Qualified Pension Plans vs. Non-Qualified Pension Plans

¶ … Pension Plan Being Qualified

What are the permitted pension benefit plans?

What is the problem?

What is the solution?

The end result

The paper shall first inform that when any individual chooses a pension plan he should try to choose a plan that is qualified as the growth in value of the investments inside the plan are not taxable till the amounts are distributed to the investor, the contributions made by an employer to the plan are also deducted from tax within limits, and the permitted contributions by the employees are also not taxable till they have been given to the employee. We shall next look at the two main types of plans are called cash balance plans and 401(k) plans. Among the two, cash balance plans are supposed to have definite benefits at the end of a certain number of years, and 401(k) plans require the contributor to make definite contributions. Apart from this the paper notes that there are differences that should be noted. We shall next analyze the problems which arise. The problem is coming up due to the availability of low funds in the pension funds in the country. The problem of pension funds is with every American who is at a level of not having a lot of surplus money. The pension payments that he gets are expected to help him when his income goes down as there is no income then. The problem now is that even recognized pension funds are not likely to pay the amounts that were expected, and these funds were supposed to be the ones with government support. It is now a difficult decision for the workers to decide what they will do in future. The paper in the next section shall deal with the various solutions offered. There may be various approaches to the problem, and the present government has concentrated on single payer plans and has recommended that the premium paid by the employers for guaranteeing the benefit to the employees be increased from the present $19 a year to $30 a year. Congress must take the steps carefully so that the financial situation of PBGC is improved. The paper concludes with the understanding that the question is one of an attitude of the government, and it can choose to support the employees or the employers.

Qualified pension plans v Non-Qualified pension plans

Introduction

One of the most important decisions that an American takes in his life is regarding the retirement plan. The reason is that he or she expects to live on the proceeds of this plan for 18 years after retirement. Thus every individual has to understand the rights and responsibilities under the plan. All members who are covered by a retirement have certain rights according to the federal government. They also have responsibilities. There are also rights and responsibilities for the persons who sponsor a retirement plan. All the concerned laws are laid out in a law called the Employee Retirement Income Security Act of 1974, or ERISA. There are different responsibilities of Federal agencies regarding the implementation of this plan. The concerned employer or anybody else has to provide the information about the plan one has participated in, as also the right to get other information from them, time to time, at no additional cost. It is also important for the concerned investor to keep abreast of the changes in the plan. (What You Should Know About Your Retirement Plan)

The importance of the pension plan being qualified

When any individual chooses a pension plan he should try to choose a plan that is qualified as the growth in value of the investments inside the plan are not taxable till the amounts are distributed to the investor, the contributions made by an employer to the plan are also deducted from tax within limits, and the permitted contributions by the employees are also not taxable till they have been given to the employee. The types of plans under this are many and some are the old types of defined benefit pension plans, the popular plan of 401(k) which has a defined contribution and other plans. At the same time, it should be noted that all such plans have to be sponsored by the employer. It should be an important matter in seeking employment that one has access to a qualified plan. This is very important for the employee to continue living after retirement. At the same time, even in a qualified plan, the design is important, and the most important is the benefit that has to be paid in a defined benefit pension. Another question is the money that is paid out then what are the eligibilities for getting the payment? If the pension is of the type called 401(k) then is the employer making an equal contribution to the fund for the employee? Finally, what is the total fund that is available? (Qualified Pension Plan)

Thus it is clear that on the normal course, all employees would like to be part of a qualified plan as the plan itself gets benefits from the government in terms of no tax having to be paid by the employees on the money that is contributed or saved in the account. At the same time, the whole issue of the pension regulations has come under scrutiny as there has been a serious mishap regarding pension funds at United Airlines. This has led Mr. Boehner, the Education and WorkForce Committee chairman to say that the laws presently governing pension funds are out of date and is now causing the workers at the peril of losing benefits and then the entire government system has to provide funds so that the pension system can work out. The entire system is only 30 years old. United Airlines is bankrupt and the four employee pension plans that it had are now being taken over by the guarantor from the federal government. (2 Republicans to Propose Fix for Private Pension Woes)

What are the permitted pension benefit plans?

