«Designed to provide security and equity to defined benefit (DB) pension plans, the Employee Retirement Income Security Act (ERISA) became law in ...»
Private Pension Protections since ERISA:
The Expanded Role of the Individual
kaRen a. ZuRlo
Rutgers, The State University of New Jersey
School of Social Work
Designed to provide security and equity to defined benefit (DB)
pension plans, the Employee Retirement Income Security Act
(ERISA) became law in 1974. Since that time, the economy has
shifted to a more globalized, non-unionized, service-based environment, where defined contribution (DC) plans replaced DB plans as the dominant type of private pension plan. Today workers and retirees bear the burden of managing their pension plans and the associated risks. To protect Americans against the financial risks they face in retirement and ensure greater economic security in old age, targeted financial education, research, and fundamental pension policy reform are required.
Key words: pensions, ERISA, retirement income, individual responsibility, financial education Primary government programs, namely Social Security and Medicare, face significant shortfalls. Social Security, for example, faces a long-term financial imbalance (Munnell, 2011).
Fewer workers will finance the retirement of the growing baby boom generation, yielding a system of benefits and current tax rates that are not sustainable in the future. Medicare, too, is at risk of not sustaining the current level of health insurance it provides adults. Between 1996 and 2005 out-of-pocket medical expenses increased by 39.4 percent (Paez, Zhao, & Hwang, 2009), a trend that is likely to continue. As a result, the role of private pensions is heightened, requiring private pensions to contribute larger amounts to retirement income. Nevertheless, the private pension landscape has shifted in ways that may Journal of Sociology & Social Welfare, December 2012, Volume XXXIX, Number 4 50 Journal of Sociology & Social Welfare result in lower private pension wealth for retirees (Kapinos, 2009).
Private pensions have experienced profound change over the past forty years. Firms have shifted from the provision of defined benefit (DB) plans, where the employer bore the economic and demographic risk (Scahill, 1999), to defined contribution (DC) plans. Although the American welfare state is premised on a mix of private, tax-subsidized benefits, that pattern is being undermined as firms shift to providing 401(k) plans and reduce the benefits they provide employees (Peters, 2005).
The transition from DB to DC plans has placed a premium on participants’ decision-making competencies (Clark & Strauss, 2008). Today individuals must take more fiscal responsibility for their pension plans and retirement income, yet many are not equipped with the knowledge to manage this responsibility. This lack of knowledge can have a profound effect on retirement income and public and private policies, as they relate to administering private pension income to America’s older adults. The erosion of employee pension benefits will have farreaching effects, potentially decreasing retirement income and increasing poverty levels in old age.
Historical Development of Private Pensions The Social Security Act and its Amendments were precursors to the large-scale development of private pension plans and prompted the growth of private pensions in the United States. Between 1940 and 1945 the number of pension plans grew dramatically. In 1940, 1,530 private pensions existed; this grew to a total of 6,700 in 1945, covering 6.5 million employees (Ippolito, 1997). This positive growth was due to changes in tax policy, the stabilization of wages during World War II and the Korean War, and actions of the War Labor Board (WLB) (Ippolito, 1997).
To finance World War II, Congress increased the top corporate and individual tax rates; six percent of the nation paid tax in 1939, which increased to nearly seventy-five percent by 1945 (Sass, 1997). As a result, tax sheltering became an important concern to the more highly compensated employees (Koff & Park, 1999). Additionally, the Revenue Act of 1942 regulated Private Pension Protections 51 tax incentives by tightening requirements for the qualification of pension plans and improving the tax advantage for qualified plans, which included no capitations on pensions paid by tax-exempt trusts, no vesting requirements, and the regulation of pension costing and funding (Sass, 1997).
The war experience demonstrated the usefulness of the pension as a compensatory instrument (Sass, 1997), where the deferred nature of the compensation would enhance employee loyalty to the company. As tax rates decreased and wage flexibility returned after 1945, the private pension emerged in the post-war era as a widely recognized management tool (Sass, 1997).
