over $100 million. You have
people who have worked all of their lives now with no recourse
and only a few people in jail. How common is that?
Mr. Warshawsky. My impression is that it is fortunately not
very common. That is something that is subject to Department of
Labor and Internal Revenue Service oversight. Perhaps I could
share my own research on this point.
In a prior position, many years ago, I used to work at the
Internal Revenue Service in the Employee Plans area. We
conducted an examination of about 400 large underfunded defined
benefit plans. We were looking to see whether there was
compliance with the current law of funding requirements, to see
whether that was a reason for why the plans were underfunded.
While we discovered some small problems, by and large plan
sponsors followed the rules. The reason why they were
underfunded was not because they were not following the rules.
They were following the rules. The problem was the rules
themselves.
The Chairman. Senator Kohl.
Senator Kohl. Thank you, Mr. Chairman.
Mr. Warshawsky, in their submitted statements three of the
next panel's witnesses advocate not only extending the saver's
credit, but also expanding it. One study estimated that about
75 percent of the benefits of all the 2001 pension provisions
go to the top 20 percent of taxpayers. In contrast, over 45
percent of the benefits of the saver's credit go to taxpayers
with income below $30,000, who most need to save.
While the administration proposes to extend a variety of
pension provisions, the saver's credit is on the chopping
block. A New York Times article reports that the Treasury
Department's explanation is that the administration is waiting
for the recommendations of its tax reform panel.
Why must the saver's credit wait, but not the other pension
provisions?
Mr. Warshawsky. Senator, it is my understanding that one
significant problem is that provisions in the code are designed
for particular groups, and they therefore become very difficult
for financial companies to market, because generally marketing
campaigns have to be done on a mass basis. They are also very
confusing because people do not know whether they are eligible
or whether they are not eligible, whether they are phased out,
and it introduces an enormous amount of complexity in the
system and precisely for individuals, lower-income individuals,
who are ill-equipped to deal with tax code complexity.
Therefore, the administration, for example, has put forward the
LSA proposal, the lifetime savings account proposal, which is
intended to be particularly appealing to low-income folks
because of the removal of various special requirements and so
on and so forth, and also to enable them to be effectively
marketed.
Senator Kohl. So you are saying the saver's credit is too
complicated?
Mr. Warshawsky. Well, I am saying that I think we need to
be very mindful of the complexity in the code, and, therefore,
that sometimes works at cross-purposes with the intent of very
specifically, carefully targeted incentives.
Senator Kohl. Here is a tax incentive which, as I pointed
out, provides benefits that lower-income families generally
take advantage of; 45 percent of the saver's credit goes to
taxpayers with incomes below $30,000. So it would seem that it
would be something that would deserve all kinds of attention
because it does exactly what we want. Yet the administration
has apparently decided that it should expire completely. While
75 percent of the benefits of all the 2001 provisions go to the
top 20 percent of taxpayers, 45 percent of the benefits of this
credit go to people with incomes less than $30,000. So why
wouldn't you say, maybe we have to simplify it or make it a
little bit easier to understand, but we should really promote
it because it does what we want it to do?
Mr. Warshawsky. Senator, I am sure that it will be
something that will be carefully studied by the tax panel,
among many of the other features of the tax code in the saving
incentive area.
Senator Kohl. Well, I hope so.
The administration has proposed split tax refunds in its
last two budgets. A recent letter from the IRS Commissioner to
Members of Congress said that split refunds cannot be
implemented until 2007 because a committee needs time to do
things like program computers and add a new schedule to the tax
forms. It is unclear why it should take two years to resolve
such minor administrative issues.
Can you assure us that everything that can be done is being
done with maximum speed? Would congressional action such as
providing more funding help speed things up?
Mr. Warshawsky. Senator, I regret to say I am not familiar
with that issue. It is more a matter of tax administration. But
we would be glad to get back to you on that question.
Senator Kohl. OK. Finally, I was struck by the fact that
you have devoted the bulk of your testimony to the
administration's proposed PBGC funding reforms. You make almost
no mention of whether current tax incentives for retirement
saving actually increase private and national saving. As I
mentioned in my statement, the government now spends more on
these incentives than Americans save. So how can you explain
this?
Mr. Warshawsky. We feel it is very important that the
benefits that are promised to workers be assured that they get
them. It is really a matter of simple fairness and equity,
Senator.
Senator Kohl. Alright. Mr. Chairman, thank you.
The Chairman. Thank you, Senator Kohl.
Senator Carper, your questions.
Senator Carper. Do you pronounce your name ``Warshawsky''?
Mr. Warshawsky. That is correct.
Senator Carper. OK. Secretary Warshawsky, just for my
purposes would you--I came in about halfway through your
testimony. Just distill for me just into a couple of small
nuggets the problem we are trying to address here.
Mr. Warshawsky. The main problem we have, Senator, in the
defined benefit system is that many plans--in fact, currently
most plans--are significantly underfunded. Therefore, this
poses a risk both to the Government through the Pension Benefit
Guaranty Corporation and even more importantly to the plan
participants of not getting the benefits that they are
promised.
That is the problem in a nutshell from the perspective of
individuals and the Government, but there is also a
macroeconomic problem, and that is, underfunded pension plans
tend to decrease national savings, which is one of the points
that we were talking here about as well. So it is actually a
broader issue as well.
Senator Carper. If we go back a decade or so, did we face
the same problem? Were we facing the same problem in the 1990's
with underfunding of these pension funds?
Mr. Warshawsky. Yes. In fact, as I described my own job at
the Internal Revenue Service, I was hired actually to lead a
research program on underfunded defined benefit plans because
there were so many and the underfunding was so significant. In
fact, it seems as if each business cycle we have a cycle of
underfunding and then adequate funding, and then each cycle it
seems to get worse and worse. So back then in the early 1990's,
there were significant problems with underfunded plans as well.
Senator Carper. I seem to recall in the 1990's there was a
time when a number of employees thought their funds were
overfunded, and they sought to take money out of their fund.
Mr. Warshawsky. In the late 1990's, as interest rates went
up and stock prices went up, there was an apparent overfunding.
But, of course, that was also related to how the liabilities
were defined. If liabilities are correctly measured, we seem to
find more underfunding than current law measurement of pension
liabilities.
