PAGENO="0001" -- / P) ~ ~4 I r) 2. lj() ~ , / TAX PROPOSALS AFFECTING PRIVATE PENSION PLANS HEARINGS BEFORE THE COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES NINETY-SECOND CONGRESS SECOND SESSION ON TAX PROPOSALS AFFECTING PRIVATE PENSION PLANS MAY 8, 9, 10, 11, 12, 15, AND 16, 1972 Part 2 of 3 Parts (May 10, 11, and 12, 1972) Printed for the use of the Committee on Ways and Means 0 O~LI U.S~ GOVERNMENT PRINTING OFFICE 78-202 0 WASHINGTON: 1972 PAGENO="0002" AL ULLMAN, Oregon JAMES A. BURKE, Massachusetts MARTHA W. GRIFFITHS, Michigan DAN ROSTENKOWSKI, Illinois PHIL M. LANDRUM, Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee OMAR BURLESON, Texas JAMES C. CORMAN, California WILLIAM 3. GREEN, Pennsylvania SAM M. GIBBONS, Florida HUGH L. CAREY, New York JOE D. WAGGONNER, Ja., Louisiana JOSEPH E. KARTH, Minnesota JOHN W. BYRNES, Wisconsin JACKSON E. BETTS, Ohio HERMAN T. SCHNEEBELI, Pennsylvania HAROLD R. COLLIER, Illinois JOEL T. B ROYHILL, Virginia BARBER B. CONABLE, JR., New York CHARLES E. CHAMBERLAIN, Michigan JERRY L. PETTIS, California JOHN J. DUNCAN, Tennessee DONALD G. BROTZMAN, Colorado COMMITTEE ON WAYS AND MEANS WILBUR D. MILLS, Aikansas, Chairman JOHN M. MARTIN, Jr., Chief Counsel 3. P. BAKER, Assistant Chief Counsel RICHARD C. WILBUR, Minority Counsel (II) PAGENO="0003" CONTENTS Press release dated Thursday, April 13, 1972, announcing public hearings Page on administration tax proposal affecting private pension plans 1 Committee print containing message from the President, letter of trans- mittal from the Treasury Department, text of the bill, and administra- tion's explanation (H.R. 12272) 3 Government Witnesses Department of the Treasury: Hon. Edwin S. Cohen, Assistant Secretary for Tax Policy 70 Hon. Joel Segall, Deputy Assistant Secretary 70 John E. Chapoton, tax legislative counsel 70 Ronald B. Gold, financial economist 70 Public Witnesses Ad Hoc Corporate Pension Fund Committee: John A. Cardon, Washington, ~ 569 Marc M. Twinney, Jr., actuary and pension manager, Ford Motor Co~~ 574 Kenneth L. buck, assistant general counsel, Bethlehem Steel Corp 578 American Association of Retired Persons, and National Retired Teachers Association, Bernard E. Nash, executive director, presented by Cyril F. Brickfield, legislative counsel 326 American Bankers Association: John M. Cookenbach, president, trust division 293 William F. Lackman, chairman, committee on employees trusts 293 Robert L. Bevan, assistant Federal legislative counsel 293 American Bar Association: Mac Asbill, Jr., chairman, section of taxation 229 Hon. Sheldon S. Cohen, chairman, special committee on retirement benefits 241 American Federation of Labor-Congress of Industrial Organizations: Andrew J. Biemiller, director, department of legislation 401 Bert Seidman, director, department of social security 401 Arnold Cantor, economist, research department 401 American Institute of Certified Public Accountants, Robert G. Skinner, chairman, division of Federal taxation 315 American Telephone & Telegraph Co., Stanley L. King, Jr., assistant vice president, human resources 516 Ammond, Harold J., national director, Political Action Committee for Engineers and Scientists 615 Anderson, Hon. John B., a Representative in Congress from the State of Illinois 112 Asbill, Mac, chairman, section of taxation, American Bar Association - - - 229 Association for Advanced Life Underwriting, Marshall I. Wolper, president 267 Augenblick, Robert L., president, Investment Co. Institute 604 Bangert & Co., San Francisco, Calif., Louis 0. Kelso, legal counsel 647 Barberg, W. Warren, chairman, National Association of Life Underwriters 267 Baskin, Charles G., secretary-treasurer, Golf Course Superintendents Association of America 350 Bassett, Preston C., director, vice president, and actuary, Towers, Perrin, Forster & Crosby 425 Beidjer, Jack, legislative director, United Auto Workers of America 507 Bevan, Robert L., assistant Federal legislative counsel, American Bankers Association 293 (III) PAGENO="0004" tV Biemiller, Andrew J., director Department of Legislation, American Page Federation of Labor-Congress of Industrial Organizations 401 Boynton, Edwin F., member, private pension plans committee, Chamber of Commerce of the United States 551 Brickfield, Cyril F., legislative counsel, American Association of Retired Persons, and National Retired Teachers Association, presenting state- ment of Bernard E. Nash, executive director 326 Bridges, John F., president, First Investment Annuity Co. of America_ - - 493 Bureau of Salesmen's National Associations, Marshall J. Mantler, managing director 413 Cantor, Arnold, economist, Research Department, American Federation of Labor-Congress of Industrial Organizations 401 Cardon, John A., Washington, D.C., Ad Hoc Corporate Pension Fund Committee 569 Casstevens, Bill, director, United Auto Workers of America, region 2 - - - 507 Chamber of Commerce of the United States: E. S. Willis, member, private pension plans committee 551 Edwin F. Boynton, member, private pension plans committee 551 Andrew A. Melgard, committee executive, private pension plans committee 551 Cohen, Hon. Sheldon S., chairman, special committee on retirement bene- fits, American Bar Association 241 College Retirement Equities Fund, and Teachers Insurance & Annuity Association of America, Dr. William C. Greenough, chairman 522 Cookenbach, John M., president, trust division, American Bankers Association 293 Council on Employee Benefits: Walter E. Klint, trustee and member, executive committee 287 Thomas H. Paine, legislative committee 287 Curtis, James, Seattle, Wash 490 Doyle, Robert, legislative counsel, National Society of Professional Engineers 338 Dreher, William A., president, William A. Dreher & Associates 454 Edwards, Nelson Jack, vice president, United Auto Workers of America. 507 Erlenborn, Hon. John N., a Representative in Congress from the State of Illinois 616 Ferster, Herbert, New York, N.Y 498 First Investment Annuity Co. of America, John F. Bridges, president 493 Fox, H. Lawrence, counsel, International Brotherhood of Electrical Workers, Local No. 8 417 Fraser, O'Hear W., Jr., Washington, D.C 547 Gertner, Marc, counsel, International Brotherhood of Electrical Workers, Local No. 8~. 417 Golf Course Superintendents Association of America, Charles G. Baskin, secretary-treasurer 350 Greenberg, Bernard, assistant director, insurance, pension, and unemploy- ment benefits department, United Steelworkers of America 631 Greenough, Dr. William C., chairman, Teachers Insurance & Annuity Association of America, and College Retirement Equities Fund 522 Halperin, Prof. Daniel, University of Pennsylvania Law School 306 Hartke, Hon. Vance, a U.S. Senator from the State of Indiana 216 Hillis, Hon. Elwood H., a Representative in Congress from the State of Indiana 220 Houck, Kenneth L., assistant general counsel, Bethlehem Steel Corp., Ad Hoc Corporate Pension Fund Committee.~ 578 International Brotherhood of Electrical Workers, Local No. 8: H. Lawrence Fox counsel 417 Marc Gertner, counsel 417 Investment Co. Institute, Robert L. Augenblick, president 604 Javits Hon. Jacob K., a U.S. Senator from the State of New York 117 Jemas, Nick, national managing director, Jockeys' Guild, Inc 32 Jockeys' Guild, Inc.: Nick Jemas, national managing director 3n2 Roger D. Smith counsel 3)2 Kelso, Louis 0., legal counsel, Bangert & Co., San Francisco, Calif 647 Kennedy Jack E., secretary-treasurer, National Council on Teacher Retirement 324 PAGENO="0005" V Page Keogh, Hon. Eugene J., New York, N.Y 258 King, Stanley L., Jr., assistant vice president, human resources, American Telephone&TelegraphCo 516 Klint, Walter E., trustee and member, executive committee, Council on Employee Benefits 287 Lackman, William F., chairman, committee on employees trusts, American BankersAssociation~ 293 Landry, Jerome, cochairman, legislative committee, National Con- ference on Public Employee Retirement Systems 249 Liebenson, Herbert, legislative vice president, National Small Business Association 610 Lippman, S. G., Washington counsel, Political Action Committee for Engineers & Scientists 615 Litton Industries, Inc.: John H. Martin, vice president 451 Deane E. McCormick, Jr., tax counsel 451 Mantler, Marshall J., managing director, Bureau of Salesmen's National Associations 413 Martin, John H., vice president, Litton Industries, Inc 451 McCormick, Deane E., Jr., tax counsel, Litton Industries, Inc 451 McKinley, Jack, the Prototype Planner 365 Melgard, Andrew A., committee executive, private pension plans commit- tee, Chamber of Commerce of the United States 551 Miller, Elliot Ira, New York, N.Y. 303 Myers, Robert J., Silver Spring, Md 283 Nash, Bernard E., executive director, American Association of Retired Persons, and National Retired Teachers Association, presented by Cyril F. Brickfield, legislative counsel 326 National Association of Life Underwriters, W. Warren Barberg, chairman - 267 National Conference on Public Employee Retirement Systems, Jerome Landry, cochairman, legislative committee 249 National Council on Teacher Retirement, Jack E. Kennedy, secretary- treasurer 324 National Education Association, W. Jack Tennant, coordinator, office of teacher retirement 253 National Retired Teachers Association, and American Association of Re- tired Persons, Bernard E. Nash, executive director, presented by Cyril F. Brickfield, legislative counsel 326 National Small Business Association: Robert C. Ware, consultant 610 Herbert Liebenson, legislative vice president 610 National Society of Professional Engineers: Paul E. Robbins, executive director 338 Robert Doyle, legislative counsel 338 Nyhart, Eldon H., president, Howard E. Nyhart Co 299 Paine, Thomas H., legislative committee, Council on Employee Benefits - 287 Podell, Hon. Bertram L., a Representative in Congress from the State of New York 623 Political Action Committee for Engineers & Scientists: Harold J. Ammond, national director 615 S. G. Lippman, Washington counsel 615 (The) Prototype Planner, Jack McKinley 365 Reynolds, J. H., & Associates: Joseph H. Reynolds, Sr 362 Miss Susan Reynolds, legal counsel 362 Robbins, Paul E., executive director, National Society of Professional Engineers 338 Seidman, Bert, director, Department of Social Security, American Federa- tion of Labor-Congress of Industrial Organizations 401 Sheehan, John J., legislative director, United Steelworkers of America. - - - 631 Skinner, Robert G., chairman, division of Federal taxation, American In- stitute of Certified Public Accountants 315 Smith, Quentin I., Jr., president, Towers, Perrin, Forster & Crosby 425 Smith, Roger D., counsel, Jockeys' Guild, Inc 352 Solenberger, Willard, department of social security, United Auto Workers ofAmerica 507 PAGENO="0006" VI Page Susman, Gerald Stephan, Philadelphia, Pa 359 Teachers Insurance & Annuity Association of America, and College Re- tirement Equities Fund, Dr. William C. Greenough, chairman 522 Tennant, W. Jack, coordinator, office of teacher retirement, National Edu- cation Association 253 Towers, Perrin, Forster & Crosby: Quentin I. Smith, Jr., president 425 Preston C Bassett, director, vice president, and actuary 425 Twinney, Marc, M., Jr., actuary and pension manager, Ford Motor Co., Ad Hoc Corporate Pension Fund Committee 574 United Auto Workers of America: Nelson Jack Edwards, vice president 507 Bill Casstevens, director, region 2 507 Willard Solenberger, department of social security 507 Jack Beidler, legislative director 507 United Steelworkers of America: Bernard Greenberg, assistant director, insurance, pension, and un- employment benefits department~~ 631 John J. Sheehan, legislative director~_ 631 Ware, Robert C., consultant, National Small Business Association 610 Whisman, Clayton J., Westerville, Ohio 618 Willis, E. S., member, private pension plans committee, Chamber of Commerce of the United States 551 Wolper, Marshall I., president, Association for Advanced Life Under- writing 267 Material Submitted for the Record Adams, R. L., benefits manager, Reynolds Aluminum, letter dated May 9, 1972, to Chairman Mills 603 Alameda County (Calif.) Bar Association: Dale I. Stoops, president, telegram dated May 6, 1972, forwarded by Sheldon S. Cohen~. 244 Harold C. Norton, secretary, letter dated May 5, 1972, forwarded by Sheldon S. Cohen~ 244 Alaska Bar Association, Mary Lafollette, telegram dated May 5, 1972, forwarded by Sheldon S. Cohen 244 American Association of Medical Clinics, Dr. Edward M. Wurzel, execu- tive director, letter dated May 18, 1972, to Chairman Mills, with statement 731 American Bankers Association, John M. Cookenbach, president, trust division, technical memorandum 297 American Dental Association, Dr. Carl A. Laughlin, president, letter dated May 19, 1972, to Chairman Mills, with enclosure 734 American Library Association, statement 743 American Life Convention and Life Insurance Association of America, joint statement 743 American Medical Association, Dr. Ernest B. Howard, executive vice president, letter dated May 19, 1972, to Chairman Mills 748 American Textile Manufacturers Institute, John E. Eek, Jr., chairman, tax committee, letter dated May 18, 1972, to Chairman Mills 748 Anish, Mel, president, Louisiana Home Furnishings Representatives, letter dated May 6, 1972, to Chairman Mills 823 Apfelberg, Alvin I., New York, N.Y., letter dated May 11, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means - - 749 Armco Steel Corp., C. William Verity, Jr., chairman, letter dated May 4, 1972, to Chairman Mills 596 Association of Long Island Engineers & Scientists, Arthur L. Rossoff, chairman, letter dated May 19, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means, with enclosure 749 Association of Mutual Fund Plan Sponsors, statement 750 Association of the Bar of the City of New York, Committee on Taxation, statement 752 Bank of America, Samuel B. Stewart, senior vice chairman of the board, letter dated May 12, 1972, to Chairman Mills 754 PAGENO="0007" VII Barnard, Morton John, president, Illinois State Bar Association, letter Page dated May 4, 1972, forwarded by Sheldon S. Cohen - - -- 246 Batts, Roscoe W., vice president, industrial relations, International Harvester Co., letter dated May 9, 1972, to the Committee on Ways and Means 600 Bethlehem Steel Corp., Kenneth L. Houck, assistant general counsel, letter dated May 10, 1972, forwarded by John A. Cardon 596 Beverly Hills (Calif.) Bar Association, Martin Gendel, president, letter dated May 1, 1972, forwarded by Sheldon S. Cohen 245 Blasier, R. D., vice president, industrial relations, Westinghouse Electric Corp., letter dated May 10, 1972, to Chairman Mills 604 Blue Bell, Inc., E. A. Morris, chairman, R. S. LeMatty, president, L. K. Mann, executive vice president, G. E. Dixon, vice president, finance, letter dated May 17, 1972, to Chairman Mills 755 Boland, Hon. Edward P., a Representative in Congress from the State of Massachusetts, statement 720 Bressler, Barry, associate professor of economics, Richmond College, City University of New York, statement, on behalf of Taxation With Repre- sentation 847 Broyhill, Hon. James T., a Representative in Congress from the State of North Carolina, statement 729 Brummund, Walter H., Appleton, Wis., letter dated May 8, 1972, to the Committee on Ways and Means 757 Bruskotter, J. W., manager, employee relations, Marathon Oil Co., letter dated May 15, 1972, to Chairman Mills 600 Buesser, Frederick G., president, State Bar of Michigan, letter dated May 5, 1972, forwarded by Sheldon S. Cohen 247 Caldwell, Robert J., president, California Products Corp., letter dated April 28, 1972, to Chairman Mills 760 California Bar Association, John S. Malone, secretary, telegram dated May 7, 1972, forwarded by Sheldon S. Cohen 245 California Products Corp., Robert J. Caidwell, president, letter dated April 28, 1972, to Chairman Mills 760 Carton, V. J., manager, employee benefits, Gulf Oil Corp., letter dated May 3, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 599 Chicago Bar Association: Milton H. Gray, president, letter dated May 3, 1972, forwarded by Sheldon S. Cohen 245 Eugene J. Farrug, economics of legal profession committee, letter dated May 2, 1972, forwarded by Sheldon S. Cohen 245 Cincinnati (Ohio) Bar Association, Robert R. Lavercombe, president, telegram dated May 4, 1972, forwarded by Sheldon S. Cohen 246 Clarke, David J., president, Denver (Cob.) Bar Association, telegram dated May 6, 1972, forwarded by Sheldon S. Cohen 246 Columbia Broadcasting System, Inc., Kenneth W. Hoehn, vice president and treasurer, letter dated May 9, 1972, to the Committee on Ways and Means 596 Cookenbach, John M., president, trust division, American Bankers Asso- ciation, technical memorandum 297 Cooper, J. W., chairman, employee trusts committee, Corporate Fiduciaries Association of Illinois, letter dated May 1 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means, with enclosure 760 Corporate Fiduciaries Association of Illinois, J. W. Cooper, chairman, employee trusts committee, letter dated May 4, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means, with enclosure 760 Council of Profit Sharing Industries, Stanley D. Noble, president, letter dated May 18, 1972, to Chairman Mills 808 Cramer, Harold, chancellor, Philadelphia Bar Association, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Credit Union National Association, Inc., George R. LaChapelle, president, statement 810 Daume, W. B., director of corporate personnel, Monsanto Co., letter dat ed May 10, 1972, to Chairman Mills 601 Davenport, John S., III, president, Virginia Bar Association, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Dechert, Price &. Rhoads, Philadelphia, Pa., Kenneth W. Gemmill, letter dated May 5, 1972, to Chairman Mills 815 PAGENO="0008" vri:i Denver (Cob.) Bar Association, David J. Clarke, president, telegram Page dated May 6, 1972, forwarded by Sheldon S. Cohen 246 Dill, Warren, Denver, Cob., letter dated May 5, 1972, to Chairman Mills. 812 Dingell, Hon. John D., a Representative in Congress from the State of Michigan, statement 722 District of Columbia Dental Society, Dr. Henry J. Heim, president, letter dated May 10, 1972, to Chairman Mills 812 Dixon, G. E., vice president, finance, Blue Bell, Inc., letter dated May 17, 1972, to Chairman Mills 755 Doyle, Paul K., vice president, Union Oil Co. of California, letter dated May 8, 1972, to Chairman Mills 604 Dresser Industries, Inc., Virgil D. Lang, attorney, letter dated May 10, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 596 Dudeck, James R., Jacksonville, Fla., letter to John M. Martin, Jr., chief counsel, Committee on Ways and Means 812 duPont, E. I., de Nemours & Co., E. R. Kane, senior vice president, letter dated May 11, 1972, to Chairman Mills 597 Dwyer, Gilbert E., vice president, administration, Kennecott Copper Corp., letter to John M. Martin, Jr., chief counsel, Committee on Ways and Means 600 Eastman Kodak Co., Carl L. Stevenson, assistant vice president, letter dated May 12, 1972, forwarded by John A. Cardon 597 Eck, John E., Jr., chairman, tax committee, American Textile Manu- facturers Institute, letter dated May 18, 1972, to Chairman Mills 748 Eli Lilly & Co., Harold M. Wisely, group vice president, letter dated May 15, 1972, to Chairman Mills 598 Elman, Leonard S., New York, N.Y., letter dated May 12, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 613 Empire State Home Furnishings Representatives Association, Edwin E. Leff, president, letter dated May 5, 1972, to Chairman Mills 813 Farrug, Eugene J., economics of legal profession committee, Chicago Bar Association, letter dated May 2, 1972, forwarded by Sheldon S. Cohen~ 245 Ferguson, William E., chairman of the board, Thomson & McKinnon Auchincboss, Inc., letter dated May 1, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 856 Finn, Michael F., Arlington, Va., letter dated May 17, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 813 (The) Firestone Tire & Rubber Co., Lowell M. Jones, letter dated May 9, 1972, to Chairman Mills 598 FMC Corp., R. F. Foster, director of personnel administration, letter dated May 5, 1972, to Chairman Mills 599 Foster, R. F., director of personnel administration, FMC Corp., letter dated May 5, 1972, to Chairman Mills 599 Freedman, Gerald, legislative committee chairman, New England Home Furnishings Representatives Association, Inc., letter dated May 8, 1972, to Chairman Mills 843 Gatz, David, Birdsboro, Pa., letter dated May 3, 1972, to Chairman Mills 814 Gemmill, Kenneth W., Dechert, Price & Rhoads, Philadelphia, Pa., letter dated May 5, 1972, to Chairman Mills 815 Gendel, Martin, president, Beverly Hills (Calif.) Bar Association, letter dated May 1, 1972, forwarded by Sheldon S. Cohen 245 Georgia Home Furnishings Representatives Association, Jim Hughes, president, letter dated May 10, 1972, to Chairman Mills 816 Gibala, Edward S., executive secretary, State Universities Retirement System, letter dated April 27, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 847 Gray, Milton H., president, Chicago Bar Association, letter dated May 3, 1972, with enclosure, forwarded by Sheldon S. Cohen 245 Gulf Oil Corp., V. J. Carton, manager, employee benefits, letter dated May 3, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 599 Halpern, Hon. Seymour, a Representative in Congress from the State of New York, statement 723 Harrison, Ronald C., president, National Home Furnishings Representa- tives Association, letter dated May 16, 1972, to Chairman Mills 838 PAGENO="0009" Ix Helm, Dr. Henry J., president, District of Columbia Dental Society, Page letter dated May 10, 1972, to Chairman Mills 812 Hiemstra, James W., Inglewood, Calif., letter dated April 28, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means - - 816 Herman, Elliot A., New York, N.Y., letter dated May 15, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 816 Hoehn, Kenneth W., vice president and treasurer Columbia Broadcasting System, Inc., letter dated May 9, 1972, to the Committee on Ways and Means 596 Houck, Kenneth L., assistant general counsel, Bethlehem Steel Corp., letter dated May 10, 1972, forwarded by Mr. Cardon 596 Houston (Tex.) Bar Association, Hartford H. Prewett, president, letter dated May 5, 1972, forwarded by Sheldon S. Cohen 246 Howard, Dr. Ernest B., executive vice president, American Medical Asso- ciation, letter dated May 19, 1972, to Chairman Mills 748 Hughes, Jim, president, Georgia Home Furnishings Representatives Asso- ciation, letter dated May 10, 1972, to Chairman Mills 816 Illinois State Bar Association, Morton John Barnard, president, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 246 Indianapolis Bar Association, William J. Wood, president, letter dated May 10, 1972, to Chairman Mills, with resolution 817 International Harvester Co., Roscoe W. Batts, vice president, industrial relations, letter dated May 9, 1972, to the Committee on Ways and Means 600 Iowa State Bar Association, Edward H. Jones, secretary, telegram dated May 3, 1972, forwarded by Sheldon S. Cohen 247 Javits, Hon. Jacob K., a U.S. Senator from the State of New York: S. 2, a bill, Pension and Employee Benefit Act 122 Extracts from "Interim Report of Activities of Private Welfare and Pension Plan Study, 1971" (S. Rept. 92-634) 194 Article, "Terminations of Pension Plans: 11 Years' Experience"~~ 211 Johnson & Higgins, Kenneth K. Keene, vice president and director, letter dated May 5, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means, with enclosure 817 Johnson, Jack B., New England Life, letter dated May 11, 1972, to Chair- man Mills 822 Jones, Edward H., secretary, Iowa State Bar Association, telegram dated May 3, 1972, forwarded by Sheldon S. Cohen 247 Jones, Lowell M., the Firestone Tire & Rubber Co., letter dated May 9, 1972, to Chairman Mills 598 Kadison, Stuart L., president, Los Angeles County (Calif.) Bar Association, letter dated May 3, 1972, to Ways and Means Committee 247 Kane, E. R., senior vice president, E. I. duPont de Nemours & Co., letter dated May 11, 1972, to Chairman Mills 597 Keene, Kenneth K., vice president and director, Johnson & Higgins, letter dated May 5, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 817 Kennecott Copper Corp., Gilbert E. Dwyer, vice president, administration, letter to John M. Martin, Jr., chief counsel, Committee on Ways and Means 600 LaChapelle, George R., president, Credit Union National Association, Inc., statement 810 Lafollette, Mary, Alaska Bar Association, telegram dated May 5, 1972, forwarded by Sheldon S. Cohen 244 Lamon, Harry V., Jr., president, Southern Pension Conference, letter dated May 18, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 845 Lang, Virgil D., attorney, Dresser Industries, Inc., letter dated May 10, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 596 Laughlin, Dr. Carl A., president, American Dental Association, letter dated May 19, 1972, to Chairman Mills, with enclosure 734 Lavercombe, Robert R., president, Cincinnati (Ohio) Bar Association, telegram dated May 4, 1972, forwarded by Sheldon S. Cohen 246 Leff, Edwin E., president, Empire State Home Furnishings Representa- tives Association, Inc., letter dated May 5, 1972, to Chairman Mills 813 PAGENO="0010" x LeMatty, R. S., president, Blue Bell, Inc., letter dated May 17, 1972, to Page Chairman Mills 755 Life Insurance Association of America and American Life Convention, joint statement 743 Los Angeles County (Calif.) Bar Association, Stuart L. Kadison, president, letter to Ways and Means Committee dated May 3, 1972 247 Louisiana Home Furnishings Representatives, Mel Anish, president, letter dated May 6, 1972, to Chairman Mills 823 Lucas, William L., vice president-secretary, Martin Marietta Corp., letter dated May 8, 1972, to Chairman Mills 601 Lurie, Alvin D., New York, N.Y., statement with en closure 823 Malone, John S., secretary, California Bar Association, telegram dated May 7, 1972, forwardedby Sheldon S. Cohen 245 Mann, L. K., executive vice president, Blue Bell, Inc., letter dated May 17, 1972, to Chairman Mills 755 Marathon Oil Co., J. W. Bruskotter, manager, employee relations, letter dated May 15, 1972, to Chairman Mills 600 Martin E. Segal Co., Robert D. Paul, president, statement 828 Martin Marietta Corp., William L. Lucas, vice president-secretary, letter dated May 8, 1972, to Chairman Mills 601 McKenna, William F., general counsel/vice president, National League of Insured Savings Associations, letter dated May 8, 1972, to Chairman Mills 839 Meyer, Henry V., Denver, Cob., letter dated May 10, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 830 Michigan, State Bar of, Frederick G. Buesser, president, letter dated May 5, 1972, forwarded by Sheldon S. Cohen 247 Mobil Oil Corp., statement 831 Monsanto Co., W. B. Daume, director of corporate personnel, letter dated May 10, 1972, to Chairman Mills 601 Morris, E. A., chairman, Blue Bell, Inc., letter dated May 17, 1972, to Chairman Mills 755 Nabisco, Inc., D. H. Scott, vice president, letter dated May 8, 1972, to Chairman Mills 602 National Association of Manufacturers, statement 833 National Home Furnishings Representatives Association, Ronald C. Harrison president, letter dated May 16, 1972, to Chairman Mills 838 National League of Insured Savings Associations, William F. McKenna, general counsel/vice president, letter dated May 8, 1972, to Chairman Mills 839 National Retail Merchants Association, James R. Williams, president, letter dated May 18, 1972, to Chairman Mills 840 National Society of Public Accountants, R. J. Passero, president, letter dated May 18, 1972, to Chairman Mills 842 New England Home Furnishings Representatives Association, Inc., Gerald Freedman, legislative committee chairman, letter dated May 8, 1972, to Chairman Mills 843 New England Life, Jack B. Johnson, letter dated May 11, 1972, to Chair- man Mills 822 Noble, Stanley D., president, Council of Profit Sharing Industries, letter dated May 18, 1972, to Chairman Mills 808 Norton, Harold C., secretary, Alameda County (Calif.) Bar Association, letter dated May 5, 1972, forwarded by Sheldon S. Cohen 244 Passero, R. J., president, National Society of Public Accountants, letter dated May 18, 1972, to Chairman Mills 842 Paul, Robert D., president, Martin E. Segal Co., statement 828 Pet, Inc., J. Price Reed, vice president and director of personnel, letter dated May 11, 1972, to Chairman Mills 603 Philadelphia Bar Association, Harold Cramer, chancellor, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Phillips Petroleum Co., W. R. Thomas, vice president, employee relations department, letter dated May 30, 1972, to Chairman Mills 603 Pittard, Dr. M. D., chairman, executive committee, Toccoa (Ga.) Clinic Medical Associates, statement 858 Prewett, Hartford H., president, Houston (Tex.) Bar Association, letter dated May 5, 1972, forwarded by Sheldon S. Cohen 246 PAGENO="0011" XI Reed, J. Price, vice president and director of personnel, Pet, Inc., letter Page dated May 11, 1972, to Chairman Mills 603 Reynolds Aluminum, R. L. Adams, benefits manager, letter dated May 9, 1972, to Chairman Mills 603 Rocky Mountain Motor Tariff Bureau, Curtis L. Wood, member, retire- ment board, letter dated May 16, 1972, to the Committee on Ways and Means 843 Rossoff, Arthur L., chairman, Association of Long Island Engineers & Scientists, letter dated May 19, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means, with enclosure 749 Schoeplein, Robert N., associate professor of economics, Institute of Government & Public Affairs, University of Illinois, statement, on be- half of Taxation With Representation 849 Scholfield, Jack P., president, Seattle-King County (Wash.) Bar Asso- ciation, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Scott, D. H., vice president, Nabisco, Inc., letter dated May 8, 1972, to Chairman Mills 602 Seattle-King County (Wash.) Bar Association, Jack P. Scholfield, presi- dent, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Southern Pension Conference, Harry V. Lamon, Jr., president, letter dated May 18, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 845 State Universities Retirement System, Edward S. Gibala, executive sec- retary, letter dated April 27, 1972, to John M. Martin, Jr., chief coun- sel, Committee on Ways and Means 847 Stevenson, Carl L., assistant vice president, Eastman Kodak Co., letter dated May 12, 1972, forwarded by John A. Cardon 597 Stewart, Samuel B., senior vice chairman of the board, Bank of America, letter dated May 12, 1972, to Chairman Mills 754 Stone, Dale D., director, corporate human resources, Sun Oil Co., letter dated May 4, 1972, to the Committee on Ways and Means 603 Stoops, Dale I., president, Alameda County (Calif.) Bar Association, telegram dated May 6, 1972, forwarded by Sheldon S. Cohen 244 Sun Oil Co., Dale D. Stone, director, corporate human resources, letter dated May 4, 1972, to the Committee on Ways and Means 603 Taggart, John Y., New York, N.Y., letter dated May 18, 1972, to the CommitteeonWaysandMeans 847 Taxation With Representation: Barry Bressler, associate professor of economics, Richmond College, City University of New York, statement 847 Robert N. Schoeplein, associate professor of economics, Institute of Government & Public Affairs, University of Illinois, statement 849 William Withers, professor of economics, Queens College, City Uni- versity of New York, statement 853 Thomas, W. R., vice president, employee relations department, Phillips Petroleum Co., letter dated May 30, 1972, to Chairman Mills 603 Thomson & McKinnon Auchincloss, Inc., William E. Ferguson, chairman of the board, letter dated May 1, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 856 Thore, Eugene M. Washington, D.C., letter dated May 16, 1972, to John M. Martin, Jr., chief counsel, Committee on Ways and Means 857 Toccoa (Ga.) Clinic Medical Associates, Dr. M. D. Pittard, chairman, ex- ecutive committee, statement 858 Union Oil Company of California, Paul K. Doyle, vice president, letter dated May 8, 1972, to Chairman Mifis 604 U.S. Savings & Loan League, statement 859 United States Steel Corp., William G. Whyte, vice president, letter dated May 19, 1972, to Chairman Mills 604 Verity, C. William Jr., chairman, Armco Steel Corp., letter dated May 4, 1972, to Chairman Mills 596 Virginia Bar Association, John S. Davenport III, president, letter dated May 4, 1972, forwarded by Sheldon S. Cohen 248 Westinghouse Electric Corp., R. D. Blasier, vice president, industrial relations, letter dated May 10, 1972, to Chairman Mills 604 Whitehurst, Hon. William G., a Representative in Congress from the State of Virginia, letter dated May 15, 1972, to Chairman Mills, with enclosures 730 PAGENO="0012" XII Whyte, William G., vice president, United States Steel Corp., letter dated Page May 19, 1972, to Chairman Mills 604 Williams, James R., president, National Retail Merchants Association, letter dated May 18, 1972, to Chairman Mills 840 Wisely, Harold M., group vice president, Eli Lilly & Co., letter dated May 15, 1972, to Chairman Mills 598 Withers, William, professor of economics, Queens College, City University of New York, statement, on behalf of Taxation With Representation - - - 853 Wood, Curtis L., member, retirement board, Rocky Mountain Motor Tariff Bureau, letter dated May 16, 1972, to the Committee on Ways and Means 843 Wood, William J., l)resident, Indianapolis Bar Association, letter dated May 10, 1972, to Chairman Mills, withresolution 817 Wurzel, Dr. Edward M., executive director, American Association of Medical Clinics, letter dated May 18, 1972, to Chairman Mills, with statement 731 PAGENO="0013" TAX PROPOSALS AFFECTING PRIVATE PENSION PLANS WEDNESDAY, MAY 10, 1972 HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, TVa8hington, D.C. The committee met at 10 a.m., pursuant to notice, in the commit- tee room, Longworth House Office Building, Hon. Al IJilman presiding. Mr. ULLMAN. The committee will be in order. Our first witness this morning is Mr. Robert Skinner, chairman. Division of Federal Taxation, American Institute of Certified Public Accountants. Mr. Skinner, we are glad to have you before the committee. Would you please further identify yourself for the record and you may proceed. STATEMENT OF ROBERT G. SKINNER, CHAIRMAN, DIVISION OP PEDERAL TAXATION, AMERICAN INSTITUTE OP CERTIFIED PUBLIC ACCOUNTANTS Mr. SKINNER. Thank you. Mr. Chairman and members of this distinguished committee, my name is Robert G. Skinner. I am chairman of the Division of Federal Taxation, American Institute of Certified Public Accountants. The American Institute of Certified Public Accountants is the sole national organization of professional CPA's. It was established in 1887 and currently has more than 84,000 members. Our comments at this hearing will be limited generally to those pro- visions of the administration bill, H.R. 12272, which may directly af- fect the members of the institute and their employees. Accordingly, our comments will cover the proposals relating to one, eligibility, two, vesting and three, contribution limitations-in the cas~ of plans which cover one or more self-employed individuals; and the proposal for deductions for individual retirement savings. In this connection, it is our general view that special restrictions or limitations on qualified retirement plans covering self-employed individuals should be imposed only where there is a clear and present need to establish rules which would not otherwise be satisfied by the general nondiscrimination provisions of the code as they relate to employee benefit plans. We therefore urge that the goal of equal treatment in this respect be a key element in your consideration of this important area of tax legislation. (315) PAGENO="0014" 316 The Internal Revenue Code does not presently contain any specific requirements for a qualified plan concerning eligibility conditions based on age or length of service, except that in the case of an unin- corporated business in which an "owner-employee" participates, the plan cannot exclude an employee who has been employed for three or more years. Apart from this exception, existing `administrative prac- tice permits a plan to limit participation to employees who `have attained a specified, for example, 40 years, who have been employed for a specified period of time, for example, 5 years or who are too close to retirement age at the time `they would otherwise first `become eligible to participate in the plan. The administration bill would not permit a plan to qualify if `it requires that an employee complete service with the employer in excess of 3 years, if it requires the employee to have attained an age in excess of 30 years, or where, as of the time he is first eligible to participate, if it requires `that `lie has not attained an age greater than 5 years preced- ing normal retirement age under the plan. In the case of plans covering self-employed individuals who are "owner-employees," the eligibility conditions could not require the completion of more than 3 years of service if the employee's age is less than 30 years, more than 2 years of service if his age is 30 years or more but less than 35 years, or more than 1 year of service if his age is 35 years or more. The institute agrees with the underlying philosophy that qualifica- tion of private retirement pl'ans should be permitted only where the eligibility conditions are not unduly restrictive as to age `and service. It is, however, a matter of judgment whether an appropriate age qualification requirement should be established within a 30- to 35- year range, or whether the service qualification requirement should be based on a 3-year formula. On the other hand, the institute does not believe that there is any basic justification for imposing additional restrictions on the qualify- ing conditions for a plan which also benefits self-employed individuals who are "owner-employees." We, therefore, oppose the so-called "3-2-1" service and age eligibil- ity tests proposed for these plans. The eligibility requirements for plans benefiting "owner-employees" should be no different, we feel, than for plans established `by corporate employers. The Internal Revenue Code does not presently specify vesting standards for qualification of employee retirement plans, and various standards have been applied administratively. Generally, the adminis- trative standards applied for profit-sharing plans have been more restrictive than those for pension plans. In the case of profit-sharing plans, vesting usually has been required to begin within the first 5 years of participation, whereas in the case of pension plans, vesting may be deferred until retirement. `The administration bill would provide the same standard for both pension and profit-sharing plans through application of a "rule of 50," or in plans which cover "owner-employees," a "rule of 35." Section 2(c) of the administration bill would also authorize the promulgation of regulations setting forth vesting requirements in the case of certain other closely controlled partnerships, and corporations, which do not include "owner-employees." In these circumstances, the PAGENO="0015" 317 regulations could impose vesting requirements which are more strin- gent than the "rule of 50," but not more stringent than the "rule of 35." The effect of these proposals would be to establish three levels of vesting standards: One, the "rule of 50" as the general rule; two, the "rule of 35" in the case of a plan covering a (10 percent) "owner- employee"; and three, a third standard falling between the "rule of 50" and the "rule of 35" to be determined by regulations in the case of certain closely controlled partnerships and corporations. The institute agrees with the basic philosophy that qualified retire- ment benefits should become fully vested at some point in time prior to retirement. Further, we believe that vesting standards should now be legislatively prescribed and that the rule of 50 is a reasonable mechanical device to establish these requirements, if it is indeed desir- able to recognize age in addition to service as an appropriate factor in the vesting of retirement benefits. While we accept the rule of 50 as a suitable method for establishing uniform vesting standards, we do not agree with the variations of the rule which result in a three-tiered standard. In proposing its legislative changes, the administration stressed the importance of eliminating artificial distinctions in the tax treatment of similar plans simply because the plans are sponsored by different types of business entities. We now urge that Congress promote greater uniforniity between and among qualified retirement plans by providing for no more than a two-tiered formula for vesting-with a rational basis for the more stringent second tier where the contributions or benefits are primarily for a limited group of participants who also have controlling owner- ship interests in the business entity. We suggest that this more restric- tive vesting provision should apply irrespective of the form of busi- ness entity. With respect to implementing this proposal, we question the test under the administration bill as to what constitutes a plan primarily for the benefit of controlling ownership interests. The bill proposes that a more than 5-percent ownership interest, or in the alternative, a more than 1-percent to 5-percent interest which, when combined with other interests, represents more than 50 percent of the value of the business, is sufficiently large to justify a separate and more strin- gent vesting standard than the proposed general rule. We suggest that ownership interest of the business is not the only factor which should be considered. Rather, the extent of benefits, whether or not vested, under the plan for those who represent the controlling ownership interests should also be determinative of wheth- er a more stringent vesting standard should be imposed. We propose, therefore, that the second standard for vesting-which should be no more restrictive than the "rule of 35"-should apply in any case where the controlling ownership interests of those who par- ticipate in the plan aggregate more than 50 percent of the value or the vote of the business entity, partnership or corporation, and their aggregate interest in employer contributions exceeds 50 percent of the total employer contributions under the plan. We urge that this second vesting standard be required by legisla- tion, rather than be the subject of regulatory authority. The adminis- trative aspects of this proposal, such as the future treatment in in- PAGENO="0016" 318 stances where the ownership interests change, could properly be the subject of Treasury Department regulations. The acimmistration bill provides a method whereby an employee, or a self-employed individual, may establish a personal retirement plan to provide for his own retirement benefits and secure a limited deduction for Federal income tax purposes. In general, the amount deductible would be limited to 20 percent of the first $7,500 of earned income, subject to further reduction for, (1) amounts contributed on his behalf under another qualified plan of his employer, or (2) for the equivalent amount of tax that would be imposed on the employee under FJCA in the case of an employee who is not covered by the social security system. The Institute urges the adoption of this provision in the proposed bill because it believes that the individual retirement plan provisions will be beneficial to employees of many business entities which do not now have employer-sponsored retirement plans. We suggest, however, that appropriate provisi~rn be made for a simple method of annual reporting by individuals. The benefits of individual retirement savings plans should not be eroded by placing onerous reporting burdens on relatively unsophisticated taxpayers who choose to adopt such plans. To meet this objective a simplified type of form 2950-SE (Statement in Support of Deduction for Contributions made on behalf of Self- Employed Individuals to Pension and Profit-Sharing Plans) should be adopted, which would also cover the requirement of existing form 4848 ("Annual Employer's Return for Employees' Pension or Profit- Sharing Plans"). The desirability of a simplified reporting procedure could be described in accompanying committee reports. The administration bill would revise the limitations on deductible employer contributions to qualified plans covering self-employed in- dividuals. Present law provides a distinction between plans covering only employees and those which also cover self-employed persons. In plans for self-employed persons $2,500 is the maximum allowable deduction for contributions on behalf of such a self-employed person. With respect to deductible contributions to qualified retirement plans, in our view there is no rational justification for distinguishing between plans covering self-employed persons and employees, and those which cover only employees. Whatever merit to such a double standard may have existed in 1962 when the H.R. 10 provisions were first enacted, it does not appear reasonable to continue that distinction now, since professional activities in most States may be carried on in corporate form, as partnerships or as sole proprietorships. This was also recognized by the President in his message of December 8, 1971, when he stated that: This distinction in treatment is not based on any difference in reality, since self-employed persons and corporate employees often engage in substantially the same economic activities. One result of this distinction has been to create an arti- ficial incentive for the self-employed to incorporate; another result has been to deny benefits to the employees of those self-employed persons who do not wish to incorporate which are comparable to those of corporate employees. In principle, therefore, we believe that there is no justification for any special limitations on contributions to plans covering self-em- ployed individuals. Nevertheless, we commend the administration pro- posal for attempting to achieve greater equity than presently exists. PAGENO="0017" 319 The present $2,500 limitation is generally inadequate to provide mean- ingful retirement benefits for self-employed individuals at all levels of earnings. With respect to the proposed new limitation of $7,500 as a deductible contribution, resulting from the 15-percent maximum rate applied to a $50,000 maximum earned income base, we offer these comments. Where earned income of a self-employed person exceeds $50,000, but the rate of contributions for covered employees is less than 5 percent, there is an actual reduction in H.R. 10 plan deductible contributions under the bill compared to the present law. This is the result of the requirement that the rate of contribution for the self-employed person may not exceed the lowest rate at which a contribution is made on behalf of any employee, and then may only be applied to the maximum earned income base, $50,000 under the proposal. For example, a self-employed person earning $100,000 who con- tributes at a 2½ percent rate for all employees would be entitled under present law to the maximum deduction of $2~500, 21/2 percent of $100,000. Under the administration proposal, the deduction would be limited to $1,250, 21/2 percent of $50,000, which represents a detri- mental change in existing law. Moreover, when the earned income limitation of $50,000 is opera- tive, there appears to be reverse discrimination; that is, the amount to be contributed and deducted on behalf of the self-employed person may be less, expressed as a percentage of earned income, then would be permitted on behalf of employees. To achieve more equality with corporate plans, we recommend that the maximum earned income base be eliminated or that it be raised substantially. This could be done even if the maximum de- ductible contribution limit is set at $7,500 per year. The stated purpose for the proposed legislative change which would impose a percentage limitation on deductible contributions for a self-employed person to the lowest rate contributed on behalf of any employee, is to raise the contribution rate on behalf of the employee in order to secure the maximum deduction for the self-employed participant. Under the present law, the maximum deduction of $2,500 can be achieved with a low contribution rate for the employees if the self- employed person has earned income substantially greater than $25,000. In recognition of this problem, and to reduce the circumstances in which the reverse discrimination mentioned a moment ago would otherwise apply, we suggest an alternative approach. The proposed maximum contribution rate should be reduced from 15 percent to the lowest rate for any covered employee only where the overall contribu- tion rate is less than the rate which is generally assumed to be made by corporate employers who have qualified plans, and this is 7 per- cent according to the Treasury Department's analysis which accom- panied the administration proposal. However, under our suggested alternative, if the rate of contribution for any covered employee is not less than 7 percent, only the general nondiscrimination rules under present law would apply to the con- tribution rate with no maximum earned income ceiling of $50,000, but with overall $7,500 and 15 percent limitations. 78202 0 - 72 - pt. 2 - 2 PAGENO="0018" 320 These overall limitations would be consistent with the $2,500-b percent limitations under present law, and would provide an important incentive for all self-employed persons to raise the contribution for- mula to at least 7 percent. This concept is illustrated in exhibit A attached to our written sub- mission. Unless some modification is made to the administration bill in this regard, we believe there will be a further incentive to incor- porate businesses, contrary to the stated purpose of the legislation, since the base income limitation does not apply to corporate plans. We also note that the statutory language expressing the rate limita- tion to be the lowest rate of contribution on behalf of any employee should be clarified so that only compensation for employees participat- ing in the plan should be considered. Gentlemen, we appreciate the opportunity to present these comments on behalf of our professional members and we hope that they are help- ful to you. If our tax division can assist you or your staff in any further analysis of these proposals, we would be pleased to do so. Mr. ULLMAN. Mr. Skinner, your organization has always been very helpful. Without objection the table will be included in the record and, if you wish, the summary of the full statement that you left out will also be included. Mr. SKINNER. Thank you, sir. (The table and summary referred to follow:) PAGENO="0019" EXHIBIT A ILLUSTRATION OF DEDUCTIBLE HR-b CONTRIBUTIONS UNDER VARIOUS ALTERNATIVES Present law H.R. 12272 AICPA alternative Earned income $150, 000 $100, 000 $50, 000 $25, 000 $150, 000 $100, 000 $50, 000 $25, 000 $150, 000 $100, 000 $50, 000 $25,000 Employee rate: 2.5 percent 2, 500 2, 500 1, 250 625 1, 250 1, 250 1, 250 625 1, 250 1, 250 1, 250 625 Cj~ 5 percent 2, 500 2, 500 2, 500 1, 250 2, 500 2, 500 2, 500 1, 250 2, 500 2, 500 2, 500 1, 250 ~ 7 percent 2, 500 2, 500 2, 500 1, 750 3, 500 3, 500 3, 500 1, 750 7, 500 7, 000 3, 500 1, 750 10 percent 2, 500 2, 500 2, 500 2, 500 5, 000 5, 000 5, 000 2, 500 7, 500 7, 500 5, 000 2, 500 15 percent 7, 500 7, 500 7, 500 3, 750 7, 500 7, 500 7, 500 3, 750 Formula: Maximum contribution rate (percent) 10 15 15 Maximum earned income Unlimited $50, 000 1 Unlimited Maximum deduction $2, 500 $7, 500 $7, 500 1 Provided at least a 7 percent contribution rate for employees. PAGENO="0020" 322 SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. The Institute's testimony is limited to the provisions of HR. 12272 relating to eligibility, vesting and contribution limitations in the case of retirement plans covering self-employed individuals and to the provision for deductions for indi- vidual retirement savings. 2. The Institute favors legislation which would eliminate differences and provide equal treatment in connection with employee benefit plans for both self-employed individuals and employees of corporations. Therefore, restrictions or limitations on qualified retirement plans covering self-employed individuals should be no greater than the nondiscrimination provisions of the Internal Rev- ernie Code as they relate to employee benefit plans generally. 3. The "3-2-1" service and age eligibility tests proposed for plans coveilng self-employed individuals who are "ow-ner-employees" should be eliminated. Thcre is no basic justification for imposing more restrictive requirements for such plans than for employee benefit plans generally. 4. The Institute approves the "Rule of 50" as a suitable method for establishing uniform vesting standards but opposes other variations which result in a three- tiered standard. 5. The Institute favors the proposal providing for deductions for individual retirement savings and recommends that a simple method of annual reporting be adopted. 