Labor, too, played a significant role in the development of pensions. Although organized labor’s main interest in private pensions did not begin until after World War II, two main forces were instrumental in its development (Hacker, 2002).
Unions, namely The United Auto Workers (UAW), put private pensions and welfare benefits at the center of their bargaining drives. These organizations embraced fringe benefits, specifically private pensions, in their negotiations with employers because they saw them as effective tools in their battle for benefits (Hacker, 2002). Second, the Federal government pushed pensions onto the bargaining table as a means to resist demands to increase public social insurance (Ippolito, 1997). In support of labor’s efforts, in 1949 the Supreme Court approved a National Labor Relations Board ruling that pensions were a legitimate issue to use in collective bargaining (Hudson, 2005).
From 1950 to 1960 the largest employers, namely manufacturers, dominated the pension plan expansion. Over this same period the number of plans increased dramatically, as did the proportion of workers covered, which grew from 12 percent to 33 percent between 1940 and 1960 (Sass, 1997). Yet, during the 1950s, complaints surfaced about losses of employee pension benefits. For those who retired early, the requirements of age and service were barriers to their receipt of pension benefits (Hudson, 2005).
Growing evidence of fraud, embezzlement, and the mismanagement of investment pension funds exacerbated these problems, and Congress responded by enacting the Federal Welfare and Pension Plans Disclosure Act of 1958 (PL 85-836), 52 Journal of Sociology & Social Welfare which was significantly amended in 1962 (McGill, Brown, Haley, Schieber, & Warshawsky, 2010). A weak component of the legislation was that plan participants had prime responsibility for monitoring pension plan activity. The individual plan participants were expected to spot fraud and criminal activity and the legislation provided them with a way to seek relief from the wrongdoing (McGill et al., 2010). This was a risk for participants because few were knowledgeable of pension plan activity and, for the most part, they had neither the time nor interest in this responsibility. Additionally, there were a number of gaps in corporate pension plans, such as the ability of a corporation to default on its obligations (Sass, 1997). These gaps alerted policymakers to the need for a new approach to retirement security. Although there were several attempts to regulate and oversee aspects of the private pension system prior to 1974, none were as comprehensive as ERISA.
ERISA While the number of workers covered by private pensions increased through the 1960s and the burden of detecting fraud and criminal activity shifted from the plan participant to the Departments of Labor and Justice, individual participants had inadequate protections (Hacker, 2002). The most prominent issues that fostered the design of ERISA were defaults, namely that of the Studebaker Company, and abuses that became public as a result of the Studebaker collapse (Wooten, 2001, 2004).
The Studebaker-Packard Corporation (Studebaker) collapse, a prime focusing event (Wooten, 2001), created the impetus for moving private pension legislation forward. At the time, Studebaker was a large automotive manufacturing company in Indiana. Known as a model welfare capitalist firm, it had a negotiated contract signed by the UAW Union (Klein, 2003). Although the UAW union was a champion of conservative funding and investing, the Studebaker pension plan did not have the assets required to redeem all the benefits that were promised (Sass, 1997). The pension plan was millions of dollars short and 7,000 workers received little or nothing from the company (Klein, 2003). Moreover, there was rigorous Private Pension Protections competition from Ford, General Motors, and Chrysler Corporation, the Big Three automakers, at the time. As a result, Studebaker closed its South Bend, Indiana plant on November 1, 1964 and terminated its labor contract one month later (Sass, 1997).
Based on the fall of Studebaker in 1964, a number of abuses in pension plan structure became public and prompted future legislation. Unreasonably high vesting thresholds prevented long-time workers from qualifying for benefits (Wooten, 2004).
Also, pension rules defined “unbroken” service in narrow terms.
For example, if a worker was re-assigned to a job with a different classification, this was considered a break in service and adversely affected the worker’s pension benefit. Additionally, courts upheld practices of employers by reserving their rights to modify, decrease, or deny benefits or eliminate pensions at will (Sass, 1997). Employers avoided a number of liabilities by asserting in plan documents that workers were claiming benefits against the plan, and not against the assets of the corporation (Klein, 2003). Due to these abuses, the Studebaker shutdown became a catalyst for reform and prompted future legislation (Wooten, 2001).