Senator Carper. So what you are saying is this is a
recurring problem.
Mr. Warshawsky. Correct.
Senator Carper. As we go through each business cycle, a
cycle of the stock market going up and down, the problem gets
worse over time.
Again, just lay out for me again just briefly the cure, as
prescribed by the administration.
Mr. Warshawsky. The cure is several-fold. One aspect, which
I emphasized in my testimony, is a simple but stronger set of
funding rules whereby, No. 1, assets and liabilities are marked
to market, measured accurately, and the difference between
assets and liabilities, if the plan is underfunded, has to be
made up within seven years.
Senator Carper. Say that last part again?
Mr. Warshawsky. In other words, if the plan is underfunded,
if liabilities exceed assets, that difference has to be made up
within seven years, which we feel is prudent--in other words,
not too fast, not too slow, it is key that it be done off of an
accurate measurement of the liability.
In addition, we also propose a new method of calculating
PBGC premiums for that insurance program that will also reflect
the risk that plans represent, so that if plans are underfunded
but are sponsored by poor credit risks, they will have to pay a
higher premium, and also they have to pay more in funding for
the plan because they represent a larger risk to the PBGC as
well as to the plan participants.
We also have a proposal to increase disclosure. We feel it
is very important that plan participants know how well funded
their plans are, those are the main elements of the proposal.
Senator Carper. What would you have us do?
Mr. Warshawsky. We have the proposal, and as I understand
it, it is being considered by the various committees--the
Finance Committee, the House Ways and Means Committee, and the
other relevant committees. We feel very strongly that this
proposal would, in fact, cure the ills of the defined benefit
system.
Senator Carper. Are hearings taking place in the House and
the Senate for the legislative committees?
Mr. Warshawsky. We had hearings at the beginning of March,
yes.
Senator Carper. What is the prognosis?
Mr. Warshawsky. I believe there is a good recognition of
the problem, and I think there is an appreciation that the
administration has come forward with a comprehensive package,
and I think there is great interest in it.
Senator Carper. All right. Thanks very much.
Senator Kohl [presiding.] Thank you very much, Senator
Carper, and, Mr. Warshawsky, we appreciate your being here
today.
[The prepared statement of Mr. Warshawsky follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Senator Kohl. On the second panel, if you would like to
step up, we have J. Mark Iwry, who is a nonresident senior
fellow of economic studies at the Brookings Institution in
Washington, DC; Eugene Steuerle, senior fellow, the Urban
Institute, here in DC; James Klein, president, American
Benefits Council, Washington, DC; and John Kimpel, Fidelity
Investments, senior vice president and deputy general counsel,
here in Washington, DC.
So maybe we will start on my left with Mr. Iwry and give
you each brief opportunity to make your opening statements so
we will have some time to ask a question or two. Mr. Iwry.
STATEMENT OF J. MARK IWRY, NONRESIDENT SENIOR FELLOW, ECONOMIC
STUDIES, THE BROOKINGS INSTITUTION, WASHINGTON, DC
Mr. Iwry. Mr. Chairman, thank you. I am Mark Iwry. I am
happy to be here with you. I commend you for holding this
hearing. I would like to start out by noting that our private
pension system has put together what is probably the largest
pool of investment capital in the world, over $5 trillion in
defined benefit, defined contribution plans, and IRAs, most of
it rolled over from employer plans. It covers about two-thirds
of the workforce at some point in people's lives, and at any
given moment about half the workforce is in an employer plan of
one kind or another. It has done a great job of delivering
meaningful benefits to millions of working families.
At the same time, we can do much more to make the system
effective in encouraging saving. We spend about $175 billion--
that is Treasury's estimate--on tax incentives for employer
plans and IRAs. Much of it is skewed, as, Senator Kohl, you
said, toward the people at the top, more skewed than it ought
to be. One reason is that the tax preference is based on tax
deductions. In other words, its value is proportional to your
tax bracket. If you are in the 35-percent bracket and you have
$1 that you contribute to a tax-preferred plan, you get 35
cents' worth of tax savings. So the dollar costs you a dollar
minus 35, or 65 cents to save. If you are in the 10-percent
bracket, you get a dime's worth of tax savings so that it costs
you 90 cents to save. This is essentially an upside down
system. We are giving the most incentive to the people who need
it the least, who have the most wherewithal already. We are
giving the least incentive to the people who need it the most
for whom retirement savings actually would represent security
and not just increased affluence.
It follows that we need to target our efforts more toward
the three out of four Americans who are in the 15-percent
bracket, the 10-percent bracket, or, in fact, the 0-percent
income tax bracket, people who pay their payroll taxes but do
not owe any income tax, and to level the playing field. As you
said, Senator Kohl, the saver's credit does that. It is the
most significant and probably the only major Federal
legislation that is directly targeted toward promoting
retirement saving for the majority of the working population.
Contrary to what Mr. Warshawsky said, who I very much
respect personally, it is not complex. It could hardly be
simpler. You contribute to a 401(k) or an IRA and you get a 50-
percent tax credit, or a tax credit at a lower percentage.
Instead of the amount you get for saving being dependent on how
well off you are, it is dependent on how much you save. It
makes a lot more sense than the deduction-based tax incentives.
Even though many people have not heard of the saver's credit,
5.3 million people took advantage of it in its first year,
2002, and again in 2003.
Mr. Warshawsky, I respectfully suggest, is dead wrong when
he says it is hard to market. It is not even a product. People
do not market the saver's credit by itself. You market 401(k)s.
You market IRAs. You market savings. The saver's credit is one
of the tools that helps you market those because it is an
additional benefit that people get when they do contribute to a
401(k) or another employer plan or an IRA, and something that
H&R Block can attest is actually very easy to get. They helped
a million people last year get a saver's credit in connection
with their contributions. It costs less than 1 percent of the
entire tax incentive package that we give employer plans and
IRAs. Less than one percent of that tax expenditure is the cost
of the saver's credit, but, unfortunately, it is about to
expire at the end of next year. It is not refundable so over 50
million people intended to get it do not get it. It does not
reach high enough into the lower-middle-income and middle-
middle-income groups. We need to make those three changes to
further improve it.