6. The Institute is opposed to the special limitations on contributions to plans covering self-employed individuals. There should be no distinction between plans covering self-employed individuals and those covering corporate employees. Mr. TJLLMAN. Are there questions? Mr. Byrnes? Mr. BYRNES. When we get into the area of attempting to equate the self-employed with corporate employees, shouldn't this have some bearing on the number of employees that an individual has? A person could be self-employed and have one person, perhaps one of his children, working for him. In that situation, he could take all of his income over a certain amount which he felt that he didn't need at the time, and put it into a deferred status. This was one of the reasons for requiring that you had to include your employees on the same basis. I am wondering if, when you take off the limit, you don't have to have some kind of a relationship to the number of employees that are then involved for that particular individual who could enjoy the priv- ilege that we extend to corporations. What would be your view on that? Mr. SKINNER. It would be hard, as I see it, to establish limitations within gradations in many size businesses it seems to me. I would think any limitation of that nature would have to vary from no employees to a few employees to a very large number of employees and it seems to me that, if percentage limitations are established with reference to earned income and if nondiscrimination is provided for the small number of employees as well as the large, I am not sure that it wouldn't be self-policing really. Mr. BYRNES. It may be that the approach would not be the number of employees, but maybe the amount of contribution that is made, or some- thing which would have to bear some relationship to the amount of money deferred for the principal self-employed individual, before this would come into play. Mr. SKINNER. I think the limitations in terms of percentages with reference to earned income would provide at least a ceiling on that that would keep it from getting out of bounds. PAGENO="0021" 323 Mr. BYRNES. I am suggesting that it might get out of bounds where you have one or two employees. Mr. SKINNER. I understand that. I think it is an area that requires attention. I don't know how significant it is but perhaps you gentlemen can gain access to it. Perhaps you might want to consider revenue im- pact on other factors that we have not addressed ourselves to. Mr. BYRNES. Thank you. Mr. GIB~ONS. Mr. Chairman. Mr. TJLLMAN. Mr. Gibbons. Mr. GIBBONS. Maybe this wouldn't work. Let me try this out on you. If you took off all the limitations upon the amount of contributions that a self-employed could make, why couldn't an individual lawyer with a small staff, perhaps his wife or daughter or some other person, set up a self-employed plan and just put enough of his income in there so that lie would almost reduce his taxes to zero. Then he could borrow back from that plan enough money to live on and deduct the rest of the interest on his income tax and probably rock along for a number of years without having to pay any income tax at all on anything and then draw all his money out whenever he wanted to retire. Couldn't he do that? Mr. SKINNER. I don't t.hink so if I understand your question cor- rectly. It seems to me that again this perhaps would be and should be limitations with reference to earned income. Mr. GIBBONS. I thought you were advocating removing them all? Mr. SKINNER. What we are stressing, I think, is equity or uniformity with plans for all other businesses including corporations. Mr. GIBBONS. Have you as accountants given any thought to the fact that we may have been too generous in the other retirement plan? Mr. SKINNER. I am not sure that we as accountants have any special expertise in judging that. It seems to me w-ith reference to your sug- gestion regarding borrowing back that this could be taken care of through prohibited transactions. Mr. GIBBONS. Well, you could borrow from somebody else. You could borrow from a bank if you have some other assets. It is not hard to borrow money if you have a little collateral. You can reduce your in- come taxes to zero and just rock along for years. Mr. SKINNER. The sitautioii that. you Iose I would agree would not be a proper result and there undoubtedly should be metes and bounds to this which would prevent the excess that you have described. Mr. ULL3IAN. Mr. Corman Mr. CORMAN. Thank you~ Mr. Chairman. It does seem to me that. we owe equity to all people. When dealing with a few people. who make tremendous amounts of money for a very short period, as compared to others who make a moderate income throughout tlieii' lives, it is difficult to structure an equitable system if we apply controls on the annual contributions that can be made on a tax defei'red basis. Do you think we might look at the possibility of placing a ceiling on the cumulative tax deferred benefits, looking to what the annuity or pension would be at age 60 or 65; theii~ establish some reasonable amount and let people contribute to that. system as rapidly as they wish until they build up a sufficient retirement fund to provide that PAGENO="0022" 324 annuity? From that point in their earning period they would have no additional tax referral. Any additional money would go into the fund on an after-tax basis. That would hold true whether they are at the moment self-employed or subsequently become employed by somebody else. Do you think that might be workable? Mr. SKINNER. I think that it has merit in terms of equity and fair- ness. I think that the suggestion is a good one. Mr. [JLLMAN. If there are no further questions, thank you very much, Mr. Skinner. You have been very helpful to us. Mr. SKINNER. Thank you, sir. Mr. TJLLMAN. Our next witness is Mr. Jack E. Kennedy. Mr. BROTZMAN. Mr. Chairman. Mr. TJLLMAN. Mr. Brotzman. Mr. BROTZMAN. If I may be recognized briefly, I would just like to welcome Mr. Kennedy to the committee. I have known him over a period of years. He has been very close to our retirement programs in the State of Colorado, Mr. Chairman, and I think that we will find his testimony to be enlightening and helpful to the committee. Mr. TJLLMAN. We certainly welcome you before the committee, Mr. Kennedy. If you would further identify yourself for the record you may proceed, sir. STATEMENT OP JACK E. KENNEDY, SECRETARY-TREASURER, NATIONAL COUNCIL ON TEACHER RETIREMENT Mr. KENNEDY. Mr. Chairman and members of the committee, my name is Jack Kennedy. I am Executive Secretary of the Public Em- ployees' Retirement Association of Colorado and the Secretary-Treas- urer of the National Council on Teacher Retirement. The National Council on Teacher Retirement represents 41 State teacher retirement systems and 14 local municipal teacher retirement systems, all of which provide retirement programs for over 2 million school teachers and employees. My testimony is limited primarily to the tax treatment of school employees who made mandatory contributions to public retirement programs. Generally, while the National Council on Teacher Retirement sup- ports the basic concept of H.R. 12272, we feel that in some aspects it is too restrictive and discriminates against public retirement plans. For many years the tax laws have been inequitable in the treatment of retired persons a.s to income tax credit for those who have not been covered by social security or railroad retirement. While this inequity continues to exist another has developed by IRS ruling to the effect that public employees are not given the same tax treatment as em- ployees under private pension plans qualified under 401 (a) unless they, too, have their public employee plan determined to be qualified. There is considerable argument as to the rationale behind these rul- ings but we do not wish to burden the committee at this time except as such requirement for qualification affects H.R. 12272. The sole pur- pose of mentioning the aforementioned inequities is simply to provide background what we believe may be additional discrimination in H.R. 12272. PAGENO="0023" 325 Unlike social security benefits which are totally tax-free, retirement benefits earned through mandatory payments to public retirement sys- tems are taxable after the mandatory contributions are recovered. This means that those teachers who derive much, and in 14 States, all of their retirement benefits from public retirement systems as opposed to social security, pay a greater amount of taxes during their retired lives on each dollar earned than do their fellow workers who derive their retirement income solely from social security. This injustice can be partially corrected by permitting tax deferment on all mandatory payments to a retirement system even though a more equitable solution would be to make the retirement benefit itself tax-free as is social security. If tax relief on retirement benefits is not possible at this time, it becomes even more necessary that favorable action be taken to grant relief from taxes on the mandatory contributions which are paid to produce these benefits. It is possible for teachers who can afford it to defer taxes on limited voluntary payments for the purchase of annuity contracts from insur- ance companies through the application of Section 403(b) of the In- ternal Revenue Code, but the teacher who does not have adequate dis- cretionary income to permit him this avenue of tax savings is still taxed on his required payments to the only retirement plan which he might have. Yet, we understand any person covered by a plan qualified under 401 (a) is not eligible for 403(b) coverage. This strange fact results in the granting of a tax savings opportunity to those who are fortunate enough to enjoy discretionary income above living requirements and who need it the least, while `at the same time denying a tax savings opportunity to those persons whose lower in- comes won't permit access to the savings. In summary, the social security program affords a tax savings by granting benefits that are tax-free after having collected on the man- datory contributions; people whose income is high relative to their current needs are afforded a tax savings opportunity through defer- ment of taxes on moneys applied to the voluntary purchase of addi- tional annuities, but persons who are required to make contributions to mandatory participation plans are afforded no relief at all. They pay tax on money which they do not see while they are working and they pay tax on retirement income when they retire. Further, the re- quirement in H.R. 12272 that employees not covered by social security must take 5.2 percent of salary up to $9,000 and add this amount to the employer and employee contribution results in considerably less deferral of income than persons covered by social security. Therefore, while we agree that a deduction for retirement savings is desirable, we strongly believe that such deduction should not be restricted to those amounts paid to a plan qualified under 401(a), or an Bmployees' trust as described in 401 (a) and exempt from tax under section 501 (a), or amounts paid for the purchase of an annuity con- tract under 404(a) (2) or bond plan under 405, or amounts paid for the purchase of a 403(b) annuity contract. Certainly any mandatory contribution made by a public employee should receive at least as much consideration. The problem is as acute for those persons, if not more so, than those w~ho can voluntarily purchase annuity contracts under the aforementioned provisions of the law and have tax benefits. PAGENO="0024" 326 Therefore., we would respectfully submit two specific recommendations to the committee. SPECIFIC RECOMMENDATIONS One, we would recommend the amendment of H.R. 12272 to elimi- nate the discrimination against public school employees who do not fall within the preferred categories set forth in the bill by excluding compulsory contributions from taxable income of all employees until they are actually received. Two, we would recommend that the provision in H.R.. 12272 estab- lishing special limitations on deductible amounts imposed on public school employees who are not covered by social security be eliminated because of the inequity resulting in less favorable tax treatment simply because they have no social security. In conclusion, the National Council on Teacher Retirement wishes to thank the committee for the opportunity to express its views relative to the tax treatment of public school employees' retirement contribu- tions, and further respectfully requests the committee's serious consid- eration of the problems of inequity and discrimination that we believe exists not only in H.R. 12272. but also in many other areas of the tax laws. Thank you, sir. Mr. ULLMAN. Does that conclude your testimony, Mr. Kennedy? Mr. KENNEDY. Yes; it does, Mr. Chairman. Mr. T5LLMAN. Are there any questions? If not, thank you very much. Mr. KENNEDY. Thank you. Mr. TJLLMAN. Out next witness is Mr. Bernard E. Nash. STATEMENT OF BERNARD E. NASH, EXECUTIVE DIRECTOR, AMERI- CAN ASSOCIATION OF RETIRED PERSONS AND NATIONAL RE- TIRED TEACHERS ASSOCIATION, PRESENTED BY CYRIL P. BRICK- FIELD, LEGiSLATIVE COUNSEL Mr. BRICKFIELD. Mr. Nash is unable to be here this morning. I am Cyril Brickfield, legislative counsel for the associations, and I would like to testify for him at this time, Mr. T5llman. Mr. TJLLMAN. Mr. Brickfield, we will be very happy to hear you this morning and if you would further identify yourself and your organization, you may proceed, sir. Mr. ERICKFIELD. Mr. Chairman, I am Cyril F. Brickfield, the legis- lative counsel of the National Retired Teachers Association and the American Association of Retired Persons-two organizations which have a combined membership of over 4 million older persons. I am accompanied this morning by Mr. James Hacking. He is an associate of mine and he is knowledgeable in tax matters, Mr. tTllman. Mr. IJLLMAN. We are very happy to have him. You may proceed, sir. Mr. BRICKFIELD. Mr. UTilman, I have a formal statement of some 18 pages which .1 would like to submit for the record to be printed and I also have a summary of that statement which runs about seven pages and which I would like to read. Mr. TJLLMAN. Without objection the full statement will be in the record. Mr. BRICKFIELD. Thank you. PAGENO="0025" 327 (The statement referred to follows:) PBEPARED STATEMENT OF BERNARD E. NASH, EXECUTIVE DIRECTOR, NATIONAL RETIRED TEACHERS ASSOCIATION AND AMERICAN ASSOCIATION OF RETIRED PERSONS I am Bernard E. Nash, Executive Director of the National Retired Teachers Association and the American Association of Retired Persons, affiliated, non- profit, nonpartisan social welfare organizations, with a combined membership of over four million older Americans. Our Associations appreciate the opportunity granted by the House Committee on Ways and Means to appear here today for the purpose of presenting, on behalf of older persons in general, and our membership in particular, our comments, criticisms and recommendations with respect to those tax proposals, affecting private pension plans, that are presently under Committee consideration. We hope that our testimony will both stimulate and assist the Committee's development of a comprehensive statutory scheme of minimum Federal standards for the effec- tive regulation and more efficient utilization of qualified plans as a means of supplementing retirement income. I. INTRODUCTORY REMARKS While certain societies have attributed particular value and preferred status to old age for a variety of political and social reasons, most individuals in society today, anticipate the advent of the declining phase of life with mixed and often ambivalent feelings of anxiety, aversion, bewilderment, helplessness, and even rebellion-typically human responses to the experience of isolation that is a too frequent incident to the process of aging. In old age, the bonds of union, which unite the individual to others, and which are the substance of human relationships, are gradually severed. Unable to pur- sue further those ends which afford both meaning to, and justification for, hu- man existence-interaction with, and devotion to others through creative ac- tivity and emotion-the individual finds himself unwillingly alone. Indeed, so common is this isolation and attendant loss of meaning and purpose in the later years of life, that atomization of the individual in our modern society has become virtually a function of the inevitable process of aging. Perhaps the pursuit of a meaningful life of participation and social interac- tion would be more attainable if the older person were not additionally con- demned to the strictures of impaired health, inadequate dwellings, immobility and subsistence income-all of which too often combine to divest the older person of his remaining zeal for life. With respect to the satisfaction of the basic, ma- terial needs of the older person, the responsibility for adequate resource alloca- tion rests with the collectivity of society. While considerable progress has been made in recent years, the degradation and humiliation of poverty persists as frequent incidents to the process of aging. While this country's economic, indus- trial and medical progress have combined to permit an increasing proportion of the population to reach old age, these factors have also combined to reduce the older person to a dependent condition, thus tending to deprive him of his tradi- tional function, status and dignity. By this trend, our Associations are acutely frustrated and profoundly dis- turbed. With a net increitse of 3.5 million persons, age 65 and over, between the 1960 and 1970 censuses, one out of every ten persons in this country today is an older American.' Moreover, the 1970 level of 20 million older persons is expected to increase to 25 million by 1985, and to 28 million by the year 2~$JO.2 The cumulative impact of a variety of disparate factors, including the Social Security earnings limitation, prevailing policies and practices of mandatory re- tirement, reduced manpower requirements, and the technological obsolesence of labor skills, have resulted in the exclusion of an increasing percentage of the older population from participation in the labor forces.3 Consequently, most older Americans are dependent for a high proportion of their total income on a variety of public programs designated to transfer current purchasing power `H. Brotinan-Facts and Figures on Older Americans: The Older Population Revisited, H.E.WT. (Social and Rehabilitation Service and Administration on Aging) Pub. No. 182, 2 `H. Brotman-The Older Population: Some Facts We Should Know HEW. (S.R.S. ~` A.O.A.) Pub No. 164, p. 3, (1971). H. Brotman-Facts and Figures on Older Americans: An Overview 1971 H.E.W. (S.R.S. & A.O.A.) Pub. No. 20005, p. 1, (1972). PAGENO="0026" 328 from the productive, younger population, to the oldeP population through a sys1 tern of transfer payments. Unfortunately, the levels of such public payment are, by themselves, quite inadequate to maintain a satisfactory level of income for re- tired persons, many of whom are without other income sources. Excluded from the labor force, the older person finds himself excluded from participation in the standard of living made possible by the increased economic productivity to which he contributed his labor during his working years. While the increases in public benefit levels during 19~ 0 have apparently arrested the prior impact of inflation on retirement income purchasing power,4 even that respite may be only temporary. H.R. 1,~ with its critically needed automatic benefit adjustment section,6 continues to languish in the Congress. Moreover, despite the 1970 increases in public benefit levels, 4.7 million persons, age 65 and over-about one-fourth of the total older population-still reside in households in which the aggregate income fell below the poverty levels established for that year.1 The projected economic status for the increasing population of older Amer- icans appears bleak indeed. To ameliorate the impact of age on individual income, new sources must be uti- lized to supplement the basic, but inadequate retirement benefits provided by the public benefit systems. To accommodate the present and I)rojected income needs of this increasingly substantial yet least visible, minority population, attention ~hould be focused on the more effective utilization of the private pension system, which has assumed a prominent role in providing supplemental retirement ben- efits for a growing portion of retirees. II. BACKGROUND: GROWTH AND DEVELOPMENT OF PRIVATE PENSIONS AS A MEANS OF SUPPLEMENTING RETIREMENT INCOME While the first private pension plan was established as early as 1875 by the American Express Company, by 1940, only 4 million persons were covered by such plans.8 However, during World War II, the ceilings imposed on direct wages by the Federal Government provided considerable impetus for the expansion of cov- erage under pre-existing plans and for the establishment of new ones.° This trend was further reinforced by the decision of the 7th Circuit Court of Appeals in Inland steel Co. v. AT.L.R.B.,'° in which pension rights were clearly designated ~ as an appropriate subject for collective bargaining under the Labor Management Relations Act of 1947.12 Today, private pension coverage extends to over 30 million workers-more than 50 per cent of the labor force-and the number of pensioners exceeds 4.2 million.13 Moreover, private plans have accumulated reserve assets of over 120 billion dol- lars, 14 which amount is expected to increase to 225 billion 1)y 1980." Indeed, the private pension system is not only a major element in the economic security of a substantial percentage of American workers, but also a significant source of financial power, the economic impact of which directly or indirectly affects the daily life of each citizen. Other indicia of the size of the private pension system are the annual amounts of employer and employee contributions and the aggregate amount of benefits paid annually to retirees. In 1968, for example, employers contributed 9.4 billion dollars to private plans and employees 1.3 billion, for a total contribution of 10.7 billion dollars.16 In the same year, 3.7 million retireees received private pension payments aggregating over 5 billion dollars.'7 However, while the 5 billion dollars 4H. Brotman-Facts & Figures on Older Americans: Income and Poverty in 1970-Ad- vance Report, HEW. (S.R.S. & A.O.A.) Pub. No. 183, p. 4 (June, 1971) HR. 1, 92nd Cong., 1st Sess. (1971). 61d. § 102. `H. Brotman-Facts & Figures on Older Americans: An Overview 1971, HEW. (S.R.S. & A.O.A.) Pub. No. 20005, p. 8 (1972). 8 P. Harbrecht, Pension Funds and Economic Poser, p. 6 (1959). Levin, "Proposal to Eliminate Inequitable Loss of Pension Benefits," 15 Vill. L. Rev. 527, 528 (1970). 10lnland Steel Co. V. N.L.1?.B., 170 F. 2d 247 (7th Cir. 1948), cert. denied, 336 U.S. 960 (1949). "Id.at 251 ~ Labor-Management Relations Act § 8(d), 29 U.S.C. § 158(d) (1969). ~ Pension and Welfare Plans; Hearings before the Subcommittee on Labor, Committee on Labor and Public Welfare, U.S. Senate, 90th Cong. 2nd Sess. 225 (p1968) (hereinafter cited as "1968 Senate Hearings"). `~ Private Welfare and Pensioa Plan Legislation: Hearings before the General Subcom- mittee on Labor, Committee on Education, House of Representatives, 91st Cong., 1st Sess. 2nd Sess. 145 (1970). 15 1968 Senate Hearings. supra note 13. 16 "Employee-Benefit Plans in 1968," 33 Social Security Bull. 43 (Table 5) (April, 1970). 17 Id. PAGENO="0027" 329 of benefit payments to retirees under private plans in 1968 was only one-third of the 15 billion paid to retirees under O.A.S.D.I. in that year, the 115 billion dollar private pension reserve fund was an enormous 400 per cent of the 28 billion O.A.S.D.I. trust fund of that time.'8 It is evident that many isolated and often unrelated factors have contributed to the expansion and continuing improvement of the private pension system. Among the more significant are: (1) the public concern for economic security fostered by the experience of the 1930's; `~ (2) the desire of workers for par- ticipation in this country's high standard of living throughout their retirement years; (3) the desire of employers to attract and retain more productive labor, and eliminate the less productive through retirement; 20 (4) the average worker's inability to provide adequately for his own retirement through personal savings and investment without a substantial reduction in his standard of living21; and (5) the extensive tax subsidies offered by the Federal Government. The Revenue Act of 1921,22 providing an exemption from current taxation of income from a trust, created by an employer as part of a stock bonus or profit sharing plan for the exclusive benefit of employees, marked the advent of the continuous Federal policy of favorable income tax treatment of private pen- sions.23 Today, the Internal Revenue Code extends preferential treatment to em- ployer pension, stock bonus, profit sharing, and bond purchase plans, provided such plans inure to the exclusive benefit of the employees and their bene- ficiaries/~ Subject to specific limitations, contributions to qualified retirement plans are deductible as a current expense by the employer,'5 and excludable from the current income of the employee.~ Until distributed to plan beneficiaries, the accumulated earnings and appreciation of plan asiets are exempt from Federal income taxation." Moreover, even employees with non-forfeitable vested interests under such plans, recognize no income until distribution is made `0-and then at preferential tax rates.20 The annual Federal revenue loss from this combination of tax concessions to qualified plans amounts to a substantial annual subsidy of about one billion dollars.'0 Despite the dimensions of the private pension systems today, and despite the significant public subsidy represented by the annual revenue loss, a high per- centage of retirees who experience coverage under one or more private pension plans for some or all of their working years, will fail to receive any benefits at re- tirement. The exact size of the group of future non-recipients is difficult to project, either in terms of numbers or as a percentage of covered workers, be- cause of the necessity to extrapolate varying trends with respect to such items as the extension of coverage, the liberalization of vesting requirements, and the fluctuation of worker mobility. It is, however, certain that a constellation of con- tingencies will substantially diminish the probability of private pension receipt. For those workers who are not, during their working years, covered by any private plan-nearly 50 per cent of the current labor force-the private pension system affords no solution to their retirement income needs. Many other workers, although covered under one or more plans, will ultimately receive no benefits be- cause of failure to meet the appropriate vesting requirements. Under most private plans, the age and/or service requirements for vesting incidentally take advan- tage of the high separation rate of this country's mobile labor force. In 1970 alone, almost 4 million workers left their jobs." Moreover, many plans fail to distinguish between voluntary and involuntary employment terminations. Lay-offs, discharges, business failures or relocations, 1833 SocIal Security Bull. 39 (Table M-5) (November, 1970). 19 U.S. Dept. of Commerce, Bureau of the Census, Statistical Abstract of the United States 293 (1967). 20 D. McGill, Fundamentals of Private Pensions 21-23 (1064). 21 Task Force for the Senate Special Committee on Aging, 91st Cong., 1st Sess., Economics of Aging: Toward a full share of abundance-a working paper viii (~1969). 22 The Revenue Act of 1921,42 Stat. 227 (1921). 23 Norman, "Private Pensions: A Study of Vesting, Funding and Integration," 21 U. Fla. L. Rev. 141, 143 (1968). `4IRC § 401(a) (2). "I.R.C. § 404. / 28 I.R.C. §~ 402(a), 403(a). "I.R.C. §1401(a), 501(a). 28SeeI.R.C. fl 72, 402(a), 403(a). `°I.R.C. §172 (a), (c), (d), (n). 30 President's Committee on Corporate Pension Funds and Other Retirement and Welfare Programs, Public Policy and Private Pension Programs, A Report to the President on Vrivate Employee Retirement Plans ii, 3 (Jan. 29, 1965) (hereinafter cited as President's Comm.). 21 Based on a separation rate of 4.8% of the total 1970 civilian labor force of over 82 million workers; this rate is slightly above the average annual separation rate of 4.7% from (Table 4), 98 (Table 15). PAGENO="0028" 330 and corporate reorganizations can deprive an employee of his potential or actual right to receive a pension. Over 1.8 million workers were laid off in 1970; 32 in the same year, over 10,000 business failures were recorded.33 Unless the pension plan provides to the contrary, an employee who, for any rea- son, ceases work, will be disqualified from pension eligibility.34 In such cases, death prior to vesting will effectively bar any benefit claim by the deceased employee's estate or beneficiaries.25 Moreover, in the absence of a death benefit provision, the survivor of even a vested plan participant will be precluded from receiving any benefits.3° Even employee disability may be an effective bar to compliance with the vesting requirements under a particular plan.37 It must be acknowledged that the private pension system is significant In term~; of the number of workers covered, the number of retirees to whom benefits are or will be paid, the aggregate amounts of employer-employee contributions, and, consequently, the extent of accumulated reserve assets and their actual and potential economic and social impact. It must be further acknowledged that the performance of the private pension system continues to improve with respect to coverage, vesting, funding, and perhaps, benefit levels. However, in order to maximize the probability of benefit receipt, comprehensive statutory regulation is needed. The very size of both the annual Federal subsidy to qualified plans and the assets accumulated by the private pension system should be sufficient justifica- ~ion for such regulation. The multiplicity of purposes, which have combined to produce the present private retirement system, must not be allowed to ~upercede society's concern for the well-being of the individual during retirement. For example, while pension plans have often been used by employers to attract and retain productive workers, the result has been to either deny benefits to the mobile employee who fails to meet the eligibility or vesting requirements or to deprive the economy of the labor force mobility necessary to accommodate rapid technological changes.28 Mobility is a characteristic of the labor force, and indeed, an important factor com~siderecl by employers in projecting the amount of contributions necessary to pay a pre- determined level of benefits; to this reality the private pension system must be accommodated. To the extent that public and private purposes in fostering the development of this system are incongruent, the public purposes must prevail. The satisfaction of the income needs of the retiree should not depend on a plethora of plan requirements which are usually arbitrary and often beyond the individual's control. As a consequence of responsible participation in society, the retiree is entitled to share equitably in its repources. III. THE PRESENT REGULATORY SCHEME While the growth and development of the private pension system has been sub- stantial, Federal regulation of its scope and operation has been minimal and piecemeal. The Securities Act of 1933 ~ and the Securities and Exchange Act of 1934 40 require that those pension trusts which purchase stock in employer corpora- tions must file annual reports. The Labor Management Relations Act4' provides for a written pension agreement, irrevocable use of trust funds for benefit pay- ments, and equal union-management representation in fund administration and arbitration of disputes.~ The Welfare and Pension Plan Disclosure Act of 1958 4' was designed to elimi- nate a variety of administrative abuses by requiring disclosure of financial and other information to plan participants, beneficiaries and the Secretary of Labor.44 However, the Act relied excessively for enforcement on fortuitous policing by plan beneficiaries.45 Although the Welfare and Pension Plan Disclosure Act 32 Monthly Lab. Rev.. August, 1971, at 9S (Table 15). ~° Levin, supra note 9. 84 Schneider v. McKesson ~ Robbins. Inc., 254 F. 26 827 (26 CIr. 1958) ; G rr v. Consoli- dated Foods Corp., 253 Mlnn Repts 375, 91 NW. 26 772 (1958). mFrietzsche v. First W. Bank t Trust Co., 168 Cal. App. 2d 705, 336 p. 26 589 (1959). ~° Webb v. Warren Co., 113 Ga. App. 850, 149 S.E. 26 867 (1966). 37Smith v. Union Carbide Corp.. 350 F. 2d 259 (6th CIr. 1965), rev'g. 231 F. Supp. 980 (ED. Tenn. 1964) ; Bogda v. Chevrotet-Bloomfiel(l Div., Gen. Motors Corp. 8 N.J. Super. 172, 73 A. 2d 735 (1950). ~ Norman, supra note at 149. ~° Securities Act of 1933, 48 Stat. 74. 40 Securities and Exchange Act of 1934, 48 Stat. 881. 41 Labor-Management Relations Act, 61 Stat. 136, 157 (1947), 29' U.S.C. § 186 (1964). 42 Norman, supra note 19, at 146. 43Welfare and Pension Plan Disclosure Act of 1958, 72 Stat. 997, 29 U.S.C. §~ 301-09 (1964). "Norman, supra note 19, at 146. "Id. PAGENO="0029" 331 Amendments of 1962, ~° granting to the Secretary of Labor the authority to promulgate rules and regulations, conduct investigations, and secure injunctive compliance, strengthened the original legislation, the Act remains essentially an information gathering device.47 The Internal Revenue Code4° and Regulations further regulate the scope and operation of the private pension system. The essence of enforcement under the tax laws lies primarily in the power of the Internal Revenue Service to grant or disallow qualified status to a pension plan-thus determining the availability of the statutory tax advantages for both the employer and employee. However, the present statutory requirements for plan qualification are limited, and are intended to assure only that employees receive the benefits from contributions and that favorable tax treatment is not accorded to plans which discriminate in favor of managerial personnel or corporate shareholder. Almost totally within the employer's discretion are the policy decisions regarding benefit levels, funding, administration, and asset investment. The eclectic nature of these various disclosures, labor and revenue statutes underscores the insufficiency of the present level of protection for the retiree. The problems with, and the failings of, the private pension system require a comprehensive legislative program dealing not only with malfeasance of plan administrators and the consequences of business failures and plan terminations, but also with the broad spectrum of questions such as adequacy of funding, minimum standards of eligibility and vesting, the transferability of credits, and insurance-in short-the establishment of certain minimum standards to which retirement plans must conform, either absolutely or as a condition of qualification under the Internal Revenue Code. While public policy must continue to provide incentives for the growth of private pension plans and improvement in the level of benefits paid by such plans, their soundness and fairness must be improved. However, the enactment of norms designed to achieve these ends must be tem- pered by the cost consequences of effecting such improvements. IV, NRTA-AARP POSITION AND RECOMMENDATIONS While the primary function of the tax laws is to provide the revenue necessary to finance the expenditures of the Federal Government, the Internal Revenue Code has also been extensively and effectively utilized as an instrument for encouraging and achieving socially desirable ends such as the rearing of families by the granting of additional exemptions49 and homeownership by allowing the deduction of interest payments.~° If it is society's objective to provide an adequate level of retirement income for as many older Americans as possible, the income tax laws, in consideration of the perpetuation of favorable tax treatment, should be amended so as to introduce: (1) minimum standards for eligibility, vesting, portability, funding and insurance, as conditions precedent to the qualification of private retirement plans; (2) tax incentives designed to encourage individual savings for retirement, and (3) more equitable treatment of owner-employee l)lans. A. Coverage.-The major inequity with respect to the present statutory rules for coverage under a qualified retirement plan is the variation in the pre- requisite service requirement for Plan participation. For a plan to qualify for favorable tax treatment, it must not discriminate against certain employees by excluding them from coverage.5' Plans which do not cover owner-employees 52 will qualify with respect to cover- age if any one of three alternative tests is satisfied.53 Under present law, the stockholder employee of a corporation is not considered ~n owner-employee. Moreover, qualified corporate plans need not cover employees with less than five years of service.54 ~° Welfare and Pension Plan Disclosure Act Amendments of 1962, 76 Stat. 35. ~ Norman, supra note 19, at 147. `~ I.R.C. §~ 401-404, 501-503. 4~LR.C. ~151(e). ~° I.R.C. 163. n~c § 401 (a) (3). 52 A owner-employer is an employer who owns an entire Interest in an unincorporated business or a partner who owns more than 10 percent of either the capital or profits of a partnership. I.R.C. § 401(c) (3). ~ § 401(a) (3)-(4). ~` I.R.C. § 401(a). PAGENO="0030" 332 Qualified owner-employee plans,~ however, must cover all employees with more than three years of servic&5~ The more rigorous requirement with respect to coverage under an owner-employee plan is apparently justified by the in- creased possibility for discriminatory abuse under such plans. By reducing the minimum service requirement for participation in corpogate employee plans from five years to three, the tax treatment of qualified corporate and `owner-employee plan's would be equalized and employee coverage necessarily expanded. Since `the employee job separation rate tends `to be higher in the earlier years of employment, and `since funds `released as a result `of emplbyee forfeitures must `be applied to reduce future employer contributions,57 `such ex- panded coverage could be effected with a minimum increase in employer costs. B. Vesting.-The statutory vesting requirements for qualification, with respect to `owner-employee and corporate retirement plans, are in need of substantial reform. An employee's right to his allocable interest under a qualified `owner-em- ployee plan, must vest immediately and completely `at the time contributions are paid.58 Corporate retirement plans, however, are not required, as a condition for qualification, to provide for vesting prior to retirement, except in the event of pl'an `termination or complete discontinuance of contributions.59 As a matter of equity `and fair treatment, an employee covered by a qualified plan should be entitled, after reasonable service, to protection of his retirement benefit against termination of employment. If `the employment of `a worker, who has willingly accepted lower wage levels in exchange for a `retirement pen- sion, is voluntarily or involuntarily `terminated prior `to vesting, `the worker for- feits `the deferred portion of the compensation he should have otherwise received. Furthermore, deferred vesting, with long-term service requirements, tends to re- `duce the `labor force mobility needed `to accommodate the rapid technolog-ical changes `of the economy. To the extent th'at a worker fails to receive anticipated benefits from a private pension plan, he is that much more dependent upon public programs for the maintenance of an adequate level of retirement income-with the increased cost burden *devolving upon the younger members of the labor force. Since the absence of early vesting provision is a major factor in the failure of otherwise covered employees to receive retirement benefits, early graded vesting, or full vesting after a period of not more than 10 years should be required by law as a condition precedent to plan qualification. Any such statutory requirement, however, must attempt to balance the factors of employee equity and labor mobility against the employer's need to attract and retain productive personnel and to limit the increased cost of retirement plans to reasonable dimensions. Obviously, the more liberally a vesting formula protects employee benefits, the more expensive the formula is. Under these circumstances, a system of early graded vesting over a period of service would probably be the most feasible and least discriminatory vesting standard from the point of view of employee equity and employer cost and would avoid the all-or-nothing approach of full vesting after a period of years. While minimum age requirements for vesting are provided by many existing retirement plans, such age limitations tend to discriminate against younger workers and tend to contribute to age discrimination in the hiring of older workers. The Internal Revenue Code'should be amended to prohibit minimum age requirements for vesting under qualified retirement plans.°° Vesting should be based solely on satisfaction of a statutorily established service requirement. C. Portability.-In view of the reality of labor force mobility which reflects a higher' rate of job separation in the earlier years of employment, early vesting requirements should be supplemented `by the establishment of a Federally-funded clearing house to enable an employee, accumulating pension credits under more than one plan, to transfer such credits between plans having similar benefit features and actuarial assumptions. Senator Jacob Javits stated the theory behind the clearing house concept as follows: vested credits by definition have some value, and it is not too difficult to compute the current discounted value of any such credit. An employee leaving Congress enacted HR. 10 as the Self-Employed Individuals Tax Retirement Act of 1962, Pub. L. No. 87-792, 76 Stat. 809 to ameliorate the disparity between the tax treat- ment of owner-employee plans and the more favorable treatment of corporate employee plans. ~°I.R.C. ~ 401(d) (3). ~7 Reg. § 1.401-7(a) (1963) ; Rev. Rul. 421, 1969-2 Cum. Bul. 59, 79. ~I.R.C. § 401(d) (2) (A). ~ I.R.C. § 401(a) (7). 6059 Geo. L. Rev. 1299, 1327 (1971). PAGENO="0031" 333 one plan and transferring to another may wish to transfer the value of his vested credits, through the clearing house, into another plan to purchase credits of an equivalent value in the second plan, under which he begins to work." The proposed Federal agency would maintain records with respect to the employee as be moves from job to job within the economy without the necessity of costly employer administrative duplication. D. Funding.-Additionally statutory requirements are necessary so that employees actually receive promised retirement benefits. Under present law, a qualified plan need only contain funds sufficient to cover benefits attributable to present employee services and the interest change on benefits attributable to service prior to the establishment of the plan.°' Since inadequate funding places an unwarranted financial risk upon employees during retirement, minimum funding standards for both corporate and owner-employee plans should require that all liabilities for benefits arising from current services be fully funded and those attributable to past services be funded over a reasonable period of time.°2 Subsequent increases in benefit levels should be found in a similar manner.°3 In order to prevent an employer from indirectly diverting pension plan funds for business use, a stautory Limitation should be set upon the amount of retire- ment trust funds which may be invested in the stock of the employer corpora- tion.~ Such a limitation would promote the diversification of plan assets and further enchance the employee security. E. Insurance.-Pension insurance should be statutorily required as a com- plementary feature to the minimum funding standards. Such insurance would protect plan beneficiaries in the event the retirement plan is terminated without sufficient funds to meet accumulated pension obligations. Morever, since an employee may not be able to meet the statutorily prescribed funding schedule, or the level of funding ratio may not have reached 100 percent when the retire- ment plan is terminated, insurance would provide the additional degree of pro- tection needed by the employee. F. Employee Contribution to Qualified Plans-Under present law, contribu- Lions to a pension plan on behalf of a self-employed individual may not be de- ducted in excess of 2,500 dollars or 10 percent of earned income, whichever is less.~ However, with respect to corporate pension plans, there are no dollar or percentage contribution limitations.66 Since benefit levels are often a fraction of pre-retirement income levels and since the public policy objective of providing adequate retirement security for as many older persons as possible is not pro- moted by the extension of large tax benefits to affluent individuals, dollar limita- tions should be imposed on the level of benefits paid by qualified private pension plans. Imposing statutory or regulatory limits on the level of contributions would be a more actuarially difficult method of achieving the same end. G. Employee Contributions to Qualified Plans.-While the tax laws presently allow voluntary employee contributions to qualified employees retirement plans,°7 such contributions are not deductible; ~ however, the earnings for such conttiba- tions are exempt from taxation until retirement.°9 Such contributions are, however, subject to limitations; corporate employees are limited to a contribution of 10 percent of ~ while owner- employees are limited to 2,500 dollars or 10 percent of compensation; whichever is less.71 However, in order to further encourage employees savings for retire- ment, such employee contributions to employer plans should be deductible within certain limitations in computing adjusted gross income but subject to reduction on account of employer contributions. H. Individual Retirement Plans.-Since private retirement plans are an es- sential factor contributing to the retirement security of older persons, it is un- reasonable to require a retiree to subsist on Social Security or other public bene- fit payments merely because he failed to receive coverage under a private plan, or, if covered, failed to receive any benefits.72 The private retirement system 61Reg. §1.401-4(c)(2)(vi)(b) (1913). 6259 Gee. L. Rev. 1322 (1971). 6~Id. ~ Id. at 1324. ~ I.R.C. 1 404(e). ~I.R.C. § 404(a) (1). ~ Rev. Rul. 185, 1959-1 Cum. Bul. 86. °~ I.R.C. § 262. ~ Rev. RuL 178, pt. 2(b), 1965-2 Cu. Bul. 94, 99. 7°I.R.C. § 401(e) (1) (B) (iii). ~ See Rev. Rul. 185, 1959-1 Cum. Bul. 86, 87. 7259 Gee. L. Rev. 1336 (1971). PAGENO="0032" 334 should permit both employees and employers to provide for retirement security through a qualified plan. The right to use qualified retirement plans, with their incidental tax advantages, was extended to owner-employees in 1962 by the Self-Employed Individuals Tax Retirement Act; ~ the extension of a similar right to corporate employees is overdue. Each employee should be permitted to establish his own private retirement plan, irrespective of the wishes of his employer.74 Each employee should be allowed to contribute to his own plan and to deduct the amount of such contributions, within reasonable limitations and subject to reduction, on a dollar for dkllar basis, by the amount contributed by an employer to a retirement plan on the employee's behalf.7~ However, to pre- clude potential abuse, it may be necessary to limit the financing method of such plans to the use of government bonds.76 If properly controlled, such plans would function as a means of providing an additional measure of retirement security for the labor force and would readily accommodate the reality of labor force mobility. v. CBITICISM AND RECOMMENDATIONS WITH RESPECT TO THE INDIVIDUAL RETIREMENT BENEFITS ACT OF 1972 While our Associations acknowledge that reasonable service requirements may* be an appropriate means of preventing the dissipation of private pension plan assets, we also realize that such requirements are often so excessively retrictive that an unacceptably high percentage of employees are arbitrarily excluded from plan participation, thereby frustrating the effective functioning of the private retirement system.. To the extent that section 2 of H.R. 12272 ~ would, as a condi- tion of qualification for favorable tax treatment, prohibit a private retirement plan from requiring, as a condition for participation under the plan, a period of service in excess of three years, our Associations support the proposal; however, to the extent that this same section would utilize age limitations as appropriate restrictions on employee participation, we must register our opposition. Age dis- crimination should not be legislated into federal regulatory standards. In view of the high degrees of mobility of our labor force and the consequent non-receipt of benefits by a significant percentage of employees who during their working years, were covered *by one or more private pension plans, NRTA- AARP urge the enactment of an early vesting requirement to reinforce the non- discrimination requirements of existing law. However, we must oppose any such standard which provides incentive for age discrimination in hiring. Our Associ- ations believe that the "rule of 50" approach proposed by section 2 of H.R. 12272, which would require a private pension plan to provide, as a condition of quali- fication, that a participant's rights in at least 50 percent of his accrued benefits vest whenever the sum of his age and his years of participation in the plan equal 50 would tend to discriminate against the older worker. While we recognize that this proposed vesting standard would be an improvement over the present conditions prevailing in the private pension system with respect to vesting, we tend to favor an early vesting service requirement and feel the different ap- proaches taken by H.R. 126978 and S. 2 78'merit strong consideration. Our Associations believe that existing law relating to savings for retirement purposes discriminates substantially against individuals who do not participate in a qualified private retirement plan, or who participate in plans providing only minimal benefits; therefore, we support the proposal of section 3 of H.R. 12272 which would allow to individuals, a deduction in computing adjusted gross in- come for amounts contributed to individual retirement plansi which they have established or to private retirement plans established by their employers. We believe that this proposal, if enacted into law, will significantly aid the individ- ual in maintaining an adequate level of income during his retirement years. Our Associations hope that the recommendations contained in other bills presently before the Congress, such as H.R. 1269 and 5. 2, each of which contain provisions which would go far beyond those of H.R. 12272 in establishing a com- prehensive statutory scheme for the regulation of private pension plans, will re- ceive favorable Committee consideration. The proposal of S. 2 that would create an independent agency to protect the rights of employees covered by private pen- ~ Pub. L. No. 87-792, 76 (Stat. 809). 7459 Geo. L. Rev. 1337 (1971). ~ Id. 7°Id ~ HR. 12272, 92nd Cong., 1st Sess. (1971). 78 HR. 1269, 92nd Cong., 1st Sess. (1971). 7~ S. 2, Cong., 1st Sess. (1971). PAGENO="0033" 335 sion plans, the early vesting requirements of both S. 2 and H.R. 1269, the pro- posed minimum funding standard and supplementing insurance programs of both bills the proposed portability of pension credits of' 5. 2, and the disclosure requirements set forth in H.R. 1269 all merit thorough consideration. Mr. BRICKFIELD. Mr. Chairman and ladies and gentlemen, our associations appreciate this opportunity to appear here today for the purpose of presenting, on behalf of older persons in general, and our own membership in particular, our comments with respect to those tax proposals affecting private pension plans, that are presently under committee consideration. We hope that our testimony will both stimulate and assist this committee's development of a comprehensive scheme of minimal Fed- eral standards for the effective reguiation and more efficient utilization of qualified plans as a means of supplementing retirement income. Today the private pension system covers over 30 million workers- more than 50 percent of the labor force-and the number of pension- ers exceeds 4.2 million.' Private plans have accumulated reserve assets of over $120 billion,2 which amount is expected to increase to $225 billion by 1980.~ Not only has this system become a major element in the economic security of a substantial percentage of American workers, but it is also a significant source of financial power, the economic impact of which directly or indirectly affects the daily life of each citizen. Many isolated and often unrelated factors have contributed to the expansion and continuing improvement of this system. Among the more significant are: (1) the public concern for economic security fostered by the experience of the 1930's; ~ (2) the desire of workers for participation in this country's high standard of living throughout their retirement years; (3) the desire of employers to attract and. retain more productive labor, and eliminate the less productive through retirement; (4) the average worker's inability to provide adequately for his own retirement through personal savings and investment with- out a substantial reduction in his standard of living; 6 and (5) the extensive tax subsidies offered by the Federal Government. Despite the dimensions of the private pension system today and despite a combination of income tax concessions that result in an estimated annual revenue loss of about $1 billion,~ a high percentage of retirees who experienced coverage under one or more private pen- sion plans for some or all of their working years, will fail to receive any benefits at retirement. `While the exact size of this group of future covered nonrecipients is difficult to project, it is at least certain that a variety of contingencies will substantially diminish the probability of private pension receipt. 1 Pension and welfare plans; hearings before the Subcommittee on Labor, Committee on Labor and Public Welfare. U.S. Senate, 90th Cong., second sess. 225 (1968) (hereinafter cited as "1968 Senate hearings." 2 Private welfare and pension plan legislation; hearings before the General Subcommittee on Labor, Committee on Education, U.S. House of Representatives, 91st Cong., first sess., second sess. 145 (1970). 1968 Senate hearings, supra note 13. U.S. Department of Commerce, Bureau of Census, Statistical Abstract of the United States 293 (1967). 5D. McGill, Fundamentals of Private Pensions 21~-23 (1964). 6 Task force for the Senate Special Committee on Aging, 91st Cong., first sess., "Eco- nomics of Aging: Toward a Full Share of Abundance-A Working Paper," viii (1969). President s Committee on Corporate Pension Funds and Other Retirement and Welfare Programs, Public Policy, and Private Pension Programs, a report to the President on private employee retirement plans, Ii, 3 (Jan. 29, 1065). 78-202 0-72-pt. 2-3 PAGENO="0034" 336 For those workers who are not, during their working years, covered by any private plan-nearly 50 percent of the current labor force- the private pension system affords no solution to their retirement income needs. Many other workers, although covered under one or more plans, will ultimately receive no benefits because of failure to meet the appropriate vesting requirements. Under most private plans, the age and/or service requirements for vesting incidentally take advantage of the high separation rate of this country's mobile labor force.8 While it may be acknowledged that performance of the private pension system continues to improve with respect to coverage, vesting, funding, and perhaps even benefit levels, nevertheless, comprehensive statutory regulation is needed to maximize the probability of benefit receipt. The inequity inherent in the present system and the size of both the annual Federal subsidy to qualified plans and the assets accumulated by the system sufficiently justify such regulation. The satisfaction of the income needs of the retirees should not depend on a plethora of plan requirements that are usually arbitrary and often beyond the individual's control. A comprehensive legislative program should deal not only with malfeasance of plan administrators and the consequences of business failures and plan terminations, but also with the broad spectrum of questions such as adequacy of funding, minimum standards for cover- age and vesting, the transferability of pension credits and insurance- in short-the establishment of certain minimum standards to which re- tirement plans must conform, either absolutely, or as a condition of qualification for favorable tax treatment under the Internal Revenue Code. While public policy should continue to provide incentives for the growth of private plans and imprOvement in the level of benefits paid by such plans, their soundness and fairness must be improved in order that they may provide benefits rather than disappointment during the employee's retirements. NRTA-AARP REOOMMENDATIONS Since it is society's objective to provide an adequate level of retire- ment income for as many older Americans as possible, our associations believe that this committee should consider amending the income tax laws so as to introduce minimum standards for eligibility, vesting, funding and insurance, as conditions precedent to the qualification of private retirement plans, and tax incentives designed to encourage indi- vidual savings for rethirement. Specifically our associations make the following recommendations: 1. A service requirement of not more than 3 years for participation in, and coverage by, qualified private retirement plans should be estab- lished in order to expand coverage and equalize the tax treatment under qualified corporate and owner-employee plans. 2. Since the absence of early vesting provisions in private plans is a major factor in the failure of otherwise covered employees to receive retirement benefits, early graded vesting or full vesting after a period 8 Based on a separation rate of 4.8 percent of the total i970 civilian labor force of over 82 000,000 workers; this rate is slightly above the average annual separation rate of 4.7 percent from 1968-70. Monthly Lab. Rev., August 1971, at 91 (table 4), 98 (table 15). PAGENO="0035" 337 of not more than 10 years should be required by law as a condition precedent to plan qualification. 3. In view of the reality of present and projected labor force mobility, early vesting requirements should be supplemented by the establishment of a federally funded clearinghouse to keep administra- tive costs to a minimum and to enable an employee to transfer accumu- lated pension credits between plans. 4. Since inadequate funding places `an unwarranted financial risk on employees during retirement, minimum funding standards should be enacted, requiring that all liabilities for benefits arising from cur- rent services be fully funded, and those attributable to past services be funded over a reasonable period of time; the funding of increases in benefit levels subsequent to the establishment of a plan should be amortized over a similar period. 5. In order to prevent an employer from indirectly diverting pen- sion plan funds for business use, a statutory limitation should be set upon the amOunt of retirement trust funds which may be invested in the stock of an employer corporation. 6. In order to protect plan beneficiaries in the event a retirement plan is terminated without sufficient funds to meet accumulated pen- sion obligations, pension insurance should be statutorily required as a complementary feature to the minimum funding standards. 7. Since pension benefit levels are usually a function of preretire- ment levels of income, and since, the public policy objective of provid- ing adequate retirement security for as many older persons as possible is not promoted by the extention of large tax benefits to affluent indi- viduals, dollar limitations should be imposed on either the level of contributions made to the plan for the projected benefit of each par- ticipant or the level of benefits paid to each beneficiary by a qualified plan. 8. In order to encourage employee savings for retirement, employee contributions to employer plans should be deductible, within certain limitations, in computing adjusted gross income, but subject to reduc- tion on acëount of employer contributions. 9. Since private retirement plans are an essential factor contribut- ing to the retirement security of older persons, each employee should be perftiitted to establish his own private retirement plan, and allowed to deduct, within reasonable limitations, the amount of his annual contributions, reduced by any amount contributed by the employer to a qualified plan for the benefit of the employee. CRITICISM AND RECOMMENDATIONS WITH RESPECT TO THE INDIVIDUAL RETIREMENT BENEFITS ACT OF 1971 To the extent that section 2 of'the proposed `Individual Retirement Benefit Act of 1971, H.R. 12272, would, as a condition of qualification for, favorable tax treatment, prohibit a private retirement plan from requiring, as a condition for participation under the plan, a period of service in excessof 3 years, our associations support the proposal. While we have urged the enactment of early vesting standards for qualified private retirement plans, we must oppose any proposed stand- ards, that provides incentive for age `discrimination in hiring; our asso- ciations believe that the rule of 50 approach proposed by section 2 Of PAGENO="0036" 338 H.R. 12272 would have, to some extent, just such a discriminatory effect. NRTA-AARP believe that the existing tax law relating to savings for retirement purposes discriminates substantially against individuals who do not participate in a qualified private retirement plan, or who participate in plans providing only minimal benefits; therefore, we support the proposal of section 3 of H.R.. 12272 which would allow to individuals a deduction in computing adjusted gross income for limited amounts contributed to individual custodial accounts established by them or to private pension plans established by their employers. We believe that this proposal, if enacted into law, will significantly aid the individual in maintaining an adequate level of income during his retirement years. In conclusion, our associations hope that the recommendations con- tained in other bills presently before the Congress, such as ILR. 1269 and S. 2, each of which contains provisions going beyond those of H.R. 12272 in establishing a comprehensive statutory scheme for the regu- lation of private pension plans, will receive favorable committee con- sideration. The proposal of S. 2 that would create an independent agency to pro- tect the rights of employees covered by private pension plans, the early vesting requirements of bot.h S. 2 and IELR. 1269, the proposed mini- mum funding standard and supplementary insurance programs of both bills, the proposed portability of pension credits of S. 2, arid the disclosure requirements and fiduciary standards set forth in H.R. 1269-all merit thorough consideration. Mr. TJLLMAN. Thank you, Mr. Brickfield. You have given us some very helpful suggestions. Would you like the full statement including the footnotes to be in the record? Mr. BRICKFORD. Yes. Mr. TJLLMAN. Without objection the footnotes will appear as though read. Are there questions? If not, thank you very much. Mr. BRIGKFIELD. Thank you. Mr. IJLLMAN. Our next witness is Mr. Paul Robbins. Mr. Robbins, we are happy to have you here today. If you would further identify yourself and your colleague for the record, we will be happy to recognize you. STATEMENT OF PAUL E. ROBBINS, EXECUTIVE DIRECTOR, NA- TIONAL SOCIETY OF PROFESSIONAL ENGINEERS, ACCOMPANIED BY ROBERT DOYLE, LEGISLATIVE COUNSEL Mr. R0BBINs. Thank you very much, Mr. LTllman. I am Paul E. Robbins, a professional engineer, the national executive director of the Society of Professional Engineers. I have with me Mr. Robert Doyle who is the legislative counsel of the Society of Profes- sional Engineers. Mr. TJLLMAN. We are happy to have you too, Mr. Doyle. Mr. ROBBINS. Thank you. The National Society of Professional Engineers, a nonprofit orga- nization, with headquarters in Washington, D.C., and consisting of PAGENO="0037" 339 nearly 70,000 individual members who are engaged in every aspect of engineering practice, and we welcome this opportunity to present its views on the administration's proposal affecting private pension plans, H.R. 12272. We speak on this measure today on our own behalf and on behalf of the American Society of Mechanical Engineers, a 65,000-member group; the American Society for Metals, with 40,000 members; and the Institute of Electrical and Electronics Engineers, a 140,000-member organization. All four of these engineering organizations, with a combined mem- bership exceeding 300,000 individual engineers, are firmly united in their judgment that improvements must be made in America's private pension plan system if the country's engineers a~nd their dependents can ever hope to enjoy any semblance of a reasonably secure retire- ment based upon economic security. Never before has the realization of need for Federal legislation to improve the pension plan system in the United States been as widely recognized and accepted as it is today; and never before has the voice of the people been raised to present-day levels in demanding relief in this particular area from the Congress. Congress knows what is nec- essary to bring about this reform. The findings of the year-long study by a subcommittee of the Sen- ate Committee on Labor and Public Weif are demonstrate beyond doubt that the reasonable expectations of employees upon reaching retirement age fail to materialize in many instances. The subcommit- tee's findings document, in tragic personal histories, case after case of workers who discovered, to their horror, that the pensions on which they relied, and to which they looked forward after a lifetime of toil, will never be theirs. Once regarded simply as a fringe benefit, the pri- vate pension, considering the pitiful inadequacy of social security and the erosion of inflation on personal savings, is now the bedrock of necessity. But the Senate study confirms the promise of the pension as illusory. in the past 20 years, as many as 95 percent of those who left jobs where they worked under a pen~ion plan never got any of the plan's benefits. More than 30 million working men and women, nearly half the labor force, now participate in private pension plans in this country; and the plans' assets, currently exceeding $130 billion, are expected to increase to over $215 billion by 1980 with anticipated coverage then extending to 42 million workers. Studies made by the Senate subcommittee staff show that there exists an almost infinite variety of ways in which pension benefits can be lost, and these studies conclude that only about 5 percent of the participants actually realize any benefit at all from America's private pension plan system. For the professional engineer in the United States, this chaotic sit- uation is exacerbated `by the peculiarities of his employment. The prac- tice of engineering in America since the end of the Second World War has `been distinguished `by an almost singularly peculiar ele- ment-the need for mobility. The country's priori'ties changed many times in very major respects, beginning almost at once with the ces- sation of hostilities in the mid-forties. There was the need to restore t'he vitality of our allies and former enemies which imposed special PAGENO="0038" 340 requirements on engineering for specialties in the technical disciplines needed to accomplish this task. This challenge was followed by similar callings on technical talent to secure national defenses during the era of the cold war; in turn followed by the need to develop wholly new vehicles, products, and processes so `that the Nation's commitment to space exploration could be accomplished. And now we find ourselves hip deep in the prob- lems of converting our aerospace and defense capabilities to domesti- cally oriented programs, projects, and national goals. Throughout these successive periods, eiigineers unselfishly gave of their skills in response to their country's callings. In many instances, in fact, the Government's urging resulted directly in many of the Nation's youth electing to pursue technical educations and careers when they might otherwise have chosen different life patterns. As the Nation made these demands on its engineering citizens, the tech- nically trained found that they were often required to follow the Government contract from one company to another. Changing jobs from one employer to another and from one locality to another, caught in the ebb and flow of quickly changing emphases and needs for technical skills indeed served the country well. But it did not serve the engineer well, at least insofar as aiding his ability to accumulate pension credits and the security necessary for a re- spectable retirement. Seldom is it possible, the engineer discovered, to acquire a "vested" interest in a pension plan when it is necessary to change jobs several times `during a working lifetime. Even where interests in fact `become vested, the total accumulation of credits is very rarely `adequate in these circumstances. The problems for which legislation must provide solution are at least sixfold: eligibility, vesting (portability), funding, insurance, disclosure, and administration. H.R~ 12272 directs itself to the first two, possibly three, of these, and, in addition, provides the means whereby individual retirement savings plans may be established with tax-deductible dollars. Engineers support enactment of [LII. 12272 but we request certain amendments for improvement. Engineers further urge passage of legislation on the balance of the problems list. H.R. 12272 provides that no private retirement plan would be per- mitted to require, as a condition of participation: that an employee have completed a period of service with an employer in excess of 3 years; or have attained an age in excess of 30 years; or not attained an age which is 5 years less than the earliest age at which an employee may retire with benefits not actuarily reduced. For the self-employed, owner-employees, no plan would be permitted to require: that the em- ployee have completed more than 1 year of service if his then age is 35 or greater, or 2 years if his then age is 30 or greater but less than 35, or more than 3 years if his then age is less than 30. In the judgment of engineers, the most desirable situation would be for all employees to be eligible to participate immediately upon taking a job with an employer who has a pension plan. Because participation conditions have a direct relationship to vesting, engineers feel that if immediate eligibility to participate is impossible of achievement, the participation requirement should not be permitted to exceed 1 year of service or attainment of an age higher than 25. The longer the restrictive period before an employee can begin pension plan participation, the longer, obviously, before any `benefits PAGENO="0039" 341 under the plan can be made to vest in his behalf. If a plan vests in 5 years, for example, and the eligibility period is retained at H.R. 12272's 3 years, vesting cannot occur until 8 years have expired. Benefits receivable, moreover, would also be reduced to the shorter period of time in which payments can be made under the plan. Engineers, therefore, suggest immediate eligibility and feel that, in any case, anything longer than 1 year will work unacceptable hardship. The same argument applied to the attainment of a partic- ular age, and engineers are convinced that equity requires that partici- pation restrictions not extend beyond attainment of 25 years. Vesting is really at the heart of the pension problem. Vesting occurs at that point in time when an employee acquires an irrevocable right to receive payment of a benefit upon retirement age. Some private pension plans have no absolute vesting provisions at all; some require as a condition that the employee have been in the service of the same employer for a specified number of years; others insist on a combination of service years with the same employer combined with the attainment of a particular age; and most provide for for- feiture of rights under a variety of conditions. It is not unusual, as the Senate subcommittee study indicates, for workers to have been employed for upwards of four decades in the same job, by the same employer, and under the same pension plan, only to be fired, to become sick, or to be unable to move to a new locale with their employer, or, for any number of other reasons, to falter over the fine print, and to lose absolutely everything-to be disentitled to every penny-on the threshold of retirement, destined for a life of poverty in the twilight years until death. For the engineer, whose life style of necessity, and frequently in response to national calling, is usually one of high mobility and fast- changing technological obsolescence, the results are predictable. The engineer is unable, in many cases, to stay at one place or with one employer long enough to accumulate any vested pension credits. In many other cases, he is unable to accumulate enough vested benefits to provide for an adequate pension. There are bills pending in this Congress which recognize mobility as a fundamental factor in engi- neering practice by proposing creation of a Federal clearinghouse for pension credits so that an employee who changes jobs can carry with him some pension rights from one employer and some from anpther, thus guaranteeing an acceptable aggregate upon retirement. This feature of course we recognize as "portability."