Congress passed the Employee Retirement Income Security Act (ERISA) to eliminate abuses through greater federal regulation and guarantees (Klein, 2003). Additionally, the UAW pension specialists devised a remedy that became a precursor to Title IV of ERISA, the termination insurance program (Wooten, 2001). The remedy moved default risk (risk that a pension plan will terminate without enough funds to meet its obligations) (Wooten, 2001) and termination insurance onto the legislative agenda and stimulated the enactment of private pension legislation, ERISA. This effort took ten years to come to fruition.
The ERISA legislation originated as a Presidential initiative under Kennedy in 1963. Although Johnson pursued the drafting of the ERISA legislation, the labor movement and leading business groups were hostile to it, so the process came to an abrupt halt (Hacker, 2002). Nixon’s administration countered the reform agenda, but with his resignation legislators were eager to prove to the American people that the political process was not broken. As a result, ERISA legislation was processed 54 Journal of Sociology & Social Welfare expeditiously. It passed in the House on August 20, 1974, in the Senate on August 22, 1974 and was signed by the newly installed president, Gerald R. Ford, on Labor Day, September 2, 1974 (Sass, 1997).
Although its creation was a lengthy process, ERISA was designed to redress regulatory shortcomings that deprived employees of old-age retirement income security (Ledolter & Power, 1984). Among its many provisions and amendments, ERISA’s over-riding purpose remains the provision of security and equity to the retirement income of private-sector employees (Altman & Marmor, 1988). As the first comprehensive legislation regulating many aspects of private pensions and savings plans, ERISA was the product of four congressional committees: the House Ways and Means Committee, the House Labor Committee, the Senate Labor Committee, and the Senate Finance Committee, which are members of the Departments of Labor and the Treasury (Scahill, 1999). ERISA’s objectives
• to ensure that workers and beneficiaries receive adequate information about their employee benefit plans;
• to set standards of conduct for those managing employee benefit plans and plan funds;
• to determine that adequate funds are set aside to pay promised pension benefits;
• to ensure that workers receive pension benefits after they have satisfied certain minimum requirements; and
• to safeguard pension benefits for workers whose pension plans are terminated. (Coleman, 1989, p. 3) The successes of ERISA are noteworthy; benefit security and fiduciary responsibility have improved, as has funding for poorly managed funds (Scahill, 1999). As a result, between 1975 and 2005 there was a significant increase in total number of pension plans, number of participants, as well as in the financial assets of private pension funds. More retirees and employees are participating in pension plans than ever before.
Through the ERISA legislation, employers are required to adhere to guidelines that did not exist prior to 1974.
Private Pension Protections 55 Pension Eligibility, Participation, and the Termination of Plans For pension plans to operate fairly and effectively, ERISA requires certain criteria to be met. For example, to participate in a private pension plan, an employee must be eligible. The term ‘eligibility’ refers to the conditions an employee must meet before being covered by a pension plan; these conditions generally involve attaining a minimum age and completing a minimum period of service with an employer (Coleman, 1989).
ERISA does not set these minimums; it only requires that these criteria are set in advance, are clearly communicated to participants, and are not arbitrarily changed by the employer (Sass, 1997).
Pension contributions begin to accrue as soon as an employee satisfies eligibility requirements and becomes a participant in a pension plan. Yet, no legal right to receive any benefits from those contributions exists until an employee becomes vested (Coleman, 1989). Vesting periods are waiting periods before rights to benefits can be exercised (Crystal & Shea, 2003). These periods are established by employers and can range from five to fifteen years. Once vested, an employee “owns” the right to receive a retirement benefit from that plan when retired; in most cases, this right is maintained even if they leave that employer (Coleman, 1989). If an employee leaves a company before vesting, they forfeit any right to a benefit upon retirement.