The other thing I would like to talk about very briefly is
something that, Mr. Chairman, you described at the beginning of
your remarks--automatic enrollment. The impact and the power of
telling people that they are in a 401(k) unless they want to
opt out, giving them advance notice and giving them a chance to
opt out at any time, is huge. One study showed that in a
particular company the 401(k) participation by low-income
people was 13 percent when they had the traditional method of
enrollment, you have to sign up. They switched to automatic
enrollment, so you are automatically in unless you sign out of
the plan. It went from 13 to 80 percent. These are people
earning less than $20,000 a year. Similarly, for Hispanic
Americans, a similarly dramatic increase in participation, from
less than half to way more than half.
The other things I would suggest that you consider, Mr.
Chairman and the other members of the committee, in thinking
about promoting automatic enrollment are the related escalation
of contributions, making it easier for employers to say, you
know, we will not only put everybody in the plan at three
percent of pay at the beginning or four percent of pay,
whatever the employer is comfortable with, but over time we
will make it easier for you to step up. Maybe next year it will
be five percent, and a couple years later it will be six
percent. But you can always step off the escalator. Anyone can
opt out or say, ``I want to stay at three percent. That is all
I want to do.''
The Chairman [presiding.] Can you speak to Senator DeMint's
comment earlier that low-income people do not really have a lot
of discretionary money, but where it is automatic and they do
not opt out, is there any study in terms of satisfaction level
with such a thing?
Mr. Iwry. There are studies that suggest that lower-income
people, contrary to what we might think, actually want to save
and do respond to saving incentives. When you give them a
chance to save, especially if you give them a match, offer them
a matching contribution, whether it is a tax credit or money
deposited in an account, they do tend to step up and save.
I was at a focus group a few days ago, apropos of your
question, Senator, where we had nine moderate- to lower-income
people around the table who are eligible for a (k) plan and
none of them were in it. They were asked why. You know, what is
keeping you out? Why aren't you saving? Then they were
introduced to this automatic enrollment concept and asked: What
do you think of this? Does this bother you? Is it a good thing?
One woman there, about 39 years old, says, ``I have been
working since I was 16. I haven't saved a penny.'' Once she
understood what automatic enrollment was about, she said, ``You
know, my company has a 401(k). I didn't even know it existed. I
found out about it by accident the other day after several
years of being with the company. If I had been put in automatic
enrollment back when I was 16, it would have been''--in her
words--``a beautiful thing. I would have just gone ahead, I
would have seen the money accumulate, and I would have a real
nest egg now.''
My suggestion is that these techniques that are focused on
lower-income people not only work in the sense that people
really respond--I mean, 5.3 million people are doing this right
now, and they are all folks--most of them are--they are all
below $50,000 in income, and it is something people have barely
even heard of.
My suggestion would be also that when you do focus on
lower-income people with savings incentives, it increases
saving. That, after all, is the topic, the focus of your
hearing today. What is the impact on saving? Give savings
incentives to people of moderate income, they tend to actually
save more. Give savings incentives to people who are very
affluent, it is a mixed bag. There is a lot of shifting. A lot
of us will take money that has been in a different account that
is not tax-favored, and we will just move it over to the tax-
favored account. No net increase in personal saving, no net
increase in national saving. Net decrease in national saving
because we just spent some tax expenditure, the Government just
gave a tax break to an individual who did not actually increase
his or her saving, but just shifted it around. So I think it
makes eminent good sense to focus on the moderate- and lower-
income.
[The prepared statement of Mr. Iwry follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you very much. Just for your notice, we
probably have a vote coming up fairly soon.
We do not have timing lights apparently operating in this
room right now, so one of our assistants is going to notify you
as to a reasonable amount of time so we can make sure we hear
all of you.
I am sorry. Pronounce your name for me.
Mr. Steuerle. ``Steuerle.''
The Chairman. Steuerle, OK.
STATEMENT OF EUGENE STEUERLE, SENIOR FELLOW, THE URBAN
INSTITUTE, WASHINGTON, DC
Mr. Steuerle. Thank you, Mr. Chairman and Senator Kohl. As
I mentioned to Senator Smith before the formal hearing began it
is a privilege to testify before this committee, in part
because I think it is one of the true bipartisan committees on
either side of the Congress. I always enjoy working with the
committee because it really does try to seek answers to
questions.
As Mark has mentioned, on the positive side the United
States is in a select group of developed countries with a very
significant share of assets in pension and retirement accounts,
and they are largely employer-sponsored. I would like to add
that the involvement of employers appears to be very crucial in
increasing retirement assets, whether the employer directly
funds these accounts or merely makes them available to
employees.
Nonetheless, the evidence that retirement and pension
incentives have done much recently for national saving is very
weak. As you mentioned, Senator Kohl, citing some statistics, I
believe, that a colleague and I came out with a few weeks ago,
total personal saving in the United States is now below just
the revenue spent on supporting retirement and pension plans.
That does not even count the revenue spent on other so-called
saving incentives that Congress has adopted. Even that
comparison further does not count other accounts in areas like
health that have a saving component.
Even if net saving were not an issue, the distribution of
retirement saving is very highly skewed, and the current system
fails to provide much in the way of retirement saving--but not
just for low-income taxpayers, whom we have been talking about,
but for middle-income taxpayers, as well. Most middle-income
taxpayers, not just low-income taxpayers, go into retirement
with very little in the way of saving. I make that comment very
strongly because among the issues we discussed, such as
automatic enrollment, it is not just an issue for low-income
people. It is even for the middle-income people who are not
saving.
I will give you one quick statistic. For two-thirds of the
population in the United States, the value of their Social
Security and Medicare benefits alone is in excess of all their
saving from every other source--their own homes, their
retirement assets, their savings accounts, every other source.
So two-thirds of the population have more in Government
benefits coming to them than from their entire saving when they
go into retirement. So it is far more than a low-income issue.
Now, one major reason is that all of these Government
subsidies that we have are not for saving. They are for
deposits. There is a big difference. A taxpayer can borrow, for
instance, and put money in a saving account or a subsidized
saving account, and he would be taking interest deductions on
the other side without saving a dime.
A second reason--and it has been mentioned by Secretary
Warshawsky--is that the extraordinary complexity of the laws
discourages saving. It discourages saving both by employees and
it discourages the offering of saving accounts or pension plans
by employers.