~ Engineers are of the judgment that portability can be provided just about as well through mandatory early vesting. If immediate vesting, for example, was required by law, there would never be any lapse in the accumulative credit process. The only problem then would be eligibility, and to establish the ideal situation, portability of eligibility would also be a necessity. How is this treated by H.R. 12272? This bill would vest participants' rights in at least 50 percent of accrued benefits when the sum of the age and the years of plan par- ticipation equal 50, this percentage to increase ratably to 100 over the next succeeding 5 years. This is not acceptable to engineers-it simply does not face up to the engineering community's problem. That HI.R. 12272 genuinely attempts to remedy existing inadequacies is not in PAGENO="0040" 342 doubt. That the rule of 50 would not measurably aid engineers is a fact. The rule has been criticized from a number of points of view. It would, it is argued, encourage discrimination against older em- ployees, would provide incentive for employers to separate workers on the verge of qualifying under the rule; would discriminate against younger workers with substantial service; and it would unevenly distribute the costs of vesting among employers. For engineers who are forced into high mobility, and must cope with rapid technological obsolescence as an integral career factor, it would result in all of these disadvantages, and would, at the same time, wholly fail to provide beneficial help in their quest for the means of beginning and continuing reasonable retirement programs throughout their entire working careers. What engineers really need is a vehicle whereby they can get into a pension plan early, stay with it until retirement, and accumulate credits along the way even though that may involve a succession of employers and a multiplicity of retirement checks from different sources at the road's end. Immediate vesting, in our opinion, would accomplish this goal. Not unmindful of objections based on increased costs on the one hand, benefit reductions on the other, and threatened employer abandonment of pensions altogether should immediate vest- ing become the law, engineers, nevertheless, recommend, in the alterna- tive, a system whereby full accrual of vesting can be accomplished over a period not to exceed 5 years of service. Such a system could commence vesting at 20 percent at the com- pletion of the first year of service and an additional 20 percent each successive year, until the entire accrued portion of the regular retire- ment benefit provided under each plan is vested at a time no later than the end of the fifth year of service. Any requirement for attain- ment or nonattainment of a particular age, as a condition of full or partial vesting, would be wholly incompatible with this engineer pro- posed system. H.R. 12272, contains other features which engineers find highly desirable. The bill would grant to the self-employed a more generous tax deduction than permitted under present law by increasing the an- nual limit to the lesser of $7,500 or 15 percent of income. Engineers fully support this proposal to raise the so-called Keogh deductions. And engineers urge that similar standards he applied to that provi- sion of the bill which would allow tax deductibility for individuals' contributions to their independent or supplementary retirement sav- ings plans. As presently proposed by H.R. 12272, this provision would permit those who do not participate in employer-financed plans to deduct 20 percent of the first $7,500 of their earned income when contributed to their individual retirement programs. For those who do participate in employer-financed plans, this 20-percent. deduction would be reduced to reflect the amount of the employer's contribution, with the rebut- table presumption being that this amounts to 7 percent of the em- ployee's earned income. As previously indicated, engineers feel that the allowable deduc- tion for contributions to plans by individuals (whether wholly inde- pendent, as in the case of nonparticipation in an employer plan, or merely supplemental to an employer-financed plan) should be equal in amount to the self-employed allowance. PAGENO="0041" 343 Furthermore, while not objecting to the principle of reduction in the supplementary case, engineers are firmly of the judgment that this subtraction should be effected only in those years in which the employer's contribution irrevocably vests to the interest or the bène- fit of the employee. The whole idea of the deduction allowance would otherwise be a nullity. An employer-plan-participant employee who is restricted in the amount he can deduct for contribution to his own retirement plan by the amount that his employer contributes to the "company plan" could eventually wind up with nothing by virtue of this limitation should the employer contribution fail to vest in his behalf. In other words, during the years he could have been fund- ing his own plan, thus providing a supplement to an inadequate em- ployer plan ~ts the proposal intends, he would be prevented from doing so because of the reduced allowable deduction and, if the employer plan fails, would wind up with the inadequate net result anyway. The reduction provision, therefore, in order to promote the bill's intention, we believe, should be revised to provide that its operative effect take place only to the extent that the employer's contribution vests uncon- ditionally to the employee's benefit. Earlier in our statement, reference was made to the other problems affecting America's private pension plan system. Although they do not directly relate to the proposals on taxation which are this coni- mittee's main consideration, we would feel remiss in not at least mentioning them in closing. One of these is the issue of funding. Federal law must provide the minimum funding standards necessary for the protection of pension plan participants' interests. Without the availability of adequate funds to back up the employer's promise of benefits at time of retire- ment, that promise is less than meaningless-it is the cruelest of hoaxes. Coupled with strengthening of the funding requirements must be a mandatory program of reinsurance to cover unfunded vested ben- efits in situations where, for one reason or another, including discon- tinuance of the employer's business, a pension plan is terminated. Improved disclosure requirements and the establishment of fiduci- ary standards are also both necessary to protect the rights and the interests of the millions of workers covered by private pension ben- efit plans. These needs are well documented, and there are other bills pending before different committees of the Congress to provide for remedies in these areas. We again thank this committee for the opportunity to express engineering's views on this critically important legislation, and urge the Congress to supply the relief so urgently needed by America's engineers. Thank you very much. Mr. CoImMAN (presiding). Thank you, Mr. Robbins. Are there any questions? Mr. Robbins, I have great respect for the Society of Professional Engmeers. I am familiar with its activities. Your member organiza- tions are both knowledgeable and sensitive to the needs of engineers. It seems to me, first of all, that there is a substantial national purpose in having portable engineers. We have found in the aerospace indus- try that engineers are needed wherever the Government decides to place a contract. Thus, it is governmental activity that really causes PAGENO="0042" 344 the engineers to change employers frequently. I-las that been your experience? Mr. ROBBINS. Yes, indeed. Mr. CORMAN. It seems to me that you come to us with an especially persuasive argument, in that we must concern ourselves as to whether or not an engineer is treated fairly when he is required, through gov- ernmental action, to move from one employer to another. I very much appreciate your contribution to this committee's delib- erations. Mr. ROBBINS. Thank you very much. Any of our organizations men- tioned here will be most happy to be of assistance to the committee with any additional information we can supply. (The following tables were supplied by the National Society of Professional Engineers:) PAGENO="0043" PENSION RIGHTS ACCUMULATION BY LENGTH AND FIELD OF EMPLOYMENT Total Less tha n 1 year 1, 2, or 3 years 4 or 5 years 6 to 10 years More than 10 years Field Number Percent Number Percent Number Percent Number Percent Number Percent Number Percent Industry: Total 6,270 100 146 100 1,002 100 747 111 1,115 100 3,260 100 Rights accumulated 4, 296 69 24 16 384 38 365 49 616 55 2,907 89 No accumulation 1, 974 31 122 84 618 62 382 51 499 45 353 11 Public utilities: Total 2,164 100 37 100 235 100 157 100 300 100 1,435 100 Rights accumulated 1, 527 71 11 30 99 42 82 52 172 57 1, 163 81 No accumulation 637 29 26 70 136 58 75 48 128 43 272 19 Federal Government: Total 2,219 100 25 100 146 100 156 100 395 100 1,497 100 Rights accumulated 2, 031 92 12 48 90 62 124 79 354 90 1, 451 97 C.a~ No accumulation 188 8 13 52 56 38 32 21 41 10 46 3 4~- State government: Total 1,695 100 20 100 208 100 154 100 280 100 1,033 100 Rights accumulated 1,404 83 14 70 115 55 100 65 212 76 963 93 No accumulation 291 17 6 30 93 45 54 35 68 24 70 7 County or municipal government: Total 1,275 100 40 100 313 100 160 100 257 100 505 100 Rights accumulated 991 78 22 55 209 67 105 66 194 75 461 91 No accumulation 284 22 18 45 104 33 55 34 63 25 44 9 Consulting firm: Total 2,567 100 96 100 512 100 319 100 536 100 1,104 100 Rights accumulated 1, 975 77 15 16 267 52 239 75 444 83 1, 010 91 No accumulation 592 23 81 84 245 48 80 25 92 17 94 9 Construction-contractor firm: Total 919 100 40 100 182 100 107 100 180 100 410 100 Rights accumulated 700 76 10 25 89 49 79 74 155 86 367 90 No accumulation 219 24 30 75 93 51 28 26 25 14 43 10 PAGENO="0044" PENSION RIGHTS ACCUMULATION BY LENGTH AND FIELD OF EMPLOYMENT-Continued Total Less tha n 1 year 1, 2, or 3 years 4 or 5 years 6 to 10 years More than 10 years Field Number Percent Number Percent Number Percent Number Percent Number Percent Number Percent Educational institution: Total 833 100 - 16 100 132 100 110 100 176 100 399 100 Rights accumulated 721 87 11 69 99 75 88 80 146 83 377 94 No accumulation 112 13 5 31 33 25 22 20 30 17 22 6 Other nonprofit organization: - Total 231 100 4 100 36 100 23 100 52 100 116 100 Rights accumulated 182 79 2 50 20 56 13 57 43 83 - 104 90 No accumulation 49 21 2 50 16 44 10 43 9 17 12 10 Other: Total 94 100 4 100 17 100 8 100 20 100 45 100 Rights accumulated 68 72 1 25 9 53 6 75 14 70 38 84 No accumulation 26 28 3 75 8 47 2 25 6 30 7 16 Grand total 18,267 100 428 100 2,783 100 1,941 100 3,311 1009,804 100 Rights accumulated 13, 895 76 122 29 1,381 50 1,201 62 2,350 71 8,841 90 No accumulation 4,372 24 306 71 1,402 50 740 38 961 29 963 10 PAGENO="0045" Industry: Employer contributed Employer paid in full Public utilities: Employer contributed Employer paid in full Federal Government: Employer contributed Employer paid in full State government: Employer contributed Employer paid in full - County or municipal government: Employer contributed Employer paid in full Consulting firm: Employer contributed Employer paid in full Construction-contractor firm: Employer contributed Employer paid in full Educational institution: Employer contributed Employer paid in full Other nonprofit organization: Employer contributed Employer paid n full Other: Employer contributed Employer paid in full Total Employer contributed Employer paid in full PENSION RIGHTS BY TYPE OF EMPLOYER CONTRIBUTION AND BY FIELD OF EMPLOYMENT Total Would lose all Field Number Percent Number Percent Would lose Number some Percent Would retain all Don't know Number Percent Number Percent 2,062 2,074 100 100 379 557 18 27 833 696 40 34 783 741 38 67 3 36 80 4 682 844 100 100 134 235 20 28 285 229 42 27 238 349 35 25 4 41 31 4 1,967 53 100 100 146 10 7 19 624 20 32 38 1,111 21 56 86 4 40 2 4 1,284 113 100 100 183 16 14 14 477 27 37 24 567 68 44 57 4 60 2 2 855 132 100 100 152 18 18 14 319 48 37 36 350 60 41 34 4 45 6 5 C.~ ~ 635 642 100 100 141 147 22 23 302 301 48 47 159 168 25 33 5 26 26 4 214 311 100 100 51 71 24 23 104 138 49 44 51 94 24 8 4 30 8 3 632 87 100 100 59 15 9 17 194 14 31 16 362 56 57 17 3 64 2 2 128 53 100 100 19 10 15 19 36 11 28 21 71 27 55 2 2 51 5 9 39 19 100 100 7 9 18 47 16 5 41 26 13 5 33 3 8 26 12, 826 100 2,359 18 4,679 36 5,294 41 494 4 8,498 4,328 100 100 1,271 1,088 15 25 3,190 1,489 38 34 3,705 1,589 44 332 4 37 162 4 PAGENO="0046" 348 ..~ ~ C., PAGENO="0047" tc)~c~4 I CO N. C~4~NJ ~a~cO 349 ~ ~ ~ ~ ~ ~ - ~ O)~~ ~ CO~ ::::~ !H:: ~H::: L ~ ~ 22~ 22~ ~ j ~~cD 0 ~: ~ ~ ~ C.) C~ 0 PAGENO="0048" 350 Mr. CORMAN. Our next witness is Mr. Charles G. Baskin, secretary- treasurer, G~olf Course Superintendents Association of America. Mr. Baskin, we are pleased to welcome you to the committee. You may proceed. STATEMENT OF CHARLES G~. BASKIN, SECRETARY-TREASURER, GOLF COURSE SUPERINTENDENTS ASSOCIATION OF AMERICA Mr. BASKIN. Thank you. Mr. Chairman and ladies and gentlemen, I am Charles G. Baskin, a golf course superintendent at the Country Club of Waterbury, Waterbury, Conn. I am the chairman of the pension committee and the secretary-treasurer of the Golf Course Superintendents Association of America, a national organization con- sisting of over 3,300 members. Golf course superintendents are the persons directly responsible for the maintenance operations and management of golf courses throughout the Nation. They form a group of highly trained and educated individuals who combine an art a.nd a science into results that make golf possible under the most enjoyable conditions. Equally important, through the product of their efforts, the golf course con- tributes immeasurably in improving the environment. There are over 11,000 individuals employed in this field in the United States. Our remarks also have the strong support of the Club Managers Associa- tion of America which is an allied association representing another professional group within the club industry. Most golf courses employ relatively few individuals and have not been able to keep abreast of the rest of the business world in pay scale and fringe benefits. Most employees of golf courses are not covered by private pension plans. In a nationwide survey taken by our association last year, it was discovered that only 26.1 percent of our membership was covered by employer pension plans. This situation applies not only to our member- ship, as 50 percent of American wage earners are not in private pension plans at the present time and do not have a tax incentive for investing in retirement plans as individuals. We believe it is in the best interest of the people and of the Govern- ment to encourage and motivate people to financially plan for their future. We want to be self-reliant. We want to be able to provide for our own retirement. You can help by providing tax incentive programs that will aid in the proper financial planning for our future. We support the administration proposal that employees who wish to save independently for their retirement, or supplement employer- financed pensions, should be allowed to deduct on their income tax return amounts set aside for these purposes. There is a great need to encouraged all Americans not covered by employer pension plans to privately invest part of their income into retirement savings as individuals. This administration's proposal, if accepted, can also help the many citizens who are presently covered by a private pension program which, even coupled with social security, will not provide an adequate retire- ment income. We must strengthen our private pension system by stimulating peo- ple through tax incentive programs to take action and invest part of PAGENO="0049" 351 their income in the development of an improved retirement program for themselves. This proposal is in the best interest of all Americans. We support a minimum standard being established in law to pro- tect the vested interest of employees in their pensions even though they leave their jobs before retirement. Golf course superintendents gener- ally advance within their profession by moving progressively from club to club. Many of the current emp]oyer pension programs give lit- tle thought to portability or the vested interest of the employee. This is a great handicap for the golf course superintendent. This problem is not unique to our profession as it is general knowl- edge that many companies cut costs by discharging employees just be- fore retirement, forcing resignation, or taking other actions that reduce the company's pension cost. This is tragic for an employee who has wasted years relying on a retirement income that will never come his way. By passing the administration's tax proposal governing the vest- ing of pensions, our private pension system can take great strides for- ward in assisting people to meet their needs in their retirement years. The Golf Course Superintendents Association of America has de- signed a retirement income plan for its members that meets the specific needs of our membership and which covers the proposals in which Congress is so vitally interested. As mentioned earlier, the golf course superintendent has a high de- gree of job mobility as he progresses within his profession. Most of our members did not have good pension coverage and still do not. Realiz- ing the need that our members have, and will have, for accumulating pension benefits, we specifically designed a retirement income plan which provides, by coincidence, the same ideal objectives that Members of Congress and the administration have expressed for a pension plan. It has liberal vesting, complete portability, fully funded benefits at all times and is reflective of the economy of the times, both before and after retirement. Over 90 percent of America's golf courses ar3 operated on a nonprofit basis and are classified under section 501 (c) (7) of the IRS Code, which exempts "club organized and operated exclusively for pleasure, recreation and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder." Therefore, a contribution to our plan by a club, exempted under sec- tion 501 (c) (7) of the IRS Code, will not result in a loss of revenue for the Government. For those few clubs that do not qualify for exempt status, our plan would result in a minimum loss in potentIal tax revenue. For your information, we have submitted our plan to IRS at the na- tional level for approval and have received approval on eight of nine "requests for ruling." Presently, they are considering the last request, which involves an interpretation of the forfeiture section under sec- tion 83 of the 1969 IRS Code. We do not feel the proposed regulation covering section 83 fully takes into consideration the nature of golf course operations, which are not geared for profitmaking operation and, are generally sub- standard in employee benefits. We, therefore, recommend that all clubs that contribute, to a trade association retirement income trust which contains strong employee benefits, such as liberal vested rights and portability of retirement benefits and also provides full funding on a current basis, be excluded 78-202 0-72 - pt. 2-4 PAGENO="0050" 352 from the forfeiture provisions of section 83 of the IRS Code. We fully recognize that any employees so covered would, once retired, have to report the retirement payments as taxable income.. This rul- ing would not only benefit the members of our association, but also persons within the club industry. `We realize that we are asking for almost individual attention on this matter. We feel that we are justified in doing so because of the unique nature of our business and because IRS has even so noted by mentioning clubs specifically in a section of its regulations. Our problem is serious. Our business is unique. We ask your utmost con- si deration. Action is needed by our Government to stimulate the growth of the private pension system. The American people want the oppor- tunity and need the incentive to properly prepare for their retire- ment needs. There are many avenues which you can take to improve our country by helping develop the self-reliance of the Arnerica.n wage earner. This can be accomplished by stimulating the people to obtain individual coverage on their own and to strengthen, for the benefit of the worker, the employer pension program. Therefore, we reaffirm our support f&r legislation that would: (1) allow employees who wish to save independently for their retirement or to supplement employer-financed pensions to deduct on their in- come tax returns amounts set aside for these purposes; (2) establish a minimum standard in law for vesting of pensions and for preserving pension rights of employees even though they leave their jobs before retirement; and (3) allow all clubs that contribute to a trade associa- tion retirement income trust which contains strong employee benefits to be excluded from the forfeiture provisions of section 83 of the IRS Code. The task before you is a great one. You can help us take great strides forward in developing our financial security and independence. Thank you for your consideration of our recommendations. Mr. CORMAN. Thank you very much, Mr. Baskin. Are there questions? Thank you, sir, for your contribution. Mr. IBA5IuN. Thank you. Mr. CORMAN. Our next witness is Mr. Nick Jemas, national man- aging director, and Roger D. Smith, counsel, for the Jockeys' Guild. Gentlemen, we are pleased to welcome you before the committee and you may proceed. STATEMENT OP NICK JEMAS, NATIONAL MANAGING DIRECTOR, JOCKEYS' GUILD, INC.; ACCOMPANIED BY ROGER B. SMITH, COUNSEL Mr. JEMA5. Mr. Chairman, my name is Nick Jemas. I am the na- tional managing director of Jockeys' Guild, Inc., 555 Fifth Avenue, New York, N.Y. 10017. The guild is a New York not-for-profit orga- nization for the health and welfare of jockeys throughout the country. This is Mr. Roger Smith, counsel for the Jockeys' Guild. Mr. Chairman, I have a prepared statement here. I would like to request that this committee enter this statement into the record and I would like to depart from the statement and just talk simply and tell PAGENO="0051" 353 you who the jockeys are, what they do, and my purpose here in plead- ing for them. Mr. CORMAN. Without objection, your full statement will appear at this point in the record and you may proceed. (The statement referred to follows:) STATEMENT OF NICK JEMAS, NATIONAL MANAGING DmEcToR, JOCKEYS' GUILD, INC. OUTLINE OF STATEMENT I. Introduction 1. Name of witness.-Nick Jemas. 2. Whom he represents.-Jockeys' Guild, Inc. and its member jockeys, who are self-employed individuals. 3. Reason for appearing-To urge the enactment of the higher limitations set forth in Section 4 of the Bill upon the maximum amount which a self-employed person can contribute to a qualified plan and to urge certain further amend- ments which will make such plans, among other things, feasible and inexpensive to administer for those at the lower end of the economic scale. II. Sections requiring amendment 1. The Gode.-Section 404(e) (1) and (2) (and conforming amendments to Sections 401(e), 72(m) (5) and 1379(b)). 2. H.R. 12272, as introduced by Mr. Mills on December 14, 1~71 (the "Bill") Section 4. III. Recommendations 1. News Limitations-Section 4 of the Bill, setting forth new limitations on the amount which self-employed individuals may contribute to qualified plans and deduct in respect thereof, should be enacted. 2. Minimum Contribution.-Section 404(e) of the Code should be further amended to permit a self-employed individual to contribute at least $720 per year ($60 per month) to a qualified plan, regardless of his earned income. 3. Income Averaging Limitation-Section 404(e) of the Code should be fur- ther amended to permit a self-employed individual to contribute to a qualified plan and deduct, in any year in which he could qualify for income averaging, an amount which does not exceed twice the percentage limitation otherwise per- mitted under Section 4 of the Bill. 4. Lookback.-Section 404(e) of the Code should be further amended to permit a self-employed individual who has not been previously covered by a qualified plan to contribute and deduct over a four-year period, in addition to the usual amounts, an amount equal to 15% of his earnings from self employ- ment during the preceding four years. I. INTRODUCTION 1. Name of witness: Nick Jemas My name is Nick Jemas. I am the National Managing ~irector of Jockeys' Guild, Inc., 555 Fifth Avenue, New York, New York 10017. The Guild is a New York not-for-profit corporation formed, among other reasons, to provide financial aid to needy jockeys. (It is exempt from federal income taxation as a social welfare organization under Section 501 (c) (4) of the Code.) Over the years the Guild has discovered that one of the best means of accomplishing its purposes is to aid needy jockeys in helping themselves. 2. Whom lie represents: Jockeys' Guild, Inc. and its nsensber jockeys, who are self-employed individuals. I am appearing on behalf of the Guild, which is the principal organization representing jockeys in the United States, and its more than 1600 members. These members consist of jockeys who ride thoroughbred, quarter and appoloosa horses in fiat races. Practically all of them are self-employed individuals. They are engaged through agents on a race-by-race basis, and do not have any employees of their own. Their professional lives are limited in most cases to not more than 10 years, and their income during these years fluctuates widely. Most jockeys are young; some are minors. Few of them have had much education. All of them are susceptible to misleading financial advice with the PAGENO="0052" 354 result that, even among those who are financially successful, few conclude their racing careers with any savings at all. For years, the Guild has been trying to sponsor some type of pension plan for these jockeys which will prevent a substantial number of them from becom- ing a financial burden on the rest of society when they reach age 60. It has been frustrated by two sets of federal laws which, in combination, have narrowed the alternatives to ones which are so complex and so expensive to administer as to be totally unfeasible. As a result, these individuals who have the greatest need for these federally-sponsored plans have been denied them. The first laws are the tax laws. These have blatantly discriminated against self-employed individuals by setting limitations on their contributions to these plans w-hich are so low- and difficult to determine that the contributions hardly cover the cost of adniinistering the plan. The second are the securities law-s. which now go so far (as a result of 1970 amendments) that they prevent self- employed individuals, such as these jockeys, from having a bank invest their funds in a regularly maintained collective trust fund of the bank (unless their participations in the fund are registered under the Securities Act of 1933, which even the largest banks in the United States refuse to do because of the cost). I am here today to talk about the tax laws. 3. Reason for appearing: To urge the enactment of the higher limitations set forth in Section 4 of the Bill upon the marimum amount which a self- employed person can contribute to a qualified plan and to urge certain further amendments which will make such plans, among other things, feasible and inecopensive to administer for those at the lower end of the economic scale. Naturally, I would most like to see this Committee rewrite the Bill to eliminate completely the present discrimination in our tax law-s against self-employed individuals, by making the same rules apply both to corporate employees and the self-employed. In the absence of such a new Bill, I am here: (i) to urge the enactment of the higher limitations set forth in Section 4 of the Bill upon the maximum amount which a self-employed person can con- tribute to a qualified plan. (ii) to urge the enactment of further amendments w-hich, among other things, will make qualified plans inexpensive to administer for those at the lower end of the economic scale. II. SECTIONS REQUIRING AMENDMENT 1. The Code: Section 404(e) (1) and (2) (and conforming amendments to sec- tions 401 (e), 72(m) (5) and 1379 (b)). My comments are all directed to Section 404(e) of the Internal Revenue Code, entitled "Special Limitations for Self-Employed Individuals". Naturally, as the Bill in its present form recognizes, changes in this section also require conform- ing amendments to Section 401 (e), 72(m) (5) and 1379(b) of the Code. 2. The Bill: Section 4. My first recommendatioi~ is already embodied in Section 4 of the Bill. My three remaining recommendations could be implemented by changing the language of Section 4 in the ways I will specifically describe. III. RECOMMENDATIONS 1. New limitations: Section 4 of the bill, setting forth new limitations on the amount which self-employed individuals may contribute to qualified plans and deduct in respect thereof, should be enacted. This recommendation speaks for itself. The higher limitations are essential for the welfare of thesejockeys because of the limited number of years in which they can practice their professional and the wide fluctuations in their income during these years. To clarify its meaning, we think the Committee Report should make it clear that the last sentence of Section 401(e) (1) (A) (Bill Sec. 4(a), page 26, beginning on line 4) only applies where the section 401 (c) (1) employee actually employs a non-section 401 (c) (1) employee. PAGENO="0053" 355 2. Minimum contribution: Section 404(e) of the Code should be further amended to permit a self-employed individual to contribute at least $720 per year ($60 per month) to a qualified plan, regardless of his earned income This provision is necessary to get these plans off the ground for those who need them most. We never know in advance whether a jockey is going to have a `bad" year or a "good" year. We rarely can convince a minor to save for the future. What we need is a simple rule which will make it feasible to cover these jockeys from the very first year they ride. In this connection, there are two factors working in favor of a practical master plan to cover these independent contractors: (1) The Guild has already established a savings plan under which the tracks deduct a portion of each amount fee earned by a jockey and forward it to the Guild for deposit in a savings account at a savings bank in the jockey's name. This collection procedure is available as a means of collecting contributions to a qualified plan. (2) The jockeys are young. Consequently, they have a longer period to age 65 than normal, during which income can accumulate. Thus, the proposed amendment would permit the Guild, as sponsor of a niaster plan, to collect the contributions of these jockeys up to $720 per year out of their mount fees on a routine basis (e.g. $5 ver mount)-contributions which, however small, could build up to a meaningful amount over the years. The more complex procedures in the Code for determining whether there have been "excess con- tributions" would only have to be applied to those who made additional con- tributions at the end of time year on the basis of their earnings during the year. This would simplify the administration of these plans both for the Government and plan managers. This amendment could be achieved simply by inserting after the words "not exceed" in Sections 404(e) (1) and (2) (A) (i.e., Bill Sec. 4(a), page 25, line 22 and page 26, line 23) the w-ords: $720. or if greater," Conforming amendments would have to be made to Sections 401(e) (1) (B) (iii) and 1379(b) (1), by in- serting the same w-ords therein (Bill Sec. 4(a), page 28, line 14 and Bill Sec. 4(b), line 6). I particularly urge you to adopt this amendment. 3. Income Averaging Limitation: Section 404(e) of the Code should be fart/icr amended to permit a self-employed individual to contribute to a qualified plan and deduct, in any year in which he could qualify for income averag- ing, an amount which does not exceed twice the percentage limitation other- wise permitted under Section 4 of the Bill This provision would permit a jockey who had one good year after four bad years to "catch up" on his contributions to a qualified plan. However, it would not result in any substantial loss of revenue to the Government. To the extent a deduction were allowed for a higher contribution to a qualified plan in a year in which a self-employed person could qualify for income averaging, less income would be available for income averaging. Furthermore, the rule we recommend would be simple to administer, because it ties in with existing Code provisions. This amendment could be achieved simply by inserting at the end of Section 404(e) (1) and (2) (A) (i.e., Bill Sec. 4(a), page 26, line 12 and page 27, line 13) the following sentence: "If in the taxable year an employee within the meaning of section 401 (c) (1) is also an eligible individual having averagable income in excess of $3,000 for purposes of section 1301, the rat.e shall be twice the rate it otherwise w-ould be under the tw-o preceding sentences". The necessary conforming amendments are set forth on a schedule attached hereto. I would again call your attention to the fact that this proposed amend- ment is primarily intended to help those w-ho have a record of low earnings. 4. Look-back: Section 404 (c) of time Code 51101(1(1 be fart/icr amended to permit a self-employed individual who has not been previously covered by a quali- fied plan to contribute and deduct over a four-year period, in addition to the usual amounts, an amount equal to 15% of /i is earnings from self em- ployment during time preceding four years This last recommendation is a plea for fairness. Every day I talk to older jockeys who know- that they must stop riding in tw-o or three years, and they say, "If I had only been covered by a pension plan". This provision would make up for past injustices to them. It would permit them, by riding for another four PAGENO="0054" years, to use their earnings over an eight year period as the basis for their con- tributions to a qualified plan. This amendment could be implemented by adding the following sentence at the end of Section 404(e) (1) and (2) (A) of the Code (i.e., Bill Sec. 4(a), page 26, line 12 and page 27, line 13): "In the first taxable year in which an employee within the meaning of section 401(c) (1) is covered by a plan included in subsection (a) (1), (2), or (3), and in each of the three succeeding taxable years, the amount deductible under sub- section (a) shall include, in addition to the amount deductible without regard to this sentence, an amount which does not exceed the lesser of the amount deducti- ble without regard to this sentence or 15% of the sum of his earned income from the trade or business in each of the four preceding taxable years (reduced by the amount already allowed in preceding years under this sentence)." The necessary conforming amendments are sot forth on a schedule attached hereto. I wish to thank you again for this opportunity to be heard by your dis- tinguished Committee on a Bill introduced by its able Chairman, Mr. Mills, on behalf of him and Mr. Byrnes. I assure you, the cause is a worthy one. Respectfully submitted, CONFORMING AMENDMENTS FOR RECOMMENDATIONS 3 AND 4 The conforming amendments required by Recommendation 3, relating to an income averaging limitation, and Recommendation 4, relating to a lookback deduction, are as follows: 1. In both instances, Section 401(e) (1) (B) (iii) (i.e., Bill Sec. 4(a), page 28, lines 12 through 18) could be amended to read simply as follows: "the amount of any contribution made by any owner-employee (as an em- ployee) which exceeds the maximum applicable limitation in Section 404(e) (1) ; and" 2. In both instances, the figure "$7,500" could be deleted from Sections 401 (e) (1) (B) (iv), 401(e) (3), and 72(m) (5) (B) (i) (i.e., Bill Sec. 4(a), page 26, line 9 and line 24) and the following words substituted therefor: "the maximum amount deductible under the applicable limitations in Sec- tion 404(e)" 3. In neither case do we see any justification for conforming amendments to Section 1379(a) (1). Mr. JEMAS. Thank you. The jockeys are all self-employed individ- uals. They start young. They start riding around 16 or 17 years old. They come from all walks of life, from big cities, poverty-stricken areas, farms, rural districts. They are very small in size physically. They do not have the opportunity to participate in other professional sports or in hard labor. Most of them lack formal education. Very few were fortunate, as I was, to get through high school. Most of our riders are asking why they can't have a pension plan like all other people in the United States and in particular like others in the racing industry tha.t they participate in. Everyone else in the racing industry now has some sort of a pension plan; but the jockey, because he is self-employed, does not have one. A jockey's career is limited. He starts off as a stableboy or some- thing like that for a year or 2 years. Then he struggles on and, when he finally gets his apprentice jockey's license, he is given a weight allowance of 5 pounds. In other words, he carries that much less weight than a professional rider so that it will be an incentive for owners and trainers to use him and so that he can gradually train himself and gain ability. He rides as an apprentice for 1 year after his fifth win, and then he must compete on an equal basis. * The riding career of a jockey is approximately 8 to 10 years. Very seldom will a jockey continue in good top form when he reaches 40 years old. We have a few phenomenons like the Longdens, Arcaros, PAGENO="0055" 357 and Shoemakers that everybody hears about. Nobody hears about the poor individuals who come from Louisiana, California, Oregon, and New Mexico, every State in the Union, and have great difficulty getting started. They struggle along for 3 or 4 years. If Ithey finally catch on they get into the big income bracket and go like that for about 5 or 6 years, then they are paying high income taxes and everything, but they have nothing to put away. Finally their income starts declining as younger boys come along and they fade away and get into minor racing, but they still remain self-employed individuals. They do not have the educational back- * ground to invest their money, to plan their futures as a lot of other professional people do, such as lawyers and doctors. The jockey is unique because he does not have much education and he cannot continue in a self-employed profession until he is 50 or 60 or 70 years old as other educated people do. It is very difficult. The guild would like to set up a master plan for those jockeys, as self-employed individuals, and administer it. We would like to have it insured and funded properly. Our attorneys will handle the legal rigamarole. I can cite myself as an example. I was a late comer as a jockey. I graduated from high school. My mother insisted on it. I originally came from Massachusetts. I worked for 2 years after high school in the greenhouses at hard labor. I had no funds to go to college to educate myself. It was difficult to get a job. I went on the race track and I lived in practically poverty until I got started. Little by little I kept picking up and after 3 years suddenly I blossomed and all the owners and trainers thought Nick Jemas was great and wanted to use me. That was fine. It lasted about 6 or 7 years. I made a big income, but I paid my taxes and everything. Finally I started declining as the younger boys started coming up, pushing me over the cliff, and I had to live on what I made then, but I had no opportunity to put any money away in a pension plan. This is what I am pleading for. I am pleading for boys who start real young and have no educational background to plan their future-so that they will not be taken advan- tage of, when they finally get some money, by sharp accountants or sharp attorneys or sharp insurance or mutual fund salesmen. We want to protect them. They are entitled to it as all other citizens are. Right now I hate to use the word, but it is a fact that they are dis- criminated against. They don't have a pension plan they can enter into properly. I leave that with you. Mr. CORMAN. Did the other witness wish to speak? Mr. SMITH. I am sure that this committee recognizes that, since 1962, the Keogh bill plans have been available to the self-employed, and a few of the top jockeys in recent years have taken advantage of them. The problem here is that we want to cover all jockeys. We want a feasible plan for all jockeys which they can get into before they `hit high earning years, if they are that fortunate, and can contribute to during those good years. These jockeys do not have much education. `They can't go to their bankers and say, "Show me a Keogh plan, sign me up." Somebody has to guide them into a program. We hope to be able to do that for them, but if we are going to do it, we have to do it in a way which is adminis- PAGENO="0056" 358 tratively feasible, in a way which will keep the administrative costs down. We have made specific recommendations here. I don't think it is worthwhile going over all of them unless you have some specific ques- tions about them. One is designed to help the jockey who has gone 4 years without earning very much and suddenly has a good year. We suggest that the amount that lie could contribute in a good year be doubled, if he could otherwise qualify for income averaging. A second recommendation is for what we call a minimum contribu- tion. Our objective is to make the administration of these plans sim- pler both for the Government and for the guild and to avoid having to check each jockey's tax returns-some 1,400 of them-to see if there are excess contributions. We would like a rule permitting a jockey to contribute up to $720 a year without regard to his earned income. Those are two of our proposals. Mr. CORMAN. Are there questions? WThat does the reasonably successful jockey made during these 8 to 10 very good years? Mr. JimrAs. It varies. We have some jockeys who are exceptionally good and they might get up to a really high bracket and might net $100,000 or $150,000. They will do that for 2 or 3 years and all of a sudden they are lucky if they get $10,000. That is the way it is. We have jockeys that go along and will start climbing the ladder and are probably netting $5,000 or $6,000. Then they get up to $20,000 and stay on that level for about 8 years and then start declining. It goes up and down. Take, for instance, the Kentucky Derby a couple of. years ago. Everybody was talking about the glorious horse that won the race and the jockey who was so fortunate and what a great thing it w-as for the State of Kentucky, but nobody talked about that boy named Hector Pilar. All he got was $25. He fell in the race and broke his back and was laid up for 2 years, his income completely stopped. Mr. Chairman, their incomes vary so much. That is why it is vitally necessary for them to have an individual pension plan that we can ad- minister for them so that they can put that money away while they have it, because you just don't know when that income is going to decline and be cut off. Mr. CORMAN. It seems to me that they might be best served by some limitation based on what the pension is going to be rather than any particular year's contribution to it. In other words, let a jockey set aside on a tax deferral basis whatever amount he wants to until he accumulates a sufficient annuity to give him a reasonable pension at age 60 or 65. It seems to me, particularly with people who have very short, well-paid careers, that might be the most useful approach. What would be your comment on that? Mr. S~rITII. I think that would be quite favorable. Any provision which will permit them to set aside a meaningful contribution in a year when they earn that money, on a money-purchase plan basis, is exactly what we want. Mr. CORMAN. Thank you very much, gentlemen. You have been very helpful. Mr. SMITH. Thank you, sir. PAGENO="0057" 359 Mr. CORMAN. Our next witness is Gerald Stephan Susman of Phila- delphia, Pa. Mr. Susman, we are pleased to have you before the committee. You may proceed. STATEMENT OP GERALD STEPHAN SUSMAN, PHILADELPHIA, PA. Mr. SUSMAN. Mr. Chairman, members of the committee and guests, for the record my name is Gerald Susman. I am a stockholder in the incorporated law firm of Bluestein & Prusky Associates in Philadel- phia, Pa. Together with my partners we have a collective experience of about 25 years with the Internal Revenue Service, much of which time was spent in examining the very plans that we are discussing today. Our practice is chiefly oriented `to the design, implementation, and administration of corporations and their related retirement programs. Today I am representing our law firm, our present clients and future clients specifically, as well as the general `effect of the proposals before us today on taxpayers in the future. For the sake of brevity and not to undu'ly occupy your time, I will limit my comments to the specific points with which I am most concerned. Mr. CORMAN. Would you like us to insert your entire statement at this point in the record and then you may summarize it? Mr. StT5MAN. I have made the statement sufficiently short that I am going to be able to incorporate that anyway. Mr. CORMAN. All ri.ght. Go rigtht ahead. Mr. SUSMAN. For purposes of summarization, I am going to be op- posing the legislation regarding any distinctions between self- employed `and corporate retirement programs. I am going to be recom- mending that vesting not be determined by any factor which takes age into account, and further recommending that years of service, in deter- mining participation and eligibility, include periods of se~1f-employed occupation. I am in favor of the increased limitation on self-employed plans and the specific administration proposals on individual retirement programs. The proposed legislation presupposes that the private pension sys- tem is an obligation of the establishing employer unit and that it must be a supplement to the social security system. This supposition appears to be predicated on the false premise that since the Government grants a tax deduction, the Government may therefore completely regulate that which is basically voluntary. If this is correct, and if the private pension system is going to be made obligatory with all of the concomitant Government regulation, then one must ask the question, "What is the difference between social security and the private pension system?" I suggest the answer may well be there is none. NEED FOR PROTECTION Any consideration of the private pension system should begin with the basic premise that a qualified plan is established on a voluntary basis, except those established as a result of a collective bargaining PAGENO="0058" 360 agreement. Being voluntary plans, intended to serve as an incentive for employers to remain in the employ of the employer and thereby have the security of a retirement fund, the Government subsidizes these good motives with a tax deduction for contributions and a pre- ferred tax treatment on distribution. Thus, the Government has a valid interest in promoting the adop- tion of such plans and in assuring that the favored tax treatment is not abused. However, any legislation that serves as an overkill will destroy the very incentive for adopting such plans which previous legislatures and administrations thought so important. Having been involved in the establishment of over 500 individually designed qualified plans for large and small businesses as well as pro- fessional corporations, and having examined many plans in operation when I -was with the Internal Revenue Service as an agent, I feel that it is my obligation to dispel the implication cast by the administration in its explanation of H.R. 12272. It is implied therein that small employers both corporate and non- corporate plot and scheme as to which employees to fire because they are getting too close to retirement or they are accruing too much of a vested interest in the plan's benefit. It is also implied that hiring de- cisions are dictated by the age of the applicant. Let me assure you that my experience in this area has indicated that nothing could be further from the truth when applying these implications to small employers. SMALL VERSUS LARGE BUSINESSES Most of you, having been involved in small businesses and practices of your own, will attest, I am sure, to the fact that in order to keep a small business profitable, you will do all you can to retain valuable experienced and seasoned personnel. One thing you will not be doing is firing employees so as to cause forfeitures of nonvested interests. Similarly, when hiring, you will search out the person best qualified for the position and not the one whose age fits best in your retirement program. Now, I will agree that when speaking about the giants in an in- dustry, the hiring and firing decision patterns may be more likely to reflect the effect of such decisions upon the retirement program. This obviously results from the fact that larger employers do not depend as heavily on specific persons and therefore can make decisions which are directly related to forfeitures of noneligibility. This again I re- iterate is not a consideration in a small business. The point is this, there is no reason for requiring more restrictive provisions on smaller employers as section 2(c) of the bill does in its addition of new subsection 401 (j). More importantly, this is the first time there would be legislated in the qualified retirement plan area provisions which discriminate be- tween large and small corporations. I might note here that the 1969 Tax Reform Act addition of section 1379 was not such a discrimination since those changes were required in order to `establish a truly non- corporate tax structure for subchapter S corporations. PROPOSALS WILL DISCOURAGE ADOPTION OF NEW PLANS The effect of these proposals on the small corporations will be such as to discourage the adoption of new plans and encourage the terrnina- PAGENO="0059" 361 tion of existing plans. This results from the increased cost of hiring under the rule of 35. While this is more liberal than the existing rules of immediate vesting, after a 3-year eligibility period for self-employed plans, it will be a new restriction for small corporations. Unlike the rule of 50 proposed for larger corporations, the rule of 35 doesn't allow for an alternative of age plus 3 years of participation under the plan before the rule is applicable. Thus, a small corporation would be foolish to hire anyone over 27 years of age. Obviously, my last remark indicates that small employers will begin taking age and length of service into consideration when making hiring and firing decisions. I don't think this is going to accomplish the purpose of the qualified area, that being to encourage the implementation and growth of the private retirement system. If the purpose of these more restrictive provisions on small corpo- rations and the self-employed is to prevent against possible abuse or manipulation, I suggest that the large corporations are more subject to the same temptations only with greater sophistication. The Internal Revenue Service has the authority to review and police the operation of all qualified retirement programs. Specifically, it is the Internal Revenue Service's function to search out and correct any discrimination in the operation of a plan. INTERNAL REVENUE SERVICE-NEW FORMS I spoke in January of this year at public hearings before the Assist- ant Secretary of the Treasury regarding four new forms and two re- vised forms for reporting the results of private retirement progams. The purpose of these forms was expressed to be the uniform collection of information and related statistics to allow the Internal Revenue Service to police discrimination in vesting, eligibility, and related areas of the present prOposed legislation. Therefore, I think the current proposals regarding vesting and eligibility should be tabled until such time as the results of the new reporting requirements may be used to propose more intelligent legis- lation with the benefit of valid statistics. PRIOR SELF-EMPLOYED SERVICES In the alternative, if legislation is to be adopted at this time, any distinctions between common law and self-employed persons should be eliminated. As stated by the President in his message of December 8, ~ * this distinction in treatment is not based on any differ- ence in reality since self-employed persons and corporate employees often engage in substantially the same economic activities." In conjunction with this, I rec~minerid that the proposals be cJari- fled so as to allow the periods of eligibility to include years of service as a self-employed person. Presently, a self-employed person who incorporates his business is not permitted to consider as years of service any period prior to incor- poration notwithstanding the fact that his common law employees who have been with him for a period of years are allowed to use that prior period. This is an inequity based upon an archaic definition PAGENO="0060" 362 of the term "employee" which should not 1e applicable in these considerations. BASE VESTING ON SERVICE ONLY Finally, the real point of this legislation should not be to provide protection to employees because of their age since this is the purpose of the social security system. Rather, this legislation should be con- cerned only with periods of eligibility and years of service since this is where the potential abuse lies. Thus the rules of 50 and 35 should be abandoned and substituted with a rule of 10 or 15 years of service which would recognize the only valid measure of an employee's right to a vested interest. To do otherwise would be discriminatory in favor of age. I appreciate the opportunity to speak before you and will entertain any questions. Mr. CORMAN. Thank you very much, Mr. Susman. Mr. Vanik. Mr. VANIK. I have no questions. Mr. CORMAN. Mr. Collier. Mr. COLLIER. I have no questions. Mr. CORMAN. Thank you very much for coming to the committee, Mr. Susman. Mr. SUSMAN. Thank you. Mr. CORMAN. Our next witness is Mr. Joseph H. Reynolds, Sr., of J. H. Reynolds & Associates, St. Charles, Mo. Mr. Reynolds, we are pleased to welcome you to the committee. STATEMENT OP JOSEPH H. REYNOLDS, SR., J. H. REYNOLDS & ASSO- CIATES; ACCOMPANIED BY SUSAN REYNOLDS, LEGAL COUNSEL, ST. CHARLES, MO. Mr. REYNOLDS. Mr. Chairman and members of the committee, I am Joseph H. Reynolds, I head a firm of pension consultants. We special- ize in installing and servicing pension plans for small corporations. I have had about 15 years experience in this area. With me is my daughter Miss Susan Reynolds. She is also my legal counsel and my right arm. Today I intend to speak on the following matters: 1. Small businesses must have pension plans too; current IRS policy prevents this. Pi~eviously established plans are being disqualified ret- roactively, and new plans are almost impossible to establish. 2. Small business must have the same "pension rights" that large business has. 3. Present IRS policy applies one set of rules to large corporations yet another set of rules to small corporations. 4. Congress should remove jurisdiction over pension plan admin- istration from the Treasury Department and establish an independent agency to administer pension rights. 