How to Restart the Pension System By Giving Executives a Stake In It
In 1973, just before ERISA, we worried about individual workers losing their defined benefits because of insufficient funding, no plan termination guarantees, and little or no vesting. Most of us did not worry about the whole system falling apart. There were just too many disappointed expectations under the previous system.
Once we found a way to stabilize the security of the defined benefit (DB) system, however, we set about shredding a central feature of the DB system’s growth. How? We just about wiped out the senior executive’s primary stake in the qualified plan system. We severely limited creditable “compensation” (IRC 401(a)(17)), while also setting a low maximum level of defined benefits under qualified plans (415), and then we piled on limit after limit (“QSLOB”s, “top heavy” rules, etc. etc. etc.).
Originally, we relied upon the non-discrimination rules (IRC 401(a)(4) etc.) to achieve benefits for the “rank and file” by riding on the coat-tails of the executives’ interest in their own retirement benefits. But what if executives lost (or severely diminished) their own interest – their own “stake” – in their own benefits under qualified plans?
In fact, little by little, senior executives saw what was originally not so plain to see: If a highly paid senior executive wants to earn a pension commensurate with his/her total level of earnings, it must be done on a non-qualified basis. And it wasn’t just the CEO and CFO who lost interest in qualified DB plans. Perhaps more importantly, it was the Senior Vice President (SVP) for HR and/or Benefits (the source from which all blessings flow?). The “clients” who oversaw all pension plan design discussions no longer saw themselves as having a primary personal pension stake in that qualified plan design. And when the “clients” lost interest in qualified DB plans, their lawyers, actuaries, and consultants got the message(s): 401(k) plans, originally designed to “supplement” DB plans, began to supplant them instead; traditional DB plans converted into cash balance versions; other DB plans froze; other DB plans terminated. And the ball game is just about over.
In the meantime, a huge new plan design game mushroomed: Non-Qualified Deferred Compensation. And DB plans, left behind, became moribund. Why? For many reasons. We tend to blame various versions of “the perfect storm” – a combination of stock market decline and interest rate decline, large and sudden unexpected increases in required contributions to DB plans, fouling up corporate budgets and expected cash flow at just the wrong time. But that was not inevitable. It was mainly an inevitable result of using unreasonable actuarial assumptions (earnings assumptions too high, and other manipulations), which of course lead inevitably to a day of reckoning. The day of reckoning always needs a villain – and the obvious villain (in most cases wrongly accused!) was the DB plan itself, and not the actuarial games that exacerbated the funding crisis.
In any event, the result was abandonment of the DB system, followed by much hand-wringing, sturm und drang, and insistence that we need to find a “replacement” for lost retirement security.
The most familiar “fix” currently being touted is a mandate – force employers, or require employees, to do something (mandatory IRAs, etc.), as if that would replace what we have lost. It won’t be sufficient, it won’t work, and it may not be necessary.
If we want the private system to work as it should, the people who design, implement and run the employer’s benefit plans must be given a major stake (their own retirements) in the employer-sponsored system. Do that, and they will solve the problem for their employees. Don’t do that, and they will not.
How can senior executives be given a sufficient personal stake in qualified DB pension plans to induce a resuscitation of the DB system? It would love to be able to say “it’s simple.” At least it’s possible. And here are a few steps to get it started.
1. Triple the maximum DB Plan benefit.
2. Triple the maximum amount of creditable compensation under 401(a)(17).
3. Search-and-find-and-adjust all other statutory and regulatory components of the barricade blocking sufficient executive DB benefits under qualified plans.
4. Redesign the interface between qualified and non-qualified plans so as to reduce the attractiveness of non-qualified plans when compared to the expanded qualified DB plans.
5. Amend the non-discrimination rules to assure that the lowest-compensated employees are not the “losers” as a result of using an unreasonably-low percentage-of-compensation DB benefit formula. (In other words, use a “safe harbor” low-comp approach, when permitting the new expanded hi-comp limits).
Can we “afford” it? A fair question, but not quite the right question. We bemoan the “loss” of the old world of DB plans. Suppose those plans had not frozen or terminated– what would have been the “cost” (tax revenue loss)? Isn’t this the same amount as the assumed cost of restoring the system? If so, then the “cost” is just the same as the “cost” of not having lost the old DB system. If we’re serious about restoring retirement security, then that’s the inherent cost, as it always has been. And we had better be prepared to pay it, because we’ll end up paying it (welfare for the elderly) one way or the other.
-- Frank Cummings