I would like to also add that some pension designs and laws
also present an assortment of problems that probably discourage
saving, such as easy withdrawals of deposits before old age and
design of traditional defined benefit plans that often
discriminate against older-age employees. In fact, I can show
you a number of cases where older employees accrue negative
pension benefits by working longer.
Yet another negative influence on saving is that most
people retire in middle age. We have a system of retirement
now, both public and private, that basically has people
retiring for about one-third of their adult lives. That is,
they are retiring in years when traditionally they have been
savers. It would be as if about 50 or 60 years ago we had
people retiring in their early 50's and then not saving for
years beyond that early retirement age.
Finally, the incentives, as has been mentioned several
times, for low- and moderate-income, even middle-income
taxpayers, are often small and sometimes nonexistent. Let me
quickly mention some ways of dealing with these issues.
One is to limit the tax breaks for those who are
arbitraging the tax system by applying limitations on their
interest deductions when, on the one hand, they are getting
preferences for so-called savings but really deposits and, on
the other hand, taking deductions--it might be mortgage
interest deductions, it might be investment interest
deductions--without actually saving at all. They are not
counting their interest receipts when taking these interest
deductions. Tightening up on withdrawals from retirement plans
before old age could enhance saving. Yet another approach is to
simplify, even though one has to admit simplification means
that some people somewhere in the system are going to lose.
Mind you that simplification is not just offering of a new
simple plan. It is reducing the extraordinary array of plans
that people have to choose from. If you look in the back of my
testimony, I show a scheme for the plans that Congress now
offers that makes the Clinton health plan, if you may remember
the design of that, look simple by comparison. The pension laws
are extraordinary complex and expensive.
Strong consideration also needs to be given to providing
safe harbors for employers in designing new retirement plans
for older workers so these older workers can save, at the same
time making it easier for them to have bridge jobs, while
removing the threat of suits that employers face from tax laws,
labor laws, and old-age discrimination laws.
Another promising approach is to provide defaults for
deposits which employers can opt out rather than opt in, as we
have talked about. Another strong possibility is to increase
the subsidy for lower- and moderate-income taxpayers.
Both of you, Senators Smith and Kohl, have asked about the
saver's credit. I would like to offer my support for expanding
the saver's credit, but also to mention three major
limitations. It does not apply to most low- and moderate-income
taxpayers. It does not cover employer deposits. The subsidy
itself does not go directly into retirement accounts. So I
think we need to work with the saver's credit, not merely just
continue or increase it.
Another promising approach is to provide a clearinghouse to
handle rollovers out of employer plans and a simplified saving
system, especially when small amounts are involved. Finally,
mandates that employees save for retirement, including in
employer-sponsored plans, should be considered as one leg of a
broader retirement stool. That issue of mandates for employee
deposits is on the table right now, but very indirectly, as
part of the Social Security debate. I think it needs to be
brought into the broader private retirement system debate as
well.
Thank you.
[The prepared statement of Mr. Steuerle follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Senator Kohl [presiding.] Thank you very much, Mr.
Steuerle.
Mr. Klein.
STATEMENT OF JAMES A. KLEIN, PRESIDENT, AMERICAN BENEFITS
COUNCIL, WASHINGTON, DC
Mr. Klein. Thank you, Senator Kohl. I appreciate the
opportunity to be here. I am the president of the American
Benefits Council. Our organization represents companies that
either directly sponsor or provide services to retirement and
health plans that cover more than 100 million Americans.
My written testimony, which is being submitted for the
record, provides a lot of data and statistics as well as a
number of specific recommendations for improvements to the
private employer-sponsored retirement system, and I would be
delighted to chat about that if there is a question-and-answer
period. But I thought that I would use my few moments during
the oral remarks to just make some observations that are not
fully developed in the written statement.
To start out, I would like to just call your attention to
three charts that I have brought with me. The first chart here
shows the growth in private pension fund assets from 1945 until
2004, and that is both defined benefit and defined contribution
assets. As you can see--or it may be a little bit hard to see
from where you are sitting--the growth in the assets really
took off in the late 1970's, early 1980's, corresponding
roughly with the advent of the 401(k) plan that provided
opportunities for both employers as well as individuals to make
additional retirement savings.
We have talked a lot about the abysmally low savings rate
in this country, and it is absolutely appropriate to do so. You
pointed out, in fact, in your introductory remarks that the
actual average amount in individuals' accounts is nowhere near
what is needed.
I would point out, though, that at least retirement savings
is the one bright light in an otherwise very dismal picture on
overall savings rates, and we have commissioned research in the
past that showed that but for retirement savings, we would have
had net negative savings in this country. So it at least
contributes to the fact that we have some modest savings.
The other notable thing I think about this chart is the
substantial dip that you see in the line from the year 2000 to
2002, and obviously that corresponds with the downturn in the
economy. But I think that that really underscores a separate
point that relates back to Secretary Warshawsky's earlier
testimony, and that it underscores, in our view, the importance
of preserving the defined benefit system, because unlike
defined contribution plans, in the defined benefit system, of
course, the employer bears the risk of ensuring that a payment
will be made. So notwithstanding the downturn in the assets,
defined benefit plans help provide some very important
protections there.
The next chart shows employer contributions to plans, and
as you can see, those have steadily risen. I think what is
significant about this chart is that it does not show the same
dip that the prior one did. Notwithstanding periods of market
downturn, employers continue to make contributions to plans,
and, in fact, notably, with respect to defined benefit plans,
the employer is on the hook to make up additional contributions
to those plans during periods of time when the plan becomes
less well funded.
If the first two charts were in large part the good news,
then this final chart is the bad news because this is a chart
showing the decline of defined benefit plans insured by the
Pension Benefit Guaranty Corporation. The height of defined
benefit plan existence, if you will, was in 1985 when there
were about 112,000 plans. Following the passage of the Tax
Reform Act of 1986, there started a decline in the number of
those plans, in large part, not entirely but in large part due
to a number of changes that were made in that law. Very
substantially, and I think what should be very worrisome to all
of us, is that in the last decade alone, from 1994 to 2004, we
lost half--half--of the defined benefit pension plans in this
country, from about 57,000 plans down to about 29,000 plans.