5. As an alternative, Congress should restate its intent regarding small corporations. All taxpayers should stand equal before the law. (1) Sn'iall businesses need pension plans, too. Current IRS policy is depriving employees of small corporations of their pension rights. I wish to discuss the plight of the small employer and particularly the plight of the small employer's employees, who find themselves PAGENO="0061" 363 without a pension plan or find that the IRS has revoked a previously qualified pension plan, and who have thus lost their pension benefits through no fault of their own. There has been considerable reporting in the news media relative to the testimony being heard by various congressional committees; much of which has involved employees who have lost pension benefits through no fault of their own, such as plants closing, no vesting, un- derfunding, et cetera. The employees of many small corporations are also covered by pension plans, and many of these Americans have lost their pension benefits due to a change in IRS policy. In the Midwest, where I prac- tice, I believe that there have been more employees of small corpora- tions lose their pension benefits as a result of this changed IRS policy than as a result of the more widely publicized reasons. (2) Current IRS policy prevents the employees of many small corporations from having a pension plan, and thus discriminates among taxpayers. Presently, all corporations wishing to install a private pension plan are not equals under the Internal Revenue Code. Any corporation employing both union and nonunion eniployees and wishing to install a pension plan must depend on the whims of the IRS which has the authority to decide when a pension plan is "fair" and thus "qualified" under IRC 401. IRS's policy is that a corporation's nonunion em- ployees cannot have a pension plan containing terms different from the terms of a plan covering the union employees. If the union employees have bargained for higher current wages and no pension plan at all, then the IRS refuses to pern'iit the non- union employees to take lower current wages and have a pension plan. The IRS argument does not stop with disapproving plans asking for initial qualification. The IRS has become an Indian giver under IRC 401, revoking previously issued Letters of Determination. This new policy, begun in 1968-69, is a drastic change in IRS pro- cedure. Previously for 26 years section 401 was applied so that various groups of employees could have w-hatever pension plan they wanted. The new policy does not affect large corporations betcause the IRS takes the position that any pension plan covering a large number of people passes their "adequate cross section" test. Only the little com- panies are affected. These are the taxpayers who cannot afford to fight back; instead, they give in and terminate their pension plans, rather than fight the IRS. Small corporations cannot afford to contribute to pension plans if they cannot deduct the contributions. Further IRS does not apply these same rules equally to the various plans w-ithin a corporation. Many corporations have two or more unions representing various em- ployees, and the various unions' plans contain different terms and benefits. Although the IRS will admit that application of the same policy would disqualify union plans also, they refuse to apply the same policy to the union's plans. The result is that the plan covering a corporation's nonunion personnel is disqualified and the nonunion employees lose their retirement plan; yet the IRS closes its eyes and looks the other way rather than apply its new policy to the union plans. By disallowing pension plans for small corporations, discrimina- tion among taxpayers results, the small corporations cannot compete PAGENO="0062" 364 with either the large corporations or the U.S. Government for prime personnel, as good employees know well the value of a pension plan. Isn't it ridiculous to permit an employee to have a funded pension plan if he works for a large corporation or the U.S. Government, and yet deny him this same benefit if he works for a small corporation. (3) A Federal pension agency should be created to make the deci- sion as to when a private pension plan is "fair" and thus "qualified." I feel that the taxtakers at the IRS are ill-equipped to make the subtle, subjective decision of when a pension plan is "fair." The IRS tends to see issues in terms of tax dollars gained or lost; not the rights of employees whose pension benefits they terminate. The IRS has even gone so far as to apply its new "adequate cross section" test retroactively, thus becoming an Indian giver under IRC 401. When the IRS terminates a plan 3 years retroactively, the cor- poration may remove contributions previously made to the plan in order to pay the additional tax due. Thus each employee's retirement security is diminished when his account is proportionately reduced. Likewise, taxes due from the trust further diminish each participant's retirement account. The bill before this committee is a well drafted bill so far as it goes. Transferring authority to make the determination of when a pension plan is "fair" and thus "qualified" from the grasp of the IRS to a separate Federal agency, which would consider the rights of em- ployees covered by the pension plan rather than the amount of tax revenues lost by permitting employees to have a pension plan, is a particularly fine proposal. But unfortunately, these proposed statutes apply to plans covering more than 25 employees. We feel that the small corporations are as much in need of "pension rights" as are large corporations. We represent many corporations employing more than 25 employ- ees; yet, many of these corporations employ both union and nonunion personnel. While totaling less than 25 total employees, the union per- sonnel are included in large union plans and will thus be protected by the new "pension rights" statutes; while the nonunion personnel totaling less than 25 also will be left under the jurisdiction of the IRS and will not receive the same "pension rights" as will their union- ized coworkers. Omitting the small plans will leave them to the mercies of the IRS, yet protect the larger plans. We have been told informally that the Congress feels that the small plans will be unable to meet the proposed requirements, and it would impose great hardship to require them to do so. Thus, they will be given a few years to "catch up" and then when they are "caught up" Congress will amend the statute to include them. In point of fact, the small companies do not need time to "catch up." Few are underfunded; and every small plan that my firm has installed contains liberal vesting provisions. It is my opinion that the small plans throughout the country are far sounder than the~ large plans that the Labor Subcommittee has been investigating. Other Federal statutes cover any employer "affecting interstate commerce" as does the Taft-Hartley Act and the recently enacted Occupational Safety and Health Act. The small corporations should also be covered by the Federal "pension rights" statute that is finally enacted. PAGENO="0063" 365 Alternatively this c)ommittee should adopt the American Bar's pro- posal that the IRS's decision as to the "fairness" of a pension plan is to he made without regard to employees covered by bargaining agreements. The IRS completely overlooks the Taft-Hartley aspects of pension plan participation: employees, whether union or nonunion, have a federally protected right to participate in a union retirement plan or not participate, as they see fit. The employer cannot interfere with that right; he cannot include union employees in any pension plan they do not choose to join; he must have their consent to include them at all. Yet, the IRS penalizes the employer for not including them. The IRS argument says that nonunion employees can have no different pension plan than a company's union employees have. This results in the nonunion employees having their pension plan negotiated for them by the union whether they wish it to be so or not. Yet, the non- union employees also have a federally protected right to be nonunion. The small corporation is trapped between IRS and the Taft-Hartley Act. The proposed amendment to the Internal Revenue Code would result in the decision as to a plan's "fairness" being made with reference to that plan only, and not in comparison with the company's other plan or plans negotiated by union employees. This is how the IRS applied the law for 26 years before the change in policy, and I feel this is what Congress intended all along. My sole purpose in appearing before this committee is to ask that you permit all corporate taxpayers to stand equal before the law. Dis- crimination among corporations on the basis of size should not be permitted, particularly by a branch of the Federal Government. Per- sons employed by these small corporations should have "pension rights" too. Gentlemen, I want to thank you for your time. I will be happy to answer any questions. Mr. CORMAN. Thank you very much, Mr. Reynolds. Mr. Collier. Mr. COLLIER. I have no questions. Mr. CORMAN. Thank you very much, sir. We appreciate your coming. We hope that you compensate your lawyer adequately for her trip to Washington. Mr. REYNOLDS. Thank you. Mr. CORMAN. Our last witness is Jack McKinley, the Prototype Planner. STATEMENT OP JACK McKINLEY, THE PROTOTYPE PLANNER Mr. MCKINLEY. Mr. Chairman, members of the committee, my name is Jack McKinley. The company's name is The Prototype Planner. I am a marketing and technical consultant to banks, insurance com- panies, and mutual funds and other employee benefit plan consultants on subjects concerning private pensions. I have a formal statement here which I shall not read because I see that you are going to adjourn soon. What I would like to do is to dis- cuss in 5 minutes or so the highlights of it. PAGENO="0064" 366 Mr. CORMAN. I am trying to see the extent of your statement. Is the entire statement here? Mr. MCKINLEY. Yes, it is. I would like to have it included in the record. Mr. CORMAN. Without abjection, that will appear in full in the record at this point. (The statement referred to follows:) PAGENO="0065" 367 ~ P~4?O~TP~ P~*I,I,fl POST OFFICE BOX 171, KEW GARDENS, NEW YORK 11415 (212) 628-7500 April 24, 1972 Mr. John M. Martin, Jr. Chief Counsel, Room 1102 Committee on Ways and Means Longworth House Office Bldg. Washington, D.C. 20515 RE: Request to offer oral testimony at the Committee's public hearings beginning on May 8, 1972. Dear Mr. Martin: In accordance with the Committee's release dated April 13, 1972, I respectively request to present oral testimony at the House of Representatives Committee of Ways and Meant public hearings on tax proposals affecting private pension plans to be held beginning on May 8, 1972. I. My name and address it Jack McKinley, The Prototype Planner, P.O. Box 171, Kew Gardens, N.Y. 11415. The capacity in which I wish to appear is as a marketing and technical consultant to banks, insurance companies, mutual funds, and other employee benefit plan consultants (hereafter referred to as financial organizations) on subject matters concerning private pension plant. At the time that the Individual Retirement Benefits Act of 1971 was introduced to Congress by the Administration, I initiated a comulting service to financial organizations entitled, "Individual Retirement Savings Plans Submission Guide" (hereafter referred to as savings plans) which is available on a subscription basis only. The service is continuous and maybe renewed from year to year and enables financial orgunizations to draft and design savings plans and alto to keep abreast of the latent developments that affect this type of plan. The initial pars of the Savings Plans service included a 27 page analysis and interpretation of Section 3 "Deduction for Retirement Savings" of the Individual Retirement Benefits Act of 1971. The overall objective of the Savings Plans service is to provide a technically correct and administratively simple product to the some 80 million Americans who will be eligible to contribute to savings plans. Many of these individuals have no means whatsoever to save for their own retirement and are not eligible to participate in any other type retirement plan. 2. Attached is a partial list of financial organizations that subseribe to the Savings Plans service. 3. I respectively request 30 minutes of time to present my direct oral testimony. 4. I ant definitely in favor of the Individual Retirement Benefits Act of 1971, since it is the most progressive and immediate step that the Administration and the Congress can take in providing coverage for retirement for those Americans who are presently not covered by any type of private pension plan. However, there are several technical and administrative provisions contained in certaln sections of the Act that should be clarified and/or expanded. 5. A topical outline and summary of comments and recommendations that will be made is attached to this letter. On behalf of the subscribers to the Savings Plans service and subscribers to The Prototype Planner, I believe that my message to members of the Committee will be constructive and beneficial in achieving appropriate legislation. 8iMcKinle~X4 78-202 0 - 72 - p1, 2 - 5 PAGENO="0066" In general, Section 3 of the Individual Retirement Benefits Act of 1971 is a giant step forward in solving the basic problem of providing retirement plan coverage to some 50% of the work force that is not presently covered by any retirement plan whatsoever. However, there are several technical deficiencies, flaws in draftsmanship, and other points in the Act that should be clarified and expanded. Comments and questions raised below apply to specific sections of the Act as it would amend the Internal Revenue Code for individual deductions for retirement savings. 1. Section 2l8(b)(2) A. The reduction mechanism is unduly complex and impractical from an administrative point of view. B. The reduction feature should be modified so that the maximum tax deductible amount would be $1500 for individuals who do not participate in their employer's private pension plan. If they participate, then the maximum tax deductible amount should be automati- cally reduced to $1000. I. This type of reduction feature has been working successfully in Canada for some 14 years now. C. The 7% of earned income reduction factor is not a valid assumption. 1. Will present evidence to support this statement. II. Section 408 (a) and 408 (a) (3) A. Reference is made to a "custodial amount" as a funding vehicle for individual retirement accounts. 1. Does this mean a "custodial account" under IRC 401 (f)? 2. Does it mean a custodian or custody account for safekeeping of securities, etc.? 3. Does it mean both? 4. Banks are not interested in acting in a custodian or custody capacity for accounts of such small size. 1. This was indicated in speeches given in March 1971 by John Nolan and in February 1972 by John Chapoton of the Treasury Department. a. Advantages and disadvantages of using this approach. C. Reference is made to "other similar arrangements" shall constitute a qualified individual retirement 1. What are "other similar arrangements"? D. Reference is made to the fact that assets of an individual retirement account must be held in trust by or in the custody of a bank or "other person who demosstrates to the satisfaction of the Secretary or his delegate that the manner in which he will hold or have custody of such assets will be consistent with the requirements of this paragraph". 1. Who may be an "other person"? 2. To qualify as sponsors of individual retirement plans under a master/prototype concept, must they make prior arrangements for custodial account facilities with a bank? III. Section 408 (a) (4) A. No reference is made no the fact that individual retirement account benefits must be paid to a beneficiary upon the death of the individual who contributed to the plan. I. This is a serious omission on the part of the draftsman of the Act and should be corrected. IV. Section 72 (p) (2) A. The 30% penalty on premature distributions from individual retirement accounts is excessive and should be modified to conform with the penalty provisions for Keogh or HR. 10 plans under IRC 72 (m)(5). V. Section 4960 A. The excise tax on excessive accumulations is unrealis' tic. There is no comparable provision for Keogh or corporate plans. I. The method of determining the amount of excessive accumulation is unduly complex and will be difficult to police on the part of the Internal Revenue Service. Summary and Conclusion In general, Section 3 of the Individual Retirement Benefits Act of 1971 is well drafted and covers most of the essential points with certain exceptions as mentioned above. In the event that the entire Act is found controversial and will be held up in Congress for one reason or another, Section 3 of the Act should be considered separately and passed upon as the only practical and immediate solution to solving the problem of providing private pension plan coverage to the some 50% of the work force that is presently not covered. 368 OUTLINE AND SUMMARY OF COMMENTS AND RECOMMENDATIONS a. See attached copies of questionnaire for survey of bank trust departments offering custodian/custody account services for in- dividual retirement accounts. Questionnaire form was sent dosing week of April 24, 1972 to some 400 bank trust departments with assets exceeding $100 million. When the results of the survey are compiled, they will be submitted to the Committee. b. Discussion of results of similar surveys con- ducted of bank trust departments in regard to services for small to medium size employ. er plans. B. May individual retirement savings plans and retire- ment accounts be qualified as master and prototype plans? - PAGENO="0067" 369 CONFIDENTIAL' QUESTIONNAIRE FOR SURVEY OF BANKS OFFERING CUSTODIAN/CUSTODY ACCOUNT FACILITIES FOR SAVINGS PLANS 1. Does your bank have facilities for custodian/custody accounts: YesE NoEl If your answer is "No", it is not necessary for you to complete the remaining portion of this questionnaire. If your answer is "Yes", please continue on to question number two. 2. Would your bank be willing to make the custodian/custody account facilities available to "other persons" so that they may meet the requirements for sponsors of savings plans? YesEl NoEl 3. If the answer to question number two is "Yes", would you impose any conditions or qualifications on these "other persons"? For example, financial stability, reputation in the community, must be a customer of the bank, etc. If so, indicate below what conditions and qualifications your bank would require? 4. If such facilities are available, indicate below your proposed fee schedule for the services that would be rendered. Include any non-recurring types of fees, i.e., acceptance fee at the time the account is established, etc. Your Editor is interested in publishing in the Individual Retirement Savings Plans Service the names of banks offering custodian/custody services for "other persons". El Yes, you may publish our name. El No, please do not publish our name. And your fee schedule as indicated above. El Yes, you may publish our fee schedule El No, please do not publish our fee schedule Otherwise the information indicated may be provided to subscribers to The Prototype Planner only upon specific request. YesEl NoEl Thank you for your time and effort in completing and returning this questionnaire. I hope that you will be able to develop some new business because of your cooperation and the information that has been supplied. Name of Bank Address S City __________________________________________ State ____________________ Zip _____________ Officer to Contact: _________________________________________ Telephone Number: ____________________ PAGENO="0068" 370 NINETY SECOND CONGRESS First Session Individual Retirements Benefits Bill of 1971 As Introduced on December 14, 1971 In the Senate of the United States as S.3012 BY Carl T. Curtis (R. Nebraska), Wallace F. Bennett (R. Utah), Peter H. Dominick (R. Colorado), Paul J. Fannin (R. Arizona), Clifford P. Hansen (R. Wyoming), Len B. Jordan (R. Idaho), and Hugh Scott (R. Pennsylvania) The Bill was read twice and referred to the Committee on Finance In the House of Representatives as H. R. 12272 BY Wilbur D. Mills (D. Arkansas) and John W. Byrnes (R. Wisconsin) The Bifi was referred to the Committee of Ways and Means In the House of Representatives as H. R. 12302 BY Gerald R. Ford (R. Michigan, Thomas E. Betts (R. Ohio), and Jack Edwards (R. Alabama) The Bill was referred to the Committee on Ways and Means PAGENO="0069" 371 A BILL To strengthen and improve the private retirement system by establishing minimum standards for participation in and for vesting of benefits under pension and profit-sharing retirement plans, by allowing deductions to individuals for personal savings for retirement, and by increasing contribu- tion limitations for self-employed individuals and shareholder-employees of electing small business corporations. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, Bill Sec. 1 SECTION 1. SHORT TITLE, ETC. Bill Sec. 1 (a) (a) SHORT TITLE-This Act may be cited as the "Individual Retirement Benefits Act of1971 `~ Bill Sec. 1 (b) (b) AMENDMENT OF 1954 CODE-Except as otherwise expressly provided, whenever in this Act an amendment is expressed in terms of an amendment to a section or other provision, the reference is to a section or other provision of the Internal Revenue Code of 1954. SECTION 2. Provides for legislation on minimum standards relating to eligibility and vesting. Bill Sec. 3 SEC. 3. DEDUCTION FOR RETIREMENT SA VINGS. Bill Sec. 3(a) (a) IN GENERAL.-Part VII of subchapter B of chapter 1 (relating to additional itemized deductions for individuals) is amended by renumbering section 218 as section 219 and by inserting after section 217 the following new section: The Internal Revenue Code of 1954 is Taxable Income," and Part VII is "Additional divided into five Subtitles - A, B, C, F, and Itemized Deductions for Individuals" and the G. Under each Subtitle is a Chapter, Sub- Section numbers are 211-218. chapter, and a Part. Within each Part, there This proposed legislation would renumber are sections or paragraphs which are assigned the existing Section 218 - "Cross Refer- numbers, e.g., 401 and 501. ences" as Section 219 and insert the following The reference above is found in Subtitle A, Section 218 - "Retirement Savings" after the first subtitle and is captioned, "Income Section 217 - "Moving Expenses," thus Taxes". Chapter 1 is "Normal Taxes and becoming the next to last Section of Part VII. Surtaxes," Subchapter B is "Computation of SECTION 218 (a) (1) - (5) SEC. 218. 1~ETIREMENTSA VINGS. `Ya) DEDUCTION ALLOWED-There shall be allowed as a deduction amounts paid during the taxable year by an individual- "(1) to a qualified individual retirement account (as defined in section 408(a)), "(2) to an employees trust described in section 401 (a) which is exempt from tax under section 501 (a), -1- PAGENO="0070" 372 "(3) for the purchase of an annuity contract under a plan which meets the requirements of section 404 (a) (2), "(4) to or under a qualified bond purchase plan (as defined in section 405), or "(`5) for the purchase of an annuity contract described in section 403 (b). Apparently, the funding vehicles for savings plans will be limited to these five alternatives. A "qualified individual retirement account" is discussed in Section 408. "Employee trust" qualified under 401 (a) and exempt under 501 (a) refers to any qualified pension, profit sharing, and stock bonus plan that has already been established by an employer company. A separate plan to receive savings plans contributions could not qualify under this section. An "annuity contract under a plan" is described in 404 (a) (2) and includes retire- ment annuities, or retirement annuities and medical benefits. Medical benefits are men- tioned in 401 (h)".. . and provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of re- tired employees, their spouses and their dependents.. .". Reg. section 1.404 (a) (8) refers to an "annuity plan", the meaning of which is found in 1.404 (a) (3) as ". . . a pension plan under which retirement benefits are provided under annuity or insurance contracts without a trust." Therefore, this would appear to be an indirect reference to an insured master plan where the insurance contracts issued directly to the adopting employer without the intervention of a trust. This is similar in concept to insured Keogh and corporate master plans. "Qualified bond purchase plans" are described in IRC 405 and 1.405-1 of the Regs. Annuity contracts under 403 (b) include those purchased for employees by a 501 (c) (3) organization or public school which are exempt from tax under 501 (a). Other employees include those who perform services for educational institutions, one of the 50 states, or one of their agencies or instrumentalities. SECTION 218 (b) (1) "(b) LIMITATION.- "(1) GENERAL RULE.-The amount allowable as a deduction under subsection (a) to an individual for any taxable year shall not exceed 20 percent of so much of his earned income for such taxable year as does not exceed $7,500. "Taxable year", in most instances, will mean a calendar year - January 1st to December 31st, since individuals file their Federal income tax returns on this basis. The term should be defined in the plan document and should appear as an elective provision in the adoption agreement. There are only some 40,000 individual taxpayers who file income tax returns on a taxable year basis other than a calendar year, and the reason appears to be due to the seasonal nature of their income and expenses, i.e., a ski lodge operator where the end of each calendar year falls in the middle of his heaviest income and expenditure period. The tax deductible amount can be express- ed in two different methods. The first, as above, is 20% of the first $7,500 of earned income; and the second as the lesser of 20% of earned income or $1,500 (the result of multiplying 20% times $7,500 which equals $1,500). A Keogh plan contribution formula is usually expressed in accordance with this latter method, e.g., lesser of 10% of earned income or $2,500, (10% of the first $25,000). Apparently, the 20% amount is derived -2- PAGENO="0071" because of its use in determining the exclu- sion allowance under 403 (b) (1) (a). The $7,500 limitation, obviously, is design- ed to discourage excessive employee contribu- tions, sufficient in amount to provide ade- quate retirement benefits, thus discouraging employers from adopting or improving private plans for their own employees. The $7,500 maximum earned income and the $1,500 maximum tax deductible amount were derived so that it would be possible to live with the revenue loss that this bill would create. This type of contribution formula (vs. a benefit formula in a stated or fixed benefit pension plan) is of the money purchase type 373 and savings plans would be considered a qualified pension plan. On the other hand, contributions are made only to the extent that the participant has "earned income" (see definition below), and if none, it would otherwise be impossible to contribute. A savings plan also has certain profit sharing attributes in that it can be assumed that if there is earned income there is taxable income and therefore a need for a tax deduction. In the event that an individual's other deductions, exemptions and credits exceeded his total income, earned or otherwise, it would still be possible to make a contribution to his savings plan, however, it would not be tax deductible. SECTION 218 (b) (2) `Y2) REDUCTION OF ACCOUNT OF EMPLOYER CONTRIBUTIONS TO QUALIFIED PENSION, ETC., PLANS-The limitation otherwise determined under this subsection for any taxable year shall be reduced by the amount (determined in accordance with regulations prescribed by the Secretary or his delegate) of any contributions made on behalf of the taxpayer by his employer during the taxpayer's taxable year. "Taxpayer" refers to the individual partic- ipant who elects to make contributions to a savings plan. In a sense, it is possible to say that savings plans can be integrated by the offset method found in the offset type of integrated stated benefit pension plan. Not only can a savings plan be integrated with social security bene- fits but also with contributions attributable to the participant and made on his behalf by the employer to the employer's own private plan. SECTION 218 (a) (2) (A)-(B) `YA) to an employees' trust described in section 401 (a) which is exempt from tax under section 501 (a), `YB) for the purchase of an annuity contract under a plan which meets the requirements of section 404 (a) (2), `YC) to or under a qualified bond purchase plan (as defined in section 405), or `YD) for the purchase of an annuity contract described in section 403 (b). Note that (A) through (D) are identical to (2) through (5) in Section (a) above. Each type of funding vehicle represents an existing plan or contract that has already been estab- -3- PAGENO="0072" 374 lished by the participant's employer. This would mean that each plan or contract would have to be amended allowing for savings plan contributions to by made by employees. (See appropriate specimen language for existing qualified plans.) SECTION 218 (a) (2) In accordance with regulations prescribed by the Secretary or his delegate, the amount of any contributions described in the preceding sentence made on behalf of a taxpayer by his employer during his taxable year may, at the option of the taxpayer, be considered to be 7 percent of his earned income for such taxable year attributable to the performance of personal services for such employer. In the event that the participant was a member of his employer's qualified plan or plans, his contribution of 20% of the first $7,500 of earned income would be reduced. The amount of reduction will be determined "...in accordance with regulations prescrib- ed by the Secretary or his delegate. . .". This presumably means an amendment to the present Federal Tax Regulations or the issu- ance of a subsequent Revenue Procedure or Ruling. There are two types of reductions. The first is the amount of contribution made on behalf of the participant by his employer during the participant's calendar year may be considered to be 7% of his earnings paid to him by the employer for performance of personal serv- ices. This represents an option that may be elected by the participant".. . in accordance with regulations prescribed by the Secretary or his delegate.. .". Before the participant selects this option, he would first want to know what percent of his pay is being contributed to the employer's plan. This represents an additional reporting require- ment on the part of the employer and additional administrative duties in policing this option if it is to be made each and every year, or only at the time contributions are first made on behalf of the participant. This election would probably be automatic in the event of fixed benefit pension plans using an aggregate funding method, since individual allocations are not made. It appears that the same procedure may be followed for savings plans as is currently suggested in the proposed regulations on lump sum distributions from corporate qualified plans. That is, a method will be determined for calculating a hypothetical employer con- tribution based on the benefits payable from the employer's existing plan. Therefore, there would be no requirement for the employer to allocate his actual contribution among the various employees. SECTION 218 (a) (3) `r3) REDUCTION APPLICABLE TO CERTAIN PUBLIC AND OTHER EMPLOYEES. -If a taxpayer has earned income for the taxable year which is not subject to tax under chapter 2, 21 or 22, the limitation otherwise determined under this subsection for such taxable year shall be reduced by an amount equal to the tax (or the increase in the tax) that would be imposed upon such income under section 3101 for such taxable year if the personal services from the performance of which such income is derived constituted employment (within the meaning of section 3121(b)). -4-- PAGENO="0073" 375 The second type of reduction or offset is based on the amount of tax'.. . or increase in tax.. ." on earned income which is not subject to social security taxes on earnings of self-employed individuals under Chapter 2 and on earnings of all other types of individ- uals in accordance with Chapter 21; and on earned income not subject to taxation under Chapter 22 - Railroad Retirement Tax Act. The Section 3101 tax represents the social security taxes paid by the participant on "wages" received by him ". . . for personal services from the performance of which such income is derived constituted employ- ment. . .". Section 3121(b) lists categories of employment that are subject to social security coverage and taxes. This type of reduction reflects the fact that social security taxes are not tax deductible to the participant. SECTION 218 (b) (4) "(4) MARRIED INDIVIDUALS-The limitation provided by this subsec- tion in the case of a married individual shall be determined without regard to the earned income of his spouse and without regard to contributions described in paragraph (2) made on behalf of his spouse. For purposes of this subsection, the earned income of a married individual shall be determined without regard to community property laws. In the case of a married couple, each spouse would be eligible to claim the lesser of 20% of earned income or $1,500 deduction, and this deduction would be applied separate- ly to each spouse. For example, if the husband has earned income of $12,000, the tax deduction he could claim is subject to the maximum limit of $1,500, since his income exceeds $7,500. If his wife has income of $7,000, her deductible contribution could not exceed $1,400 (20% times $7,000). Between both of them, they would be permitted a total deduction of $2,900 ($1,500 for the husband plus $1,400 for the wife.) Community property laws are found in eight states - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Washington. Under the community property system, property is either separate property of the husband and wife, or community property of both. Property acquired by either spouse as wages or earnings after marriage is considered community property in which each spouse has a half interest. Take another example in which the hus- band earns $16,000 and the spouse has no other earnings. Under community property, half or $8,000 would be considered earnings of the husband and the other half earnings of the spouse. However, under this subsection, the husband could deduct the maximum of $1,500 but the spouse could take no deduc- tion since she had no other earned income. SECTION 218 (b) (5) (A) `Y5) EARNED INCOME DEFINED-For purposes of this subsection, the term `earned income' has the meaning assigned to such term in- "(A) in the case of a self-employed individual, section 401 (c) (2), and Earned income (see specimen plan) for a self-employed individual is defined in 401 (c) (2) as ". . . net earnings from self- employment . . . such net earnings shall be -5- PAGENO="0074" 376 determined. . . only with respect to a trade or business in which personal services .. . are a material income producing factor.. Section 1.401-10 (c) (1) of the regs further defmes earned income as ". . . net earnings from self-employment .. . to the extent such net earnings constitute compensation for per- Section 911 (b) defines earned income for an individual who's not self-employed as "...wages, salaries, or professional fees, and other amounts received as compensa- lion for personal services actually render- ed, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribu- lion of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors,. . . a reasonable allowance as com- pensation for the personal services render- sonal services actually rendered within the meaning of IRC 911 (b)." Thus, a self-employed individual would compute his earned income for purposes of a savings plan, using the same method as under a Keogh plan. ed by the taxpayer, not in excess of 30% of his share of the net profits of such trade or business, shall be considered as earned income." P.L. 89-809 amended the IRC and elimina- ted the 30% restriction above for self- employed individuals and was effective for taxable years beginning after December 31, 1967. According to 401 (c) (2) (C), earned in- come also includes".. . gains and net earnings derived from the sale, .disposition, or transfer of any property or the licensing of the use of the property by an individual whose personal efforts created such property." Such individ- ual would be an author or an inventor. BILL SECTION 3(b) (b) INDIVIDUAL RETIREMENT ACCOUNTS-Part I of subchapter D of chapter 1 (relating to pension, profit sharing, stock bonus plans, etc.) is amended by adding at the end thereof the following new section: This section of the proposed legislation would amend the IRC by adding at the end of section 407 entitled, "Certain Employees of Domestic Subsidiaries Engaged in Business Outside of the United States", this proposed section 408 - Individual Retirement Ac- counts. Chapter 1 is "Normal Taxes and Surtaxes", Subchapter D is captioned "De- ferred Compensation, Etc., and Part I is "Pension, Profit Sharing, Stock Bonus Plans, Etc." and contains IRC sections 401 through 407. SECTION 218 (b) (5) (B) "(B) in the case of an individual who is not a self-employed individual, section 911 (b)" -6- PAGENO="0075" SECTION 408 (a) "SEC. 408. INDIVIDUAL RETIREMENTACCOUNTS. "(a) REQUIREMENTS FOR QUALIFICATION-A tnist, custodial ac- count, or other similar arrangement created or organized in the United States shall constitute a qualified individual retirement account under this section only if- SECTION 408 (a) (1) "(1) it is maintained for the purpose of distributing to `the individual who established it, his spouse, or his beneficiaries, the contributions thereto and the income therefrom; The first requirement is that the savings account must be maintained for the sole purpose of distributing the contributions and income thereon to the participant, his spouse, or his beneficiaries. Note that this is the first reference in the bill to the participant's "beneficiaries". The language of this legisla- tion makes continuous reference to the partic- ipant and his spouse, leading one to conclude that the only individuals that may be entitled to receive benefits from a savings account would be limited only to these two. Actually, 401 (a) describes plans and trusts for the exclusive benefit of the participant and his beneficiaries, and all throughout the code and regs the particular reference is identical. SECTION 408 (a) (2) "(2) except as otherwise provided in subsections (b) (1) and (2), contributions thereto during any taxable year may not exceed the limitation provided by section 218 (b) for such taxable year and may be made only by the individual who established it or his spouse; 377 A ". . . qualified individual retirement ac- count. . ." (hereafter referred to as a "savings account") (see section 408 (a) (3)) below may consist of".. . a trust, custodial account, or other similar arrangement. . .". As with corporate and Keogh plans, a savings account must meet certain requirements under pro- posed section 408 in order for it to be cOn- sidered a qualified trust which would be exempt from taxation under IRC 501 (a). The second requirement for purposes of qualification is that contributions may not exceed' the lesser of 20% of earned income or $1,500 limitation except in the instances of a transfer of assets from one savings plan to another as provided in the proposed bill section 408 (b) (1) and in the event of an excess contribution under 408 (b) (2). In addition, contributions may be made by only the participant or his spouse. -7- PAGENO="0076" 378 SECTION 408 (a) (3) "(3) except as otherwise provided in subsection (b) (3), the assets thereof are not commingled with the other property of the individual who established it or his spouse, and are held in trust by, or in the custody of, a bank (as defined in section 401 (d) (1)), a credit union described in section 501 (c) (14), or other person who demonstrates to the satisfaction of the Secretary or his delegate that the manner in which he will hold or have custody of such assets will be consistent with the requirements of this paragraph; The third requirement is that assets of a savings plan may not be commingled with the other property belonging to the participant or his spouse. In other words, the contributions made to the savings plan must remain separate and apart from the participant's and spouse's personal property, i.e., checking account, securities account, life insurance policies, etc., except that investment of the assets may be made in a common trust fund sponsored by a bank or trust company per subsection 408 (b) (3). This requirement also states that the saving plan's assets must be ". . . held in trust by, or in custody of: l.a bank, as defined in 401 (d) (1).. Here a bank is a corporation which under the laws of the State of incorpora- tion is subject to supervision and exam- ination by the commissioner of banking or other officer of such State in charge of the administration of the banking laws of such State. . .". A bank is further defmed under section 581 and the last sentence states that a bank ". . . means a domestic.building and loan association." 2. ". . . a credit union, described in section 501 (c) (14) . . ." In this section, a credit union without capital stock is included in the list of exempt organizations under 501 (c) and must operate without profit for the mutual purposes of providing reserve funds for, and insurance of, shares or deposits in domestic building and loan associations, cooperative banks, and mutual savings banks. 3.".. . or other person who demonstrates to the satisfaction of the Secretary or his delegate that the manner in which he will hold or have custody of such assets will be consistent with the requirements of this paragraph. It appears that it would be possible to establish either a savings account trust or a custodial account, the latter of which is conceived under IRC section 401 (f) and section 1.401-8 of the regs. A "trust" would involve a formal plan document that would be entered into by the participant in the savings plan and a trustee. There is no indication as to whom the trustee may be, but it is assumed that it could be a bank. Provision for a "custodial account" was first made under H.R. 10, or the Keogh Act, and this type of funding vehicle is described below. However, it appears that a "custodial account" may also mean a custodian or custody arrangement which would refer to anybody under state law who is permitted to hold the assets of some other person. Includ- ed in this category would be a bank using a custodian account or a member firm of the New York Stock Exchange where their only responsibility is safekeeping of the assets, maintenance of adequate records, etc. This type of arrangement implies no fiduciary obligation or duty and certainly would not be subject to the laws that would affect an ordinary trust. This is certainly quite different compared to the requirements for Keogh plans where section 401 (d) (1) of the Code and section 1.401-12 (c) (2) of the regs state the trustee of a Keogh trust must be a bank. The same Code section and 1.401-12 (c) (4) provide for an exception to this requirement. The bank-trustee requirement does not apply to a trust which uses annuity, endow- ment, or life insurance contracts of a life insurance company exclusively to fund the benefits prescribed by the trust, if the life insurance company supplies annually such information about trust transactions affecting owner-employees. . .". This same reg section further states that the proceeds under the contract must be payable directly to the -8- PAGENO="0077" 379 employee or his beneficiary and ". . that the plan must contain a provision that the em- ployer is to substitute a bank as trustee or custodian of the contracts if the employer is notified by the IRC that such substitution is required because the trustee is not keeping such records, or making such returns, or rendering statements, as are required.. It is interesting to note the holding of Rev. Rul. 66-253. This ruling involved a Keogh plan where the trust agreement names the sole proprietor, who was the only participant and therefore the only beneficiary under the trust, as the sole trustee of the plan, which was funded through the purchase of annuity or other insurance contracts. The question was raised whether or not a trust had been created, since the beneficiary and the trustee were the same individual. It was held that the plan could qualify as a non-trusteed annuity plan under IRC 403 (a) and that a trust would not be necessary provided that the contracts purchased under the plan are non-transferable meeting the requirements of 1.401-9 of the regs. Based on this precedent, it is possible to conclude that the participant in a savings plan could also act as trustee of his own plan. Despite the fact that the participant's spouse may also be a beneficiary under a savings plan, she could also be named as trustee. HR. 10, or the Keogh Act, first introduced the concept of the custodial account as a funding vehicle for retirement plans. This alternative is being used by various mutual fund sponsors of both Keogh and corporate plans where a bank acts as custodian in a trustee capacity under a custodial agreement. H.R. 10 added section 401 (f) (section 1.401-8 of the regulations) to the IRC in 1962 and states that a custodial account may be treated as a qualified trust if the following five requirements are met: 1. The custodial account must otherwise satisfy all the other requirements of section 401 that are applicable to qual- ified trusts, i.e., must be a written agreement constituting a valid contract under local law, etc. 2. The custodian must be a bank as defined in IRC section 401 (d) (1). 3. The custodial agreement specifically pro- vides that investment of the funds is made SOLELY in one or more mutual fund shares OR SOLELY in annuity, endowment, or life insurance contracts issued by an insurance company. 4. The mutual fund shares must be register- ed in the name of the custodian or its nominee and the covered employee must be the beneficial owner. 5. The insurance contracts must be held by the custodian until distributed in accord- ance with the provisions of the plan. "Or other person" does not necessarily mean an individual person but apparently an organization other than a bank, insurance company, mutual fund, or trade and profes- sional association, all of whom are currently eligible to act as sponsors of both corporate and Keogh master/prototype plans. At this time, it seems that "other person" may include member firms of the New York Stock Exchange. Other candidates, such as general agents of life insurance companies, broker/ dealer organizations, employee benefit con- sulting firms would have to".. . demonstrate to the satisfaction of the Secretary or his delegate that the manner in which (they) will hold or have custody of such assets will be consistent with the requirements of this para- graph.. This is the first indication in the proposed legislation that a formal plan document "...or other governing instrument...' (see 408 (a) (5)) and a trust or custodial agree- ment will have to be designed and drafted and probably be submitted to the IRS's National Office in Washington for pre-approval prior to the time that savings plans could actually be sold by the various types of financial organi- zations. This procedure would probably be similar in concept to the Keogh and corporate master and prototype arrangements which are currently being used by eligible sponsors, including banks, insurance companies, mutual funds, and trade and professional associations. According to John Nolan formally of the Treasury Department in a speech given March, 1971 at the Annual Meeting of the Associa- tion for Advanced Life Underwriting during his discussion of tax deductible employee contributions, "Master and prototype plans -9- PAGENO="0078" 380 paralleling the H.R. 10 and corporate experi- ence would be set up by banks, insurance companies and mutual funds and would be widely advertised and promoted." Many government officials agree that sav- ings plans will be approved as master! prototype plans, but there is some diverse opinion on this matter. Any further word on this will be included as part of a supplement to this Guide. The question now arises whether or not it would be possible to design and draft a custom designed savings plan for the partici- pant and his spouse. This approach would be desirable if the participant is dissatisfied with the master/prototype plans offered by the sponsors, especially since many of the plans would be tied to the sponsors' own products, i.e., insurance contracts, mutual fund shares, or bank commingled or collective trust funds. Let's compare the experience of custom designed plans vs. master/prototype plans in the Keogh area. Based on one set of figures that is available, there were 306 custom designed Keogh plans approved by the IRS during the first three months of 1970 which are always the heaviest approval months, since most Keogh plans are submitted prior to December 3 1st of the previous year. This figure can be compared to 54,489 Keogh plans, both master/prototype and custom designed, approved for the quarter ending March 31, 1969. As you can see the incidence of Keogh custom designed plans is infintisimal compared to pre-approved prototypes. In the savings plans area, the number would be even smaller since this would represent a direct out-of-pocket expense. The legal expenses incurred by a self-employed individual, pro- prietor, or partnership are tax deductible to the appropriate entity. They may or may not be deductible to the individual participant. SECTION 408 (a) (4) "(4) except as otherwise provided in subsection (b) (1), under the plan or other governing instrument, no benefits may be paid to the individual who established it, except in the case of his becoming disabled (within the meaning of section 72 (m) (7)), before he or his spouse attains the age of 59V2 years; The fourth requirement for qualification of an individual retirement account is that bene- fits under the plan may not be paid to the participant or his spouse prior to attaining age 59Y2 (insurance age 60) except in the event of disability of the participant (not the spouse. Section 72~of the Code concerns itself with annuities and proceeds of endowment and life insurance contracts that are* included for purposes of determining gross income for federal income tax purposes. Subsection (m) lists special rules applicable to employee annuities and distributions under employee plans. Disability for purposes of a savings plan is defined according to section 72 (m) (7) as "...the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite dura- tion." (See section 1.72.17 (1) of the regs for further clarification of the meaning of disabil- ity.) Compared to disability, as defined under most other types of qualified plans, this is a liberal definition and is similar to the one used under section 223 of the Social Security Act in order to be entitled to social security disability benefits. The only difference ap- pears in the last phrase which states that the physical or mental impairment ". . . can be expected to last for a continuous period of not less than 12 calendar months.. .". It can be concluded that if the participant is entitled to social security disability benefits, it is possible to distribute the assets of the savings plan without being considered a premature distribution and subject to the penalty tax. -10- PAGENO="0079" A comparable early benefit distribution date is also applicable to Keogh plans under 401 (a) (9) (A) and 1.401-11(e) (2) of the regs. It is important to note that not a single section of this bill refers to death of the participant or his spouse. In other words, no specific provision is made concerning distribu- lion of the assets in the savings account in the event of the participant's death regardless of his age. This represents a serious omission on the part of the draftsmen of this bill and will probably be corrected upon examination in committee. The rule against premature distributions does not have the converse meaning, i.e., that distributions must begin immediately after age 59Yz has been reached. Actual distribu- tions to the participant after attainment of age 59½ are determined by the provisions "...under the plan or other governing instru- ment.. .". For example, if the savings plan provides for a normal retirement age of 65, the participant would not be entitled to a distri- bution from the plan merely because he had attained age 59½, so says 1.401-12 (m)(2) of the regs. Therefore, it may be desirable to provide for an early distribution date after age 59½ and a normal distribution date at 70½ (see specimen plan and section 408 (a) (5)). Let's look at the situation where the participant "retires" prior to age 59½, or the The fifth requirement for qualification of a savings plan is that the entire interest in the savings account must be distributed to the participant not later than the taxable year in which he attains age 70½ (insurance age 71). This should be considered the normal distrib- ution date of the plan (see specimen plan). However, the participant does not have to retire at age 70½ although benefits must 381 plan was terminated prior to the time the participant had attained age 59½, and a premature distribution of all the assets in the savings account was made to the participant. Probably one reason why a savings plan is terminated is because the participant is not able to make substantial contributions to the plan because he no longer has earned income. Section 1.401-12 (m) (1) (ii) of the regs provides that ". . . no contribution shall be made under the plan by, or for, an owner- employee (in a Keogh plan) during any of the five taxable years of the plan beginning after the distribution is made." In effect, this penalty provision could be meaningless since no further contributions would be made in the event the participant "retired" or the savings plan was terminated. However, it was held in Rev. Rul. 65-21 that the age 59½ restriction must remain applicable despite the fact that the Keogh plan is terminated. A savings plan must contain an affirmative provision against premature distributions even though local law requires payment on de- mand, so says Rev. Rul. 69-313. Here, an insurance company submitted a prototype Keogh plan that omitted the usual affirmative provision because the applicable state insur- ance law requires an insurance company to pay the cash surrender value at any given time upon request of the insured or other party. It was held that the prototype plan would not be approved. commence to be paid from the plan at this age. According to reg section 1.401-11(e) (7), it is possible to continue working and also to make new deductible contributions. A comparable normal benefit distribution date is also applicable to Keogh plans under IRC 401 (a) (9) (A) and reg section 1.401-11 (e) (2) (see also Rev. Rul. 66-12). SECTION 408 (a) (5) "(5) under the plan or other governing instrument, the entire interest of the individual who established it will be distributed to him not later than his taxable year in which he attains the age of 70?/2 years, or will be distributed, commencing not later than such taxable year. -11- PAGENO="0080" 382 SECTION 408 (a) (5) (A)-(B) in accordance with regulations prescribed by the Secretary or his delegate, over- "(A) the life of such individual or the lives of such individual and his spouse, or "(B) a period not extending beyond the life expectancy of such individual or the life expectancy of such individual and his spouse; and In the event that a distribution of the entire interest is not made to the participant, then the assets of the savings account must be distributed: 1. Over the participant's life time or the lives of the participant and his spouse or 2. over a period of time that does not exceed the participant's life expectancy or the joint life expectancy of the participant and his spouse. A comparable provision applies to Keogh plans and is found under IRC 401 (a) (9) (B). SECTION 408 (a) (6) "(6) if contributions thereto may be used for the purchase of annuity or similar contracts issued by a life insurance company, under the plan or other governing instrument, any refunds of premiums and any amounts in the nature of a dividend or similar distribution must be held by the issuer of such contract and may be applied only toward the payment of future premiums or to the purchase of additional similar benefits. The sixth and final requirement for qualifi- cation of a savings account is that in the event that the savings plan provides that contribu- tions are to be applied toward the ". . . pur- chase of annuityor similar contracts issued by a life insurance company.. .", then the prem- ium refunds, dividends, or other "similar distributions" may not be refunded to the participant, but must be held by the insurance company and may be used only to offset premiums made in subsequent years or may be applied toward the purchase of additional insurance contracts that are similar in nature. This, sixth requisite conforms to code sec- tion 401 (a) (2) which provides that the plan assets must be used for the exclusive benefit of the participant and his beneficiaries and may not be diverted for any other purposes. Section 404 (a) (2) discusses deductions for contributions made by an employer for the purchase of employees' annuities, including retirement annuities, and states that refunds of premiums (dividends) must be applied toward the purchase of additional annuity contracts. Further, the regs 1.404 (a)-8 (a) (3) say that the forementioned requirement "...must be a definite written arrangement between the employer and the insurer. . . The arrangement may be in the form of contract provisions or written directions of the employer or partly in one form and partly in another." Refunds of premiums means "...payments by the insurer on account of credits such as dividends, experience rating credits, or surrender or cancellation credits." (See also Rev. Ru!. 69-42! Part 3 (fl) -12--- PAGENO="0081" 383 SECTION 408 (b)(l) `Yb) SPECIAL RULES.