The two main types of plans are called cash balance plans and 401(k) plans. Among the two, cash balance plans are supposed to have definite benefits at the end of a certain number of years, and 401(k) plans require the contributor to make definite contributions. Apart from this there are four differences that should be noted. The first of these is that in a cash balance plan, there has to be no definite contribution by the workers to the pension plan, whereas in the case of a 401(k) type of a plan, the worker has to definitely choose to make a contribution to the plan. This may be the full contribution or part thereof. The second difference is in the area of investment risks and in the case of cash balance plans, the employer manages the funds generated and gains from the benefits or shortfalls in the cash balance. He may also have an investment manager for the purpose. The benefits that are promised to the employees are not affected by the growth or decline of the funds themselves. (Frequently Asked Questions about Cash Balance Pension Plans)

In contrast, 401(k) plans often allow the members of the fund to let the funds flow to certain permitted categories. In this case, the risks are borne by the participants due to any extra growth or shortcoming in the fund. The third difference is that cash balance funds have to provide the benefits to the members in the form of annual annuities which is not permitted in the 401(k) plans, in general. Finally there is an organization called the Pension Benefit Guaranty Corporation which has to guarantee all cash benefits to the cash balance plans as it insures all cash balance funds. Defined contribution plans including 401(k) plans are not insured by the corporation and it has no responsibility to pay pension benefits to their members, which it has to pay to the members of a cash balance fund after assuming the trusteeship of the fund from the previous trustees which have insufficient funds on hand at a time. (Frequently Asked Questions about Cash Balance Pension Plans)

While both the defined benefit plans and cash balance plans generally offer the pension benefit as a series of benefits extending throughout the life of the employee, in general the benefit plans define the benefit as one which has to start from the date of retirement of the employee. On the other hand cash benefit plans define the benefit as a 'cash balance' stated for the employee. These accounts are not like other accounts s they do not reflect deposits or withdrawals, or even increases due to interest or decreases due to losses. In a typical cash balance plan, the account is credited every year due to a pay credit, and this may be 5% of the annual salary of the employee in general. Another credit is due to the interest on the balance and this is at a variable rate, generally depending on the Treasury bill rate. These increases or decreases do not change the benefits that are to be paid to the employee. Thus the investment dangers and rewards are totally on the employer who runs the plan. Ultimately, the employee reaches the age when he should be given the benefit, and this is determined by the account balance that he has.

Let us suppose that an employee has a balance of $100,000, at the age of 65, when he or she retires. On retirement, the person would be entitled to an annuity. This annuity may be an amount of $10,000 a year and this annuity would be paid to the person for the balance of remaining life. There are also cash balance plans where instead of this annuity, the participant could choose to obtain a lump sum benefit, and this depends on the balance in the account. This option is of added benefit to the employees as they can take this option even before retirement age, if they decide to leave employment from the employer. The definition of the plans is of two types -- defined benefit plans and defined contribution plans. The defined benefit plans specify a benefit that will be made available to the employees at retirement age, whereas defined contribution plans specify the contributions that are to be made by the employer towards the retirement account of the employees. Where the account is of a defined contribution type, the benefits made available to the employee will depend on the amount that is available in his account at the time of retirement. (Frequently Asked Questions about Cash Balance Pension Plans)

What is the problem?

The problem is coming up due to the availability of low funds in the pension funds in the country. The total shortage has been calculated to be $353.7 billion at the end of 2004, as per the announcement by Pension Benefit Guarantee Corporation on June 7, 2005. Earlier, in 1980, the share among U.S. workers in the defined benefit pension plans was 80%, and this has now dropped to 40%, according to PBGC. Since the plans that are being used by the workers are now of the defined contribution type, the worker has to meet the risk that the rates of return are low on the retirement plan assets. According to figures, there are now more than 100 million employees contributing to private retirement plans and of these, 60% are ones with a defined contribution, according to figures received from Employee Benefit Research Institute. (U.S. Pension Plan Funding Under Scrutiny)