So while it is good news that through defined contribution
plans we are absolutely increasing a tremendous amount of
wealth accumulation--and I am sure Mr. Kimpel will discuss that
in greater detail--there are challenges here, both with respect
to defined contribution plans and certainly on the defined
benefit side.
The sum total, I think, of these charts says, to me at
least, two messages. First, that is really imperative for
Congress to deal this year with the issue of funding reforms.
While we at the American Benefits Council embrace a lot of the
goals that the administration has laid out, we have tremendous
concerns that the specifics of many of the proposals that they
have put forward will, in fact, very much unintentionally,
undermine the defined benefit system and will cause a lot of
companies to exit the system. At the end of the day, what
should probably keep us awake at night is not the notion that a
few more seriously underfunded plans will terminate and impose
those liabilities on the PBGC. That is a concern that we have,
and, in fact, we have a very extensive report which enumerates
many proposals that we have for how to shore up the pension
system. Obviously, as premium payers, the sponsors of well-
funded plans are very much concerned when poorly funded plans
dump their liabilities on the PBGC. But really the bigger issue
and the bigger backdrop against which all of this needs to be
considered is not that a handful of underfunded plans will
terminate, but that tens of thousands of very well-funded plans
are exiting the system and their exit from the system may be
exacerbated if we--that is, Congress--make the wrong decisions
with respect to funding reforms.
The second related issue to defined benefit plans concerns
the one bright light in the defined benefit system, and that is
the creation over the past several years of so-called hybrid
plans, cash balance plans, and other types of varieties. The
legal status of these plans is very much in doubt, both in
Congress and certainly in the courts, and we urge the Congress
to act sooner rather than later, very quickly to try to
establish that these are legal, legitimate plans. Arriving at
that conclusion is inextricably linked with the fiscal health
of the Pension Benefit Guaranty Corporation because there are
roughly 1,200 so-called cash balance or hybrid pension plans in
this country. They cover over 7 million Americans, and they are
predominantly very well-funded plans, by the way, and they
represent fully 20 percent of the premium revenue that goes to
the PBGC. So not dealing with the issue of the legal status of
hybrid plans can have a very deleterious impact on the health
of the overall defined benefit system and the health of the
PBGC.
In conclusion, I just want to hit four very quick points
for your attention, and then if I may, either at the end or as
part of the question-and-answer period, address this whole
question about whether or not we are getting adequate value for
the tax expenditure, which has come up a number of times.
The first point that I would make is that clearly this is
not a hearing about Social Security, but I think that there can
be and should be bipartisan agreement that the private
retirement system needs to be strong, and that to the extent
that it is not, the financial pressure on Social Security to do
more will be made even larger. So we would very strongly urge
two things: first of all, as Congress proceeds in whatever it
chooses to proceed on the issue of Social Security reform, that
it take into account the implications for employer-sponsored
plans; and, second, that Congress should really not consider
Social Security reform without also addressing a variety of
things that need to be done to help improve the defined benefit
and defined contribution private system.
The second very quick point is that one of the greatest
threats to retirement security in this country is what is
happening on health care costs, and it is very important not to
lose sight of the fact that health care costs are absorbing the
available resources that would otherwise be put into what we
think of as more retirement income plans. These two issues must
be considered together.
The third point is that the retirement system not only is
obviously crucial for providing retirement income security, but
also is the source of most of the investment capital in this
country, and I see you perhaps want to----
Senator Kohl. The time for the vote is just about out, and
Senator Smith will be back in just a minute and will resume the
hearing. But I need to recess so I can get over.
Mr. Klein. Absolutely.
Senator Kohl. So he will be back in just a minute. I thank
you.
Mr. Klein. Thank you.
Senator Kohl. We will be in a short recess. [Recess.]
The Chairman [presiding.] We will reconvene this hearing.
Regrettably, the Majority Leader does not run the Senate
schedule around the Aging Committee's schedule. We mean no
disrespect, and we truly appreciate your participation.
Mr. Klein, I believe you are finishing, and please proceed.
Mr. Klein. Gosh, I was hoping I would be able to start from
the top again. [Laughter.]
The Chairman. Anything you want to recapitulate for me, I
would appreciate it.
Mr. Klein. Well, I would be delighted to, either now or in
part of the question-and-answer period.
I guess the two last points that I would make is that we
need to think both short term, which is what I have addressed
thus far, as well as long term. In that regard--and I will not
take the time now as part of these oral remarks, but in that
regard, we have developed a very extensive report called ``Safe
and Sound,'' which is a long-term strategic plan about what
both the health and the retirement system might look like 10
years from now. In that report, we establish three retirement
policy goals. They are very specific, measurable goals relating
to financial literacy, increasing coverage in employer-
sponsored plans, and also boosting overall retirement savings.
Then, not surprisingly, we followed up with a substantial
number of very specific initial policy recommendations to help
us achieve those goals, and with your permission, I would like
to submit that report as part of the formal hearing record.
The Chairman. We will include that.
[The report follows:]
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Mr. Klein. The last point I would like to just pick up on
is something I was not necessarily planning on discussing, but
in light of the fact that it has been discussed so extensively
already, I just want to comment on it. That is the issue about
whether or not we are really getting our money's worth with
respect to the tax expenditure for employer-sponsored
retirement, which is one of the largest tax expenditures in the
budget. I agree with some of what has been said, but also would
point out the following:
First of all, in terms of whether or not an adequate
portion of the tax expenditure is going to lower-income
individuals, as my testimony indicates, we very strongly
support both extension and, frankly, the expansion of the low-
income saver's credit. We think that it is extremely important
to do more to help low-wage workers save more effectively. So I
am in complete agreement on that point.
But there is a very comprehensive, many would say
extraordinarily onerous set of nondiscrimination rules that
govern the employer-sponsored retirement system that are
designed to ensure that a disproportionate amount of the value
of the tax expenditure not go just to the very highly paid. So
it is not like Congress has somehow ignored this issue and not
tried to design the system in order to ensure that workers
across the income spectrum are benefiting from this system.