- "(1) TRANSFER OF ASSETS-Subsections (a) (2) and (a) (4) shall not be applied to prevent the contribution of amounts to which section 72 (p) would otherwise apply to a qualified individual retirement account for the benefit of the same taxpayer or the same taxpayer and his spouse. In addition to the six requirements for qualification of a savings account, the pro- posed legislation calls for, three "special rules". The first concerns itself with "transfer of assets" and says that assets of one savings plan may be transferred to any other savings plan despite the fact the total amount of assets involved in the transfer may exceed the 20% of earned income or $1,500 limitation. Such a transfer will not be considered a premature distribution even if the transfer is made prior to the time the participant reaches age 59½ or becomes disabled. Section 72 (p) is entitled, Cross Reference, and says, "For limitation on adjustments to basis of annuity contracts sold, see section 1021." This latter section of the Internal Revenue Code is part of Chapter 1, Subchapt- er 0 - Gain or Loss on Disposition of Property, Part II - Basis Rules of General Application, and section 1021 is headlined as Sale of Annuities and reads as follows, "In case of the sale of an annuity contract, the adjusted basis shall in no case be less than zero." For further amplification see regs 1.1021-1. Because of the problems of transferring Keogh assets to corporate plans, precedent has been established in the form of several revenue rulings (55-427, 55-368, 67-213, and 68-160), an informal letter ruling dated Feb- ruary 18, 1971 (see October 1971 issue of The Prototype Planner), and more recently, Rev. Rul. 7 1-541. These rulings conclude that a participant would not be in receipt of income if the savings plan assets are trans- ferred directly from one funding medium to another without being made available to the participant. Although this principle is not specifically mentioned in this bill, it certainly would be applicable to savings plans. SECTION 408 (b) (2) "(2) LIMITATION ON CONTRIBUTIONS-Under regulations prescrib- ed by the Secretary or his delegate, rules similar to the rules provided in paragraphs (2) and (3) of section 401 (e) (relating to excess contributions to a qualified individual retirement account to the extent necessary to carry out the purposes of this section. The second special rule discusses contribu- tions that exceed the lesser of 20% or $1,500 limitation and regulations similar to the rules contained in IRC 401 (e) (2) and (3) will be proposed by the IRS in order to carry out the purposes of this section (2). IRC 401 (e) (1) defmes an excess contribu- tion that is not deductible under section 404, which for purposes of a savings plan would mean any contribution greater than 20% of the first $7,500 of earned income. In fact, 401 (d) (5) says that if the plan provides that excess contributions may be made, the plan will not qualify. In other words, the plan must specifically state that amounts in excess of the limitation may not be contributed on behalf of the participant. (See specimen plan.) This does not mean that the plan will be disqualified in the event of excess contribu- tions. In fact, 401 (d) (8) requires that the plan should provide that any excess contribu- tions are to be repaid to the participant. This sounds like gobble-de-gook, but this is what the code says. -13-- 78-202 0-72-pt. 2-6 PAGENO="0082" However, 401 (e) ends by saying ". . the amount of any contribution which is allo- cable. . . toward the purchase of life, acci- dent, health, or other insurance shall not be taken into account." This is further explained in reg section 1.401-13 (b) (1), ". . . The amount of any contribution which is allocable to the cost of insurance protection (P.S. 58 costs) is determined in accordance with reg section 1.404 (e)-1 (f) and IRC 1.72-16 (b). The former says that ".. . such amounts are neither deductible nor considered as contribu- tions for purposes of determining the maxi- mum amount of contribution that may be made on behalf of (the participant).. .". The latter concerns itself with the treatment of the cost of life insurance protection and provides an example how to determine the amount of additional taxable income attribut- able to the cost of life insurance protection that must be reported by the participant for income tax purposes. It has even been held in Rev. Rul. 68-56 that the extra premium added to the cost of the insurance contract by reason of the substandard health condition of the partici- pant is not included in determining whether a contribution to a savings plan is an excess contribution. Because contributions to savings plans may fluctuate up and down with changes in a participant's earned income, 401 (e) (3) pro- vides for a three year averaging method to facilitate payment of level annual premiums as follows: A participant may purchase insur- ance policies on his own life and the amount of the level annual premium may be based on his earned income for the most recent three taxable years ending prior to the date the latest contract was issued or modified to pro- vide additional benefits under the plan. Once the participant begins to pay the premium, he will not have to cancel the policy should his income drop below the average. However, his tax deduction is based solely on earned in- come for the current taxable year. This was the holding of Rev. Rul. 69-38. On the other hand, Rev. Rul. 65-200 says that if average earned income increases, an additional policy may be purchased or an existing contract may be increased, and the last policy issued under the plan will be considered to be issued in the current taxable 384 year. However, if the participant pays premiums on the policies based on earned income using the three year averaging rule in order to avoid the effect of the excess contribution rule, the $1,500 limitation on premiums paid for such contracts includes the cost of the insurance protection, according to 1.401-13 (c) (1) (ii). If the amount of excess contribution made to a savings plan and any income earned thereon are repaid to the participant within six months after receiving notification from the IRS that the amount was excessive, the participant will not lose his deduction for the contribution to the extent that it was not excessive. In addition, any income earned on the excess contribution will be includable in his gross income. If the excess contribution and any income earned are not repaid within six months after notification, the savings plan is temporarily disqualified. Until such time the excess amount is returned, the participant will not be permitted to take a tax deduction for any contributions made to the plan in subsequent years. In addition, income earned on assets attributable to his interest will be included in his gross income for the period during which the excess was not repaid. (See 401 (e) (2) and 1.401-13 (d)(2) for further amplification.) Note that the amount of contribution to be returned is the excess ". . . less any loading charge or other administrative charge ratably allocable to such excess contribution. . ." per 1.401-13 (d) (4). However, Rev. Rul. 69-571 involved the purchase of no-load mutual fund shares that declined 20% in value after two years, and the ruling concluded that the loss in market value, between the time the contri- bution was made and the time that it was determined that a portion is excess, is not a loading or other administrative charge despite the fact that the loss in value brings the contribution within the limitation. According to Isidore Goodman in a speech given on September 27, 1967, "Where a participant willfully makes an excess contrib- ution, his entire share must be turned over to him and he is barred from participating in any qualified plan as a self-employed individual for five years." Whether this means that a participant in a savings plan could not con- tinue to be a member of his employer's -14- PAGENO="0083" 385 qualified plan for five years, poses an interest- ing question. Mr. Goodman continues on to say that in the event of a willful excess contribution, ". . . there is no provision for repayment of the excess contribution in order to avoid the penalty." (See Paragraph 29,508 Prentice Hall and citations provided.) If the savings plan is funded through the purchase of U.S. Government Retirement Bonds, as provided for in 405, the excess contribution rule does not apply. SECTION 408 (b) (3) `r3) USE OF COMMON TRUSTFUNDS.-Subsection (a) (3) shall not be applied to prevent the investment of the assets of a qualified individual retirement account in a common trust fund. The third and last special rule applies to the use of "common trust funds," and says that contributions made to a savings plan may be invested in a "common trust fund" even though some of the other property of the participant or his spouse may also comprise part of the fund. This represents an exception to the requirement for qualification that savings account assets may not be commingled with the participant's or his spouse's other property, as provided in sub- section 408 (a) (3). "Common trust funds" are defined under IRC 584 as,".. . a fund maintained by a bank exclusively for the collective investment and reinvestment of moneys contributed thereto by the bank in its capacity as a trustee, executor, administrator, or guardian; and in conformity with the rules and regulations of the Board of Governors of the Federal Re- serve System or the Comptroller of the Currency pertaining to the collective invest- ment of trust funds by national banks." (See Rev. Rul. 56-267 for requirements of a common trust fund for qualified trusts under 501 (a) of the Code.) SECTION 408 (c) `Yc) TREATMENT AS QUALIFIED TRUST BENEFITING OWNER- EMPLOYEE.-For purposes of subchapter F and subtitle F, a qualified individual retirement account shall be treated as a trust described in section 401 (a) which is part of a plan providing contributions or benefits for employees some or all of whom are owner-employees (as defined in section 401 (c) (3)), the individual who established such qualified individual retirement account and his spouse shall be treated as owner-employees for whom such contributions or benefits are provided, and the person holding or having custody of the assets of such qualified individual retirement account shall be treated as the trustee of such trust. Subtitle F is headed, "Procedure and Ad- ministration" and concerns itself with sub- jects relating to information, reporting and filing of tax returns on behalf of the savings account. Subchapter F - Exempt Organiza- tions contains sections 501-504 providing for exemption of the savings account from taxa- tion. This section provides that a savings account shall be treated as a trust as described in section 401 (a) which is part of a plan providing contributions or benefits for em- ployees some or all of whom are owner- -15- PAGENO="0084" 386 employees. An owner-employee is defined in 401 (c) (3) as ". . . an employee who owns the entire interest in an unincorporated trade or business; or 10% of either the capital or the profits interests in such partnership." Section 1.401-10 (d) of the regs further defines an owner-employee as "...a proprietor or a proprietorship, or, in the case of a partner- ship, a partner who owns more than 10% of the profits interest of the partnership." The second statement of this section says that the individual who establishes the savings account and his spouse shall be treated as owner-employees. Therefore, they would be subject to all the sections of the code and the regulations that affect owner-employees un- der Keogh plans, as opposed to common law employees or other owner-employees who retain less than 10% interest in the capital or profits of a partnership. The rules affecting these other employees are not mentioned in this Guide since only an individual with earned income, his spouse, and their beneficiaries are entitled to benefits under a savings plan. The third and final statement is that the "...person holding or having custody of the assets of a savings account shall be treated as the trustee such trust." It is desirable again to point out the requirement applicable to Keogh plans as provided in 401 (d) (1) wherein a bank must act as trustee for a trust established for self-employed individuals. Subchapter F also includes the sections of the code and the regs that incorporate all the prohibited transaction rules applicable to Keogh plans. Section 503 (g) (1) of the code and reg section 1.503 (j) (1) provide ". . . that the term "prohibited transaction" includes any transaction in which the trust, directly or indirectly, (1) lends any part of the corpus or income of the trust to; (2) pays any compensation for personal services rendered to the trust to; (3) makes any part of its services available on a preferential basis to; (4) acquires for the trust any property from, or sells any property to; any other trust described in 503 (c) (see for further specifics), or to any owner-employee, a member of the owner-employee's family, or a corporation controlled by the owner- employee through ownership as outlined in these sections. SECTION 408 (d) (1) "(d) TAXABILITY OF BENEFICIARY OF QUALIFIED INDIVIDUAL RETIREMENTACCOUNT.- "(1) iN GENERAL-Except as provided in paragraph (2), the amount actually distributed or made available to any beneficiary by a qualified individual retirement account shall be taxable to him, in the year in which so distributed or made available, under section 72 (relating to annuities). This is the fourth and next to last sub- section under 408 - Individual Retirement Accounts and says that if any or all of the assets in a savings account is ". . . actually disttibuted or made available to any benefici- ary... the entire amount must be included in the beneficiary's gross income for the year in which the distribution was made or in which the savings account was first made available to the beneficiary. Reference to the term "made available" occurs through both the code and the regulations. According to Isidore Goodman in a speech given in 1962, terms "made available" and "construc- tive receipt" are synonymous and are used interchangeabily. The problem is to determine when an amount, representing a participant's interest under a savings plan has been paid or made available." -16- PAGENO="0085" 387 SECTION 408 (d) (2) "(2) RECONTRIBUTED AMOUNTS-Paragraph (1) shall not apply to any amount distributed or made available by a qualified individual retirement account to the individual who established such account to the extent that, within 60 days after the day on which such amount is distributed or made available, such amount is contributed to a qualified individual retirement account for the benefit of such individual or such individual and his spouse. In accordance with the exception mention- ed in paragraph (1), the amount in a savings account actually distributed or made available to any beneficiary will not be includable in gross income for tax purposes if such amount is actually "recontributed" to another savings account for the benefit of such individual and his spouse within 60 days after the day on which such amount is distributed or made available. This 60 day requirement is referred to in IRC 72 (h) and Rev. Rul. 59-94 which say that if the participant elects within 60 days after termination of employment to take a lump sum distribution in the amount of his interest, and the amount of distribution is applied toward an annuity contract, then the amount of the lump sum distribution is not taxable at the time that it is paid to the participant. SECTION 408 (d) (3) "(3) APPLICABILITY OF SECTION 72 (m). -Under regulations pre- scribed by the Secretary or his delegate, an individual establishing a qualified individual retirement account shall be treated as an owner-employee for purposes of applying paragraphs (1), (2), (3), and (4) of section 72 (m) (relating to special rules applicable to employee annuities and distributions under employee plans). IRC Section 72 (m) is entitled, "Special Rules Applicable to Employee Annuities and Distributions Under Employee Plans" and contains seven paragraphs, the first four of which are referred to specifically in this paragraph of the proposed bill. Paragraph (1) is headed, "Certain Amounts Received Before Annuity Starting Date" and says that amounts received under insurance contracts are includable in gross income to the extent that such amounts do not exceed the aggregate premiums applied toward the purchase of the contracts for taxable years during which such premiums represented de- ductible contributions under proposed IRC section 218 (a). Paragraph (2) is "Computation of Consid- eration Paid by the Employee" and provides that in computing the aggregate amount of premiums paid for insurance contracts (invest- ment in the contract), the portion of the premium allocable to the cost of the insur- ance contract (P.S. 58 costs) which is taxable to the participant is not included for purposes of determining the aggregate premium applied toward the purchase of the policies. The third paragraph is "Life Insurance Contracts" and states that contributions made to a savings plan, deductible to the partici- pant, and used for the purchase of insurance contracts are fully taxable to the participant in the year when so applied. In addition, in the event of the death of the individual under the insurance contract, the amount of the cash value of such contracts shall be treated as a payment or distribution from the plan and the difference between the face amount and the case values (pure insurance element) is not -17-- PAGENO="0086" 388 included in gross income for tax purposes. The fourth and last paragraph mentioned in this proposed legislation is headed, "Amounts Constructively Received" and says that if a participant assigns or pledges any portion of his interest in the savings account, such portion shall be treated as a distribution from the savings account. ifl addition, if the partici- pant receives, directly or indirectly, any amount from an insurance company as a loan under a policy purchased by the savings plan and issued by the insurance company, such amount shall be treated as an amount received under the contract. SECTION 408 (e) `re) CAPITAL GAINS TREA TMENTAND LIMITATION OF TAX NOT TO APPLY TO DISTRIBUTIONS-Section 72 (n), section 402 (a) (2), and section 403 (a) (2) shall not apply to any amount distributed or made available by a qualified individual retirement account." This is the fifth and last paragraph under section 408 of these bills and as the title says capital gains treatment and the limitation of tax does not apply to distributions made from savings plans. Section 72 (n) is headed, "Treatment of Total Distributions" and states that amounts distributed to a beneficiary of a savings plan within one year on account of the participant's death, separation of service after the participant has attained age 59'/2, or after becoming disabled, shall not be consider- ed a gain from the sale or exchange of a capital asset held for more than six months as provided in 402 (a) (2) and 403 (a) (2). Reg. sections 1.72-18 (aXd) provide for a limitation on the capital gains treatment. Where the individual has participated in the plan for five or more years prior to the year of such distribution, the tax is five times the increase in tax resulting from adding 20% of the taxable portion of the distribution to his other income. As captioned in the heading of this 408 (e), the provisions in the code concerning this limitation of tax are not applicable to savings plans. These same rules are also applicable to owner-employees and other self-employed in- dividuals (but not common law employees) under the Keogh act. BILL SECTION 3(c) (1) (c) TREATMENT OF DISTRIBUTION FROM QUALIFIED INDIVID- UAL RETIREMENTACCOUNTS.- (1) IN GENERAL. Section 72 (relating to annuities) is amended by redesignating subsection (p) as subsection (q) and by inserting after subsection (o) the following new subse ction: This is the third section of the bill and it amends IRC (72) and assigns the letter (q) to existing section (p) - "Cross Reference" and adds section (p) below after section (o) - "Annuities Under Retired Serviceman's Family Protection Plan". -18- PAGENO="0087" 389 SECTION 72 (p)(1)(A) AND (B) "(p) PREMA TURE DISTRIBUTIONS FROM QUALIFIED INDIVID- UAL RETIREMENTACCOUNTS- "(1) APPLICATION OF SUBSECTION-This subsection shall apply to- "(A) distributions from a qualified individual retirement account, and "(B) amounts which are received from a qualified trust described in section 401 (a) or under a plan described in section 403 (a), but only to the extent attributable under regulations prescribed by the Secretary or his delegate to amounts with respect to which a deduction was under section 218 (relating to retirement savings) which are includible in gross income and which are received by the individual who established such qualified individual retirement account or who was allowed such deduction (or the spouse of such individual) before he or his spouse attains the age of 591/2 years, for any reason other than his becoming disabled (within the meaning of subsection (m) (7)), but only to the extent that such amount is not contributed within 60 days after the day on which such amount is distributed or made available to a qualified individual retirement account for the benefit of such individual or such individual and his spouse. This new section is entitled, "Premature Distributions from Qualified Individual Re- tirement Accounts" and states that unless a participant in a savings plan is considered disabled, as defined in 72 (m) (7), he may not withdraw any of the assets from the plan until he is at least age 59½. In the event of such a distribution, it is éalled a "premature distribu- tion", and is includable in the gross income of the participant or his spouse, provided that the actual distribution itself is not "recontrib- uted" to another savings plan for the benefit of the participant and/or his spouse within 60 days after the amount was distributed or made available. This ban on premature distrib- utions serves to prevent savings plans from becoming income-averaging devices under which deductible contributions would be made in high-income tax years and the assets in the savings plan would be used in low- income or loss years when little or no tax would be payable. SECTION 72 (p) (2) "(2) AMOUNT OF PENALTY-If an individual is required to include in gross income for the taxable year an amount to which this subsection applies, there shall be imposed an additional tax'for such taxable year equal to 30 percent of such amount. Any tax imposed under this paragraph shall not be reduced by any credit under part IV of subchapter A (other than sections 31 and 39 thereof), and shall not be treated as tax imposed by this chapter for purposes of section 56.". In the event of a premature distribution to the individual (which includes the participant his spouse, or his beneficiary), a tax penalty will be imposed on the amount of the premature distribution which is taxable to the individual. The penalty is 30% of the amount that is considered a premature distribution. For example, if the amount of the distribu- tion was $10,000, the penalty tax would be $3,000 (30% times $10,000). Under a Keogh plan as provided for in 72 (m) (5) of the Code, there is a double penalty for a premature distribution. One results in partial disqualification and the other is also in the form of a tax penalty which is much less severe compared to the penalty called for -19- PAGENO="0088" 390 under this subsection. In Keogh, the penalty is determined by two different methods depending upon whether or not the amount of distribution is more or less than $2,500. If the distribution exceeds $2,500, the tax imposed is the greater of (1) the increase in tax which is attributable to the inclusion of the distribution in gross income for the taxable year in which the distribution is received or; (2) 110% of the increase in tax that would have resulted if the distribution had been subject to income tax in equal installments over the year in which the distribution was made and the preceeding four years. In the event that the amount of the premature distribution is less than $2,500, the tax due is 110% of the increase in tax which results from including the amount of the distribution in gross income for the year in which it is paid. The second type of penalty is provided for under 401 (d) (5) (C) and 1.401-12 (m) (i) and is imposed on the individual who accepts a premature distribution. According to these sections, no contribution may be made on behalf of the participant during any of the five taxable years of the plan beginning after the distribution is made. This must be specif- ically provided for in the plan document (see specimen plan). Although no contributions are being made on his behalf, the savings account assets may still accumulate tax free, and he could continue to enjoy all the other rights and priviledges of participation. The second sentence of 72 (p) (2) says that the amount of penalty tax shall not be reduced by any credit under part IV - "Credits Against Tax," of subchapter A - "Determination of Tax Liability," other than by section 31 - "Taxes Withheld on Wages" and section 39 - "Certain Uses of Gasoline, Special Fuels, and Lubricating Oil.". In other words, the penalty tax imposed on the amount of premature distribution from a savings plan is not diminished by any federal withholding taxes or by any federal taxes imposed on gasoline used for farming pur- poses or on fuel and lubricating oil used by vehicles not using the public highways. In addition, the amount of penalty tax on a premature distribution shall not be considered as a tax in determining the minimum tax for purposes of section 56 - "Imposition of Tax," Part IV - "Minimum Tax for Tax Preferences," Subchapter A, Chapter 1 of the Internal Revenue Code. BILL SECTION 3(c) (2) (A) (2) INVESTMENTIN THE CONTRACT.- (A) Subparagraph (A) of section 72 (c) (1) (relating to definition of investment in the contract) is amended by inserting after "contract" the following: "for which no deduction was allowed under section 218 (relating to retirement savings)". Section 72 (a) provides that an individual's gross income includes any amount received as an annuity under an insurance contract and 72 (b) continues on by stating that gross income does not include any part of an annuity which bears the same ratio as the "investment in the contract," as of the "annuity starting date," (defined below) bears to the expected return under the contract. "Investment in the contract" is defined in IRC 72 (c) (1) (A) and (B) as "...the aggregate amount of premiums or other con- sideration paid for the contract, minus the aggregate amount received under the contract before the annuity starting date to the extent that such amount was excludable from gross income.. .". (See reg section 1.72-6 (a) for description of the method of computing the "investment in the contract". In addition, there are three examples illustrating this method.) This 3 (c) (2) (A) section of the bill -20- PAGENO="0089" proposes to amend subparagraph 72 (c) (1) (A) of the Code by inserting after the first word "contract" in the above definition the following: "...for which no deduction was allowed under section 218 (relating to retire- ment savings)." In other words, amounts contributed to a 391 savings plan that are not tax deductible to the participant are comparable to premiums paid for insurance policies and are included in the exclusion ratio for purposes of calculating the taxable and non-taxable elements of annuity payments. BILL SECTION 3(c) (2) (B) (B) Section 72 (d) (2) (relating to employees' annuities) is amended by striking out "and" at the end of subparagraph (A), by striking out the period at the end of subparagraph (B) and inserting in lieu thereof "; and", and by inserting after subparagraph (B) the following new subparagraph: Section 72 (d) is entitled, "Employees' Annuities" and paragraph (2) is headed, "Special Rules for Application of Paragraph (1) Employee's Contributions Recoverable in 3 Years." This proposed section 3 (c) (2) (B) would amend subparagraph A of the present Code section 72 (d) (2) by first deleting the word "and" after the first of two subparagraphs, eliminating the period at the end of subpara- graph (B) and inserting the word "and" after the last word "employee" of this subpara- graph. These two changes would then make it possible to add a third subparagraph (C) as follows: SECTION 72 (d) (2) (C) "(C) any contribution made with respect to the contract shall not be treated as consideration for the contract contributed by the employee to the extent that a deduction was allowed under section 218 (relating to retirement savings) for such contribution." This proposed subparagraph 72 (d) (2) (C) of the Code states that contributions made to a savings plan by the participant that are also tax deductible are not considered as an "investment in the contract," and therefore may not be included as part of the exclusion ratio in determining taxable and non-taxable elements of annuity payments from insurance policies. Obviously, since the participant is entitled to deduct his contributions, he is deferring income until retirement, and at that time it would be necessary to include in his income any annuity payments received. Note that the word "employee" is used in this subparagraph in order to conform to the use of "employee" in previous subparagraphs (A) and (B) under 72 (d). And this is despite the fact that the word "individual" appears in all the other sections of this bill. -21- PAGENO="0090" 392 BILL SECTION 3(c) (3) (3) AMOUNTS RECEIVED BEFORE ANNUITY STARTING DATE.- Section 72 (m) (1) (relating to special rule applicable to amounts received before annuity starting date) is amended to read as follows: The "annuity starting date" is defined in 1.72-4 (b) (1) of the regs as ". . the first day of the first period for which an amount is received as an annuity . . and shall be which- ever of the following is the later: (i) the date upon which the obligations under the contract becomes fixed, or (ii) the first day of the period.., which ends on the date of the first annuity payment. This section 3 (c) (3) proposes to amend 72 (m) "Special Rules Applicable to Employee Annuities and Distributions Under Employee Plans." Paragraph (1) is captioned, "Certain Amounts Received Before Annuity Starting Date," and would be amended to read as follows: SECTION 72 (m)(1) "(1) CERTAIN AMOUNTS RECEIVED BEFORE ANNUITY START- ING DATE. -Any amounts received under an annuity, endowment, or life insurance contract before the annuity starting date which are not received as an annuity within the meaning of subsection (e) (2) ) shall be included in the recipient's gross income for the taxable year in which received to the extent that such amounts, plus all amounts theretofore received under the contract and includable in gross income under this paragraph, do not exceed the aggregate premiums or other consideration paid for the contract- The above is identical to the existing Code section 72 (m) (1) (A) and (B), and the only difference is that (A) and the first part of (B) are added to the end of 72 (m) (1), and as proposed, the last part of (B) now becomes: SECTION 72(m) (1)(A) "(A) while the employee was an owner-employee which were allowed as deductions under section 404 for the taxable year and all prior taxable years, or And the new paragraph (B) would be as follows: SECTION 72(m) (1) (B) "(B) which were allowed as deductions under section 218 for the taxable year and all prior years, except to the extent that, within 60 days after day on which such amounts are received, such amounts are contributed to a quallfied individual retirement account for the benefit of the recipient or the -22- PAGENO="0091" The last sentence above is identical for both the existing and revised code sections. "Not received as an annuity (within the meaning of subsection (e) (2)" pertains to section 72 (e) (2) - "Amounts Not Received as Annuities" and contains a general rule that if an amount is received under an insurance policy as an annuity, such amount, if received on or after the annuity starting date, shall be included in gross income. If for any reason the foregoing rule does not apply, such amount shall be included in gross income, but only to the extent that the amount exceeds the aggregate premiums or other considera- tion paid. Any amount received which is in the nature of a dividend or similar distribu- tion shall be treated as an amount "not received as an annuity". Subsection 72 (e) (2) has "special rules" for the application of 72 (e) (1). These rules are that for purposes of 72 (e) (1) any amount received, whether in a single sum or otherwise, under an insurance policy in full discharge of an obligation under the contract which is in the nature of a refund of the consideration paid for the contract; and any amount received under the contract on its surrender, redemption, or maturity shall be treated as amounts not received as an annuity. Note that the word "recipient" is used here because this is the reference made in the present Code section. Obviously, for purposes of a savings plan, it means the participant, his spouse, or any beneficiary. This proposed amendment as it pertains to savings plans may be summarized as follows: Any amount received before the annuity starting date under an insurance policy which is not received either as a lump sum payment in discharge of the obligation under the policy, or as a dividend on the policy, or any amount received representing the policy's cash surrender or maturity value shall be taxable to the participant or his spouse to the extent that such amount and all previous amounts received from the same contract which were taxable under this same provision are not in excess of the total premiums paid for the policy, if such premiums were deduct- ible under section 218 of this bill for the current and all prior years. However, if the amounts received are "recontributed" to an- other savings plan for the participant or his spouse within 60 days, then such amount would not be taxable to the participant. BILL SECTION 3(d) (d) EXCISE TAX ON EXCESSIVE ACCUMULA TIONS.-Subtitle D is amended by adding at the end thereof the following new chapter: This is the fourth section of the bill and would amend Subtitle D - "Miscellaneous Excise Taxes" of the Code. A new Chapter 43 entitled, "Individual Retirement Accounts" would be added to the end of this subtitle, and the new section number 4960 is headed with "Excise Tax on Individual Retirement Accounts". SECTION 4960 (a) "CHAPTER 43 - iNDIVIDUAL RETIREMENT ACCOUNTS "Sec. 4960. Excise tax on individual retirement accounts. 393 recipient and his spouse. Any such amounts so received which are not includable in gross income under this paragraph shall be subject to the provisions of subsection (e)." -23- PAGENO="0092" 394 "SEC. 4960. EXCISE TAX ON INDIVIDUAL RETIREMENT ACCOUNTS. "(a) TAX IMPOSED-There is hereby imposed for each taxable year on the assets of a qualified individual retirement account (as defined in section 408 (a)) a tax equal to 10 percent of the excessive accumulation for such year. The tax imposed by this section shall not apply for any taxable year prior to the taxable year in which any individual who contributed to the plan attains the age of 70V2 years. In the event that there should be "excessive accumulations" (defined below), a tax, referr- ed to as an excise tax, would be imposed on such accumulations. The amount of the tax is equal to 10% of such accumulations, and would be applied for taxable years of the "... individual who contributed to the plan. . ." after he had aggained age 70½. This excise tax would not be imposed for".. . any In order to determine the amount of the excise tax that would have to be paid, it is first necessary to calculate the amount of "exessive accumulation". According to this section (b) of the proposed amendment, there would be an excessive accumulation if the "value of the assets" held by the savings ac- count at the beginning of the taxable year, i.e., as of January 1st of any year, is greater than `.~ . the present value of a joint and sur- vivor annuity payable to the individual and his spouse. . .". For purposes of determining the "present value", the amount of the annuity. benefit as of the beginning of the tax- able year, i.e., January 1st, would be equal to the total amount of benefits payable from the savings plan to the participant and his spouse during that year. For example, if the monthly benefit paid taxable year prior to the taxable year. . ." in which the participant became age 70½. For example, if the participant reaches age 70½ in 1972 and he files his tax returns on a calendar year basis, i.e., January 1 st - December 3 1st, and there were "excessive accumulations" during 1972 the tax would have to be paid in 1972, and each year thereafter as long as "excessive accumulations" existed. to either the participant or the spouse in prior years is $100, the "annual amount" is $1,200 ($100 times 12). It would then be necessary to calculate the "present value" of $1,200 as of January 1st of the year in which the participant reaches age 70½. If the dollar amount of this "present value" is greater than the "value of the asset" of the savings plan as of that January 1st, then there would be an "excessive accumulation" and the penalty tax is calculated and paid accordingly. Note that "value of assets" is not defined and could mean either the market value or the cost or book value, the latter representing the aggregate of all prior contributions made to the savings plan. The procedure in determining the "present value" will probably be outlined in subse- ciuent regulations that will amplify this pro- SECTION 4960 (b) "(b) EXCESSIVE ACCUMULATION-For purposes of this section the excessive accumulation for any taxable year is the excess (if any) of- "(1) an amount equal to the value of the assets held by the plan at the beginning of the taxable year, over "(2) the present value of a joint and survivor annuity payable to the individual and his spouse, providing for an annual payment payable at the beginning of each year in an amount equal to the total amount actually distributed under the plan to the individual and his spouse during such year. The present value described in paragraph (2) shall be determined in accordance with regulations prescribed by the Secretary or his delegate." -24- PAGENO="0093" 395 posed section of the Code. Note that there is no comparable excise tax for Keogh plans, and remember that this excise tax is levied in addition to the penalty tax on premature distributions, which has already been described as excessive and bur- densome when compared to Keogh plans. BILL SECTION 3(e) (1) (e) CONFORMING AMENDMENTS.- (1) ADJUSTED GROSS INCOME-Section 62 (relating to definition of adjusted gross income) is amended by inserting after paragraph (9) the following new paragraph: This is the fifth section of the bill and it discusses "conforming amendments" to other sections of the Internal Revenue Code that must be amended or changed for purposes of meeting all the requirements and conditions for individuals to make tax deductible con- tributions. Section 62 of the Code is found in Subtitle A, Chapter 1, Subchapter B - "Computation of Taxable Income", Part I - "Definition of Gross Income, Adjusted Gross Income, and Taxable Income." Section 62 is* entitled, "Adjusted Gross Income Defined" and this proposal would amend the section by adding this last paragraph (10) at the end: SECTION 62(10) "(10) INDIVIDUAL RETIREMENT SAVINGS-The deduction allowed by section 218." Therefore, Section 62 would read that the term "adjusted gross income", means in the case of an individual, gross income minus certain deductions listed in paragraphs (1) through (9) and now paragraph (10) - de- ductions for contributions made to savings plan. BILL SECTION 3(e) (2) (2) PENSION PLAN RESERVES.-Section 805 (d) (1) (relating to definition of pension plan reserves) is amended by striking out "or" at the end of subparagraph (C), by striking the period at the end of subparagraph (D) and inserting in lieu thereof ";or'~ and by adding at the end thereof the following new subparagraph: "(E) purchased under contracts entered into with trusts, custodial accounts, or other similar arrangements which (as of the time the contracts were entered into) were deemed to be qualified individual retirement accounts (as defined in section 408 (a) )." -25- PAGENO="0094" 396 The second conforming amendment relates to the definition of "pension fund reserves" under section 805 (d) which is found in Chapter 1, Subchapter L - Insurance Com- panies, Part I - Life Insurance Companies, Subpart B - Investment Income, and section 805 is entitled, "Policy and Other Contract Liability Requirements". This proposed sec- tion 3 (e) (2) of the bill would amend existing section 805 (d) - Pension Plan Reserves by adding a new subparagraph (E), as indicated above. Therefore, pension plan reserves would mean that portion of the life insurance reserves which is allocable to contracts pur- chased under savings accounts which are deemed to be qualified savings plans, as defined in 408 (a). BILL SECTION 3(e) (3) (3) AVERAGEABLE INCOME-Paragraph (2) (A) of section 1302 (a) (relating to definition of averagable income) is amended by striking out "section 72 (m) (5)" and inserting in lieu thereof "section 72 (m) (5) or 72 (p)'~ Section 1302 (a) (2) (A) is found in Chapter I, Subchapter Q - Readjustment of Tax Between Years and Special Limitations, Part I - Income Averaging, Section 1302 - Definition of Averagable Income which means the amount by which taxable income for the computation year (reduced as provided in paragraph (2) exceeds 120 percent of average base period income. Paragraph (2) - Reduc- tion says that taxable income for the compu- tation year shall be reduced by the amount (if any) to which section 72 (m) (5) applies. This conforming amendment proposes to eliminate "section 72 (m) (5)" and insert "section 72 (rn) (5) or 72 (p)". In other words, for purposes of income averaging, as provided under this section of the Code, the amount of taxable income is reduced by the amount of income that is considered a premature distrib- ution under section 72 (m) (5) for Keogh plans or the proposed section 72 (p) for individual savings plans. BILL SECTION 3(e) (4) (4) EARNED INCOME-Section 1348 (b) (1) (relating to definition of earned income) is amended by striking out "72 (n)" and inserting in lieu thereof "72 (n), 72 (p)'~ Section 1348 (b) (1) is also found in Chapter 1, Subchapter Q, Part VI - Other Limitations, and Section 1348 is headed, "Fifty Percent Maximum Rate on Earned Income". Subsection (b) (1) defines earned income as "...any income which is earned income within the meaning of section 401 (c) (2) (C) or section 911(b), except that such term does not include any distribution to which section 72 (m) (5), 72 (n), 402 (a) (2), or 403 (a) (2) (A) applies, or any deferred compensation within the meaning of section 404." This proposed conforming amendment would insert "72 (p)" after "72 (n)". Therefore, taxable income, resulting from premature distributions under either Keogh or individual savings plans or taxable income resulting from lump sum distributions from other types of corporate qualified plans, is not included for purposes of determining earned income subject to the 50% "max-tax" rate. -26- PAGENO="0095" 397 BILL SECTION 3(f) (1), (2) AND (3) (f) CLERICAL AMENDMENTS.- (1) The table of sections for part VII of subchapter B of chapter 1 is amended by striking out the item relating to section 218 and inserting in lieu thereof the following: "Sec. 218. Retirement savings. "Sec. 219. Cross references." (2) The table of sections for part I of subchapter D of chapter 1 is amended by adding at the end thereof the following new item: "Sec. 408. IndIvidual retirement accounts." (3) The table of chapters for subtitle D is amended by adding at the end thereof the following new item: "CHAFFER 43. Individual retirement accounts." This section of the proposed legislation would require three different clerical amend- ments to the Internal Revenue Code which result in amending the tables that appear immediately after each Part, so that appropri- ate reference may be made to the proposed section 218 - Retirement Savings, section 408 - Individual Retirement Accounts and chapter 43 - Individual Retirement Accounts. BILL SECTION 3(g) (g) EFFECTIVE DATE.-The amendments made by this section shall apply to taxable years ending after the date of enactment of this Act. These proposed amendments providing for savings plans would become effective and apply to taxable years ending after the date of enactment of this Individual Retirements Ben- efits Act of 1971. For example, if the Act was passed by Congress and signed by the Pres- ident on June 1, 1972, the first ". . . taxable year(s) ending after the date of enact- ment. . ." would mean 1972, since most individual taxpayers file their federal income tax returns on a calendar year basis ending as of December 31st of each year. Therefore, if any individual had earned income for the year 1972, it would be possible to contribute 20% of the first $7,500 of income, subject to a maximum of $1,500, to a savings plan and take a tax deduction for this amount on his 1972 federal income tax return. -27- PAGENO="0096" 398 Mr. CORMAN. Will you summarize? Mr. MCKINLEY. Attached to the statement is an outline of summary, comments and recommendations. It concerns itself only with section 3 of IELR. 12272 which provides for tax deductible employee contribu- tions. I would like to raise several comments and questions concerning certain sections of the act at this time. In section 218 (a) (2), the re- duction mechanism is unduly complex and impractical from an admin- istrative point of view. The committee and its aides should consider the reduction mechanism operative under Canadian law which says that if an employee participates in his employer plan the maximum tax deductible amount is $2,500 and if not covered by any retirement plan the maximum is then $4,000. This type of reduction feature has been working successfully in Canada for 14 years. The percent earned income reduction factor is not a valid assumption and included in my statement are some statistics put out by the chamber of commerce prov- ing this point. In section 408 (a) and 408 (a) (3) reference is made to a custodial ac- count. Is this a custodial account as provided for under 401(f) or a custodian account which is offered by certain banks for the safekeeping of securities, collection of dividends and interest, et cetera? I do not believe that banks are typically interested in action as custodian for small accounts. In fact, I have prepared a questionnaire form for a survey of banks offering custodial services and have sent it to some 400 banks throughout the country with trust assets in excess of $100 mil- lion. Since the questionnaire was mailed during the week of April 24, 1972, unfortunately I do not have the results at this time. When they are available, I shall present them to the committee for further con- sideration. I have performed other surveys of bank trust departments and find that they are generally not interested in such smal] accounts. I believe that individual retirement savings plans should be qualified as master and prototype plans. This would be similar to the corporate and H.R. 10 concept presently being used. This was indicated in speeches given in March of 1971 by John Nolan, in February 1972 by John Chapoton, and by Assistant Secretary Cohen on Monday. Who may be sponsors of these master and prototype plans? Assist- ant Secretary COhen mentioned investment advisers in addition to banks, insurance companies, mutual funds, trade and professional associations? I believe that sponsors of savings plans should be limited to just these types of organizations. Section 408(a) (4) makes no reference to the fact that the assets in an individual retirement account should be paid to a beneficiary upon the death of the individual contributing to the plan. This is a serious omission and should be corrected when the final draft of the bill is prepared. Section 72(p) (2) provides for a 30-percent penalty on premature distributions from an individual retirement account. I feel that this is excessive and should be modified to conform with the penalty pro- visions for Keogh or H.R. 10 plans under Internal Revenue Code section 72(m) (5). Section 4960 provides for an excise tax on excessive accumulations. This is unrealistic. There is no comparable provision for Keogh or corporate plans and why should individuals be penalized in this way? PAGENO="0097" 399 In summary, I feel that section 3 of H.R. 12272 is well drafted and covers most of the essential points with certain exceptions as mentioned above. In the event that the entire bill is found controversial and will be held up in Congress for one reason or another, section 3 of the act should be considered separately and passed upon as the only practical and immediate solution to solving the problem of providing private pension plan coverage to some 50 percent of the working force that is presently not covered. Thank you and if you have any questions I will be happy to answer them. Mr. CORMAN. Thank you very much. Are there questions? Thank you very much, Mr. McKinley. We appreciate your contribu- tion. Mr. MCKINLEY. Thank you. Mr. CORMAN. The committee stands adjourned until 10 o'clock to- morrow morning. (Whereupon, at 12 noon, the committee adjourned to reconvene at 10 a.m., Thursday, May 11, 1972.) 78-202 0-72 - pt. 2-7 PAGENO="0098" PAGENO="0099" TAX PROPOSALS AFFECTING PRIVATE PENSION PLANS THURSDAY, MAY 11, 1972 HOUSE OF REPRESENTATIVES, C0MMIrrEE ON WAYS AND MEANS, Washington, D.C. The committee met at 10 a.m., pursuant to notice, in the committee room, Longworth House Office Building, Hon. James 0. Corman presiding. Mr. CORMAN. The Committee on Ways and Means will resume its hearings on H.R. 12272 and related matters. I would observe for the witnesses this morning that the chairman is unavoidably detained. He will be along shortly. The House is in session and we probably will have quorum calls or votes. If the witnesses are willing they might wish to summarize their statements and place the full text in the record, as we may from time to time be interrupted be- cause of our duties on the floor. We are pleased to have as our first witness Andrew J. Biemiller, director, department of legislation, American Federation of Labor and Congress of Industrial Organizations. STATEMENT OP ANDREW L BIEMILLER, DIRECTOR, DEPARTMENT OP LEGISLATION, AMERICAN FEDERATION OF LABOR-CONGRESS OP INDUSTRIAL ORGANIZATIONS, ACCOMPANIED BY BERT SEID1\~AN, DIRECTOR, DEPARTMENT OP SOCIAL SECURITY, AND ARNOLD CANTOR, ECONOMIST, RESEARCH DEPARTMENT Mr. BIEMILLER. Thank you, Mr. Chairman. I am accompanied by Mr. Bert Seidman, chairman of the social security department of the AFL-~CIO and by Arnold Cantor, econo- mist from our research department. Our statement is quite short so that I think I will just present it. Mr. Chairman, on behalf of the AFL-CIO, I wish to thank you for the opportunity to present our views on H.R. 12272, the administra- tion's pension proposal. While the administration bill does address itself to establishing Fed- eral standards of vesting, the provisions relating to income tax deduc- tions for individuals and for the self-employed have far more impact on Federal tax policies, the economy, and the distribution of wealth in the United States than they do for pension reform In fact, we regard the administration proposal as simply a new tax loophole for the wealthy under the guise of pension reform. There has been a remarkable consistency about the administration's (401) PAGENO="0100" 402 economic and tax policies which are making the rich richer and the poor poorer. Let me cite just a few of the new loopholes that have been initiated by this administration: 1. A new depreciation system, officially called the asset deprecia- tion range (ADR) system-speeds up by 20 percent the tax writeoff allowance for business machinery and equipment. 2. The 7-percent investment tax credit. 3. A new provision which empowers U.S. companies to funnel their exports through subsidiaries-known as Domestic International Sales Corporations-wherein the tax on one-half of their export profits is deferred, perhaps indefinitely. The above measures afford tax relief primarily to wealthy corpora- tions. The Individual Retirement Benefits Act of 1971, the adminis- tration's pension proposal, would afford tax relief primarily to wealthy individuals, and would result in huge tax subsidized profits to private insurance companies, banks, and mutual funds. The bill provides that individuals may take an income tax deduc- tion amounting to 20 percent of earned income up to a maximum of $1,500 per year for sums set aside for an individual retirement plan. But as a practical matter the plan has little value to those with low incomes. To determine who will benefit from this proposal, the committees might consider these questions: How many families with an earned income of $5,000 per year can save $1,000? How many with a $6,000 income can save $1,200? How many families with a $7,500 income can save $1,500? How many families with an annual income of even $10,000 can save $1,500 in this time of sky-high living costs? Now, ask the same question for those with annual earnings of $15,- 000, $20,000, $50,000, and up. Clearly~ the percentage of families which will be able to take full advantage of this deduction will rise with in- come. Thus, the effect of this provision will be extremely regressive, benefiting all the rich who wish to take advantage of it and none of the poor. Even if a family of four could save $1,000 out of a $5,000 income their income tax would be reduced by $98. Thus, the Federal Govern- ment would be subsidizing the retirement savings at the rate of 9.8 percent. The same family of four earning $10,000 would save $285 in taxes and the Federal Government would be subsidizing their retire- ment plan at the rate of 19 percent. The $50,000 family of four would recoup 48 percent of their retirement contribution or $720 in taxes. The Federal subsidy to the retirement savings of individuals at vari- ous income levels is summarized in table TI. But that is not all. A worker with a $5,000 income even if he could take full advantage of this legislation could save only $98 in taxes. In contrast a wealthy investor who made $200,000 from clipping coupons and received a $5,000 consulting fee as his sole earned income could save $700. At the same time this program is being advertised as "helpful to older workers" when clearly only a very small percentage of them can even anticipate saving enough to provide for their future security. PAGENO="0101" 403 Thus, the proposed legislation is class legislation. The rhetoric from the administration does not deceive us nor do we believe it will deceive this committee or the public. In this connection, we wish to present certain facts that relate to the ability of low- and middle-income fami- lies to save. In 1970, according to the latest survey of the U.S. Bureau of the Census, median family income in the United States was $9,867. Half of all families were below this amount; half were above. Nevertheless, for that year: 1. The U.S. Bureau of Labor Statistics reported that an income of $10,664 was considered the standard for a moderate budget for an urban family of four-and no savings were included in such a budget. 2. Some 25.5 million persons, or 12.6 percent of the Nation's families, were below the poverty income threshold which, according to official Government estimates required an income of $3,968 for a family of four in 1970. 3. Among families with only one wage earner, only one out of every four families had incomes of $12,000 or above. 4. Only one out of six black families achieved the $12,000 and above mark, and for families headed by a woman only one in 10 attained that level. Who, therefore, will benefit from the enactment of H.R. 122~T2? We have stated that the administration is making the rich richer and the poor poorer. We recognize that this is a serious charge but the facts amply support our contention. Between 1960 and 1968, for example, the Census Bureau data show that there was a modest but nevertheless real and continuing trend of improvement in the way in which the shares of the Nation's income were flowing. Over that period, the bottom 20 percent of the Nation's families increased their share from 4.9 percent of income to 4.7 percent while the share of the top 20 percent declined from 42 percent to 40.6 percent. This trend came to an abrupt halt in 1968. Between 1968 and 1970 the portion of the Nation's income received by the lowest 20 percent dropped to 5.5 percent while the top 20 percent increased its share of the Nation's income from 40.6 percent to 41.6 percent. The detailed data are shown on table 1 which I have attached to my atement. And of course these figures do not tell anywhere near the whole ory, for huge chunks of the income of the very wealthy are not c nted. The cens s figures for example do not consider capital gains as i ome-a on top of that, the IRS only taxes such income at half the rates which apply to the income of a wage earner. The new proposed loophole would accelerate the trend toward distributing more of the Nation's income, its wealth and its tax resources to the well-to-do. H.R. 12272 would also raise deductible limit on pension contribu- tions made on behalf of the self-employed from 10 percent of earned income up to $2,500 per year to 15 percent of income up to $7,500. The AFL-CIO opposed the original Keogh bill as a tax avoidance program and we oppose the expansion of this tax loophole now. The main beneficiaries of this program have been doctors and lawyers and PAGENO="0102" 404 not proprietors of "mom and pop" groceries or other small business- men. If a doctor goes into practice at age 35 and saves $7,500 for 30 years, he will have not only a tax shelter for his savings over this period but also a tax savings on the interest earnings on his account so that by age 65 he will have accumulated the tidy sum of $592,950 assuming 6~percen:t interest on his savings. While this is somewhat short of making every doctor a millionaire upon retirement, the estimate ig- nores any capital gains that might accrue under a Keogh retirement plan. Even more than the individual tax deduction, the threefold increase in the present maximum deduction for the self-employed would bene- fit only high-income individuals. It also, like the individual tax deduction, is extremely regressive. These new tax gimmicks will greatly benefit the wealthy who can afford to take advantage of them. As Secretary-Treasurer Lane Kirk- land of the AFL-CIO stated when the administration first announced its proposal.: For the average man, the President's pension proposal Is an exercise in deceit. It promises much but it will deliver nothing for today's elderly and nothing in the future for those whose income is below $10,000 a year. It is a bonanza for banks, insurance companies and mutual funds-another raid on the Federal treasury to benefit the wealthy. While we favor national standards of vesting for single employer plans, we have serious reservations with regard to the rule of 50 which would be required under H.R. 12272. This rule would vest one- half of an employee's accrued benefit when a combination of his age and his years of service totaled 50 years. In order to avoid placing a cost burden on business, employees within 5 years of retirement would not be covered. The vesting standard could easily result in discrimination in em- ployment against older workers. The annual cost required to fund a pension benefit for a person at or near age 50 is very high, and many emnloyers would be unwilling to underwrite this cost. For single employer plans, we favor a vesting standard of 10 years. Multiemployer plans should be exempt from this standard because employee pension credits are portable as workers move from one em- ployer in the industry or trade to another. As stated in the 1967 AFL- ClO Convention resolution on health, welfare, and pension plans: The pension credits of workers covered by a multi-employer plan are portable as between different participating employers. Whether financed by employer con- tributions, joint contributions or solely out of union dues, such plans provide continuing coverage for workers remaining in the plan's jurisdiction regardless of where they work. Moreover, the bankruptcy of one employer in a multi-employer plan does not affect the solvency of the pension trust. Thus a multi-employer plan continues to protect the rights to benefits of workers who may lose their jobs because of the shut-down or failure of their participating employer but who continue to be covered by the plan through employment with another participating employer. Because of these built-in safeguards in multi-employer plans, standards of vesting and funding required for single-employer plans are not appropriate for multi-employer plans. Therefore, be it Resolved, The AFL-CIO favors the inclusion in private pension plans of adequate and appropriate vesting and funding provisions. To provide adequate safeguards to workers covered by single-employer plans we favor federal legislation establishing minimum requirements of vesting and PAGENO="0103" 405 funding. Because multi-employer plans, whether financed by employer contri- butions, joint contributions or solely out of union dues contain built-in safe- guards for the pension rights of workers covered by them, any such legislation should exempt multi-employer plans. In summary, the AFL-CIO is opposed to the creation of new tax loopholes for the wealthy. Enactment of this class legislation would reduce taxes for the rich and result in further shifting the tax burden to low- and middle-income Americans. Last year, before this committee, President Meany noted that "America needs genuine tax reform" and that "the U.S. Treasury must be used in the public interest to build a better America for all Ameri- cans, not as a trough for private greed and private gain." That is our position and that is why we urge this committee to reject H.R. 12272. Mr. CORMAN. Thank you, Mr. Biemiller. Without objection the tables attached to the statement will be in- cluded at this point in the record. Mr. BIEMILLER. Thank you. (The tables referred to follow:) TABLE 1.-PERCENT OF AGGREGATE INCOME GOING TO FAMILIES, 1960-70 1970 1968 1966 1964 1962 1960 Lowest 5th 5. 5 5. 7 5. 5 5. 2 5. 1 4.9 2d5th 12.0 12.4 12.4 12.0 12.0 12.0 Middle 5th 17. 4 17. 7 17.7 17. 7 17. 5 17.6 4th 5th 23. 5 23. 7 23.7 24.0 23. 7 23. 6 Highest 5th Top 5 percent 41. 6 14. 4 40. 6 14. 0 40. 7 14. 8 41. 1 15. 7 41. 7 16. 3 42. 0 16. 8 Source: U.S. Bureau of the Census; Current Population Reports, Series P-60, No. 80: `Income in 1970 of Families and Persons in the United States." TABLE 11.