Tax treatment and funding challenges in qualified versus nonqualified 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 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)

In short, this is to stop them from telling things that they would not be able to ensure. Is this not somewhat like stopping them from promising 'the moon' to the child of workers? It is also an attempt to help the PBGC and that is probably required by the government, as PBGC is an institution of the government. But, how does it help workers who are already on the verge of loosing a part of their pension? The proposed bill also talks about increasing the premiums that companies would have to pay to the federal guarantor of pensions, PBGC. The companies are getting some time for this -- the companies with shaky plans are getting three years of time, and the companies with strong plans are getting five years. (2 Republicans to Propose Fix for Private Pension Woes) This is quite generous considering that the major trouble of airlines has come due to the incidents of 9/11. That incident has not been five years away.

The bill is also trying to set the legal position of cash balance plans in order, and this has been brought into question now as a federal judge has ruled that these plans discriminate against older workers in an illegal manner. There are also some modifications suggested in the methods of calculating benefits, and these are in the calculations of benefits that would be due in the future. This would compel the companies that offer a lump-sum distribution to ensure that 'run on the bank' is avoided on them. These could end up retiring workers to push a benefit fund into liquidation through rapidly taking out its assets. The bill is however not totally accepting the thinking of the government on benefits due in the future. The calculations are based on interest rates, and the administration has criticized the sector that they were among the last to believe that interest rates vary according to the terms of the contract that they have with the members.

This is reflected in the picture that banks and issuers of bonds pay lower interest rates for shorter term deposits, but the pension funds apply the same rates of interest for all types of members whatever number of years their membership be for. The bill would take into the approach of the administration, though they would not use a full range of interest rates. The funds would use three rates with one for amounts due in less than 5 years, another rate for obligations for periods between 5 and 20 years, and the third for dues to be paid after 20 years. (2 Republicans to Propose Fix for Private Pension Woes) One can only hope that the workers in 'recognized' pension funds would not have to loose one third of their savings later.

The end result

It was earlier expected that a qualified pension plan ensured for the employee a pension that had been promised to him or her earlier, but the latest turn of events show that it is not true. The government is more interested in protecting its own organization, PBGC, rather than the employees. In the case of United Airlines, the employees are loosing two thirds of their money, and this would naturally lower their pension. In the case of a private fund, the guarantees would be only from the people running the fund, and no guarantees from the government. The only difference that exists now is from the point of taxation of contributions to the fund.

Conclusion

The question is one of an attitude of the government, and it can choose to support the employees or the employers. Short-term benefits may come from supporting the employers, but that may end up not observing the principles of natural justice.