Moreover, there are at least two reasons for what would
appear to be a disconnect between the amount of the tax
expenditure and also the amount of taxes that are being paid
out on the benefits. That, of course, relates to simply the
present value that workers now today are getting as an
exclusion for money that is being put into a plan. In the case
of their 401(k) plans, companies get a deduction, individuals
get an exclusion for the amount that they put in, as well as
the amount that their company puts in on their behalf. But, of
course, those benefits will then be paid out later on when
those individuals retire, including, of course, those high-
income people for whom these large deductions and exclusions
presumably are taking place. So I think that one has to keep in
mind, uppermost in mind, the timing issue.
The other point, of course, is that we are dealing right
now demographically with a situation whereby there is a larger
group of baby boomers who are in the working population for
whom these deductions and exclusions are being taken and being
made and a comparatively smaller group of retirees. But once we
baby boomers retire, we are going to be in the population that
will be paying taxes on the benefits that are paying out.
So I think that these are very crucial points to keep in
mind in answer to Senator Kohl's earlier questions around this
point.
With that, I would conclude and be delighted to answer
questions later.
[The prepared statement of Mr. Klein follows:]
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The Chairman. Thank you very much.
Mr. Kimpel.
STATEMENT OF JOHN M. KIMPEL, SENIOR VICE PRESIDENT AND DEPUTY
GENERAL COUNSEL, FIDELITY INVESTMENTS, BOSTON, MA
Mr. Kimpel. Thank you, Mr. Chairman.
Fidelity is the largest mutual fund manager in the country.
In addition to that, we are the largest provider of employer-
sponsored plan services. The main part of that business is in
providing investment management and recordkeeping services to
defined contribution plans. All of you have received a copy of
a report that we have done now for 5 years drawing on the data
that we have as the largest defined contribution recordkeeper.
We currently record-keep over 10,000 plans covering over 8
million employees with assets approaching $500 billion. The
report is all based on data at the end of 2003. We are in the
process of gathering the data and putting together a report for
2004.
With that, I just want to focus on three or four points.
The first, in looking through this and trying to get a
capsule of who is the average defined contribution or 401(k)
participant, who is it, and what we see from our database is it
is a person 44 years old, who earns about $53,000; who is
contributing 7 percent of his or her compensation a year, that
works out to slightly more than $3,500 a year; and who has an
average account balance--and I am jumping ahead because I just
received the numbers for the end of 2004--of a little over
$61,000 in that account balance.
Now, the good news there is that average participant still
has approximately 20 years to grow that number into a
significant retirement nest egg.
As the presentation I provided and the report also shows,
all of the important things we care about--participation rates,
deferral rates, and account balances--increase as the
participant's income goes up, as the participant ages, and,
importantly, as the participant's job tenure with the employer
increases.
Now, the opposite of that is also true, as we have all
talked about as well, that a lower-paid, short-tenured, low-
compensation participation will have less. But if you make some
reasonable assumptions about where that person will ultimately
be, you can see that those account balances will grow,
participation rates will grow, and deferral rates will grow.
So the issue that I would like to focus on in particular is
trying to put these numbers in the appropriate context, and
what I would like to do is focus on the importance that the
employer plays in all of this. In addition, as you know,
Fidelity is a very large IRA provider. We have some experience
in that market as well. But what is significant to us--and if
you look at one of the pages in the presentation, if you look
at participation rates comparing employer-sponsored DC plan to
IRA, if you look at deferral rates or contribution rates, and
if you look at account balances, what you see is significantly,
wildly larger numbers under the employer-sponsored plan. The
most important of those is the participation rate. Sixty-six
percent of people who are offered the opportunity to
participate in a 401(k) plan do so. We sometimes complain that
is not high enough, that it should be higher, that it should be
100 percent, and God knows we all wish it were 100 percent. But
the figure for employees who do not participate in an employer-
provided plan, the contribution rate or the participation rate
for them in IRAs--and all of them have the ability to
participate in an IRA--is only 5.5 percent. So the power of the
workforce, the power of the employer providing a plan is very
significant.
The Chairman. Sixty percent versus 5?
Mr. Kimpel. It is 5.5 for IRAs.
Now, then we get to the question of what to do. People have
talked about automatic enrollment. We think automatic
enrollment is terrific. We are doing it with a lot of plans.
Treasury regulations allow it today. Anything to encourage
greater use of automatic enrollment is terrific. To make it
unanimous, we, like the other panelists, are in favor of the
continuation and possible expansion of the saver's credit.
But there is one other thing I would like to bring up that
nobody else has talked about, and that is, when you have
automatic enrollment, where does the money go? How is it
invested? Another thing that we think is important to put on
the legislation table is having the default fund be a life
cycle fund or some kind of a balanced fund, because what
everybody does now is the money goes into a money market fund.
Again, looking at our data base, fewer than 5 percent of the
participants are defaulted into a life cycle fund. A life cycle
fund is one that invests in different asset classes, that
change as the participant ages, so it is appropriate for that
age, so it is a higher--it would be a higher investment in
equities, and then as the participant ages, it will go
increasingly away from equities into money market.
The Chairman. So is that something that exists or something
you want us to create?
Mr. Kimpel. It exists, Senator. The problem is the
fiduciary rules under ERISA and Section 44(c) in particular.
They do not provide any relief from liability to an employer
who identifies the life cycle fund as the default fund because
participants are not deemed to exercise control over the
default fund. So what employers all do, therefore, is default
to a money market fund. That, coupled with automatic
enrollment, would be a huge benefit under the current system.
The Chairman. What percent of, say, their 7 percent, their
personal and their employer contributions, what percent would
it take to do the default fund?
Mr. Kimpel. Well, I am not sure----
The Chairman. Is this something separate that you created?
Mr. Kimpel. No, no.
The Chairman. An extra percent or something?
Mr. Kimpel. No. The question is what happens to a
participant who does not identify where his or her account
should--what investment should be allocated to. So when you
think of automatic enrollment----
The Chairman. Oh, I understand now. OK. You are not talking
about somebody whose investments tank.
Mr. Kimpel. No, no. No, I am just talking about someone who
was automatically enrolled into a plan----
The Chairman. But they do not designate where----
Mr. Kimpel. They do not designate an investment fund.
The Chairman. Of those who enroll with Fidelity, what kind
of a program do you offer them? High risk? Medium risk? Low
risk? What does the average participant do? Do they spread it?