-EFFECT OF TAX CHANGES, HR. 12272 [Married couple with 2 dependentsj Percent of pension contribution Wage or salary income 1972 tax Tax under HR. 12272 Tax reduction paid for through tax relief $5,000 $6,000 $7,500 $10,000 $15,000 $25,000 $50,000 $98 245 484 905 1,820 4, 240 13,100 0 $70 245 620 1,490 3,820 12,380 $98 175 239 285 330 420 720 9.8 14.6 15.9 19.0 22.0 28.0 48.0 1 Assumes: (1) tax burden based on personal deductions equal to 10 percent of income, the low-income allowance or standard deduction, whichever is higher and; (2) each taxpayer takes full advantage of pension deduction. Mr. CORMAN. Mrs. Griffiths? Mrs. GRIFFITH5. I would like to ask a question. How do you propose that a privately employed individual set up a pension plan. Don't you really feel that he is at least as entitled to a pension plan as any other American? Mr. SEIDMAN. It seems to us that there is a fundamental difference between the usual type of plan which you have in private industry, PAGENO="0104" 406 most of which are increasingly noncontributory and covering all of the employees, and a proposal such as the one that the committee has before it which would give a tax advantage to those people who could afford to set aside the funds for this purpose. One is, at least as far as the employees in the particular plant are concerned, universal. The other is not at all. It would be regressive and it would mean that those individuals with the highest incomes and the ability therefore to set aside these funds would get the tax advan- tage. People who couldn't afford to do so, and this I think would apply to most employees now who tend to be low paid when they are not covered by private pension plans, would not be able to take advantage of this provision. Mrs. GRIFFITHS. What is your plan for taking care of all of these people, because, I think it is really unfair that people who do not have pensions are paying prices that create pensions for other people while they, themselves can't save anything. They have no pension at all. So let's hear a plan. Mr. SEIDMAN. Well, this committee actually has considered many times the plan that we think is the best to deal with the problem that you are talking about, `Congresswoman Griffiths, and that is substantial improvements in social security. This is what will take care of the needs of these people. These people are not people who can afford to set aside funds in savings accounts or in mutual funds. Mrs. GRIFFITHS. If that is the way you are going to do it then every- body else is going to do it that way too, and remove all other pension plans. You know, you just have to have the same kind of treatment for everybody, in my opinion. Mr. `SEIDMAN. If we reach the point where social security becomes really adequate to provide a retirement income which is close to or at least is not too far off from the preretirement income, then perhaps the day might come when we would no longer need these private pension plans. The private pension plans were developed precisely because social security payments were inadequate. Mrs. GRIFFITHS. But they are developed for only a few. There are millions of Americans who do not qualify under any private pension plan and the thing that is totally unfair is that those millions are buy- ing 10 million cars a year into which they are paying a price that covers a pension of $500 a month or approximately that for an auto worker. How are we supposed to accumulate those pensions? Mr. SEIDMAN. I don't think that most of the people who are in that situation would be able to tak\e advantage of the provisions of the legislation that you are now e~nsidering. Their incomes are too low. They are in the kind of employment where there is no private pension precisely. because the employer who is paying low wages can't afford to add the cost of a private pension plan. Mrs. GRIFFITHS. Of course, the employer is getting low wages too in most of these instances. He is not really making that kind of money so that he could pay. It seems to me that if we are going to have pen- siOns that the pension system has to work for everybody and I just think we have to come up with that. PAGENO="0105" 407 Some of the members on this committee seem to resent the fact that we are suggesting that we change this system so that either all pensions be taxed at the level at which people are earning when it goes into the fund or that nobody be. I don't think that is fair. I don't think it is fair that I pay a tax as my money goes into the fund and that for millions of others it is set aside out of the tax stream and they are not paying taxes on it at all until they draw it. Mr. SEIDMAN. Of course, the only basis on which that is permitted is when the pension fund is set up in such a way that it provides pay- ments on a nondiscriminatory basis to all of the employees covered. The kind of proposal that you have before you would be terribly different from that. It would be regressive and, when you ask us for a solution to this problem, frankly, we just don't see any solution to it through the tax system. We think the solution has to come through the social security system. Mrs. GRLFTITHs. I think the tax system is the only system that should be considering it. What I think this committee ought to be doing is to set up a system and say the fund and the plan must conform to this standard or no tax deduction. You can't take it out of the stream of taxes. Mr. SEIDMAN. There are some people whose incomes are so low that they don't pay any taxes and there is no tax credit which is going to provide a pension for them, and there are others who may be paying very small taxes but they certainly can't afford to set aside the money which is contemplated under this bill. Mrs. GRIFFITHS. The original Keogh bill insisted that the employer set up the pension for everybody employed by him. Mr. SEIDMAN. You mean under the self-employed type of employer? Mrs. GRIFFITHS. Yes. If you set up a pension for yourself you had to set it up for all your employees. Mr. Si~ IDMAN. That is correct, but there is nothing in this bill which requires going beyond the Keogh bill for the tax credit up to $1,500 a year, and I don't know that this would solve the problem because these people are not in a position to put aside that kind of money. Mrs. GRIFFITH5. There are very few people in a position to put aside any kind of money. I made a speech the other day critical of even congressional pensions, and I got back a lot of flack that really you, everybody could save $7,000 a year and achieve a congressional pension. That is just plainly ridiculous. There arc a lot of people who cannot save $7,000 a year under any circumstances. Mr. SEIDMAN. Nevertheless, it is true that as income goes up the ability to save rises and at very low incomes there is no ability to save at all. Mrs. GRIFFITHS. Yes, but it seems to me that what we ought to be doing under all these systems is to treat everybody fairly and the present system certainly doesn't do it. It is discriminating most against the small person who owns a small business or is a professional. That person is most discriminated against. Thank you very much. Mr. CORMAN. Are there questions? PAGENO="0106" 408 Mr. Conable? Mr. CONABLE. Thank you, Mr. Chairman. Of course you understand the pi~essure for doing something here with self-employment pensions comes from the fact that people who are employed and have fairly high incomes can get staggering bene- fits under qualified pension plans now, staggering tax advantages. Do you have any thoughts, as to how we can deal with that side of the equation here without moving to greatly improve self-employ- ment opportunities in the pension field or do you feel that we couldn't monkey around with the corporate pension treatment without damag- ing the interests of your constituents too? Mr. SEIDMAN. I don't know exactly what types of changes you have in mind Congressman. Mr. CONABLE. I am just wondering if you have any thoughts on the corporate pension side as to ways in which the inequalities could be reduced. Mr. SEIDMAN. One thing that we have insisted on is in the rather complicated formulas which the Treasury Department has developed to~ assure that there would be nondiscrimination in private pension plans as between the high paid and the lower paid employees. It is our feeling, that Treasury has bent over backwards to give a better deal to the higher paid employees. Now, we would think that somebody ought to take a very sharp look at that. Admittedly it is a very technical area and I don't pretend to be an expert in it myself but I think we ought to take a sharp look at that to make sure that we are not doing better even proportionately, not to speak of in terms of the absolute amounts of money, for the higher paid employees under these private pension plans than the rank and file employees. Mr. CONABLE. You don't have any specific legislative proposals though in that respect? Mr. SEIDMAN. I don't know that it would require legislation. I think it is a question of the way in which these provisions are administered by the Treasury Department. Mr. CONABLE. Thank you, Mr. Chairman. Mr. CORMAN. Mr. Mills? The CHAIRMAN. Mr. Biemiller, let me get one thing clear in my mind. On page 5 you read us the resolution adopted by the 1967 AFL-IO Convention on health, welfare and pension plans. You used down in the resolved part the term, "multiemployer plans." Let me understand clearly your definition of what you mean by multiemployer plans since you are suggesting that any legislation that is passed by us should exempt these type plans from its effect. Mr. BIEMILLER. Mr. Seidman. Mr. SEIDMAN. Mr. Chairman, those are plans which cover all of the workers in a particular industry or in a particular trade either na- tionally or for a fairly large geographical area. We feel that under those circumstances, because there is complete portability of pension rights from one employer to another as long as the worker stays in that particular industry, that he has the kind of protection that he never would have if he were working for a single employer who had Ins own pension plan. PAGENO="0107" 409 The CHAIRMAN. Let me take an example to be clear in my mind. Let's assume that the UAW, for example, has a plan that operates with re- spect to General Motors, Ford, Chrysler and the American Motors Co. Is that what we are talking about? Mr. SEIDMAN. Actually they don't. They have single employer. The CHAIRMAN. I know they do, but that is the type of arrangement you have in mind. Mr. SEIDMAN. A better example might be, for example, in the ladies' and men's garment industries where they have a single pension plan covering all the workers in the industry. The CHAIRMAN. How do the employers get together in developing such a plan? Is that done through insurance or how? Mr. SEIDMAN. It may be or it may be self-insured but there is an as- sessment based on a percentage of payroll for each of the employers under the plan. These are usually joint trusts, that is, they are jointly administered by the union and the employer or the employer's associa- tion, and there are negotiations from time to time as to what the amount of that contribution should be. The CHAIRMAN. In any event, there is this pooling of the funds. Mr. SEIDMAN. There is a pooling of all the funds; yes, sir. The CHAIRMAN. Do you think it has sufficient supervision now that it should not in any way be affected by the legislation, that no safe- guards should be written in? Mr. SEIDMAN. No. We are actually in favor of some of the proposals which have been made with respect to, for example, fiduciary respon- sibility and these are before other committees of the Congress. The CHAIRMAN. Is there complete vesting in these multiemployer plans? Mr. SEIDMAN. The vesting provisions vary from one plan to another but in a certain sense there is a built-in vesting even if there isn't a formal vesting for any worker who remains- The CHAIRMAN. In that industry? Mr. SEIDMAN (continuing). In that industry or in that trade. The CHAIRMAN. I see. Thank you, Mr. Chairman. Mr. CORMAN. Mr. Carey? Mr. CAREY. Thank you, Mr. Chairman. I want to commend the distinguished legislative representative of the AFL-CIO for a very positive statement that enunciates the con- cern of the AFL-CIO in this kind of legislation in cleaning up what appears to be a rather cloudy and vague arrangement throughout the country that leaves many workers in doubt as to whether their cover- age is going to be maintained when a plan collapses. For that I am very enthusiastic in support of your resolution. As to the professionals, doctors, lawyers, et cetera, who are taking ad- vantage now of the Keogh plan, the phenomenon, of course, is develop- ing in which aside from self-employed persons going into such plans we now have the emergence of the professional corporations. This is extremely widespread in the jurisdiction I represent. I think you would agree that under the professional corporation the Keogh plan may or may not be advantageous, depending, as the corporate activities. PAGENO="0108" 410 They may decide if it is a highly profitable professional association to set up a corporate pension plan, which is their right, to take advan- tage of every kind of tax advantage in setting up that plan and be as generous to the owners of the corporation, the professional people who own the corporation and as generous or not to the employees of that corporation as they may please. Your statement doesn't touch this but this is a very very important development. The professional corporation is going right ahead and setting up its own pension plan if it pleases to do so out of the lucrative profits in the profession and the only alternative to that kind of cor- poration would be enlargement of the self-employed plan as it is now contained. How do you feel about the professional corporations? Mr. SEIDMAN. Of course, we recognize what you have described as also being a very considerable loophole in effect which gives favored treatment to those particular groups of professionals and what we are saying here is that we don't think that this ought to be opened up still more by sweetening the Keogh arrangements. To the contrary, we think that the other arrangements ought to be tightened. Mr. CAREY. Here we seem to have a dilemma. I would like a rec- ommendation from you on how to tighten it. If the States authorize professionals to incorporate, as my State has done, we can't over- ride that. It is their right. The State creates corporations. They are creatures of the State. If the State decides it wants to create that kind of a device and make it available, that is within the right of the State; we can't override it. At the same time you wouldn't say that any corporation should be denied the right to have a pension plan. That would work injuriously to your workers. The fact of a corporation applies not only to professionals now but to the industrial corporation. We can't write a law and say that pension plans are all right for industrial corporations but not all right for professional corporations allowed by the State. That isn't a loophole; that is the whole law. Mr. SEIDMAN. I think that gets back again to the way in which the discrimination provisions are dealt with in the first place. Secondly, it seems to me that you are in a quite different situation from the situa- tion where you have large numbers of employees and you are trying to make sure that there is no discrimination between the rank-and- file employees and large numbers, at least relatively large numbers as compared with the kind of corporations that you are talking about, of higher paid employees, too. Mr. CAREY. I can point to a little sheet metal plant in my district where the total employment doesn't exceed 25 persons and they have a pension plan, and not too far away in the same area a professional corporation which may have 60 employees. We can't make a deter- mination based on size here. In every case where it has so far been tried, the courts have upheld the rights of a State to permit incorporation of professionals and made no distinction between professional corporations and industrial corporations. Now, you are suggesting that there can be a distinction. PAGENO="0109" 411 Mr. SEIDMAN. I am not saying that there should be a distinction. I am saying that we should make sure that these provisions are adminis- tered as tightly as possible, but regardless of that the reason for this proposal is to give an additional advantage to some wealthy individuals which they do not have now and we don't see any reason for piling that on top of the advantages that they already have. Mr. CAREY. I think we are in trouble, though, because part of the reason as I understand it for the proposal of this legislation is to get control of those professionals who are selecting this type plan and get- ting that kind of control which we don't have if they go into the pro- fessional corporation. This is the only device we have of creating a disincentive to the pro- fessional corporation. That is why I think the proponents of the plan are asking to increase the allowable deferral to $7,500. The other question I would pose and I think this may be a toughy is, what are you going to do if the next stage comes about and the pro- fessional corporations decide to go into multiple corporation pension plans? Then they would be under the very exemption you are seeking for multiemployer plans where a number of professional corporations get together and say, "We are covering all of the persons in the Bar Association of Brooklyn, N.Y.," and if the law clerks and stenogra- phers stay in the Bar Association of Brooklyn, N.Y., and continue there we ask you to exempt them from vesting and portability and so forth." They would have that right. I am just trying to point out that we are getting into a very complicated area of attempting to settle juris- diction and piecemeal legislation unless you take a little broader view of these professional people's problems. They are not all too wealthy. I know lawyers and doctors who are still in family practice and legal service to communities who are not making that kind of money and the only way they are able to provide for their declining years is through this plan. As far as a wealthy fat cat getting advantage of a big deduction now in addition to his unearned loophole, I am in agreement with you, but there are many lawyers, doctors, professionals of all kinds including those in the social service field who have only this as a means of accu- mulating an estate for their children. We don't want to injure that. I am worried about the down-range applications of the professional corporations and what may emerge as the multiemployee professional corporations who would then place themselves under the very exemption you are seeking in your resolu- tion. Isn't that possible? Mr. SEIDMAN. I think it is if you interpret it literally and without regard to how these things would be defined. I think they would have to be defined so that you are talking about a reasonable number of employees. If you weren't, then you wouldn't have any real built-in vesting or funding which you do have in these large multiemployer plans that we are talking about that cover tens of thousands and hun- dreds of thousands of workers. Mr. CAREY. I hope you will stick with us on the exploration of these highly complicated matters because iii addition to lawyers and PAGENO="0110" 412 doctors and engineers, and so forth, we now have the stock exchange firms which are incorporating, allowed to incorporate. They have a corporate personnel. They have a major number of employees and all of them I suspect are going to try to take advantage of every pos- sible provision such as this. So that it is an expanding field and I hope you can help us come into it in such a way that we don't so complicate the legislation that it is inexplicable to its beneficiaries. Thank you, Mr. Chairman. Mr. COIiMAN. Mr. Karth? Mr. KARTH. I have no questions. Mr. CORMAN. Mr. Biemiller, I wonder about the possibility of our looking at the other end of tax deferraL Instead of attempting to place ceilings on the amount that can be tax deferred, why not look at the ultimate benefits and put a ceiling on those, not just for pension plans but for everyone. The big problem is that if you seek to achieve equity with the cor- porate executive, you have to provide the same equity to the doctor or lawyer. Why not `fix some :reasonable pension, $500 a month or $9,000 a year or whatever, and provide that as long as the individual is accumulating assets toward that goal that income will be tax deferred? But when he reaches that limit then all other contributions to his retirement system would be taxable at the time they are earned. One of the problems that concerns me is what do you do with the man who has a very short, very high earning capacity. We heard yesterday about the jockeys. A jockey may earn the same number of dollars over a 40-year period that a factory worker or store clerk earns. If we can solve the problem of people storing up half a million dollars tax deferred it would brin'g some equity. I wonder if that has been considered by your staff. Mr. CANTOR. Congressman, we haven't considered it at all. It does sound rather imaginative and innovative and we would certainly like to take a look at it. Mr. CORMAN. I would appreciate your thoughts on it. I agree that the tax laws must be equitable, but the trouble always seems to be' that we `give away a big `chunk to a few people `and then have to give another chunk to some other people and pretty soon there is no tax base left. person, then they could continue in 1 year or over a 40-year period so that there is a limit in overall benefits that is the same for each person. Then they could continue in 1 year or over a 40-year period depending on their pattern of income. But there would be some rea- sonable time at which these benefits would be cut off. Of course, that would have to be true whether the contributions are made by the employer or the employee. I suspect that the person who has a relatively modest average income throughout his entire life would never reach that ceiling but it would affect some people who store up great sums of wealth on a tax deferral basis. Gentlemen, we thank you very much. Our next witness is Marshall J. Mantler, managing director, Bureau of Salesmen's National Associations. Mr. Mantler, we are pleased to welcome you to the committee. PAGENO="0111" 413 STATEMENT OF MARSHALL J. MANTLER, MANAGING DIRECTOR, BUREAU Oi? SALESMEN'S NATIONAL ASSOCIATIONS Mr. MANTLEI~. Mr. Chairman, I wish to thank you and your com- mittee for this opportunity to appear before you today. My name is Marshall J. Mantler and I am managing director of the Bureau of Salesmen's National Associations. I am here today to express the views of approximately 40,000 salesmen in the apparel industry respecting H.IR. 12272, the proposed Individual Retirement Benefits Act of 1971. The bureau appreciates this opportunity to comment upon the pro- posed legislation and to comment on the efforts of this committee to protect the rights of participants in employee benefit plans and to establish a system of qualified individual retirement savings plans. We are well aware of the problems in this area and are interested in all pension-related legislation now pending before this Congress. In this connection, we wish to express our qualified support of ELR. 12272 and direct our remarks to three primary areas: Vesting, fund- ing, and qualified individual retirement savings plans.. As an organization representing many employee-salesmen, the bu- reau is concerned with the increasing `frequency of pension plan failures, the inadequate protection of employees' vesting rights and the various other abuses which have received public attention in recent years. Within this context we would suggest that these problems be viewed in historical perspective. When the Great Depression of the 1930's greatly weakened the U.S. economy, it also injured millions of workers by destroying or substantially impairing the few rights then available to them under pension plans. At the present time, our econ- omy is in the process of recovery `from its most recent recessionary period, and the wave of employee losses through forfeiture of pension plan rights suggest the need for governmental concern and curative legislation. Accordingly, the'bureau suggests that prompt congressional action is needed to assure today's worker that his rights to economic secu- rity-which he has earned-will be available to him upon his retire- ment or other termination of employment. The bureau believes that the responsibility for solving the great and complex problems in this area falls to the Congress, and }I.R. 12272 represents an attempt to provide solutions to some of those problems. For this reason the bureau extends its qualified support for the bill and endorses its underlying philosophy. VESTING Unless and until an employee's `interest in a pension plnn becomes vested, his "rights" under the plan are illusory and nothing more than an expectancy. If the employee should leave his employment prior to full vesting, the employer contributions toward this employee's benefits become available for use in reducing the employer's future obligations to the plan with respect to the remaining employees. Thus, the em- ployer realizes `a financial gain from employees' leaving before full vesting, especially if full vesting is achieved only at the normal retire- ment date. The Bureau believes that this situation points up the need for minimum vesting standards. PAGENO="0112" 414 An employee is encouraged to view his pension plan as a portion of his compensation and, more importantly, as providing some degree of financial security. In this latter respect the existence of a pension plan serves as a disincentive to the accumulation of individual retire- ment savings, for the pension plan is viewed as providing the security he would otherwise be required to provide on his own. Without reason- able and well-defined vesting requirements this expectancy may never be realized. This situation is both dangerous and unjust. Some will contend before this committee that vesting, as well as funding, is more properly a matter for individual negotiation between the employer and the employee or his union. To some extent this may be persuasive, but the difficulty of achieving effective protection dem- onstrates the problems inherent in this approach. The present short- comings result from a number of reasons, ranging from the relative bargaining positions of the parties to the frequent lack of sophistica- tion on the part of the employee or his representative. These factors are of particular significance in the case of our members because many apparel salesmen are faced with the necessity of dealing with their employers on an individual, one-to-one basis which places them at a decided disadvantage. The problems created by lack of effective vest- ing will continue to exist until the present approach is supplemented and corrected by Federal legislation. The Bureau particularly wishes to suggest that any vesting require- ments imposed by Federal legislation should be looked upon only as minimum standards necessary for rudimentary protection of the em- ployee. Within this basic and minimum standard, the Bureau believes ample room remains for bargaining and negotiation between workers and their employers. FUNDING The Bureau believes that basic minimum funding requirements should receive the highest priority in any pension reform legislation, because funding relates to the very existence of a pension plan. With- out funding, any provisions relating to vesting are necessarily illusory, for an unfunded plan has no practical existence in that there are no assets to be protected on behalf of the employee-it is like being given a doughnut hole without a doughnut aroimd it. An unfunded pension plan places the employee at the mercy of the employer's credit. If the business should fail, or if the managers should simply determine that it is impracticable to continue, the employee must stand in line with other creditors of the business unless and until adequate funding re- quirements are imposed. The Bureau submits that this is an unconscionable situation. The employment relationship is one of reciprocal trust, carrying with it many mutual responsibilities and dependencies. A major responsibility of the employer is to pay to the employee the full compensation due him. In the modern business world, with its emphasis on fringe bene- fits, the pension plan has become an integral part of that compensa- tion. The possible resultant erosion of the employee's financial security piaces the burden of this economic and social problem upon the indi- viduals least able to bear such burdens. In a very practical sense, lack of funding is dangerous for the em- ployers as well. If the. funding of the plan is deferred for an extended PAGENO="0113" 415 period, the accrued liabilities may be so large when they become due that payment jeopardizes the solvency of the business. The results of these circumst~inces are detrimental to all concerned. Accordingly, the Bureau strongly recommends that this committee consider adding provisions relating to mandatory funding in order that the basic phi- losophy underlying H.R. 12272 may become a practical reality. The Bureau would also suggest the need for amendments to the Bank- ruptcy Act to provide some degree of priority for employees who, through no fault of their own, are victimized by the failure of an employer who has not funded his accrued pension plan liability. INDiVIDUAL RETIREMENT SAVINGS PLANS The Bureau wholeheartedly supports the underlying philosophy of the qualified individual retirement savings plan; however, the Bur~au strongly recommends that this committee consider means of reducing the complexity of the program. The effectiveness and the public ac- ceptance of the program requires an understanding of the advantages to be obtained through it and ease in utilizing it. The success of the program will necessitate a major educational and promotional effort on the part of the Treasury Department and the financial industry. However, if the terms of the program are needlessly complex, potential participants will find it difficult to understand, and the resultant con- fusion will tend to frustrate the goals of the program. Especially important in this connection is the fact that the program would apparently seek to benefit primarily employees in lower income groups. These individuals are not accustomed to thinking in terms of tax deferral and, in contrast with the typical "owner-employee" under H.R. 10, may not be a relatively sophisticated businessman accustomed to obtaining the advice of accountants, lawyers, and actuaries. Accordingly, the effectiveness of the proposed plan will depend upon its simplicity. While the financial industry would probably in- vest large amounts of their time and resources in advertising and promoting these plans, this will not be feasible unless the plan can be readily understood by the intended participants. If the participating employee cannot readily understand the advantages and conditions of the plan, or if the complexity of the program imposes a substantial administrative burden on the participating members of the financial industry, the result will be failure of the program. The Bureau sub- mits that the creation of a retirement savings plan should be as easy as opening a savings account. In keeping with this goal of simplicity, the Bureau wishes to suggest two modifications in the proposed formulas for computing the limitation on deductible contributions to a qualified individual retirement savings plan. With respect to employees not presently covered by an employer- sponsored plan, the proposal would allow a deduction in the amount equal to the lower of 20 percent of earned income or $1,500. In view of the limited means of the affected employees and the overriding policy of simplicity, which the Bureau feels is absolutely necessary, we submit that the 20-percent test is superfluous. Only persons earning less than $7,500 per year would be subjected to the test, and these individuals seldom, if ever, would be able to contribute 20 percent of their earnings 78-202 0 - 72 - pt. 2 - 8 PAGENO="0114" 416 in any event. Further, the Bureau feels that the $1,500 figure is inade- quate. Accordingly, the Bureau recommends that, at a minimum, a flat $2,500 limitation on deductibility be provided, to simplify the proposal while still providing a sufficient safeguard. Further, it might seem more logical to provide equality with the proposed treatment under H.IR. 10 plans; that is, $7,500. With respect to employees who are presently covered by an em- ployer plan, the deduction is limited by the contributions made on be- half of the individual by his employer. As I already stated, the Bureau is of the view that the 20-percent figure adds complexity and serves no useful function. While the purpose of the reduction computation is evident, it, too, serves to complicate the proposal to such an extent that many of the individuals to whom this program is directed will not readily understand its operation. Inasmuch as the Bureau believes the effectiveness of the plan will largely be determined by its clarity, we submit that this feature of the proposal should be modified. Even where the employee is presently covered by an employer plan, how- ever, there should be a simple fixed dollar ceiling, for this simplifies the proposal and still provides a sufficient safeguard against revenue loss. The Bureau would not disagree that the dollar limitation in this case should be only $1,500. The Bureau would also like to direct its comments to the penalties for early withdrawal. We believe that such penalties would be espe- cially inappropriate as applied to the situation of low-income em- ployees. The lack of other available resources on the part of such in- dividuals renders them more dependent upon savings such as those accumulated pursuant to the proposed plan. Because of the lack of alternative funds for these individuals, their greater susceptibility to financia.l emergency, and the necessity for simplicity, we would sug- gest that withdrawal penalties should be eliminated, or, at maximum, be applied on a very limited basis. The elimination of the penalty, and the taxation of the withdrawal at the employee's unadjusted ordinary rates, would be the most appropriate approach to the proposed legis- lative scheme. If the committee deems it essential to impose somt~ penalty, that penalty should be imposed only in the situations that do not fit within the broadest possible definition of an "emergency" and should take a form other than the imposition of an increased cash cost to the taxpayer; for example, it would seem sufficient to forbid de- ductible contributions during that year and the 2 following years. CONCLtTSION The long process of study and research which has culminated in H.R. 12272, and similar legislation now pending in both Houses, presents the 92d Congress with a unique opportunity to act before the problems in the area of pension reform become insuperable. What is needed is not a system for punishing or confining the employer but, rather, rea- sonable. standards designed to provide the employee with presently existing security in place of a mere expectancy which may or may not achieve fruition. Further, the qualified individual retirement savings plan would create a method whereby individuals might simply and easily supplement or provide for their income during their retirement years. PAGENO="0115" 417 You, Mr. Chairman, and the committee have taken a leadership role in curing these problems. We applaud your efforts and, for the reasons outlined above, urge you and your colleagues to continue toward enact- ment of these much needed measures. The Bureau is grateful for this opportunity to make its views known and stands ready to assist in any manner possible. In conclusion, sir, our organization was very, very active in working with the Congress on the original formulation of the H.R. 10 plan. We became involved back when the bill was known as the Jenkins- Keogh bill, and we worked with the great Tom Jenkins and Eugene Keogh. We enlisted the support of the American Medical Association, the American Bar Association, and the American Dental Association, and helped form the American Thrift Association which worked hard to eliminate what we. considered existing second-class citizenship. We felt then that the corporate employee enjoyed certain rights that the self-employed did not. In our zealousness and our effort to achieve equal citizenship for all, we appeared to ignore a third group of forgotten men, the Nation's pensionless employees. Now that we are trying to rectify and do away with the second- class citizenship provided for the pensionless employee we cannot understand, sir, differentiating between the pensionless employee arid the self-employed. Therefore, we feel if the self-employed is entitled to a $2,500 deduc- tion how could we discriminately say that if you are a corporate em- ployee Congress favors you more or less when you don't have a pension plan. Therefore, we urge equality of treatment for the corporate em- ployee, the pensionless employee, and the self-employed. Whether the limitation be $2,500 or whether it be $7,500 we see no reason to dis- criminate in withdrawal benefits, in fines imposed, or dollar amount. Thank you very much. Mr. CORMAN. Thank you. Are there questions? Mr. BETrS. I just want to compliment you Mr. Mantler for sug- gesting a way of simplifying the proposal. It is a rare occurrence for somebody to come here and suggest a way to simplify our tax laws. I just want you to know that it has not fallen on deaf ears. Mr. MANTLER. Thank you, Mr. Betts. Mr. CORMAN. Thank you very much, Mr. Mantler. You have been helpful. Mr. MANTLER. Thank you. Mr. CORMAN. Our next witnesses are H. Lawrence Fox and Marc Gertner, International Brotherhood of Electrical Workers, Local No.8. Gentlemen, we welcome you to the committee. STATEMENT OP MARC GERTNER, COUNSEL, LOCAL NO. 8, INTERNA- TIONAL BROTHERHOOD OF ELECTRICAL WORKERS; ACCOM- PANIED BY H. LAWRENCE POX, WASHINGTON COUNCIL Mr. CORMAN. if you would care to summarize your statements they may appear in full at this Doint in the record. (The statements referred to follow :~) PAGENO="0116" 418 STATEMENT OF H. LAWRENCE FOX AND MARC GERTNER ON BEHALF OF LOCAL No. 8, INTERNATIONAL BROTHERHOOD OF ELECTRICAL WORKERS RETIREMENT PLAN AND TRUST Gentlemen: The following written statement is submitted in connection with our appearance and oral presentation on May 11, 1972, on behalf of Local No. 8, International Brotherhood of Electrical Workers Retirement Plan and Trust be- fore your Committee in its public hearings concerning House Bill No. 12272. A. BACKGROUND OF PARTIES Local No. 8 is a local union affiliated with the International Brotherhoed of Electrical Workers. The Local Union has 1,250 full time members who are jour- neymen and apprentices in the electrical industry. The Local Union is the duly designated collective bargaining representative of its members for work done within a 17 county area in Northwestern Ohio. The Toledo Chapter of the National Electrical Contractors Association is a local affiliate of the national organization and is the representative of substantially all electrical contractors working in Northwestern Ohio. B. BACKGROUND OF MULTI-EMPLOYER RETIREMENT PLAN AND TRUST Effective May 1, 1967, Local Union No. 8 and the Toledo Chapter of National Electrical Contractors Association established the Local No. 8, International Brotherhood of Electrical Workers Retirement Plan and Trust as a result of col- lective bargaining by and between the parties. The Plan is a purchase money, allocated account pension plan with a t\vo~year vesting schedule. Contributions are made by the employing contractor on behalf of all covered employees at a rate established by the collective bargaining agreement between the parties. The contributions are allocated directly to an account in the name of the employee for whom the contributions are made. At the time the employee is entitled to a distribution from the Plan, i.e., at death, retirement, disability or termination of employment, the employee receives the amount allocated to his account. The Plan is a qualified Plan and the Trust is a tax-exempt trust. The Plan and Trust were established and are maintained in compliance with Section 302(c) of the Labor-Management Relations Act (Taft-Hartley Act) and other applicable fed- eral statutes. A plan like this one has the potential for unallocated forfeitures. Assuming an unprecedented volume of commercial, industrial and residential construction in the area, the Local Union will be unable to supply the demands of contractors in~~the jurisdiction. Unemployed electricians who are members of the Interna- * tional Brotherhood of Electrical Workers working out of local unions in other areas will then come as "travelers" to work. During such a period, the travelers are within the jurisdiction, and under the aegis of Local No. 8 and contributions will be made to the Retirement Plan and Trust in accordance with the Collective Bargaining Agreement. Normally the travelers will return to their respective home local unions before they have qualified for vesting under the Plan. C. PENDING ACTION TO RESOLvE FORFEITURE PROBLEM It is believed that the most desirable solution to the problem of an unallocated forfeiture account is to amend the Plan as follows: (1) Reduce the vesting time. This would dramatically lessen future un- allocated forfeitures. It would not resolve the problem of existing unallocated funds. (2) Take the balance of the unallocated forfeiture account and allocate it back to the individual accounts of the vested participants. This i's the simple solution for handling existing unallocated funds. However, it ap- pears that such a simple solution may not be allowed because of section 401(a) (8) of the Code. D. BACKGROUND AND CONSIDERATION OF SECTION 401 (A) (8) Section 401 (a) (8) provides a's follows: A trust forming part of a Retirement Plan shall not constitute a quali- fied trust under this section unless the Plan provides that forfeitures' must not be applied to increase `the benefits any employee would otherwise re- ceive under this plan. PAGENO="0117" 419 After a thorough review of this section and its antecedents, it is respectfully suggested that this section does not apply to a reallocation of unallocated forfeitures to the vested participants of a multiple employer retirement plan. If this interpretation is questionable, the Code section should be clarified. This provision was added to the Code by the Self-Employeed Individuals Tax Requirement Act of 1902 (Pub. L. 87-792, October 10, 1962', 76 Stat. 809). The rulings under this section have uniformly held that plans which attempted to provide that all forfeitures would be added to increase benefits of employees do not qualify. There are no rulings dealing with a situation where there were forfeitures greater than anticipated and where direction was sought to the problem of such excess forfeitures. The history of 401(a) (8) can be traced through the Committee reports. The Senate report and the Conference report are silent as to the reason for the Amendment. However, the House Committee report states that this Section was added with respect to all Retirement Plans (not just small business Re- tirement Plans, which was the general subject matter of the 1962 Amend- ment) in order to modify the existing regulations. The only reference in the pre-1962 regulations to the treatment of foreitures was in section 1.401-2(b) (1) which provides: A Retirement Plan within the meaning of section 401(a) is a plan es- tablished and maintained by an employer to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement. Retirement benefits generally are measured by, and based on, such factors as years of service and com- pensation received by the employees.. The determination of the amount of retirement benefits and the contributions to provide such benefits are not dependent upon profits. Benefits are not definitely determinable if funds arising from forfeitures on termination of service, or other reason, may be used to provide inoreased benefits for the remaining participants instead of being used to reduce the amount of contributions by the employer This regulation strongly suggests that the reason for 401(a) (8) is to limit 401 to trusts with definitely determinable benefits. Obviously, if forfeitures were, as a matter of course, added to increase the benefits of remaining participants. the benefits would not be determinable. However, the need for certainty would not seem to be affected by an election adjustment, particularly in the case where there are multiple employers. Moreover, the rulings over the years suggest that the historical concern behind section 401 (a) (8) would not be undermined by an election adjustnient approved by representatives of the employers and the employees. Over the years, the Service has published a number of rulings in the form of guides which have provided a lengthy discussion of what is required for qualification. The first of these was' Rev. Rul. 33, 1953-1 C. B. 267. That ruling touched on forfeitures at Part 5(a) (1) (1953-1 C. B. 267 and 279) where it is stated that: (1) Application of ForfeItvres-Funds under a qualified plan arising from forfeitures because of termination of service or other reason must not be allocated to the remaining participants in a manner that will affect the prohibited discrimination. In a retirement plan, this requirement is met by complying with the rule regarding definitely determinable benefits, to-wit: Benefits are not definitely determinable if forfeitures may be used to pro- vide increased benefits for the remaining participants instead of being used to reduce the amount of contributions by the employer. Rev. Rul. 33 was modified by Rev. Rul. 57-163, 57-1 C. B. 129. However, Part 5(a) (1), relating to forfeitures, remained unchanged. Rev. Rul. 61-156, 01-2 C. B. 65 further modified Rev. Rul. 33. This ruling reorganized Part 5, and forfeitures were treated at Part 5(d). However, the language in (b) was the same as that appearing in the previous rulings under Part 5(a) (1). Therefore, prior to the 1962 Amendment to section 401, the rulings with respect to for- feitures stated that the concern with forfeitures was that an unlawful dis- crimination would result. `The rulings further stated that an inference of dis- crimination could be avoided by stating that forfeitures could not go to increase benefits of employees. `Subsequent to' the Amendment of Section 401, Rev. Rul. 33 was further modified by Rev. Rul. 65-157, 65-2 C, B. 94. Forfeitures are no longer treated in Part 5 of the modified `ruling, but, rather, in a separate discussion in Part 7(a) where it is stated as follows: PAGENO="0118" 420 A qualified Reitrement Plain must provide that forfeitures arising from severance of employment, debt, or for any other reason, must not be applied to increase any benefit any employee would otherwise receive under the Plan at any time prior to the termination of the Plan or the complete discontinuance of employer contributions hereunder. The amounts forfeited must be used as soon as possible to reduce the employer's contributions under the Plan. In short, it appears that the reason behind the forfeiture application rule is that the plan will discriminate in favor of long-time, key employees or owner- employees, and that the benefits are not definitely determinable. If section 401 (a) (8) is interpreted to prevent an election to allocate forfeitures without a corresponding credit to the employers, an election allowing only an adjustment and not the qualification of a plan that provides for an improper application of forfeitures would be in keeping with the original intent of section 401 (a) (8). Such an election would also be in keeping with the concept of collectively bargained retirement plans, a device that was not a vogue in 1962. E. UNDERLYING ECONOMIC AND PHILOSOPHICAL CONSIDERATIONS 1. Trend of collectively bargained retirement plan and trusts Collectively bargained, jointly-trusteed pension and retirement plans are a relatively new development in the labor-management area. Their history can be traced only to the adoption of the Labor-Management Relations Act which, in Section 302(c) allowed value to pass from management to labor subject to the conditions therein provided. Originally, the collectively bargained pension trusts were those commonly referred to as "fixed benefit plans and trusts." These plans typically provide that the participating member must work for ten to fifteen years as a member of the collective bargaining unit represented by the union and for a participating employer to become vested; after which, upon re- tirement, the member receives a monthly benefit at* a stipulated rate per year of credited service. Under such a plan a member who works a substantial period of time may not vest and therefore may receive no ultimate retirement benefits for his many years of `service. Faced with these realities, lab~ ~or~and management have in the past year or two increasingly negotiated purchase money allocated account retirement plans, either in addition to or in lieu of the fixed benefit plans, to reward a member for shorter periods of service. It is respectfully suggested that there will be an increasing use of such plans as a result of collective bargaining. All of thes jointly-trusteed (by labor and management) plans ultimately will face the problem of unallocated forfeitures. 2. Prohibited alas discrimination As has been noted above, an important consideration in the introduction of section 401 (a) (8) into the Code was to prohibit discrimination in favor of a prohibited class, i.e., the highly compensated employer-entrepreneur. This is a legitimate concern of a proprietary retirement plan; i.e., one established uni- laterally by an employer for his employees in which all corporate employees participate. Such a concern is irrevelant in a jointly-trusteed, collectively bar- gained retirement plan and trust, since no members of the prohibited cla'ss participate in the plan. The plans by definition are limited to members of the collective bargaining unit represented by the union and expressly exclude highly compensated management employees. Therefore, allowing a reallocation of for- feitures to other participants in the plan will not inure to the benefit of the highly compensated management class, but only to the peer group of employees. 3. Deprivation of the employees' negotiated economic package Traditionally, when labor and management collectively bargain the labor con- tract, the parties negotiate an entire economic package. When agreement is reached, the dollar amount so determined is then divided into wages and fringes (pension, welfare or other benefits). Thus the money which management has agreed to contribute on a per hour rate to a qualified pension plan and tax-exempt pension trust is truly a part of the employees' compensation earned for services rendered. A narrow interpretation of section 401 (a) (8) could grant an employer credit against subsequent contributions to a retirement plan in the amount of the unallocated forfeitures. This would reduce the consideration paid by the employ- ers in deferred compensation and create taxable income to the employees when credited forfeited dollars are subsequently paid as wages. PAGENO="0119" 421 4. Interference with the collective bargaining process, if the credited forfeited dollars are not paid as wages As noted in Sub-Section 3 above, labor and management negotiate an overall economic package via the collective bargaining process, which is then allocated, again by the collective bargaining process, into wages and fringe benefits. Apply- ing section 401(a) (8) to the collectively bargained jointly-trusted retirement plan might create the bizarre situation of authorizing the employers, by law, to pay less than the bargained rate of compensation to the employees. This would mate- rially damage the collective bargaining process since the management group would have legal sanction to avoid compliance with the terms of their negotiated agreement with the collective bargaining representatives of the employees. Not only would such a result be inequitable but it would have far reaching implica- tions for the entire collective bargaining process. F. RECOMMENDATIONS The interpretation of the prohibition in section 401 (a) (8) to collectively bar- gained, jointly-trusteed purchase money allocated account retirement plans is un- certain. This should be clarified by technical amendment. Such an amendment would be consistent with the original intent of the statute. SUMMARY OF WRITTEN STATEMENT A. BACKGROUND OF MULTI-EMPLOYER RETIREMENT PLAN AND TRUST In recent years many retirement plans and trusts have been established as a result of collective bargaining. Our plan is qualified under section 401 and is a purchase money, allocated account pension plan with a two year vesting schedule. Contributions are made by the employing contractor on behalf of all covered em- ployees at a rate established by the collective bargaining agreement between the parties. The contributions are allocated dirCetly to an account in the name of the employee for whom the contributions are made. At the time the employee is entitled to a distribution from the Plan, i.e., at death, retirement, disability or termination of employment, the employee receives the amount allocated to his account. A plan like this one has the potential for unallocated forfeitures. Frequently the local labor force is insufficient and members of the International Brotherhood of Electrical Workers working out of other local unions will then come as "travelers" into our area. Normally, the travelers return to their respective home local unions before they have qualified for vesting under our Plan. This creates unallocated forfeitures. B. PENDING ACTION TO RESOLVE FORFEITURE PROBLEM In order to reduce such forfeitures the vesting period can be shortened. How- ever, the existing unallocated forfeitures can be absorbed only by allo~ating them back to vested participants. It appears that such a simple solution might not be allowed because of section 401 (a) (8) of the Code. C. BACKGROUND AN)) CONSIDERATION OF SECTION 401 (A) (8) Section 401 (a) (8) provides: A trust forming part of a Retirement Plan shall not constitute a qualified trust under this Section unless the plan provides that forfeitures must not be applied to increase the benefits any employee would otherwise receive under this Plan. Phi~ provision was originally enacted by the Self-Employed Individuals Tax Requirement Act of 1982. After a thorough review of this section and its antecedents, it is respectfully suggested that this section does not apply to a reallocation of unallocated for- feitures to the vested participants of a multiple employer retirement plan. If this interpretation is questionable, the Code section should be clarified.' The House Committee report implies that this section was added with respect to all Retirement Plans in order to modify the existing regulations concerning definitely determinable benefits. PAGENO="0120" 422 The applicable Revenue Rulings prior to the 1962 amendment tend to indicate that the concern with forfeitures was that an unlawful discrimination would result. Subsequent rulings tend to confirm the interpretation that the forfeiture rule was intended to prevent that discrimination in favor of long-time, key employees or owner-employees as well as to insure that the benefits are definitely determinable. If section 401 (a) (8) is interpreted to prevent an election to allo- cate forfeitures without a corresponding credit to the employers, an amendment allowing only an adjustment and not the qualification of a plan that provides for an improper application of forfeitures would be in keeping with the original intent of section 401(a) (8) Such an amendment w-ould also be in keeping. with collectively bargained retirement plans, a device that was not in vogue in 1962. D. UNDERLYING ECONOMIC AND PHILOSOPHICAL CON5IDERATIONS (1) Trend of collectively bargained retirement plan and trusts Collectively bargained, jointly-trusted pension and retirement plans are a relatively new development in the labor-management area. Their history can be traced to the adoption of the Labor-Management Relations Act. Because of the vesting schedule associated with the original plans, many employees have not received sufficient retirement benefits. Accordingly, labor and management have in the past year or two increasingly negotiated purchase money allocated account retirement plans, either in addition to or in lieu of the fixed benefit plans, to reward a member for shorter periods of service. In the years to come, there will be an increasingly number of such plans through collective bargaining. All of these jointly-trusted (by labor and management) plans will face the problem of unallocated forfeitures. (2) Prohibited class discrimination As has been noted above, an important consideration in the introduction of section 401 (a) (8) into the Code w-as to prevent discrimination in favor of a prohibited class. Such a concern is irrelevant in a jointly-trusted, collectively bargained retirement plan and trust, since no member of the prohibited class participates in the plan. (3) Deprivation of the employees' negotiated economic package Traditionally, w-hen labor and management collectively bargain the labor con- tract, the parties negotiate an entire economic package. The dollar amount so determined is then divided into w-ages and fringe benefits (pension, welfare or other such fringe benefits). A narrow interpretation of section 401 (a) (8). could grant an employer a credit against subsequent contributions to a retirement plan in the amount of the unallocated forfeitures. This would reduce the considera- tion paid by the employers in deferred compensation and create taxable income to the employees when credited forfeited dollars are subsequently paid as wages. (4) Interference with the collective bargaining process, if the credited forfeited dollars arc not paid as wages As previously noted, labor and management negotiate an overall economic package via the collective bargaining process, which is then allocated, again by the collective bargaining process, into wages and fringe benefits. Applying section 401 (a) (8) to the collectively bargained jointly-trusted retirement plan might create the bizarre situation of authorizing the employers, by law, to pay less than the bargained rate of compensation to the employees. This would materially damage the collective bargaining process since the management group would have legal sanction to avoid compliance with the terms of their negoti- ated agreement with the collective bargaining representatives of the employees. Not only would such a result be inequitable but it would have far reaching implications for the entire collective bargaining process. F. RECOMMENDATIONS The interpretation of the prohibition in section 401 (a) (8) to collectively bar- gained, jointly-trusted purchase money allocated account retirement plans is uncertain. This should be clarified by technical amendment. Such an amend- ment would be consistent with the original intent of the statute. Moreover, since the appropriate vesting schedule of a multiple employer plan cannot be estab- lished until the plan has been in existence, there is bound to be unallocated forfeitures for a time. Allowing section 401(a) (8) to prohibit the reallocation of such forfeitures is inequitable. PAGENO="0121" 423 STATEMENT AND SUMMARY ON BEHALF OF INTERNATIONAL BROTHERHOOD OF ELECTRICAL WORKERS, LOCAL No. 8 I am Marc Gertner, counsel, Local No. 8, International Brotherhood of Elec- trical Workers Retirement Plan and Trust. With me today is H. Lawrence Fox, Washington counsel who has dealt with deferred compensation problems both in and out of government. Local No. 8's plan is one of a dozen collectively bargained `trusteed plans that I represent in Northwest Ohio. In my advisory capacity to multiple em~lo'yar deferred compensation' plans and as a lecturer at the National Foundation of Health, Welfare and Pension Plans' Annual Educational Conferences, I have learned of the possible need of a technical amendment to section 401(a) (8) of the Internal Revenue Code of 1954. Section 401(a) (8) of the Internal Revenue Code of 1954 was originally enacted in 19G2 and provides: A trust forming part of a Retirement Plan shall not constitute a qualified trust under this section unless the plan provides that forfeitures must no't be applied to increase the benefits any employee would otherwise receive un'der this Pl'an. Based upon the House Committee Report, it appears that this Code section was adopted in order to prevent the allocation of forfeitures to a prohibited group. For example, `assume that an owner-employee establishes