President Gerald Ford at his desk in the White House. Photo by Marion S. Trikoso. Courtesy of the Library of Congress.
In 2007, Dow Chemical Co. followed the trend of many companies and froze its traditional pension plan. But in an unusual move, Dow used the power of a 2006 law to become one of the first large companies to adopt a hybrid, or cash-balance defined benefit plan, instead of creating or boosting an existing 401(k) plan for workers.
Dow closed the old plan and opened the new one for several reasons, said Janet Boyd, Dow’s director of government relations, tax and benefits. Modern workers don’t stay in their jobs for decades like they used to, and workers like to see an account balance similar to what is shown in a 401(k) plan. Dow used the flexibility of the new rules to create a benefit that dovetailed with the needs of its workers.
Plus, the 2006 law, called the Pension Protection Act, updated issues not seen in the original legislation that was passed several decades earlier.
It “provided clearer rules in how a hybrid plan could be designed,” Boyd said. “We felt it was helpful to take advantage of the new rules.”
And that flexibility is what the founding law of retirement plans — the Employee Retirement Income Security Act — has been attempting to accomplish since it was passed 40 years ago under the Ford administration. No doubt there have been missteps, but the original law and subsequent rulings have helped the industry develop, allowing millions of U.S. workers to participate in and benefit from a regulated retirement system. In 2011, U.S. Labor Department statistics show 683,647 retirement plans in America compared with 311,094 in 1975.
“The law was a piece of art,” said Kevin Wagner, senior consultant at Towers Watson & Co. Lawmakers “did such a great job of dealing with issues that we don’t have anymore.”
It was Labor Day — Sept. 2, 1974 — when President Gerald Ford signed ERISA into law. For the past 40 years, employers who offer retirement plans have had to promise workers certain rights and protections.
“ERISA isn’t perfect, but I still think the concept works, and the basic principle still makes sense,” Boyd said.
At its core, ERISA’s intent was to secure U.S. workers’ retirement money. It set standards for coverage, meaning who was able to participate; vesting, or how long people needed to work before getting benefits; and minimum funding. Now employers or plan sponsors have to make decisions that are in the best interests of their participants.
Before the law, companies with pension plans could use money set aside for benefits for other purposes. Companies could also close an underfunded plan without owing participants any money.
The turning point for federal oversight happened when Studebaker-Packard Corp. closed its South Bend, Indiana, plant in 1963. The company had an underfunded pension plan, thousands of workers walked out with less than 15 percent of their retirement benefit, and some got nothing at all.
“When Studebaker failed, that became the rally cry that created the political impetus to do something,” said Ann Combs, former assistant secretary of labor for pensions during the George W. Bush administration and now head of government relations for investment company Vanguard Group. “It was a legendary company that everybody knew, and it failed.”
For the first few years after ERISA’s passage, the number of defined benefit plans grew, and by 1980 nearly 36 million private-sector workers, or 46 percent of the private-sector workforce, was covered by this kind of plan, according to data from the Employee Benefit Research Institute. With defined benefit plans, employers define the benefit based on a predetermined formula. The employer funds and invests the money, and the payout is typically an annuity.
In the 1980s, Congress and the Reagan administration fiddled with funding rules for over- and underfunded plans as well as changed the premium structure for the insurance agency, the Pension Benefit Guaranty Corp., which was set up to backstop defined benefit plans. Tightening funding rules meant fewer tax-free dollars in pension plans and more taxable dollars in the economy.
Translation: while Congress was able to give Americans tax breaks on their income, these new laws gave plan sponsors no incentive to prepare for hard times.
“Congress in the 1980s and early ’90s discouraged the very purpose of the law, which was to get benefits funded,” said Sylvester Schieber, an author who is the former chairman of the Social Security Advisory Board and the retired director of retirement research at Towers Watson. Plan sponsors “were caught in this calamity and said they can’t do this, so they started closing plans.”
It was the virus that infected defined benefit plans, Towers Watson’s Wagner said.
In 1983, there were 175,143 defined benefit plans, Labor Department statistics show. By 1992, there were only 88,621. In 2011, that number shrank to 45,256.
“Congress may have received short-term tax value, but it really essentially destroyed the defined benefit system,” Wagner said. “The ability to have a secure retirement is much more tenuous today than it was 30 years ago.”
The U.S. workforce was changing, too. A more mobile workforce was evolving, and the years it took to qualify for traditional benefits didn’t suit many employees. Statistics from a 2012 Bureau of Labor Statistics report showed that workers born between 1957 and 1964 have held an average of 11 jobs during their prime working years.
Employers started realizing they didn’t want to take on all the responsibility of a pension plan, but still wanted to offer a tax-deferred retirement savings plan. It wasn’t until 1981 when the U.S. Internal Revenue Service’s regulation under Section 401(k) made it clear that portions of workers’ regular salaries could be contributed to secondary savings plans on a tax-deferred basis.
The popularity of the employer-sponsored, but employee-funded 401(k), or defined contribution plan, took off. The number of defined contribution plans more than doubled in a decade’s time to 599,245 in 1990 from 340,805 taxable plans in 1980.
A shift was definitely taking place.
“Yes, it was overregulation. Yes, it was continued effects of policymakers using pension funds [tax-preferred status] as a source of revenue, but it was also a trend that reflected a dramatically changing workforce as well as all the positive aspects of a vibrant defined contribution system,” said Jim Klein, president of the American Benefits Council.
Employees liked the plans, too. By 2000, 51 million people participated in a defined contribution plan compared with the 22 million who took part in a defined benefit plan. There were 687,000 defined contribution plans with $2.9 trillion in assets compared with 49,000 defined benefit plans with $2 trillion in assets, according to the Investment Company Institute.
Since 1985, more contributions have flowed into defined contribution plans on an annual basis than defined benefit, Labor Department figures show.
“The savings rates were far more robust than anyone anticipated,” Schieber said. “As a result, the state of the DC system is far more robust than it is being given credit for.”
As defined contribution plans grew and have become the main way people save for retirement, the industry has tried to put defined benefit aspects into 401(k) plans. The typical 401(k) plan in the ’90s had workers signing up, looking at prospectuses and deciding how much and where to invest. In many ways, workers were expected to be professional money managers, and there was concern and evidence that they weren’t doing too well.
In 2006, Congress passed the Pension Protection Act. The law helped plan sponsors automate a lot of the decisions for workers, making it easier to save. It also cleared up rules on the defined benefit side for companies like Dow Chemical to set up cash balance plans.
“It was a recognition that most people were going to be saving through defined contribution,” said Combs, who headed the Labor Department’s pension division when the law was passed. “It was about trying to put the plan to work for the participant.”
More than half of plans surveyed in 2013 by the Callan Investments Institute automatically enroll participants; of that group, 87 percent automatically bump worker contributions annually. As of December 2013, defined contribution plans held $5.9 trillion in assets, dwarfing the $3 trillion defined benefit market.
Even though there are $23 trillion in total retirement assets today, many wonder whether America has saved enough money to last through retirement. There are forces in play that seem to be repeating the past mistakes discouraging Americans to save as much as possible. Last year, President Barack Obama proposed to limit the amount workers could save from all types of retirement accounts. Congress, too, is eyeing the tax-preferred status of plans to possibly help solve the country’s growing deficit problem.
Maybe we should look at the past to see what happens when Congress tinkers with the tax benefits of retirement plans, Schieber said.
“Either we have to start paying for services or reduce what we spend, and quit robbing future retirees of their ability to save,” he added.