Mr. Kimpel. The average participant--well, let's go back to
the default issue. Approximately, I believe, 20 percent of
participants end up being in one fund, and typically that one
fund will be the default fund, which is why that issue is so
important. Beyond that, what we----
The Chairman. What does a default fund earn?
Mr. Kimpel. Money market rates.
The Chairman. Just the same money market rate.
Mr. Kimpel. Yes, typically. If the money market fund is the
default fund. If you look at this across different age
spectrums, what we see is that there is some level of
appropriate--of reasonably appropriate--at least on average, of
appropriate allocation among participants, among equity, fixed
income, and money market. In other words, you see significantly
higher concentrations of equity funds in participants' accounts
when they are younger, and that percentage declines over age.
I think the typical holding, number of funds held, it will
again depend on the particular plan because it is the plan
sponsor who designs the plan, decides what investment options
to provide and how many of them. So you will get variations
depending on how many plan options are available.
The Chairman. The 20 percent who go into the default fund,
why don't they choose? What is their excuse? They are not
educated? They are not told? They are not given an option?
Mr. Kimpel. Well, the why, I am not sure we know the answer
to.
The Chairman. I mean, you know, they have to sign up for
it.
Mr. Kimpel. Correct. They have signed up. I think it is
because they simply--I think, and this is just opinion, I think
they don't have confidence in terms of what it should be, what
they should be doing.
Now, going back to the life cycle funds, we do see more and
more employers offering them as an option, and we see more and
more people going into them of their own volition. But we also
have not been able--and this is one of the things we are trying
to do in the data point, is track what people do. In other
words, if they go into a default fund, do they stay there? We
think most of them, unfortunately, do.
The Chairman. Does Fidelity handle any defined benefit
plans?
Mr. Kimpel. Yes, we administer defined benefit plans as
well, and we also manage defined benefit plan assets.
The Chairman. Can you share with me the pros and cons? I am
looking for an answer why is--beyond the complexity of defined
benefit plans and the cost--why is one declining and the other
going up?
Mr. Kimpel. Well, I think the simple reason that defined
benefit plans are declining is not so much the cost but the
uncertainty of the cost. If you are a corporation, what you do
know with defined contribution plans, if you are contributing 5
percent or 7 percent, or whatever that number is, no matter
what happens fiscally to your company, that is the rate you
will have to contribute each year. But in a defined benefit
plan, you don't know from year to year what that contribution
is going to be because it will be in part determined by your
workforce and your compensation, which you have some control
over, but it is also going to be determined by how well your
investments do. That uncertainty, in our experience, drives
corporate treasurers crazy.
The Chairman. The mobility of our society today, I assume a
lot of employees, as they become educated with respect to in
401(k) plans, they are asking for that instead of defined
benefit plans.
Mr. Kimpel. I think that is true, too.
The Chairman. Because it goes with them. There is no red
tape. It is theirs, they own it, they grow it, they manage it.
[The prepared statement of Mr. Kimpel follows:]
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Mr. Steuerle. Senator, could I speak to that?
The Chairman. Yes, please.
Mr. Steuerle. We have done some studies at the Urban
Institute speaking exactly to your point. The traditional
defined benefit plan over time only favored a small segment of
the employee population, mainly----
The Chairman. It is usually the high-income.
Mr. Steuerle. The higher-income, but also those who are
long-term employees with the same firm, not the more mobile
population. If you look at the distribution of benefits by age
and time with the firm, it is a hill-shaped. The very young get
almost nothing because if they leave the plan at age 30 or 40,
the plan is not indexed for inflation. The benefits are often
almost worthless. The middle-aged people on the other hand
start getting a huge buildup of assets, but that works badly
for retaining employees. If you are an employer, all of a
sudden you have some middle-aged employees say in a firm in
Detroit who become very expensive. It is sometimes cheaper to
close down the plant and move to Kentucky. Whereas, if you are
on the other side of the hill, if you are on the down side, as
I mentioned earlier in my testimony, sometimes the benefits go
negative for older employees.
Are employers looking for older employees? I think they are
a major demand in the future as these people who are now
retiring 55 to 75 and are the largest underutilized pool of
human resources in our economy. The traditional defined benefit
plan has not adjusted to figuring out how to provide them with
a modicum of benefits.
One thing all four of us have spoken to at one level or the
other is how important it is to provide employers with some
simple default options that they can use for a variety of
pension reform issues so they are not threatened with suits
under the labor laws, the tax laws, and the age discrimination
laws. They know they can set it up. In many cases they don't
want broad fiduciary responsibilities. They don't mind making
deposits on behalf of employees, but they generally don't want
long-term fiduciary responsibilities that threaten them with
lawsuits. I think we spoke of this challenge for cash balance
plans, automatic enrollment and automatic escalation plans and
allowing life cycle plans. The notion that in the law or at
least in the regulations there are safe harbors that reduces
the threat of lawsuits, I think, is a very important advance,
which I think all four of us would support.
The Chairman. Can I ask you a question? I don't know the
answer to it. I am looking for education for myself. Where you
have a company like United Airlines who--I believe one of their
problems is the whole defined benefit plan liability. A new
airline is set up called Ted. What does Ted offer to their
employees? Is it a 401(k) or is it a defined benefit plan?
Mr. Klein. Well, I don't specifically know what is offered
to that airline----
The Chairman. I mean, there are lots of examples like that.
Mr. Klein. I assume that they do not provide the same level
of benefits, retirement or otherwise, but it is clear that in
that industry they are facing pressure. Some of the companies,
the legacy carriers, are facing pressure not only from those
who have terminated their plans, like the Uniteds and U.S.
Airways, but also some of the newer low-fare air carriers that
clearly do not have a defined benefit pension.
The Chairman. Would JetBlue have a 401(k)?
Mr. Klein. I would think they do.
Mr. Iwry. Mr. Chairman, I agree----
Mr. Klein. I also--go ahead, Mark.