a `pension plan which requires that the employee~ stay with the company for ten years in order to have all of `their benefits fully vested. If an employee left prior to the completion of the ten-year period, any of the funds previously contributed to the `plan on behalf of the employee could not inure to `the benefit `of the owner-employee. Subsequent to 1962, there has been a trend toward the establishment of collec- tively bargained jointly-trusteed pension `and retirement plans. These plans nor- mally call for a fixed contribution by all of `the employers on behalf of all covered employees. After a sufficient interval for learning experience, the vesting schedule originally created with such plans will normally have `to be changed. At that juncture there will be some unallocated forfeitures. Such forfeitures may be insignificant or quite large if members of the National Union have come to work on the local level as "travelers" since travelers usually leave prior to qualifying for vesting. Amending the vesting schedule will eliminate unallocated forfeitures for the future but it will not resolve the question of how `to treat the unalloeated funds already in existence. The logical solution would `be to reallocate such funds to those members who have already qualified for vesting. This simple solution may not be in keeping with a strict interpretation of section 401(a) (5). A strict interpretation of section 401 (a) (8) in the case of a multiple employer pension and retirement plan would be highly inequitable because: (1) the reallocation of forfeitures would not inure `to the benefit of any prohibited group, and (2) the reallocation of forfeitures would not disturb the requirement that plans have a fixed or determinable amount since `the rem'aining employee's would `have greater retirement benefits, not diminished retirement benefits. In addition to `the inequitable results previously stated, some employees would receive taxable wages, instead of deferred compensation, where employers f~lt obligated to "pay out" the dollars they received a's a credit in the plan. Other employees would receive nothing since some employers may feel their legal obliga- tions have be'en met when forfeitures' are credited to their accounts. Discrimi- nation of employees is unfair. Moreover, confusion would abound in labor-man- agement relations. * In order to prevent `the `misinterpretation of section 401 (a) (8) to the multiple employer pension and retirement plan, it is respectfully recommended that a technical amendment to section 401 (a) (8) be adopted by the committee. Mr. cTERTNER. Mr. Chairman and members of the committee, I am Marc Gertner. Toledo, Ohio, counsel for Local No. 8 International Brotherhood of Electrical Workers Retirement Plan `and `Trust. With me today is H. Lawrence Fox. Washington counsel who has dealt with deferred compensation problems both in and out of government. With me also are Donald R. DeBolt, business agent of Local No. 8 and Curtis Schick, chapter manager of the National Electrical PAGENO="0122" 424 Contractors Association in Toledo. These gentlemen are here to make it clear to the committee that the presentation which follows is of mutual concern to labor and to management. Local No. 8's plan is of a dozen collectively bargained jointly trusteed plans that I represent in northwest Ohio. In my advisory capacity to multiple employer deferred compensa- tion plans and as a lecturer at the National Foundation of Health, Welfare and Pension Plans' Annual Educational Conferences, I have learned of the possible need of a technical amendment to section 401 (a) (8) of the Internal Revenue Code of 1~54. This section was originally enacted in 1962 and provides: A trust forming part of a retirement plan shall not constitute a qualified trust under this section unless the plan provides that forfeitures must not be applied to increase the benefits any employee would otherwise receive under this plan. Based upon the 1962 House committee report, it appears that this code section was adopted in order to prevent the allocation of for- feitures to a prohibited group. For example, assume that an owner-employee establishes a pen- sion plan which requires that the employees stay with the company for 10 years in order to have all of their benefits fully vested. If an employee leaves or is severed prior to the completion of the 10- year period, any of the funds previously contributed to the plan on be- half of the employee could not inure to the benefit of the owner- employee. Subsequent to 1962, there has been a trend toward the establish- ment of collectively bargained jointly trusteed pension and retirement plans, particularly money purchase pension and retirement plans. These plans normally call for a fixed contribution by all of the employers on behalf of all covered employees. After a sudden interval for learning experience, the vesting schedule originally created with such plans will normally have to be changed. At that juncture there will be some unallocated forfeitures. Such forfeitures may be insig- nificant or quite large if members of the national union have come to work for the local level as "travelers" since travelers usually leave prior to qualifying for vesting. Amending the vesting schedule will eliminate unallocated forfei- tures for the future, but it will not resolve the question of how to treat the unallocated funds already in existence. The logical solution would be to reallocate such funds to those members who have already quali- fied for vesting. This simple solution may not be in keeping with a strict interpretation of section 401 (a) (8). A strict interpretation of section 401 (a) (8) in the case of a multi- employer collectively bargained pension and retirement plan would be highly inequitable because (1) the reallocation of forfeitures would not inure to the benefit of any prohibited group, and (2) the realloca- tion of forfeitures would not disturb the requirement that plans have a fixed or determinable amount since the remaining employees would have greater retirement benefits, not diminished retirement benefits. In addition to the inequitable results previously stated, some employ- ees would receive taxable wages, instead of deferred compensation, where employers felt obligated to "pay out" the dollars they received as a credit in the plan. PAGENO="0123" 425 Other employees would receive nothing since some employers may feel their legal obligations have been met when forfeitures are credited to their accounts. Discrimination of employees is unfair. Moreover, confusion would abound in labor-management relations by interfer- ence with the collective bargaining process. In order to prevent the misinterpretation of section 401 (a) (8) to the multiple employer collectively bargained pension and retirement plan, it is respectfully recommended that a technical amendment to section 401 (a) (8) be adopted by the committee. Such an amendment would be consistent with the original intent of the statute and would provide an equitable solution to the problem raised in this presentation. Thank you very much. Mr. CORMAN. Thank you very much, Mr. Gertner. Are there additional statements from your other colleagues? Mr. GERTNER. Not at this time. Thank you, Mr. Chairman. Mr. CORMAN. Are there questions? Thank you very much, gentlemen. Mr. GERTNER. Thank you. Mr. CORMAN. Our next witness is Mr. Quentin I. Smith, Jr., presi- dent, and Preston C. Bassett, director, vice president and actuary, Towers, Perrin, Forster & Crosby, Philadelphia, Pa. STATEMENTS OP QUENTIN I. SMITH, TR., PRESIDENT, TOWERS, PERRIN, PORSTER & CROSBY, ACCOMPANIED BY PRESTON C. BASSETT, DIRECTOR, VICE PRESIDENT, AND ACTUARY Mr. BASSETT. Thank you, Mr. Chairman, committee members and staff for this opportunity to appear before you. My name is Preston C. Bassett, and I am vice president and actuary, and a director of Towers, Perrin, Forster & Crosby, consultants to management. With me today is Mr. Quentin I. Smith, Jr., president and chief executive officer of our company. We are appearing here to present the views of our company and of many of our clients. Mr. Smith joined our firm in 1957 and was manager of our New York office before becoming our president. He has been active in the pension field for over 20 years and during this time has been person- ally involved in designing employee benefit plans for many of the Nation's largest corporations. Besides directing the activities of nearly 200 professional consult- ing staff members, he is a speaker before management and professional groups. Mr. Smith would now like to give, the opening remarks. Mr. SMITH. For over 50 years, Towers, Perrin, Forster & Crosby, has been consultants to the management of both large and small orga- nizations in the United States, Canada, and Europe. Currently, we are consultants to over 1,200 firms, including major corporations, nonprofit organizations, and States and local govern- ments. We recognize that proposed pension legislation is controversial and that there are many valid, yet varying, points of view about it. Nonetheless, we believe it is important, as responsible consultants and actuaries, to take a position on this subject. PAGENO="0124" 426 Because of the time limitations, I do not want to recite all the facts that confirm the success of the private pension system. However, I cannot help but emphasize the fact that almost 5 mil- lion retired persons are currently receiving benefits under this system and that the private pension system is responsible for providing pen- sions to a significant portion of the total retired population. In 1970, employers contributed $9.7 billion, almost $10 billion to private retirement funds on behalf of 35 million covered employees. This money has been irrevocably set side for the benefit of employees. I think the dramatic growth of the private pension system can best be seen by noting that in 1950 there were only about 9,200 private plans qualified by the TIRS and in 1970 this had grown to over 128,000 p~.ans. As far as the persons covered, there were about 10 million in 1950 and over 35 million in 1970. In dollars paid to retirees and beneficiaries $370 million in 1950 and over $6.7 billion in 1970. The following table demonstrates the dramatic growth of private pension plans: Year Number of private pension plans qualified by IRS Number of employees covered by private plans Annual benefits paid to retirees and beneficiaries 1950 1960 1970 9,232 38,808 128, 148 10,255,000 23,015,000 35, 080, 000 $370,000,000 1,750,000,000 6,730,000,000 Note: Not including profit-sharing plans or any plans covering local, State, and Federal Government employees. Our basic position is that any legislation should be directed toward strengthening the private pension system. This system has existed for over 50 years with the most significant growth occurring during the last two decades. We believe the system is sound and in the vast majority of cases has proven to be both financially and socially re- sponsible. This outstanding achievement has been unfavorably pictured as a result of some distortion by the news media. The stressing of dramatic and isolated situations leads readers and listeners to believe that such unusual situations are the rule and not, as our experience leads us to believe, rare exceptions. Because of our knowledge and experience on pension and profit sharing plans we believe we are well qualified to comment on the pro- visions of H.R. 12272 and I want to ask Mr. Bassett to comment on some of its details. He is a member of the American Academy of Actuaries, the Society of Actuaries, the Conference of Actuaries in Public Practice, and of several other local international actuarial orgamzations. He, too, has been active in the private pension field for over 20 years. Within this time period, he has been involved personally in the de- velopment and growth of the pension programs of hundreds of com- panies in the United States. PAGENO="0125" 427 Mr. BASSErr. I would like to comment on H.R. 12272. I will comment on vesting, tax deductible employee contributions, and the other provisions of H.R. 12272. We recommend, for your consideration, four principal modifica- tions to H.R. 12272 in regard to vesting: One, participation in a qualified plan should not be deferred for more than 3 years regardless of the age of the employee. In our opin- ion, there is no need to defer the crediting of pension benefits until an employee reaches age 30. Two, benefits credited to an employee should vest at the later of 5 years of service, or when the age of an employee plus his service is equal to 50. We agree that the vesting should be graded from 50 percent to 100 percent over the next 5 years. Three, we believe employers should be given 5 years in which to comply with this vesting provision. The cost of providing for vested benefits can be a burden for many organizations. In addition, we be- lieve the growth and expansion of the private pension system wilt be seriously hampered if this vesting provision were to be effective with- in a shorter period of time. Four, benefits should be vested for all years of credited service and not just for years of participation in a plan subsequent to 1973. Other- wise, employees terminating within the next few years will very likely be distressed when they learn that their vested benefits exclude all serv- ice prior to 1974. They will probably believe this bill requires all prior benefits to be vested in them. For example, an employee age 55 with 20 years of service who terminates in 1974 may be quite shocked when he learns that he is only vested in 50 percent of the benefits credited to him since the beginning of 1974. He would be losing 19 years of credited service. TAX DEDUCTIBLE EMPLOYEE CONTRIBUTIONS Here, we recommend two modifications to H.R. 12272: One, there should he no reduction or penalty in the amount of the tax deductible contribution an employee can make on his own behalf when This has the advantage of being both easier to understand and to administer. An employee in such a plan, who terminates prior to becoming eligi- ble for a vested benefit, would be treated unfairly if he could not con- tribute a reasonable amount for his own protection. Therefore, we pro- pose an annual employee contribution limit of 10 percent of pay or $1,500, if less, whether or not employees participate in a qualified plan. This has the advantage of being both easier to understand and to ad- minister. Two, because an employee's ability to save can fluctuate from year to year, provision should be made to carry forward some or all of any unused prior contribution limits. Also, since it is often difficult for em- ployees to save during their earlier working years, some provision might be made for carrying forward these unused limits into later working years when obligations such as raising and educating chil- dren are out of the way. PAGENO="0126" 428 FUNDING STANDARDS, INSURANOE FOR UNFUNDED LIABILITIES AND PORTABILITY We concur with H.R. 12272 on these issues and recommend that ac- tion on them be deferred until further study has been completed. Re- cent studies clearly demonstrate that the level of funding in private pension plans has created a high degree of benefit security for employees. As a matter of fact, existing Federal tax law in effect already creates certain minimum funding standards. Further, it should be noted that funding requirements and related benefit security are meaningful only in the event of plan termination-~an improbable event in the vast majority of situations. The concept of insurance for unfunded plan liabilities raises a num- ber of difficult questions that cannot be answered quickly or easily. For example, how will the amount of unfunded liability be determined and by whom? How will the insurance premium be determined and to whom will it be paid? We thank you for this opportunity to present our views. Within the next several days, we plan to submit our detailed recom- mendations. Finally, we would like you and the committee to know that we are available for further consultation at any time you might wish it. Thank you. These are our recommendations in regard to H.R. 12272. I would like Mr. Smith now to make a few concluding remarks. Mr. BURLESON (presiding). Mr. Smith you are welcome and you may proceed. Mr. SMITH. By way of supplementing this summary, next week we plan to submit our detailed recommendations to this committee and would like those detailed recommendations to be a part of your full record. Mr. BURLESON. Without objection they will be included. (The information referred to follows:) TESTIMONY ON PROPOSED PENSION LEGIsr~&TIoN (HR 12272) For over 50 years, Towers, Perrin, Forster & Crosby have been consultants to the managements of both large and small organizations in the United States, Canada and Europe. Currently, we are consultants to over 1,200 firms, inclu~1ing major corporations, non-profit organizatioi~s, and state and local govenment.s. We recognize that proposed pension legislation is controversial and that there are many valid, yet varying, points of view about it. Nonetheless, we believe it impor- tant, as responsible consultants and actuaries, to take a position on this subject. GROWTH OF THE PRIVATE PENSION SYSTEM Regardless of the measurement criteria adopted, the growth of the private pension plan system has been extraordinary. The number of qualified pension and profit sharing plans has grown from 12,925 plans in 1950 to 230,003 such plans by the end of 1970, a rate oC growth over these past 20 years of 15.5% annually. More importantly, the percent of non-agricultural workers in private industry covered by these private plans has grown from 22.5% in 1950 to 48.3% by the end .of 1970. Other indicators of the tremendous growth of private pension and profit shar- ing plans are shown in the following table: PAGENO="0127" 429 PRIV ATE PENSIO N AND PROFIT -SHARING PLA NS-SELECTED STATISTICS Year Employees covered 1 (millions) Employer contributions (billions) Employee contributions (billions) Number beneficiaries (millions) Benefit payments (billions) Reserves (billions) 1950 1955 9. 8 15.4 $1. 75 3.28 $0. 33 . 56 0. 45 .98 $0.37 .85 $12. 1 27.5 i960 1961 21.2 22.2 4.71 4.83 .78 .78 1.78 1.91 1.72 1.97 52.0 57.8 1962 23.1 5.20 .83 2.10 2.33 63.5 1963 23. 8 5. 56 . 86 2. 28 2. 59 69. 9 1964 24.6 6.37 .91 2.49 2.99 77.7 1965 25. 3 7. 37 . 99 2. 75 3. 52 86. 5 1966 26.3 8.21 1.04 3. 11 4. 19 95. 5 1967 27. 5 9. 05 1. 13 3. 41 4.79 106. 2 1968 28.0 9.94 1.23 3.77 5.53 117.8 1969 29.0 11.42 1.36 4.18 6.45 127.8 1970 Annual growth rate (percent) 29.7 12.58 1.42 4.72 7.36 137.1 5. 7 10. 4 7. 6 12. 5 16. 1 - 12. 9 1 Excludes retired employees and employees of governmental units covered under plans not funded with private agencies. Source: Table 7 in `Trends in Employee Benefit Plans in the Sixties,' W. W. Kolodrubetz, Social Security Bulletin, April 1972, vol. 35, No. 4. These growth statistics indicate the increasing magnitude of benefits provided under private pension plans. In addition, extensive research studies in recent years have provided some very useful indicators of: (1) the extent to which private pensions supplement Social Security for employees covered under private plans, (2) the extent to which employees have vested rights to benefits promised under private plans, and (3) the extent to which these vested benefits are covered by assets held in reserves established under these plans. The increase in average benefits paid under private pension plans has been impressive. In 1970, average payments per beneficiary reached $1,654, a 62% increase over the average payment of $1,021 for 1960. The average Social Security payment to retired workers for 1970 was $1,417. Although it is dangerous to make too many assumptions about these two averages, it seems reasonable to assume that workers covered by both Social Security and private pension plans were getting about 50% of their pension income from each-probably somewhat less than 50% from private plans for workers at the lower earnings levels and more than 50% for workers with earnings at the higher earnings levels. As to the probable extent of vesting under private pension plans, the highly regarded series of Studies of Industrial Retirement Plans prepared by Bankers Trust Company of New York, documents the dramatic increase in vesting pro- visions under private pension plans (both of the negotiated and non-negotiated type) and the steady liberalization of vesting requirements. The study is based on industries classified in 71 different categories, and analyzes plans covering approximately 7.8 million employees. The 1970 edition points out that 90% of the negotiated "pattern plans" and 98% of the "conventional plans" reviewed in the 1965-70 period include provisions for vesting (including early retirement), up from 82% and 90%, respectively, for these plans in the 1956-59 period. These studies also document the progressive liberalization of the age and/or service requirements an employee must satisfy in order to achieve vested rights to his accrued benefits. Extensive data was collected for a study of private plans conducted for the Pension Research Council of the Wharton School of Finance and Cömmerce.~ The basic conclusions of this study analysis emphasize the prudent and con- scientious financing policies adopted by most employers and unions with respect to benefits promised under private pension plans: As of the central date of this study, a very high degree of benefit security had been accomplished by a vast majority of the plans included in the study. (In most cases these plans are those qualified under Internal Revenue Service regulations and subject to those regulations.) For example, assets accumulated to the date of valuation were sufficient, on the a~erage, to 1 ~S'tatots of Funding nnder Private Pension Plans, Frank L. Griffin Jr. and Charles L. Trowbriclge; Richard D. Irwin, Inc., Homewood, Ill.; 1969. PAGENO="0128" 430 cover 94.4% of all accrued benefits under plans whose effective ftnding periods were 15 years or more. . . . Consistent results apply to plans at the other funding durations. Assets were, of course, sufficient to cover an even greater proportion of vested accrued benefits. The foregoing very brief review of the growth of the private pension plan system is all too frequently ignored when discussions focus on "what's wrong" with the system rather than on "what's right" with it. The balance of our comments relate to the factors which continue to support its development. We have also set forth our comments on HR 12272, the proposed pension legislation now under consideration by the Committee. FACTORS FOSTERING PRIVATE PENSION PLAN SYSTEM The basic factors which fostered the growth and present levels of success of the private pension syste~ni are: 1. Economic needs of retirees, 2. Employee demands for better and better pension benefits, 3. Employer profitability and desire to provide pensions, and 4. Congressional creation of a legislative climate favorable to the initiation and development of private pension plans. The first factor which contributed to and supports the further development of private pension plans is the economic needs of retired individuals for income to replace the wages and salaries they earned while actively employed. Social Secu- rity provides basic income to help cover these needs, but only the private pension system is sufficiently flexible to respond satisfactorily to the heterogeneous financial needs and desires of most retired individuals and the varying abilities of employers to help provide for these needs. The economic needs of retired individuals are far from being satisfied, but Social Security and the private pen- sion system have substantially improved the economic status of retired individ- uals. Further substantial improvements are very much dependent on this continued partnership of the government and private systems to help meet the increasing demands for more retirement income. The second factor, employee demands (directly or through union representa- tives) for better and better pension plan benefits, has increased significantly over the last 10-20 years. As a result of such demands, pension income levels and vest- ing provisions, ia particular, have been substantially improved in recent years. This factor will undoubtedly continue to play an important role in the future development of the private pension system. Naturally, the continuance of the private pension system depends on the ability of the American economy to provide the resources needed to cover the require- ments of both the employed and unemployed. This third factor, then, is that employers must continue to run their business on a profitable basis so that con- tinued pension improvement can be financed. Since the needs and demands of active employees tend to take precedence over the needs of retired individuals, decreasing profit margins would tend to affect retirement income much more severely than the compensation levels of active employees. The fourth essential factor is the active role played by Congress in promoting the private pension system particularly since the early forties. In addition to creating a social, legal and tax climate favorable to the creation of a broadly applicable private pension system, legislation to date has had an important and salutary effect on both the design and funding of private pension plans. Through the present concept of "qualified plans" introduced into the Internal Revenue Code in 1942 and modified several times since then, Congress has promoted private pension plans which provide nondiscriminatory l)enefits for nondiscriminatory classifications of employees and has created a tax framework which has resulted in the substantial funding of the benefits promised under private plans. Thus, the private pension plan system has been stimulated, nurtured, and shaped by favorable legislation in the past; its future is very heavily dependent on future Congressional actions. COMMENTS ON PROVISIONS OF HR 12272 Our basic position is that any legislation should he directed toward strengthen- ing the private pension system. This system has existed for over 50 years, with the most significant growth occurring during the last two decades. We believe the system is sound and in the vast majority of cases has proven to be both financially and socially responsible. PAGENO="0129" 431 This outstanding achievement has been unfairly pictured as a result of some distortion by the news media. The stressing of dramatic and isolated situations leads readers and listeners to believe that such unusual situations are the rule and not, as our experience confirms, rare exceptions. So much for the background. Because of our knowledge and expertise on pension and profit sharing plans, we believe we are well qualified to comment on the provisions of HR. 12272. VESTING TPF/C believes that after a reasonable period of service, employees should be entitled to vested rights to their credited pension `benefits even though service with their employer is `terminated. While we recognize that many employers cur- rently provide reasonable vesting and that there is a trend for more companies to provide more liberal vested benefits, we still believe some legislative minimums are desirable. Under most plans, benefits credited during the early years of employment do not produce a significant proportion of a person's retirement income. In an expanding economy with an increasing cost of living, `benefits credited during the early years tend to lose significance by the time an employee reaches retirement age. Because of this, we feel that benefits based on the later years of employment should he vested. Benefits which vest after age 45, for example, can produce a meaningful pension at retirement age. For `this reason, we believe that age should be a significant factor in determining when benefits become vested under a pen- sion plan. Therefore, we support the "rule of 50" in contrast with other vesting proposals. However, we also believe a minimum period of service should be re- quired. We do not believe that an employer should be required to provide vested benefits to employees who job-hop at frequent intervals. Thus, while we support the "rule `of 50," we believe in addition an employee should have at least 5 years of service with his employer before vesting is re- quired. This is `only a slight modification of the Administration Bill which pro- vides that an employee may be excluded if hired within five years of retirement, and that an employer may also exclude an employee's first `three years of service from a pension plan. For these reasons, we recommend that Section 2(a) (12) (A) be amended so that subparagraph (i) which contains the phrase "period of par- ticipation in `the plan" `be changed to "period of service with the employer" and that subparagraph (ii) be changed to read "after five years of service with the employer." We support graded vesting starting at 50% and increasing 10% per year to 100% after an additional five years ol' service. You will note that under our modi- fication, after an employee has five years of service and a combination of age and service equal to 50, his vesting applies to benefits credi'ted for all years of service. This will generally produce a higher benefit than under the Administration Bill which completely excludes service prior to participation in the plan. We also recommend the elimination of subparagraph (B) from Section 2(a) (11). If we really believe that employees earn their pensions during their work- ing careers, we see no justification for eliminating those years worked prior to age 30. Those in favor of eliminating years prior to age 30 say that younger people have a tendency to terminate employment and have not yet settled down. Even if true, this would have no effect on vested `benefits because the age of the employees plus their service would not equal 50. Under our proposal, on `the other hand, those employees who do stay beyond age 30 are given credit for all their years of service with the employer. Consequently, an employee ` age 35 with 15 years of service would have a 50% vested right under the plan. This vested benefit would be based on 15 years of service. Under the Administration Bill, this employee would not have a vested right and would have to continue to work for another five years at which time he would only be vested in 10 out of a total of 20 years of credited service. We also recommend that vested benefits include benefits for all prior service and not just service subsequent to December 31, 1973. We believe that the Ad- ministration Bill providing for vested benefits `based on service in 1974 and later years will prove to be a disillusionment to employees, particularly to those who lose their jobs after long years of service. These employees probably will not realize that the Administration Bill only requires employers to vest the pension benefits after December 31, 1973. For example, an employee age 55 with 20 years of service and laid off in 1974 could be quite shocked to learn that he is only vested in 50% of the benefits credited to him since the beginning of 1974. If 78-202 0-72-pt. 2-9 PAGENO="0130" 432 Congress is to pass a bill requiring vesting, we believe it should be meaningful and that credited service should include all service prior to date of termination. We recognize that the above modification to H.R. 12272 will add more costs to pension plans provided by employers than was contemplated under the Ad- ministration Bill. However, we feel these costs are justified if the objectives of the Bill are to be realized. In order that employers may prepare to meet this increased cost, we recommend that the last paragraph of Section 2(a) (11) be changed to allow an employer to comply with the provisions of this Act any time within five years of its effective date. This should be ample time for union negotiated contracts to be renegotiated and for unilateral plans to be amended and .for companies to recognize the costs for this vesting pro~ision which can be substantial. We would like to make some additional recommendations in regard to the required vesting provisions under qualified pension plans. First, we believe that the Act should make it clear that the vesting is ony for lifetime pensions and does not Include ancillary benefits such as death benefits, disability benefits, or other extra benefits. Also, we believe the Act should make clear that the vested pension benefits should be payable no earlier than age 65. If paid earlier than age 65, they would be the actuarial equivalent. The statement has been made that vesting should not be required because it will discourage the hiring of older employees. The implication here is that the cost of vesting is more significant at older ages than at younger ages, but it is important to note that vesting costs nothing unless an employee terminates his employment. Taking into account the much higher probability of termination of employment at the younger ages than at the older ages, we believe the real cost of vesting is more heavily concentrated at the middle ages, or at the younger ages under some of the proposals now before the Congress. From a social point of view, it is obviously much more important for benefits to vest after age 45 than at the younger ages. TAX DEDUCTIBLE EMPLOYEE CONTRIBUTIONS We enthusiastically support the concept of allowing employees to make con- tributions to a qualified plan on a tax deductible basis. We believe that employees who are not now participating in a private pension plan should be allowed to contribute, whether or not the employer establishes a qualified plan. We also believe that all employees should be encouraged to set aside personal savings for their own retirement, and we endorse the principle, of providing incentives to these employees to accumulate such funds. By making employees' contributions to a qualified plan tax deductible, we hope some employers, who do not now have plans, will he encouraged to supplement employee-paid benefits by installing a qualified plan. Some employers who may have felt that they could not afford a reasonable pension program, may feel that such a program could be adopted with the help of employee contributions. Thus, another step would be taken to provide coverage for the significant group of em- ployees who are not now participating in the private pension system. We recommend that H.R. 12272 be amended so that there would be no reduction or penalty in the amount of the tax deductible contributions employees could make on their own behalf when participating in a qualified plan sponsored by his employer. There are many reasonsivhy we object to this penalty. First, we feel it is inequitable to the many employees who terminate their service with an employer before qualifying for a vested benefit. For these years of service, the employee receives no credit under the employer's qualified pen- sion plan, and he is also prohibited from making reasonable contributions on his own behalf. Thus, employees, who have worked for several employers over many years, could wind up with no benefits to their credit under the private pension system. Second, the administration of such a deduction would be extremely com- plicated and would lead inevitably to considerable detailed regulations. The proposed offset of 7% of compensation under the Administration Bill is arbitrary and can only be justified as an expedient. To satisfy employees, employers will be required to make tests with some set of assumptions to illustrate that their contributions to employees' benefits are less than 7%. Under most funding methods, the value of an employer's contribution with respect to any individual employee can only be arbitrary and, therefore, subject to dispute. If there is no offset for employer contributions, there will be an increase in loss of tax revenue. Therefore, we recommend that the amount of the tax deductible PAGENO="0131" .433 employee contribution be rethiced below that proposed in the Administration Bill. We suggest a limit of 10% of pay up to a maximum of $1,500 per year. We believe these two changes will make the plans easier to understand and administer. Because an employee's ability to save can fluctuate from year to year, we believe a provision should be made to carry forward some or all of any unused prior contribution limits. Also, since it is often difficult for an employee to save during his early working years, some provision should be made so that he could carry forward Ms unused limits into his later working years when obliga- tions such as raising children and educating them are out of the way. This is similar to the tax provision that allows carry-forwards of losses from sales of securities or the fact that capital gains realized in the sale of one's home can be carried forward if a new home is purchased within a year. While not strictly analogous, the principle of carrying tax credits forward is not new. Finally, we wonder if it would be possible to provide for a partial withdrawal of employee contributions without severe, penalties. Emergencies and disasters do occur, and it could well be more important for an employee to have some funds immediately available than having them held to age 65-an age he might not even reach. FUNDING STANDARDS AND INSURANCE FOR UNFUNDED LIABIEITIES AND PORTABILITY We agree with the comments of President Nixon when he introduced the Administration Bill, and recommended that action on these items be deferred until further study has been completed. Recent studies clearly demonstrate that the level of funding in private pension plans has created a high degree of bene- fit security for employees. For an excellent treatise on this topic, we refer the Committee to the article written by Griffin and Trowbridge under the auspices of the Pension Research Council. Also, in effect, certain minimum funding standards a1read~ exist under federal tax law. Further, it should be noted that funding standards and related benefit security are meaningful only in event of a plan termination-an improbable event in the vast majority of situations.. More study is needed to determine the extent of plan terminations, the number of employees affected, the amount of lost bene- fits, and whether or not funding requirements would have had a significant effect on the results. The Treasury Department is. now collecting data to provide statistics on these items. Many difficult questions remain to be answered with respect to these items and whether or not any legislation is desirable. COMMENTS . BY CLIENTS A special PPF/C Letter was sent to all of our clients on May 3rd, setting forth our position on pending legislation. A copy of this Letter is attached Al- though time was short, the following companies responded to our Letter. Almost all of these companies endorsed our position without reservation. A few sug- gested modifications or alternatives: The Boeing Company. Brockway Glass Company, Inc. Burroughs Corporation. Campbell Soup Company. Coats & Clark Inc. Commonwealth Telephone Company. Cone Mills Corporation. Delma'rva Power & Light Company. Diamond Shamrock Corporation. Eastman Kodak Company. Ethyl Corporation. Farmers Bank of the State of Delaware. The First National Bank of Tampa. The First Pennsylvania Banking and Trust Company. Fleer Corp. ` The R. T. French Company. . Gleason Works. Gulf Oil Corporation. Hallmark Cards Incorporated. PAGENO="0132" 434 Harri&-Intertype Corporation. The Hartford Steam Boiler Inspection and Insurance Company. The Home Insurance Company. Honeywell Inc. 101 America Inc. ITE Imperial Corporation. Lawyers Co-operative Publishing Co. Lincoln Rochester Trust Company. Magic Chef. Minnesota Mining and Manufacturing Company. Mohasco Industries, Inc. Mountain Fuel Supply. New York State Electric & Gas Corporation. Pacific Gas and Electric Company. Penn Virginia Corporation. Pennsylvania Power & Light Company. Pennwalt Corporation. Philadelphia Electric Company. Philadelphia Saving Fund Society. Reliance Insurance Companies. Retail Credit Company. Reynolds Metals Company. Rochester Gas and Electric Corporation. Rockwell Manufacturing Company. Rohm and Haas Company. Royal Crown Cola Co. St. Regis Paper Company. Smith Kline & French Laboratories. Staley, A. E., Manufacturing Company. Sun Oil Company. Sybron Corporation. Unigard Insurance Group. Union Pacific Corporation. United-Carr. Washington Gas Light Company. Western Pennsylvania National Bank. We thank you on behalf of our clients and ourselves for this opportunity to present our views. Finally, we would like you and the Committee to know that we are available for further consultation at any time you might wish it. TPF/C POSITION ON PENSION LEGISLATION As we indicated in the April 19, 1972 Special Supplement of the TPF/C Letter, public hearings on proposed legislation will be held by Chairman Wilbur Mills, of the House Committee on Ways and Means, beginning on May 8. TPF/C requested an opportunity to testify at those hearings, and we are sched- uled to appear on May 11. We recognize that proposed pension legislation is con- troversial and that there are many valid, yet varying, points of view about It. Nonetheless, we believe it important, as responsible consultants and actuaries, to take a position on this subject. BACKGROUND Our basic position is that any legislation should be directed toward strength- ening the private pension system. This system has existed for over 50 years with the most significant growth occurring during the last two decades. We believe the system is sound and in the vast majority of cases has proven to be both financially and socially responsible. The following demonstrates the dramatic growth of private pension plans: Year Number of private pension plans qualified by IRS N umber of employees covered by private plans Annual benefits paid to retirees and beneficiaries 1950 1960 1970 9, 232 38, 808 128, 148 10, 255, 000 23, 015, 000 35, 080, 000 $370, 000, 000 1, 750, 000, 000 6, 730, 000, 000 Note: Not including profit-sharing plans or any plans covering local, State, and Federal Government employees. PAGENO="0133" 435 In 1970, employers contributed $9.7 billion to private retirement fund~ on behalf of 35 million covered employees. This money h~s been irrevocably set aside for the benefit of those employees. The pension legislation now before the Congress deal~ essentially with the following: Fiduciary responsibility and disclosure. Vesting and portability. Minimum funding standards and insurance for unfunded liabilities. Deductibility of employee contributions. TPF/C's position with respect to each is set forth in this Supplement. FIDUCIARY RESPONSIBILITY AND DISCLOSURE We support an amendment to the Welfare and Pension Plans Disclosure Act that: (1) assures that administratoi~s and trustees of pension plans and funds observe the highest standards of fiduciary responsibility, (2) relies on the "prudent man" rule as a sufficient standard for the invest- ment of funds, (3) provides for forthright positive, continuing disclosure of essential provisions and operations to employee~ and government authorities, (4) simplifies and standardizes the forms and information required by various government agencies. TPF/C does not support any limitations on the investment of funds in employer securities beyond those which presently exist. As to disclosure, we support a form of general information on an annual basis to employees, but do not support required disclosure on an individualized basis except to the extent of notifying terminated participants of their vested rights and how to obtain them. Further, TPF/C feels that the general disclosure of a plan's financial condition ~should be limited to a statement of the plan's liabilities for vested benefits and the approxi- mate extent to which such liabilities are funded. VESTING AND PORTABILITY TPF/C supports vesting of pension, benefits. However, TPFJC recognizes the significant cost implications of liberal vesting and the inhibiting effect that such costs might have on the adoption of new plans as well as the improvement of exist- ing plans. Therefore, TPF/C believes that any minimum vesting requirements should reflect a balance of both social and financial considerations. For this reason, TPF/C supports a provision which would require 50% vestin.g of all pension benefits credited when age and services total 50, with a minimum period of service of five years, increasing 10% for each of the next five years to 100% vesting. Employees should be eligible for participation in a plan no later than after three years of service. There should be a five-year transition period during which existing plans can conform to the vesting requirements. (The italicized portions in this paragraph represent modifications of the Adminis- tration BUl.) TPF/C does not support the enactment of any legislation on portability at this time, becausG we believe it is a complex subject requiring a great amount off additional study. In the context of the proposed pension legislation, portability would provide for the transfer of the value of vested pen~ions under the plan to a central clearing house or another qualified agency. MINIMUM FUNDING STANDARDS AND INSURANCE FOR UNFUNDED LIABILITIES Recent studies clearly demonstrate that the level of funding in private pension plans has created a high degree of benefit security for employees. As a matter of fact, existing Federal Tax Law in effect already creates certain minimum fund- ing standards. Further, it should be noted that funding requirements and related benefit security are meaningful only in the event of plan termination-an im- probable event in the vast majority of situations. The concept of insurance for unfunded plan liabilities raises a number of diffi- cult questions that cannot be answered quickly or easily. For example, how will the amount of unfunded liability be determined and by whom? How will the insurance be determined and to whom will it l)e paid? TPF/C recognizes that there may be a need for a responsible legislation provid- ing benefit security. Such legislation might include minimum funding ~tandards PAGENO="0134" 436 and insuranêe for unfunded liabilities. We recommend a thorough study of these areas. DEDIJCTIBILITY OF EMPLOYEE CONTRIBUTIONS In order to encourage the further development of the private pension system, TPF/C supports the deductibility of employee contributions either to an employer sponsored plan or to an individual-regulated savings/retirement plan. Specifically, TPF/C supports the deductibility each year of an amount equal to the le~ser of 10% of basic earnings or $1,500. Because of the varying financial ability to make contributions from year to year, some provision should be made for carrying forward unused prior limits. In order to achieve equity and simplicity, this deduc- tion should be granted regardless of participation in a qualified pension or profit sharing plan. TPF/O also ~upports a liberalization of the tax-deductible contributions per- mitted for self-employed individuals under HR 10 plans. Our testimony will be strengthened if it is supported by the organizations we serve. Therefore, if you agree with our position, we encourage you to inform us of this fact as quickly as possible so we can indicate your support to the Com- mitteee. If you do not agree with our po~ition, we would appreciate knowing those points with which you disagree. Mr. SMITH. Thank you. In that same connection, we would like to also include in the record letters from various of our clients in support of our position. We wrote out just a week ago to our clients and highlighted briefly the position that we were taking on this legislation and in less than a week's time we have received a substantial number of letters from clients supporting this legislation and would like to put those in the record. I think you might be interested in some of the. names that we heard from already who do support this position. The Minnesota Mining & Manufacturing Co.; Pacific Gas & Elec- tric Co.; Sun Oil Co.; Burroughs Corp.; Rohm & Haas Co.; St. Regis Paper Co.; the Boeing Co.; Eastman Kodak Co.; Harris-Intertype Corp.; the Home Insurance Co.; Cone Mills Corp.; Delmarva Power & Light Co.; the First Pennsylvania Banking & Trust Co.; I-T-E Imperial Corp.; the Lawyers Co-operative Publishing Co.; Union Pacific Railroad Co.; New York State Electric & Gas Corp.; Phila- delphia Electric Co.; Rochester Gas & Electric Corp.; Diamond Shamrock Corp.; Coats & Clark, Inc.; Lincoln Rochester Trust Co.; Gleason Works; Pennsylvania Power & Light Co.; Mohasco Indus- tries, Inc.; Pennwalt Corp.; Reliance Insurance Companies; Honey- well, Inc.; Unigard Mutual Insurance Co.; Brockway Glass Company, Inc.; Mountain Fuel Supply Co.; Rockwell Manufacturing Co.; Smith Kline & French Laboratories; Western Pennsylvania National Bank; ICI America, Inc.; Sybron Corp.; Penn Virginia Corp.; the Philadelphia Savings Fund Society; Campbell Soup Co.; and Wash- ington Gas Light Co. Mr. BURLESON. Are we to understand, Mr. Smith, that you already have these or are these the ones you are to secure? Mr. SMITH. These are the ones that we already have. We are of the opinion that we will have others and would like to put all of them in the record that we will submit with you next week. Mr. BURLESON. Will you work with the staff of the committee in arranging the time in which they may be submitted? Mr. S~rITII. Yes. Mr. BURLESON. Without objection, so ordered. (The letters referred to follow:) PAGENO="0135" 437 BOEING, Co., VERTOL DIVISION, BOEING CENTER Philadelphia, Pa., May 8 1972. Mr. MARTIN J. FRANK, A.S.A. Towers, Perrin, Forster ~ Crosby, 3 Penn (Jenter Plaza, Philadelphia, Pa. DEAR MARTY: This will confirm our conversation of Friday, May 5, 1972 in which I informed you that the Boeing Company Supports T.P.F.&C. in their pro- posed position on Pension Legislation as outlined in your memo to me dated May 2, 1972. I have reviewed your document with Mr. John Look of our Corporate Staff, and he concurs with your proposal. He does have some additional comments which you may want to take into consideration in your final draft. On the question of portability, we feel that allowing for the liberalization of Vesting provisions over a somewhat more expansive period than the five years as recommended would be in order The problems surrounding portability are indeed complex, and we recommend that you consider coming out with some stronger words of opposition to it. On the matter of Minimum Funding and Insurance for Unfunded Liabilities, we strongly oppose the insurance approach since it could well encourage some to defer to improper funding. We recognize your point that any insurance ap- proach must `be accompanied with the minimum funding approach and agree that one would, and should compliment the other. Turning to the matter of Deductibility of Employee Contributions, we find no argument against this except that if it should be allowed to carry forward the unused prior year amounts, you will place the employer in a position of main- taining a burdensome amount of records. Again, we do support your efforts and ask that you give consideration to the points made above. Sincerely, D. P. HESLIN, Manager, Compensation and Benefits. BROCKWAY GLASS Co., INc., Broekway, Pa., May 5, 1972. TOWERS, PERRIN, FORSTER & CROSBY, Three Penn Center, Philadelphia, Pa. GENTLEMEN: We have reviewed your position on proposed Federal pension legislation as outlined in the May 3, 1972 Special Supplement of the TPF/C letter and wish to state that this company is in agreement with those positions. You are further authorized to disclose our support of the stance you are taking. Yours very truly, JOHN E. AIKMAN, secretary and General Counsel. BURROUGHS CORP. Detroit, Mich., May 4, 1972. Mr. ALAN W. MYERS, Consultant, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR AL: The proposed TPF&C testimony to he presented to the Mills Com- mittee regarding the proposed pension legislation represents a reasonable ap~ proach to matters dealing with-fiduciary responsibility and disclosure; vesting and portability; minimum funding standaikls and insnrance for unfunded lia- bilities, and deductibility of employee contributioiis-taking into consideration the interests of all concerned. We support your position. Very truly yours, EARL McCARTER, Director, Pensions and Insurance. PAGENO="0136" 438 CAMPBELL Sour Co. Camden, N.J., May 10, 1972. Mr. JOHN J. BOND, Consulting Actuary, Towers, Perrin, Forster ~ Crosby,Inc., Three Penn Center, Philadelphia, Pa. DEAR JOHN: We have reviewed the position which TPF&C proposes to take in testifying before the House Ways and Means Committee on proposed pension legislation. Inasmuch as this position is generally in accordance with our own views, you have our authority to indicate our support to the Committee. One point which is not covered in the statement is the growing problem of~ state legislation. There are bills pending in California and New Jersey and, per- haps, in other states affecting some of the same matters which the House Ways and Means Committee is considering. I would hope that the suggestion would be made in the course of testimony before the Committee that Federal legislation preempt the field in the case of qualified plans. Sincerely, D. H. SPRINGER, Treasurer. COATS & CLARK, INC., New York, N.Y., May 8, 1972. Re pension legislation Mr. DONALD E. KERN, Consultant, Towers, Perrin, Forster c~ Crosby, Inc., New York, N.Y. DEAR DON: Thank you for your letter of May 3rd with the attachments con- cerning hearings to be held beginning May 8th on proposed pension legislation. In your letter you state that if we agree with your position you would like to be informed of this fact so that you can indicate our support to the House Chin- mittee on Ways and Means. I believe that the position you will take as explained in your letter of May 3rd represents a realistic approach to the consideration of this problem and I would be happy to have you use our name in support of your position. Very truly yours, JOHN T. WoosTim, Vice President. COMMONWEALTH TELEPHONE Co., Dallas, Pa., May 16, 1972. TOWERS, PERRIN, FORSTER & CROSBY, INC., Three Penn Center, Philadelphia, Pa. GENTLEMEN: I read your testimony to the House Oommittee on Ways and Means concerning pension legislation. We wish to state that we are in complete agreement with the proposals which you have submitted. They are certainly an improvement over the legislation as originally proposed. Very truly yours, F). S. BARBER, Personnel Director. CONE Mn~r~s Conp., Greensboro, N.C., May 5, 1972. Mr. JOHN J. BOND, Consulting Actuary, Towers, Perrin, Porster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR JOHN: Thank you for your letter of May 2 and the summary of Towers, Perrin, Forster & Crosby's position on pension legislation. As you know we have several qualified pension and profit sharing plans in effect for employees of the company and its subsidiaries, the oldest dating back to 1934. We have always believed our plans should be soundly financed and have made frequent improvements in them to keep them up to da:te with changing trends. In principle we support the ideas expressed in the summary of your position on current pension legislation. We strongly favor your position on vesting, portability, and deductibility of employee contributions. With kindest regards. Sincerely, BYRON C. CALHOUN, f~ecretary. PAGENO="0137" 439 DELMARVA POWER & LIGHT Co., Wilmington, Del., May 8, 172. Mr. CLYDE D. BEERS, F.S.A., Towers, Perrin, Forster ci Crosby, Inc. Three Penn Center, Philadelphia, Pa. DEAR MR. BEERS: We have reviewed your memorandum of May 2, 1972 on Pen- sion Legislation and agree, in essence, with your position. Please feel free to use our name in support of your testimony before the House Committee on Ways and Means scheduled for May 11, 1972. Sincerely, J. L. HAMMOND, Vice President. DIAMOND SHAMROCK CORP., Cleveland, Ohio, May ~9, 1972. Mr. PRESTON C. BASSETT, Vice President, Towers, Perrin, Forster c~ Crosby, Three Penn Center, Philadelphia, Pa. DEAR MR. BASSETT: This will refer to your April 19th and May 3rd Special Sup- plement Letter regarding TPF&C's position on pension legislation. This will confirm our telephone call to Phil Alden indicating that the Diamond Shamrock Corporation supports your position 100% on the proposed pension legislation. You may use our name to the Committee in support of your position. Sincerely yours, C. R. BROWN. EASTMAN KODAK Co., Rochester, N.Y., May 8, 1972. Mr. CHARLES D. RooTs, Jr., Towers, Perrin, Forster ~f Crosby, Three Penn Center, Philadelphia, Pa. DEAR CHUCK: We have carefully reviewed the "Summary of TPF&C Position on Pension Legislation" which you plan to submit as part of your testimony at the House Ways and Means Committee's hearings on HR. 12272. We can support your summary with the following qualification on the subject of vesting and the Rule of 50: We believe it is logical to view an employee's right to an accrued pension benefit as a function of his years of work for an employer rather than deter- mining this right in part by how old he is. This is particularly true if one ac- cepts the philosophy that a pension benefit is a part of earned compensation which a person is entitied to as a result of his contribution to an employer over a period of years. In our opinion, because of its reliance on age plus service, the Rule of 50 would create inequities among employees of different ages. With ever increasing frequency, people in both government and private in- dustry are becoming concerned about employee understanding and acceptance of pension and welfare plans. Confusion among employees is due, in great part, to the fact that plans themselves are ~omplex and defy simple ex- planation. Both government and industry share the responsibility for this. The Rule of 50 would introduce a complexity into many plans that does not exist today. For the above reasons, we feel strongly that any vesting standard mandated by legislation should be based on straight years of service. Mindful of the financial impact of mandated vesting on some plans, one possibility would be a formula that would provide 50 percent vesting after 10 years of service increasing by 10 percent per year for each of the next five years. There are, of course, many variations. In addition, to further ease the adjustment which some plans would have to make, we would recommend that vesting requirements apply only to bene- fits and/or contributions made after the five-year transitional period you are suggesting. PAGENO="0138" 440 You have our approval to use our name in support of your summary as quali- fied by this letter. We would appreciate your submitting this letter to the Ways and Means Committee along with your testimony. Sincerely yours, CARL L. STEVENSON, Assistant Vice President, Director, Compensation and Benefits. ETHYL CoRP., EMPLOYEE RELATIONS DEPARTMENT, Richmond, Va., May 5, 1072. Mr. JOHN FISHER, Towers, Perrin, Forster ~ Crosby, Inc., 1750 K Street, NW., Washington, D.C. DEAR JOHN: I have read TPF/C's position on pension legislation as outlined in your letter of May 3. The purpose of this letter is to advise you that Ethyl Corporation's basic posi- tion is that there is no need for any further governmental regulations concern- ing the private pension system and, therefore, we are opposed to any further legislation. If, however, Congress should decide that additional legislation is re- quired, then we do support TPF/C's position as outlined in the above-mentioned memorandum. We have no objection if you wish to refer to our support at your scheduled meeting with the House Committee on Ways and Means on May 11, 1972. Very truly yours, WALTER A. COSGROVE. FARMERS BANK OF THE STATE OF DELAWARE, Wilmington, Del., May 10, 1972. Mr. CLYDE D. BEERS, F.S.A. Consultant, Towers, Perrin, Forster ~ Crosby, Inc. Three Penn Center Plaza, Philadelphia, Pa. DEAR CLYDE: It is our understanding that TPF/C has requested an opportunity to testify at the public hearings on proposed pension legislation held by Chairman Wilbur Mills, of the House Committee on Ways and Means, beginning May 8, 1972. The Farmers Bank supports the position taken by TPF/C and you may cite this fact in your testimony. Verytruly yours, FRANCIS X. MoRRIS, Vice President. FLEER, CORP., May 10, 1072. TOWERS, PERRIN, FORSTER & CROSBY, 3 Penn Center, Philadelphia, Pa. GENTLEMEN: In reference to your bulletin of May 3, 1972, we wish to add our endorsement to the position TPF/C is taking on current Pension Legislation. We find the bulletins informative, and appreciate being kept up to date on this important subject. Yours truly, CHARLES H. MARVEL, Jr., Director, Industrial Relations. THE FIRST PENNSYLVANIA BANKING & TRUST Co., Philadelphia, Pa., May 8, 1972. TOWERS, PEI~RIN, FORSTER & CROSBY, Three Penn Center, Philadelphia, Pa. Attention : Mr. Stanley Freilich GENTLEMEN: On behalf of the First Pennsylvania Banking & Trust Company, I would like