At the same time, PBGC insulates the workers against some of the downsides of the collapse of a defined benefit plan. This has led to a situation where many of the defined benefit plans do not have the money to deliver what they have promised and this is due to lax accounting rules, below par returns on investments and competitive pressures in some sectors. The plans in the case of United Airlines were under funded to the extent of $9.8 billion, but the PBGC will only pay $6.6 billion of this. As a result, there will be severe cuts in the benefits of the employees. In the case of United, the decision to allow the Airline to waive off this liability was given by a court as the company had gone into liquidation. This is only a sign of the real situation in other companies in equivalent positions. (U.S. Pension Plan Funding Under Scrutiny)

What is the solution?

There may be various approaches to the problem, and the present government has concentrated on single payer plans and has recommended that the premium paid by the employers for guaranteeing the benefit to the employees be increased from the present $19 a year to $30 a year. This will force the companies which have not provided enough funds to the plans to pay up the premiums and change the accounting for accounting of its assets and liabilities. The present situation of the companies with private pension plans is making it difficult for the government to proceed on its Social Security reform plans. This view is being mentioned as the reduction in benefits of the retirees from these companies will make the households depend on maintaining of current levels of public benefits. (U.S. Pension Plan Funding Under Scrutiny)

Congress must take the steps carefully so that the financial situation of PBGC is improved. This has to be done without increasing the requirement of private funds as that sort of action will increase the chances of the company to reduce employees or stop existing pension plans. (U.S. Pension Plan Funding Under Scrutiny) The risk to workers got the focus and attention when the ruling came from a federal judge last month when he gave the ruling about United Airlines. He permitted the airline to default of $9 billion it had on pension obligations as a part of the airline trying to find its way out of bankruptcy. This ruling thus shifted the responsibility for paying the benefits for 120,000 of the current and former workers of the airline to PBGC. The problem is that the agency is liable only for about two thirds of the amount. This problem thus reminds one of the savings and loan crises that occurred in the 1980s. Then many of thrift companies, in hundreds, became insolvent and the problem had to be solved by direct take over and compensations from the federal government. The study by the Congress of that episode put the costs of the federal government at $480.9 billion. (Overhaul of Pension-Funding Rules Sought)

The present problem has been caused in part by the rules that have been set up for these companies by the government according to the government's own findings. The measurements of assets and liabilities for the companies with such a scheme are faulty. One of the reasons found by the committee is that the companies can contribute in the form of 'credit' to the plans instead of cash contributions which are required. This has led companies to avoid making cash contributions, and during the period of 1995 to 2002, there have been 39% of the defined benefit plans have been funded by them at less than the 100% requirement. On top of this, it was seen that about 60% of the funds, some of them the biggest in the country, are using credit for their minimum requirement instead of paying cash, and thus ending up with no cash contributions. (GAO: Rules Worsen Private Pension Problem)

According to PBGC Executive Director, Bradley Belt, the company under consideration, United has not made any cash contributions to the fund for many years or even paying any additional premium to the agency. This is revealed in an analysis of data from corporate pension plans that it made, with regard to pension plans of companies whose promised benefits exceed the assets by a minimum of $50 million. PBGC itself is financed by the premiums which are paid by the corporations, and is now facing a shortfall of at least $23.3 billions directly on this account. This is for the companies which are now in trouble, and recently these companies have been the airlines. (Private pensions' $353B shortfall)

The legislature is now trying to take some action and a new plan is expected to be introduced in the House Committee on Education and WorkForce by Representatives John A. Boehner, Republican of Ohio, and Sam Johnson, Republican of Texas. The core of this plan is that companies would have to put more money in to support the promises made by them in their pension plans, and also provide greater information to workers about the security of their pensions. Summaries of the proposed bill were distributed by Boehner, and these showed an attempt at protection of Pension Benefit Guaranty Corporation. This is to be achieved through stopping companies and unions from giving out promises of increases in pensions or benefits if the pension plan was in financial trouble already. (2 Republicans to Propose Fix for Private Pension Woes)