Mr. Iwry. I am sorry. I was just going to add to what Jim
Klein is saying, that the newer carriers and in general the
newer industries in our country have gone much more toward the
401(k) model, and this answers both of your questions in part,
in addition to the factors my colleagues have mentioned. The
defined benefit has been associated traditionally with
manufacturing and with unionized industries particularly. As
the share of the workforce represented by unions has declined
and as the share of the workforce in this country involved in
manufacturing has declined in favor of service industries, we
have seen that mix of----
The Chairman. That accounts for part of the decline of one
and the rise of the other. But are there any union pension
funds that are or were defined benefit, are any of them
transferring to 401(k)?
Mr. Iwry. Yes, or they have added 401(k)s.
The Chairman. They have added it.
Mr. Klein. Mr. Chairman, if I might also further embellish
upon the answer to your question about the reasons for the
decline, which are many, and kind of refer back to the chart
that I showed during my comments. You know, at its peak in
1985, we had 112,000 of these defined benefit plans insured by
the Pension Benefit Guaranty Corporation. In 1986, the Tax
Reform Act was enacted. Now, admittedly it did, through some of
its changes, get rid of a number of very, very small defined
benefit plans that maybe were only covering one or two people
in a professional organization. But once you clear those out of
there I want to debunk the notion that employers do not really
necessarily want a defined benefit plan. I think that a lot of
the provisions and the regulations that have followed on top of
the provisions from the Tax Reform Act of 1986 and its progeny
have made it very difficult for companies to have defined
benefit plans.
I completely agree with John Kimpel's comment that it is
not so much the actual cost as it is the uncertainty about the
cost. I hear that time and again from our Fortune 500 company
members who are saying they find it very, very difficult to
make the case to their boards of directors and their
shareholders that it is worthwhile having a defined benefit
plan given the unpredictability. That is why we are so
tremendously concerned about certain features of the
administration's proposals on funding.
The last point is the notion that people have obviously
experienced, notwithstanding the dip during the market
downturn, an enormous amount of wealth accumulation in 401(k)
and other types of defined contribution plans. So from an
employee relations point of view, there is a tremendous amount
of interest in those kinds of plans, which brings us back to
the beauty, I think, of the cash balance and other kinds of
hybrid plans that combine the best features of both. It is a
defined benefit plan. Its benefits are guaranteed by the
Pension Benefit Guaranty Corporation. The employer funds it,
but it is more transparent and individuals have a better sense
of the value that they have.
I will just leave you with one fascinating anecdote. A
member company of ours did a survey of its workers about the
extent to which those workers value different kinds of
benefits, and they found that they placed a far superior value
on the company-run gymnasium than they did on the defined
benefit pension plan, notwithstanding that the company was
obviously spending vastly more resources on the defined benefit
plan. That speaks to the issue of communications and why it is
important to engage people in the value of their defined
benefit plan since it is not as evident to them as the defined
contribution plan.
But I think also that survey was done prior to the market
downturn, and I think a lot of people began to realize the
value of that security of the defined benefit plan. Most large
companies obviously sponsor both or try to sponsor both.
The Chairman. I have to apologize. There is another vote.
We have only a few minutes left.
Do any of you have any concluding comments that you can say
briefly that would add to our record? Yes, Mr. Iwry.
Mr. Iwry. Mr. Chairman, I would like to reinforce and
expand upon something that Mr. Kimpel called attention to.
401(k)s can be made easier and more effective in a number of
different ways, really in all three phases: contributing to the
plan, accumulating through sound investment, and then paying
out.
Mr. Kimpel is absolutely right that the accumulation phase
needs some legislative comfort, and Gene Steuerle said this as
well. We can use some more fiduciary reassurance for employers
that if they default people into a life cycle fund instead of a
money market fund or into a managed account where there is a
professionally managed individual account for employees, if
they want to let a professional manage it the way we run our
defined benefit plans, with professional management, we will
have made a great step forward and moved the system away from
the excessive dependence now on self-direction. Every employee
having to become their own investment expert, their own
investment manager, it is too great a demand on people.
Again, if I can refer to these focus groups that the
Retirement Security Project has arranged, we saw people
essentially begging for help with the investments. They do not
know exactly how they ought to be investing their money. They
want some professional help.
You can have the right to opt out and have the right to
continue to choose your own investments, the way we do today in
401(k)s, but let the employer have a default that represents a
diversified and balanced fund or managed account.
Mr. Klein. Mr. Chairman, my only final comment would be to
echo what is in our written statement commending you for the
efforts that you articulated earlier with respect to automatic
enrollment and associate myself with the comments of the others
on the panel.
The Chairman. Thank you.
Yes?
Mr. Steuerle. Senator, the one comment I would add is that
for some of the options we have been talking about at the end--
the automatic enrollment, the clear statements as to fiduciary
responsibilities and the removal of possibilities of a
lawsuit--I think there is fairly uniform agreement. I really do
hope that Congress moves ahead in those areas. But in some
ways, those are the easier decisions. Especially at this time
of budget stringency, we have to admit that some aspects of our
current system are not working well, and I do not want to leave
you with the notion that some harder decisions do not have to
be made.
I would mentioned one, for instance. We have a system now
where people can borrow on the one side, take interest
deductions, put money into accounts that get interest receipts,
not save a dime, not make a dollar of interest income on net,
and yet get substantial amounts of tax savings--tax savings, by
the way, that can be as great or greater than these given to
the people that actually do save. I have given other instances
in my testimony.
Consider early withdrawal options that are so easy for
employees that sometimes they take money out of saving that the
Government has subsidized, and leave nothing by the time of
retirement age. The people then are more likely to turn to the
Government for help in old age. Maybe it is nursing home help.
Maybe it is retirement help.
There are some tough decisions to be made here to encourage
more people to keep money in a retirement solution. If the
Government is going to be subsidizing people, and especially
subsidizing additions to the saver's credit, which most of us
favor, we have to take a hard look in making sure that this
money is adding to net saving and actually does stay in a
retirement solution.
The Chairman. Gentlemen, thank you all so very much. I know
you have given me some ideas of things to add to my bill, and I
invite and encourage and ask for your continued engagement with
my office and other Senators, because we have got to start
working on this soon because we have got a real economic or
retirement tsunami ahead of us if we do not get ahead of this.
So thank you all so much. It has been a very enlightening
hearing, and you have added to the public record in a
measurable way.
With that, we thank you and we are adjourned.
[Whereupon, at 4:16 p.m., the committee was adjourned.]
A P P E N D I X
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