to go on record supporting the TPF/C position on proposed pension legislation. PAGENO="0139" 441 We find that your proposal is realistic and relevant to the current pension deficiencies. We have already made many of these changes in our proposed new plan, and would encourage the adoption of similar legislation. Sincerely, WALTER H. POWELL, Senior Vice President. THE FIRST NATIONAL BANK OF TAMPA, May 8, 1972. Mr. GEOFFREY A. POWERS III, Towers, Perrin, Forster ~ Crosby, Inc., 3400 Peachtree Road NE., Atlanta, Ga. DEAR NICK: Thanks for your letter of May 4th setting forth the position of TPF/C on the proposed Federal pension legislation and advising that TPF/C will testify before the House Ways and Means Committee on May 11th. We feel that your position is sound and you are hereby authorized to attach the name of The First National Bank'of Tampa to the brief to be presented on that date. Very truly yours, E. P. TALIAFERR0, Jr., President. THE R. T. FRENCH Go., May 11, 1972. EVERETT ALLEN, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. Dz~ Ev: This will confirm our telephone conversation during which we expressed our verbal endorsement of the Summary of TPF/C Position and Pension Legislation. The positions taken are both progressive and practical and you may use our name as a co-endorser when making your pres- entations to the Ways and Means Committee hearings. Sincerely, ROBERT F. WITZEL, Treasurer. GLEASON WORKS, Rochester, N.Y., May 4, 1972. Mr. CHARLES P. RooT, Jr., Vice President, Towers, Perrin, Forster ~ Crosby, Inc. Three Penn Center, Philadelphia, Pa. DEAR CHUCK: I just finished reading your bulletin of May 3 with respect to pension legislation which suggests that if we agree we should let you know. We certainly do agree with your general thesis and as far as I, can understand them with all of the details. We are, therefore, happy to be considered among your supporters. With best wishes, Sincerely, RANDOLPH E. CARLSON, Secretary-Treasurer. GuLF On~ CORP., Pittsburgh, Pa., May 8, 1972. Mr. MARIO LEo, Principal, Towers, Perrin, Forster ~ Crosby, Three Penn Center, Philadelphia, Pa. DEAR MARIO: I noticed that you requested outside comments on TPF/C's position on pension legislation as set forth in the May 3, 1972 Special Supple- ment of the TPF/C letter. I agree with all but one of the positions you have taken. I cannot agree completely with your unqualified support of the principle underlying vesting by the "Rule of 50" with a minimum period of five years' service. (The latter feature seems to add Complexity to an already complex proposal.) Basically, however, the "Rule of 50" is quite a departure from the traditional evolution of vesting related to service only. I would therefore like to suggest PAGENO="0140" 442 that you modify your position on vesting to urge an exemption from the "Rule of 50" for those pension plans which provide for full vesting after 10 (or less) years of service and complete exemption for all profit sharing and savings plans. Through the Washington Pension Report Group, Gulf was recently asked to endorse Lee, Toomey and Kent's proposed statement on the HR 12272. You may be interested to know that Jack Cardon will ask to exempt from the "Rule of 50" those pension plans which already provide for liberal vesting related to only service. Best regards. H.G. WEISER. HALLMARK CARDS INC., Kansas City, Mo., May 5, 1972. Mr. DON SULLIVAN, Towers, Perrin, Forster c~ Crosby,. Inc., 120 South LaSalle Street, Chicago, Ill. DEAR DON: Attached is TPF&C's special supplement letter of May 3 which has just arrived. Let me say that with one exception I personally believe the view your people intend to express is sound. That one exception is support of vestment under the "rule of 50". I have tested the practical result of this method and frankly, it becomes an accounting night- mare. In addition is the fact it could have the result of subtly discouraging the employment of people above the 40 mark, plus the fact I think it is going to sound unfair to younger people. Personally, I would far rather see some such more easily understood rule used. I think for starters it should be something like 12 years service and age 40 for 100% vesting. One other comment. It seems odd to me that no one is proposing a review of the IRS rules to see if there is not some concessions that can be made so that setting up plans will be easier with less concern about some of the technical aspects of so-called "discrimination". TPF&C is to be congratulated for taking a stand and appearing at the hearing. Sincerely, FRANK MaCLURE, Personnel Department. HARRIS-INTERTYPE CORP. Cleveland, Ohio, May 5, 1972. Re TPF&C Position on Pension Legislation Mr. PRESTON C. BASSETT, Vice President, Towers, Perrin, Forster c~ Crosby, Three Penn Center, Philadelphia, Pa. DEAR PRESS: This note is to let you know that I agree with the current TPF&C position on pension legislation as outlined in the "Special Supplement TPF&C Letter", dated May 3, 1972. Your efforts toward bringing logic and reason into the proposed pension legis- lation is a much appreciated service to the business community and ultimately to the American working man. I wish you success in your appearance on May 11th at the public hearings on proposed legislation held by Chairman Wilbur Mills, of the House Committee on Ways and Means. Cordially yours, A. L. COLLINS, Manager of Benefit Planning and Investment. THE HARTFORD STEAM BOILER INSPECTION AND INSURANCE Co. Hartford, Conn,., May 12, 1972. Mr. A. NORMAN CROWDER III, Towers, Perrin, Forster ~ Crosby, Inc., One Boston Place, Boston, Mass. DEAR NORM: Yes, I wish to indicate my general support of your approach to- wards the new pension legislation, as outlined in your letter of May 3, 1972. Sincerely, WALLE, Vice President and Treasurer. PAGENO="0141" * 443 THE HOME INSURANCE Co., New York, N.Y., May 5, 1972. Re Pension Legislation Mr. ERNEST S. KACHLINE, Principal, Towers, Perrin, Forster ~ Crosby, Inc. 90 Park Avenue, New York, N.Y. DEAR ERNIE: I have reviewed the position paper enclosed in your letter of May 3, 1972 with regard to your testimony `before the House Ways and Means Committee on the new pension legislation. The Home is in accord with your position as set forth and, accordingly, you have our permission to so indicate if it is desirable to do so. Sincerely, ROBERT H. TULLI5, Jr., Executive Vice President. HONEYWELL, INC., Minneapolis, Minn., May 10, 1972. Re TPFC pension legislation hearing before Ways and Means Committee, March11, 1972. TOWERS, PERRIN, FORSTER & CROSBY, INC. 3 Penn Center, Philadelphia, Pa. Please add Honeywell Inc. to your list of supporting companies. We have 50,000 U.S. employees. We are also supporting hearing of Washington Pension Report Group and Council on Employee Benefits. E. G. SHERMAN, Manager Employee Benefits. ICI AMERICA INC., Wilmington, Del., May 5, 1972. Mr. PRESTON C. BASSETT, Towers, Perrin, Forster d~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR PRES: I have reviewed your testimony for Pension hearings and agree with it. You may quote my endorsement of your testimony. Sincerely, W. S. THOMPSON. ITE IMPERIAL CoRP., Philadelphia, Pa., May 4, 1972. Mr. CHARLES D. ROOT, Jr., Vice President, Towers, Perrin, Forster c~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. Dia&n CHUCK: We have read over the TPF/C memo dated May 2, 1972, on the subject of proposed new Federal legislation on private pensions. After reading over your position on this pending legislation, we find ourselves in agreement, and support the proposals and recommendations indicated therein. You may use the name of this company in your testimony, indicating our sup- port of your position. Sincerely, JOHN F. MANNING, Treasurer. THE LAWYERS CO-OPERATIVE PUBLISHING Co., Rochester, N.Y., May 8, 1972. Mr. CHARLES fl RooT, Jr., Vice President, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR CHUCK: We were very pleased to hear that your firm Will have the privilege of testifying in the public hearings before the House Committee on Ways and Means regarding proposed pension legislation. As you know, our Pension Committee ha~ been very interested and concerned about the increasing amount of pension legislation. We are especially concerned that any new legis- lation is constructive and that it serves to strengthen the private pension system. PAGENO="0142" 444 After reviewing your comments with regard to proposed, legislation in the areas of fiduciary responsibility and disclosure, vesting and portability, mini- mum funding standards and insurance for unfunded liabilities, and deductibility of employee contributions, we find that we share the basic thrust of your position. We strongly urge you to impress on the Committee that pension expense is, for most employers, the largest single expense other than payroll. That is the case with this company. Therefore, we feel that the private sector should be heard carefully, and should be convinced that all areas of proposed pension legislation have been researched and studied exhaustively prior to the pas- sage of any of the currently proposed bills. Very truly yours, THOMAS GOSNELL. LINCOLN ROCHESTER TRUST Co., Rochester, N.Y., May3, 1972. Mr. EVERETT P. ALLEN, Jr., Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR Ev: We agree with your position and we also agree that you may indicate our endorsement when you testify before Congress. Sincerely, RICHARD L. S. GIRARD. MAGIC CHEF, INC., May 9, 1972. Mr. GEOFFREY A. POWERS III, Towers, Perrin, Forster ~ Crosby, Inc., 3400 Peachtree Road NE., Atlanta, Ga. DEAR Mn. Powm~s: We have reviewed the statement of TPF/C's position with regard `to the proposed Federal pension legislation and wish to assure you that we are in wholehearted agreement with the position. We feel very strongly that some of the proposed pension legislation is punitive in nature and entirely unnecessary in protecting the rights of employees. Many private employers, such as our company, have voluntarily instituted excellent pension plans for the benefit of their employees without being required to do so by the government. In fact, some of the proposed legislation would work to the detriment of em- ployee benefits and rights under some existing pension plans. TPF/C is to be commended for defending `the private pension system. Again, we assure you of our support. Very truly yours, S. B. RYMER, Jr., President. 3M Co., $t. Paul, Minn., May 10, 1f~72. TOWERS, PERRIN, FOESTER & CROSBY, INC., Three Penn Center, Philadelphia, Pa.. GENTLEMEN: We endorse the general concepts outlined in your May 3rd TPF/C Special Supplement Letter on pension legislation and are willing to l)e so reported in your testimony. I would only add that if there is any weakness in the TI. S. private pension plan system truly deserving Congressional attention, it is the fact that existing Federal regulation is one of a number of reasons why some employers, including many small employers, have been slow to adopt private pension plans. It is our hope that any additional legislation will promote the spread of the system. Very truly yours, P. E. GARRETSON, Treasurer. PAGENO="0143" 445 MOHASCO INDUSTRIES, INC., Amsterdam, N.Y., May 11, 1972. Mr. JOSEPH N. DAVI, Towers, Perrin, Forster ~ Crosby, Inc., 90 Park Avenue, New York, N.Y. DEAR JOE: I am writing in response to your letter of May 3, 1972, concerning proposed federal pension legislation. As I mentioned to you in our telephone conversation of May 10, I can generally support the position taken by your orga- nization on pension legislation, as I understand that position. I do have misgivings as to your positions on partial vesting based on a "rule of 50," the omission of a minimum entry age for eligibility, and the relationship of the latter to vesting. However, on balance your organization's position- which closely follows that proposed by the Administration Bills-is generally acceptable and supportable by me. Also, it is preferable to other bills introduced on pension legislation. I would appreciate your keeping me advised on the progress of the House Ways and Means Committee hearings. Sincerely, THOMAS A. BOYAN, Vice President, Personnel. MOUNTAIN FUEL SUPPLY, May 8, 1972. Mr. PRESTON C. BASSETT, FSA, Vice President, Towers, Perrin, Forster d~ Crosby, Three Penn Center, Philadelphia, Pa. DEAR MR. BASSETT: In response to your special supplement letter concerning pension legislation dated May 3, 1972, we support all of TPF and C's proposals. Good Luck. WILEY BEAVERS, Vice President, Administration. NEW YORK STATE ELECTRIC & GAS CORP., Binghamton, N.Y., May 8, 1972. Mr. A. W. MYERS, Consultant, Towers, Perrin, Forster ~ Crosby, Three Penn Center, Philadelphia, Pa. DEAR AL: We have examined the position statement attached to your letter to me under date of May 2nd, which represents the basis for the proposed testimony which TPF&C will make before the Mills Committee on May 11th. We find that we are in substantially full agreement with the position you have taken. It is the purpose of this letter to advise you that you do have permission to use our Company's name in your testimony. I have received official sanction to so advise you. Sincerely, J. M. DAVIDGE, Manager, Employee Relations. PACIFIC GAS & ELECTRIC Co., San Francisco, Calif., May 10, 1972. Mr. JAMES J. SWEENY, Towers, Perrin, Forster ~ Crosby, One Embarcadero Center, San Francisco, Calif. DEAR JIM: This will confirm my statement to you on the telephone this morn- ing that PGandE may be named by TPF&C as generally supporting the position which it is taking in hearings before the House Ways and Means Committee on pension plan legislation. I cautioned, however, that our support be stated in such fashion that we would not be committed to all of the details of the TPF&C testimony which, of course, we have not seen. Sincerely, FREDERICK T. SEARLS, Vice President and General Counsel. PAGENO="0144" 446 PENN VIRGINIA CORP., Philadelphia, Pa., May 8, 1972. Mr. CHARLES D. RooT, Jr., Vice President, Towers, Perrin, Forster G Crosby, Inc., Three Penn Center Plaza, Philadelphia, Pa. DEAR MR. Roar: Please regard this letter as your authorization to use the names of Penn Virginia Corporation, Westmoreland Coal Company, General Coal Company, and our other affiliated companies, as clients of Towers, Perrin, Forster & Crosby, Inc. supporting your position on pension legislation. I understand that you intend to articulate this position at public hearings to be held by Chairman Wilbur Mills, of the House Committee on Ways and Means, beginning this week. Your proposal will be based on a document entitled Summary of TPC/C Position on Pension Legislation, which we discussed on May 3, 1972. Best personal regards. JOHN A. H. SHOBER. PENNWALT CORP., Philadelphia, Pa., May 4, 1972. Re Pension Legislation Mr. JOHN J. BOND, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center Plaza, Philadelphia, Pa. DEAR JOHN: We have received and reviewed your proposed statement to the House Committee on Ways and Means which you sent us on May 2, 1972. This will let you know that Pennwalt fully supports your position and that you may make this fact known to the Committee. Sincerely yours, NICHOLAS M. WALKER, Manager, Legal Department. PHILADELPHIA ELECTRIC Co., Philadelphia, Pa., May 9, 1972. Mr. JERMAIN B. PORTER, Consultant, Towers, Perrin, Forster c~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR JERRY: We have reviewed the testimony which you intend to present to the House Committee on Ways and Means regarding pension legislation. We agree with your comments, especIally with reference to the care that should be exercised in providing legislation in this very complex area. Sincerely yours, H. T. BRYAN, Vice President, Personnel and Public Relations Department. THE PHILADELPHIA SAVING FUND SOCIETY, Philadelphia, Pa., May 5, 1972. Mr. CLYDE D. BEERS, Consultant, Towers, Perrin, Forster c~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR CLYDE: This will acknowledge receipt of your letter dated May 3, 1972 and the enclosures. We have examined all of the enclosures, particularly the Summary of PPF/C Position on Pension Legislation, and I assure you that we agree in general with the position you have outlined. Obviously we would want to discuss the details as they apply to our particular plan before implementing any changes. I hope your appearance before the Committee is endorsed by all of your clients and that the Committee gives thoughtful consideration to your testimony. Sincerely, STANLEY T. HALLER, Jr., Vice President, Personnel Department. PAGENO="0145" 447 PENNSYLVANrA PowER & LIGHT Co., Allentown, Pa., May 10, 1972. Mr. JERMAIN B. PORTER, Consultant, Towers, Perrin, Forster tf Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR MR. PORTER: This is in response to your 1e~tter of May 2, 1972 in which you transmitted an outline of your proposed testimony `before the House Corn- mittee on Ways and Means relating to proposed pension legislation. We are very interested in `this important legislation from bedh the standpoint of our employees `and `the effect on the Company and its customers. We have reviewed the outline of your proposed testimony and have no objection to using our n'ame in support of such testimony. Sincerely yours, R. R. FORTUNE, Vice President, Financial. RELIANCE INSURANCE Co., Philadelphia, Pa., May 9, 1972. Re TPF/C's position on pension legislation Mr. WILLIAM J. MURDOCH, Jr., Consultant, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center Plaza, Philadelphia., Pa. DEAR BILL: We have reviewed your position statement on the proposed pen~ si'on `legislation. We are in agreement with the position that you `are taking and you have our permission to indicate our support to the Committee. Very truly yours, P. J. KORSAN, Vice President and General Counsel. RETAIL CREDIT Co., Atlanta, Ga., May12, 1972. Mr. GEOFFREY A. POWERS III, Towers, Perrin, Forster c~ Crosby, Inc., 3400 Peachtree Road, NE., Atlanta, Ga. DEAR NICK: We have reviewed very carefully the material which you sent us with resp~ct to proposed Federal pension legislation, particularly the printed statement of your firm's position. This is to advise that we are completely in accord with the viewpoints ex- pressed by you and hope that the Congress will see fit to tailor its bill `along these lines. Very truly yours, H. L. HILLS, flecretary and Treasurer. ROCHESTER GAS & ELECTRIC CORP., Rochester, N.Y., May 8, 1972. Mr. EvEREUr T. ALLEN, Jr., Consultant, Towers, Perrin, Forstcr ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR Ev: In connection with public hearings on proposed pension legislation which will be held by the House Committee on Ways and Means beginning on May 8, Towers, Perri'n, Forster & Crosby, Inc. has submitted a summary of its position with regard to this proposed legislation, under date of May 2, 1972. This is to advise that Rochester Gas and Electric Corporation agrees with the TPF/C position, Sincerely, PAUL W. BRIGGS. ROCKWELL MANUFACTURING Co., Pittsburgh, Pa., May 3, 1972. Mr. STANLEY R~ FREILICH, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR STAN: In reply to your request by phone, Rockwell is willing to endorse TPF&C's position on pension legislation. 78-202 0 - 72 - pt. 2 - 10 PAGENO="0146" 448 You requested that TPF&C be permitted to use Rockwell's name when appear- ing before the House Ways & Means Committee. The answer is affirmative; you may include Rockwell with the other companies encibrsing your position. Sincerely yours, W. L. NEELY, Treasurer. ROHM & HAAS Co., Philadelphia, Pa., May 5, 1972. Mr. CHARLES E. PEARTREE, Towers, Perrin, Forster c~ Crosby, Inc., 3 Penn Center, Philadelphia, Pa. DEAR MR. PEARTREE: Thank you for your letter of May 2 with the TPF & C position paper on the proposed pension legislation which will be presented to the House Committee on Ways and Means on May 11. We have reviewed the written testimony recognizing the fact that some pension legislation is inevitable, and you are authorized to include Rohm and Haas Company in the list of your major clients supporting your position. Very truly yours, E. M. MORGAN, Jr., Secretary, Pension Plan Comnvittee. ROYAL CROWN COLA Co., Columbus, Ga., May11, 1972. Mr. JOsEPH W. SATTERTHWAITE, Vice President, Towers, Perrin, Forster t~ Crosby, Inc., 3400 Peachtree Road NE., Atlanta, Ga. DEAR JOE: In your absence today I spoke with your secretary and asked her to telephone your proper people the authority to include RCCs name in your brief about pension legislation before the House Ways and Means Committee. 1 regret having been so tardy, but your request arrived the day I left for ex- tensive traveling. Yours truly, LAWRENCE B. MOCK, Finance Vice President. ST. REGIS PAPER Co., New York, N.Y., May 5, 1972. Mr. JAMES H. BREN1NAN, Jr., Principal, Towers, Perrin, Forster ~ Crosby, Inc., 90 Park Avenue, New York, N.Y. DEAR JrM: Confirming our `phone conversation, I am in general agreement with your Pension Legislation position as outlined in your letter of May 3rd. Yours very truly, ARTHUR C. JAGER, Benefits Administrator. SMITH KLINE & FRENCH LABORATORIES, Philadelphia, Pa., May 4, 1972. Mr. JOHN J. BOND, Consulting Actuary, Towers, Perrin, Forster ~ Crosby, 3 Penn Center, Phiiade~phia, Pa. DEAR JOHN: We support the testimony on proposed pension legislation you plan to present at the public hearings of the House Committee on Ways and Means, and agree with the positions you are taking as outlined in your Summary of TPF/C Position on Pension Legislation. Sincerely, RAYMOND B.. KNIPE, Director, Corporate Compensation and Benefits. PAGENO="0147" 449 A. E. STALEY MANUFACTURING Co., Decatur, Ill., May 9, 19~72. TOWERS, PERRIN, FORSTER & CROSBY, INC., 120 $outh LaSalle tgtreet. Chicago, Ill. (Attention: Mr. Ed Bush, Jr.) DEAR ED: I have read the TPF&O letter dated May 3, 1972, concerning your position on current pension legislation. We essentially agree with the positions you have taken and would permit the use of our name and this letter as demonstration of our interest. Sincerely, W. S. ROBERTSON, Director, Risk Management. SUN OIL Co., St. Davids, Pa., May 4, 1972. Mr. CHARLES E. PEARTREE, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Center, Philadelphia, Pa. DEAR CHARLIE: This letter will serve as your authority to include Sun Oil Company among the corporations specifically supporting and endorsing TPF/C's position paper and testimony to be presented to the Ways and Means Commit- tee hearings on pending pension legislation. Sincerely yours, FORNLY HUTCHINSON, Jr., ______ (for DaleD. Stone). SYBRON Coin'., Rochester, N.Y., May 11, 1972. TOWERS, PERRIN, FOR5TER & CROSBY, 3 Penn Center, Philadelphia, Pa. (Attention: Mr. Everett Allen). GENTLEMEN: This will serve to confirm our endorsement of your position on proposed pension legislation as outlined in your memorandum of May 2, 1972. Your truly, D~&N S. ALDRIDGE, Management Employee Benefits. UNION PACIFIC CORP., New York, N.Y., May 10, 1972. Mr. DONALD E. KERN, Principal, Towers, Perrin, Forster c~ Crosby, Inc., 90 Park Avenue, New York, N.Y. DEAR MR. KTmN: The Union Pacific Corporation has followed, with a great deal of interest, the broad array of legislative issues relating to the proposed expansion of the Federal role in the regulation of the private pension system. Due to the fact that for a number of years Towers, Perrin, Forster and Crosby, Inc. has been closely associated with and directly involved in the development and implementation of the Union Pacific Corporation's Pension Programs, we were delighted to learn that on May 11th your organization is scheduled to tes- tify on the proposed pension legislation at the public hearings arranged by Repre- sentativé Wilbur D. Mills, Chairman of the House Ways and Means Committee. Appropriate members and officers of Union Pacific's Corporate management have thoroughly reviewed the basic pension legislation positions to be taken by Towers, Perrin, Forster and Crosby during these public hearings. We fully endorse the testimony your firm has prepared for its presentation, especially in the areas of fiduciary responsibility and disclosure, vesting and portability, minimum funding standards and insurance for unfunded liabilities and deduc- tibility of employee contributions. We hereby grant permission to list the Union Pacific Corporation among the other major companies who support your position in the very important effort to prevent the critics of the private pension system from dominating these public hearings. Very truly yours, LEWIS J. RINGLER. PAGENO="0148" 450 UNIGARD INSURANCE GROUP, Seattle, Wash., May 8, 1972. TOWERS, PuRRIN, FORSTER & CROSBY, Ixc., Three Penn Center, Philadelphia, Pa. GENTLEMEN: Your Letter of' May 3, 1972, describing TPF/C Position on Pen- sion Legislation stated you are scheduled to testify at public hearings on pro- posed legislation on May 11 and that if we, one of the organizations you serve, agree with your position, you would appreciate hearing from us. We do agree. You have served us well for nearly 10 years. We trust your ex- pertise on all aspects of the pension field and know your testimony will be aimed toward legislation that will be in the best interest of employers, employees, the government, and the public alike. It is essential that all of these segments of society be kept in mind; otherwise, the legislation enacted may become a de- terrent to private pension plan expansion in the future. Sincerely, JACK E. HULBURD, Vice President, Personnel. IJNITED-OARR, Burlington, Mass., May 15, 1972. TowERs, PERRIN, FORSTER & CROSBY, INC., One Boston Place, Boston, Mass. (Attention of Mr. A. Norman Crowder III, principal). GENTLEMEN: We have received your May 3, 1972 Special Supplement to the TPFO Letter which outlines the position you propose to take on pension legis- lation. In general we are in agreement with the viewpoints you state in the Supple- ment. In particular we `agree with your suggestion that a minimum period of service of five years be used in the proposed provision that pension plan vesting take place when age and service total 50 years. We believe a minimum service requirement is desirable in order to avoid immediate vesting of newly employed employees who are 50 years of age or over at the time of employment and who remain in the service of the employer only briefly. Yours very truly, JOHN M. DRY. WASHINGTON GAS LIGHT Co., Washington, D.C., May 5, 1972. Mr. JOHN W. FISHER, Manager, Towers, Perrin, Forster ~ Crosby, Inc., 1715 K Street NW., Washington, D.C. Da&R MR. FISHER: This is in reference to your letter dated May 3, 1~72, setting forth the position of Towers, Perrin, Forster & Crosby, Inc. with respect to pro- posed pension legislation. We fully support the position taken by your firm on proposed pension legis- lation and hereby grant permission to use our name in connection with any testimony you may give in that regard. Very truly yours, EDGAR R. MELLON, Vice President-Finance. WESTERN PENNSYLVANIA NATIONAL BANK, Pittsburgh, Pa., May 8, 1972. Mr. CHARLES E. PEARTREE, Towers, Perrin, Forster ~ Crosby, Inc., Three Penn Ccnter, Philadelphia, Pa. DEAR CHARLIE: This is to confirm our phone conversation last Friday regard- ing the proposed pension legislation before the House Committee on Ways and Means. As I mentioned to you, this is the type of topic that would be extremely difficult to get any consensus of opinion among the Bank's top management. On the one hand, they would be looking at it on a business standpoint as we deal in PAGENO="0149" 451 Trust pension funds, and on the other hand, as individuals who may be personally concerned with the outcome of the legislation. Rather than agree or disagree with the particular recommendations before the House, I would prefer to offer my support to the capabilities of your organiza- tion and its recommendations~ Over the last three years `that we have worked with your firm, we have relied heavily on your recommendations and as a result, I feel, have implemented a competitive benefit package which meets the needs of our employees. I continue to have the highest regard for your organization and look forward to a lasting relationship. If I can be of any other assistance in this matter, please do not hesitate to contact me. Sincerely, ROBERT G. NORTON, Vice President, Persoanel. [Telegram] REYNOLDS METALS Co., Richmond, Va., May 10, 1972. JOHN W. FISHER, Towers, Perrin, Forster ~ Crosby Inc., 1750 K ,S'treet NW., Washington, D.C. Reynolds Metals Company hereby endorses the testimony to be presented by Towers, Perrin, Forster & Crosby, Inc. before the House Ways and Means Committee regarding pension legislation on May 11th, 1972. R. L. ADAMS, Benefits Manager. Mr. SMITH. We thank you for the opportunity to present our views and will be glad to cooperate in any way that you deem reasonable in order to arrive at some constructive legislation in this field. Mr. BrIRLESON. We thank you both. Mr. Schneebeli, do you have questions? Mr. SCHNEEBELI. I would say that in the light of the broad corn- prdhensive consulting work that you have done and I am sure the good advice that you have given to these companies and also because of the specific recommendations that you have made here to this spe- cific legislation that we are very indebted to you for your thoughts. I think you have had a lot to offer. Thank you for coming. Mr. SMrrH. Thank you. Mr. BURLESON. The next witness is Mr. John Martin, vice presi- dent, Litton Industries, Inc. Identify yourself for the record further, ple~asc. STATEMENT OF JOHN H. MARTIN, VICE PRESIDENT, LITTON, IN- DUSTRIES, INC.; ACCOMPANIED BY DEANE E. McCORMICK, JR., TAX COUNSEL Mr. MARTIN. My name is John H. Martin. *With me, today, iS Mr. Deane E. McOormick, Jr., tax counsel of Litton Industries, Inc. I would like to make a brief statement on a very narrow point of this issue. Throughout its many operating divisions, Litton has 66,000 em- ployees who participate in pension plans. We are pleased to see this committee considering legislation aimed at strengthening and ex- tending the private pension plans. While many Americans are today enjoying the pension benefits which have been provided in the past, we believe the strengthening of PAGENO="0150" 452 the system will materially contribute to the extension of these bene- fits to many more citizens and contribute favorably to the stability and dignity of the people of our Nation. - DEDEICTIBILITY OF EMPlOYEE'S CONTRIBUTION There are many parts of the `bill under consideration which we welcome and readily support; in fact, we are pleased to realize that the participation and vesting proposals have been more than satisfied by the Litton plan for many years. However, the specific proposal of tax deductibility of the employee's contribution to which' I address myself needs revision in our opinion. While this is an extremely desirable provision in principle, its usefulness has been severely limited by providing for an offset if an employer contributes on the employee's behalf. This limitation on the deductibility of the employee's contribution will obstruct the goal which the legislation seeks. A little `background. Because of its many operating divisions, Lit- ton has many pension plans but the pla4ns which the vast majority of our employees participate in, over 50,000, whether salaried employees or hourly employees, whether union or nonunion, are plans to which both the employer and the employee make contributions. The employee may contribute either 2, 3, or 4 percent of his salary during the course of his employment. The employee then receives an- nually 50 percent of his total accumulated contributions following his retirement. We believe that meaningful benefits are o'btained by allowing the employee to contribute. He realizes that providing `for the future is a costly but a valuable right. Having made contributions to the plan, we believe that the employee takes a greater interest in the plan and more fully understands the benefits and the costs. The company tries to stress to the employee when lie first enters employment and periodically thereafter the benefits of providing for the future. Virtually all of the employees appreciate the free- dom that our joint contribution approach affords them to make their own decision as to whether they should invest in retirement and if so, how much. Obviously, the younger employees who may not plan to make a career in business choose to direct their money to other pur- suits. Often, a young man with small children will decide it is wiser for a few years to provide greater life insurance coverage currently for his family and will enter a retirement program only after he has made adequate provision in case of his untimely death. Naturally, a much higher percentage of older employees invest to the fullest pds- sible extent in their prospective retirement income. We believe that this flexibility in, the usage of funds is desirable from an individual, company, and national viewpoint. It enables the individual to tailor his finances to his own particular requirements and relieves his employer from the burden of providing ~unwanted benefits. Overall economy is therefore achieved by this flexibihty. It is my understanding that the restrictions on the deductions that are contained in the proposed legislation were felt to be necessary because of the adverse impact on the revenue. PAGENO="0151" 453 However, Congress cannot allow large, but budgetable costs to deter it from providing for reasonable and efficient funding of pension plans to hasten the expansion of meaningful retirement coverage to many more employees. The question is not whether the cost of reason- able retirement income will be incurred, but how the cost will be paid. It is our basic position that providing a reasonable tax incentive to the employee will encourage the growth of employee contributory plans. Such plans are both desirable and essential. Such a cooperative approach permits maximum flexibility to meet individual circum- stances and should result in better total pensions for the individual since costs are shared between the company and the employee. Smaller firms, which today hesitate to undertake the cost of a reasonable pension program, would be encouraged to join with their employees to achieve goals presently unreachable. Incidentally, at Litton, we have found that the average worker finds a 4-percent con- tribution to a pension plan, in addition to his social security taxes, about the maximum he can realistically invest in retirement. Further, we believe such an expansion of employee contributory plans will assist in the growing problem of hiring the older worker, since the higher cost will be shared. Our specific recommendation is that in lieu of the 7 percent of total income offset proposal, one of two alternatives be adopted by Congress. One, a flat deduction of up to some amount, perhaps $1,500-this is the Canadian approach, but theirs is $2,500. Two, a percentage of the social security wage base-say 15 percent. This has the advantage of keeping the deduction in line over the years with what the Congress considers a reasonable level of earnings to be used in establishing the basic retirement level-social security. In summary, we urge that the individual be given a right to a tax postponement when he invests in his retirement up to a reasonable level which is similar to the right a company has to invest for him or a self-employed has to invest for himself. This right to be exercis- able whether he invests in a separate individual plan or one which his company helps him build to a larger total retirement income. Thank you, Mr. Chairman. Mr. BIJRLESON. Thank you, Mr. Martin. Does that complete your testimony? Mr. MARTIN. That completes our testimony. Mr. BtrRLESON. Mr. Schneebeli will inquire. Mr. SOHNEEBELL. I would like a little enlightenment on your basic proposition here. You say an employee is entitled to put in up to 4 percent of his salary and then upon retirement gets 50 percent of the total accumulated back per year? Mr. MARTIN. Right. Mr. SOHNEEBELI. If he lives 10 years beyond, he gets five times what he invested. Mr. MARTIN. Yes, and he is supposed to live 15 years as you know. Mr. SCHNEEBELI. What is the company's participation in this? Mr. MARTIN. The company provides the actuarial amount neces- sary-depending on the age distribution of the group concerned, et cetera-to reach that level of benefit which you just described. PAGENO="0152" 454 Mr. SCHNEEBELI. I see. Then he gets 50 percent of what he contributes over 15 years with the balance being supplied- Mr. MARTIN. The balance being supplied by the company and the earnings of the fund. Mr. SCHNEEBELI. With the improvement in geriatrics being what they are you may be jeopardizing your funds, wouldn't you think? Mr. MARTIN. We have one 92-year-old in it. Mr. SOHNEEBELI. It sounds like a pretty good gamble. Mr. MARTIN. It is actuarily sound. That is one of the reasons we can completely agree with the other proposals. In total, all of the vested requirements of our plans are funded. Mr. SOUNEEBELI. Most people come into the top 4 percent only as they develop in later years. Mr. MARTIN. Not necessarily. It varies tremendously. A little aside: you would think that we probably would get very few women in the plan. We have one division that has a great many women employees where we found a very good sign-up, that is, a very good participation. They were treating it as a savings plan. They planned to get married to get their retirement income but they like what comes back to theme the money they had put in, to have as a nest egg. Some young people can see how it builds up for them and think of it highly and on the other hand, some pay no attention to it. Mr. SCHNEEBELI. It sounds attractive. Do many industries have this proposal? Mr. MARTIN. Not many, I am sure, but yes, we think it is a very good plan. We have had very good success with it and it is well thought of. Mr. SCHNEEBELI. Thank you very much. Mr. BtTRLESON. Thank you, Mr. Martin. We appreciate your coming. Mr. MARTIN. Thank you. Mr. BURLESON. Our next witness is Mr. William A. Dreher, presi- dent, William A. Dreher and Associates of New York City. Will you identify yourself further, please. STATEMENT OP WILLIAM A. DREHER, PRESIDENT, WILLIAM A. DREHER & ASSOCIATES Mr. DREHER. Yes, sir. G'ood morning, Mr. Chairman and members of the committee. My name is William A. Dreher. I am a consulting actuary and president of William A. Dreher and Associates, Inc. Our clients include corporations, joint labor-management trust funds, and State and local governments. My testimony reflects 18 years of experience with the design, fund- ing, and administration of pension, profit sharing, stock bonus, thrift, and savings plans, including funds wholly funded by employers and those partially and fully financed by employees. I am a member of the American Academy of Actuaries, a fellow of the Society of Actuaries and the Conference of Actuaries in Public Practice. I am currently a member of the board of governors of the Society of Actuaries and a member of its Committee on Continuing Education, with responsibility for its Subcommittee on Retirement PAGENO="0153" 455 Plans. I belong to the American Pension Conference and am currently a member of its steering committee. I am appearing before you today as an individual. I am in favor of the stated objectives of H.R. 12272: To provide minimum standards of participation in the benefits offered by.an employer-sponsored retirement plan; and To offer greater tax benefits to individuals who choose to invest in a retirement savings plan. In my opinion, the bill does riot move far enough or fast enough to accomplish tihese objectives nor is it responsive to ano'ther need which should be promoted by retirement plan legislation. I refer to the en- couragement for adequate funding of private retirement plans. On specific points within the legislation, as proposed, I believe that its scope does not adequately recognize the role which a stock bonus, thrift, or savings plan can play in a total plan established by an em- ployer. These plans are qualified under the same section of the Internal Revenue Code that applies to profit-sharing plans and I believe should be comprehended in the treatment accorded all 401 qualified plans that are `subject to legislation. I have specific reference to several of the plans established by our clients under which they will have `both a pension plan and/or a savings plan. Under the pension plan, the vesting requirements may be less liberal than those specified in H.R. 12272 but, if you take all of the employee's rights included under `both programs, you can demonstrate that the total vested interests accruing to an employee are, in fact, quite liberal and achieve the objectives of the proposed bill. My testimony includes an exhibit which illustrates that point as it would apply to a typical petroleum industry `benefit program. Mr. BURLESON. Did you wish that to be a part of the record? Mr. DREHER. Yes, sir. Mr. BURLESON. Without objection, it will be included. (The exhibit referred to and Mr. Dreher's statement follow:) PAGENO="0154" 456 PAGENO="0155" 457 1. Tuning up the National Pension System (page 3) 2. Options for Pension Plan Sponsors (page i6) By William A. Drelier, FSA, FCA Two speeches presented at the forum, `The Private Pension System; Options for Survival", held by The First National City Bank on April 29, 1971. PAGENO="0156" 458 Tuning up the National Pension System Retirement fund assets today are one of tile largest enclaves of capital in the U.S. economy. And how well those assets are being used becomes a more important question with every passing day. The national systens of income maintenance for retired workers has been under fire for nearly a decade now. i)uring that decade retirement fund assets- private pension and profit sharing pbs, Plus programs sponsored by state and local governments-have grown to nearly $200 billion. This is a truly awesome figure when you consider that the total assets of the country's go largest banks at the end of i 970 were only $278 billion, the assets controlled by the go largest life insurance companies were only $172 billion, and the national debt only $382 billion. Even the venerable Fortune goo had a net worth of barely $430 billion at that date. Today, retirement fund assets are still growing-by approximately $13 billion a year-but so is the clamor for restrictive legislation. The Challenges to As a result, every employer, investment manager, and actuary in this nation needs the Private Pension System to take a cold, hard look at the questions that are being asked: U Is the retirement system doing its job? U Are benefits large enough? U Are these programs granting and delivering benefits in tile proper form and subject to appropriate eligibility requirements? U Have the assets beeis effectively iisvested, considering their freedom from taxation, the absence of any real constraints on investnsent policy and the positive cash flow? U Have plan sponsors and their trustees been aware of their responsibilities to protect and communicate employees' rights? In short: Is the system efficient and, if not, what ought to be done about it? U Improve benefit structures? U Increase tile productivity of accumulated assets? or U Impose legislative and regulatory restrictions on invest nsent policy, eligibility requirements and aclnsinistrative policies? 3 PAGENO="0157" 459 Clearly, many legislators think that the system is inefficient and underproductive. And a look at the evidence suggests that their conclusion is not without some merit. In my opinion though, radical new legislation is not the answer. What the system needs is a tune-up, some new parts and a driver education program. To make a model change and hire a chauffer would be too extreme. Coping with the Problems Just opposing legislation will not be enough, however. We need a clear picture of what is wrong with the private pension systens, what's involved in tuning it up and what stance employers, trustees, asset managers and actuaries should assume in order to avoid a simple, sudden and final "solution" of pension problems by legislative fiat. First of all, we need to recognize that with such large concentrations of tax-sheltered wealth, some abuses and deficiencies are inevitable. And I'm afraid that we must also recognize that some form of legislation is no doubt coming. Finally, we must understand what deficiences exist among all three parties-at-interest in pension plan operations: i. Plan sponsors themselves, 2. The organizations responsible for investing fund assets, and 3. The actuaries whose computations determine plan liabilities and annual cost. The record shows that some employers have been slow to broaden coverage by vesting benefits for employees who leave after extended periods of service. In gen- eral, early retirement benefits are meager, and few retired workers have pen- sions protected against the eroding effects of inflation. The record also shows that a considerable fraction of investment man- agers-either through poor investment policy or lack of skill in managing money -have produced sub par investment returns. Finally, my own profession is not exempt from criticism. An excess of caution in selecting actuarial assumptions can lead to unnecessarily high levels of funding, or unduly low benefits. At the other end of the spectrum an excess of optimism can weaken pension benefit security, and expose plans to intolerable cost increases in later years. Greater realism in the selection of each actuarial assumption is critically important in today's environment. We must couple better judgment in selecting actuarial assumptions with greater awareness of the social, economic and politi- cal atmosphere within which the private pension system operates. We will serve you all better by putting less emphasis on high-priced, repetitive arithmetic.., and by concentrating more attention on assisting clients in a re-examination of basic employee benefit policy. A fundamental review of pension and other economic security plans is critically important and the time for action is now. 4 PAGENO="0158" 460 Pressures in Washington are growing, and souse of the proposed legislative solutions are stark: U Minimum vesting of pension rig/its. . beginning after five years, U Mandatory reinsurance of unfunded liabilities, U Stricter funding requirements, U Limitations on benefits for higher paid einplo~ees, U Portability of assets tvhen employees leave with vested rights, U Elaborate procedures for reporting administrative transactions and corn- nzunicating tvith employees. These proposals would fall with unequal force ots plan sponsors and their employees, create pressures for standardization of plan i ovisions.. . and substan- tially raise costs for many plans. Some older and more progressive plans may already have spent tlte money this legislation would mandate. But even they would be burdened by a new layer of administrative requirements, unnecessary costs and reduced flexibility in benefit design and investment practices. What should we all be doing to cope with the situation? First, I think we should accept the reality that some legislation will be passed-if only to expose and curb abuses of the sort that have already been found. Second, plan sponsors need to develop a fuller understanding of tlteir plans. Limiting new costs and reporting requirements to tolerable levels will criti- cally depend upon your ability to demonstrate how tlte various proposals will affect your program, your employees, future costs, earnings per share.. . and even the market value of your common stock. Third... get involved. Use your understanding of your own plamis to educate local legislative representatives aboctt the practical consequences of proposed legislation. More persuasive. . . and constructive. . . testimony before congres- sional hearings might have muted the great pension controversy a long time ago. Many of us have waited too long to become sensitized to the pressure for increased federal control over private pension plans. In retrospect, we can question the wisdom of the cold shoulder attitude displayed by business men and their advisers when the President's Cabinet Com- mittee report on Private Pension Plans was released in m965. The l)rmnciPal conclusions of the Cabinet Committee report are pallid by contrast to today's legis- lative demands. We now face far greater demands for change, and less willingness to heed the voice of moderation. It maybe necessary for businessnsen and their professional advisers to step up now and support some legislative proposals actively. Otherwise, we may find ourselves in a strait jacket imposed by restrictive legislation. 5 PAGENO="0159" 461 Reviewing Developing the requisite understanding of your own plan and how it would Actuarial and Other Factors be affected by proposed legislation depends first upon getting your actuarial house in order. . . and then upon recognizing the magnitude of the cost increases you might expect if some of the penditig bills were enacted. Make f97t get-closer-to-your-actuary year. You just might have a few surprises, because many plans today have significantly higher or lower pension liabilities tItan existing assumptions show. Accordingly, actuaries and plan sponsors share an obligation to take a new look at each actuarial factor, from mortality and turnover rates to salary scales, from retirement rates and asset valuation methods to the schedule for amortizing past service costs. Unfortunately, many actuarial assuml)tioiis are not sufficiently conservative. In practice the investment return assumption is often lowered in an effort to compensate for other assumptions that may be too optimistic. But this is merely a form of robbing Peter to pay Paul and can disguise a plan's true financial con- dition-which may in fact be either better or worse than the results indicated by a crudely selected set of actuarial assumptions. For example - . . the pension liability in many plans is understated by as much as ten per cent because their mortality tables underestiniate the iniproving life expectancies of retired plan participants. A further understatement of as much as iq to 25 per cent can occur in plans which assume an average retirement age of 67 or 68. An increasing number of people in all plans are retiring below age 65. Today, an average age of 62 or 6~ is not uncommon, and this trend is likely to continue. The tremendous surge of younger people into the work force will enhance pressures for earlier retirement, as will changing technology in many industries. The incentive to retire early will also be stimulated by further increases in Social Security benefits, and by benefit improvements in private plans themselves. Still another source of understatement is the salary scale projection. Most of you are familiar with the old saw: "\Ve catinot use an inflation factor in the salary scale because the Internal Revenue Service will not permit it". Personally, I challenge this truism. In fifteen years I have not had a salary scale projection rejected by the Internal Reventie Service. But even if this were truly the Internal Revenue Service's position, management should still know the long-term effects of inflation on pension liabilities. Pension plan costs are in danger of material utiderstatement if the actuarial valuation fails to project properly the level of salary a decade or a generation from now, particularly in plans which base benefits on average pay in the years near retirement. In combination, the understatement of pension liabilities as a result of unreality in these three areas alone could reach fifty per cent . . . which may or 6 PAGENO="0160" 462 or may not be offset by conservatism in the investment return assumption. On the other side of the ledger, a re-assessment of actuarial factors includes two which might have a favorable effect on costs: o The employee turnover assumption, and O The asset valuation method Turnover-the termination of employment before retirement-is doubly impor- tant today. First, employees who leave before benefits vest are not 1sart of your pension liability. And if your plan uses a turnover assumptiois established several years ago, you may be overstating casts, because job mobility has been on tlse increase. If so, tlsis would help offset understatements due to other actuarial assumptions. Second, one of the principal peission reform proposals is earlier vesting. If assumed turnover rates do not fairly and reasnnahly reflect the key variables in tlse turnover equation, namely, age, sex and length of service, the true cost arising from proposed vesting legislation may he disguised. Another important influence on your plan's pension liability is not an actuarial assumption per se, but rather the niethod used each year to determine the liability amount that remains unfunded: that is, the method of valuing assets, particularly common stocks. Like the investment return assumption, valua- tion methods have tended to be conservative, recognizing little of unrealized appreciation and depreciation on common stocks. New accounting requirements aside, many plan sponsors today need to shift from asset valuation methods which emphasize hook value to methods which emphasize market value. A failure to allow adequately for unrealized gains in some systematic way will result in overstating tile total pension liability. t'Vhen all other ingredients of the actuarial basis properly reflect future prospects, you will have a minimal need to use the irsvestisient return assumption as a buffer. The actuary can then recommend an assumption that ties in more realistically with expectations for the fund's future investment policy. Finally, a pension plan's cost and contributions can vary widely.. . depend- ing on the schedule for amortization of liabilities created at the plan's inception or upon subsequent plan amendments. Many plans are fully funded and others are completing the process on a ten or twelve year schedule; hut many extend the funding process indefinitely by paying the minimum allowed by the Internal Revenue Service. Regardless of regulatory or accounting requirements.. . it is questionable in my opinion forsmahher companies and those in higlsly conspetitive, declining or teclsnologicahly-threatened industries to stretch out their past service funding arrangements. PAGENO="0161" 463 Whatever funding schedule you settle upon, the kind of intensive review I have described will enable you to know the present financial and actuarial condition of your programs, and thus better equip you to test the incremental cost effects of proposed legislation. These incremental costs fall into two categories: The direct costs of legislated requirements for minimum vesting, funding and reinsurance; and 2. Indirect costs associated with mandatory transfer of assets when employees terminate with vested rights. . and additional administrative costs for more elaborate reporting to regulatory agencies and plan participants. The direct costs of funding, vesting and reinsurance proposals cannot be fully separated because they are interdependent. Reinsurance premiums will depend upon the unfunded liability, which in turn depends upon the required amortiza- tion rate and upon the vesting schedule. Funding The cost effects of minimum funding proposals will depend mainly upon your schedule for amortizing past service costs. These bills would require thinly funded plans to start catching up under either of two formulas: Existing unfunded liabilities will have to be covered within forty years and new liabilities within no more than thirty years, or a. Annual contributions would have to cover the vested liability within aq years plus normal cost and interest on unfunded, unvested liabilities. The forty year rate is set by the Javits Bill, S-a, and the Carney Bill, House Resolu- tion 6122. The twenty five year rate for funding vested liabilities is set by the Dent Bill, HR 1269. If you're amortizing past service costs less rapidly than either of these two formulas, your annual costs would clearly go up. You can estimate the size of the increase rather simply in the case of the Javits Proposal, but the increase under the Dent Bill would depend upon your plan's vesting provisions. Vesting Proposals Vested benefit costs cannot be so simply estimated, both because they depend upon the nature of the covered employee group and because the minimum vesting proposals cover a wide range. Mr. Nolan of the Treasury Department has recently been running a "Rule of Fifty" proposal up the flagpole. This formula would entitle an employee whose age and service totalled fifty to 50 per cent vesting in his accrued benefits. For each additional year of service, the employee's vesting percentage would increase by ten per cent. Thus, an employee age 35 with 15 years of service would have a minimum vesting of fifty per cent. By the time he has completed twenty 8 78-202 0 - 72 - pt. 2 - 11 PAGENO="0162" 464 years of service his accrued benefits would be fully vested. Similarly, an employee age 45 with five years of service would have fifty per cent vesting, and he would have full vesting after ten years service. Two other basic proposals for minimum vesting are included in the pension bills now before Congress: D The Dent Bill, HR 1269, requires minimum vesting in all plans svhich have been in existence at least five years. The eventual goal is that employees with ten years of service svould be fully vested in all accrued benefits. Fortunately the bill would permit the plan to disregard service prior to age 25. It also includes a wide variety of transitional arrangements is/sic/s allow ten years to elapse before the full vesting requirement applies. fl The Javits Bill, S-2, and the Carney Bill, HR 6122, are much more restrictive. And t/sey do not provide the wide varietyof options available under the Dent Bill. The Carney Bill requires the plan to vest at least ten per cent of an employee's accrued benefit after five years of service ivith an additional ten per cent each year thereafter. Consequently, an employee with 14 years of service would be fully vested in all accrued benefits. The bill does not permit the plan to disregard any service, but it does exempt plans covering 25 or fesver employees. The Javits Bill is essentially the same, but starts t/se vesting after 6 years of service at thie ten per cent rate and builds up to one hundred per cent after fifteen years of service. The cost of vesting has been the subject of considerable controversy, and we've heard several generalizations on the subject. For example, Mr. Nolan has asserted that the typical plan would have increased costs of only seven per cent if his rule of fifty were adopted. Even an accurate rule of thumb can be misleading, however, on the principle of the old story about a man drowning in a river with an average depth of only six inches. Examples of Vesting Costs It's the effect which mandatory vesting has on your plan which counts. To demonstrate these cost effects we tested seven different vesting schedules for the salaried employees of a large food chain which now has very limited vesting in its plan, as shown in Figure i. Alternative Vesting Schedules (Figure s) s. ~o% vesting after i~ years of service, increasing so% per year thereafter to soo% vesting after so years of service. a. ioo% vesting after age 40 and so years of service. PAGENO="0163" 465 3. 50% vesting after age pius service equal 50, increasing i o% per year thereafter to aoo% vesting after age plus service equal 6o. 4. 1 o% vesting after q years of service increasing i o% per year to full vesting after 14 years of service. 5. a oo% vesting after ao years of service. 6. 50% vesting after q years of service increasing i o% per year to full vesting after ao years of service. 7. i oo% vesting after ~ years of service. Although several of these vesting schedules are not included in any current legislative proposals they are nonetheless significant. Tile first scliedule-qo per cent vesting after fifteen years of service-was discussed back in 1965 in conjunc- tion with the Cabinet Committee Report on Private Pension Plans. .. and is an illustration of the mildness of those proposals. The sixth schedule-Fifty per cent after five years of service is my best guess about where we may beheading with either the Carney or Javits Bills, since ten per cent vesting after five years of service will obviously produce tiny amounts of protected pension. The seventh schedule has no formal sponsor, but illustrates the need to look well ahead when forming your views on proposed legislation. The turnover assumptions used in our calculations were based on laistorical studies. Their effect is shown in the following two figures: Illustration for Plan without Vesting (Figure a) Nuni her Expected to Retire Plan (Normal Die While Age Members and Early) Employed 05 1310 72 so 30 2103 235 50 35 a8.jg 364 6~ 40 1527 466 72 45 1198 524 64 50 884 532 46 55 623 519 25 6o+ ~o6 5o6 10,000 3218 342 to PAGENO="0164" 466 Illustration for Plans with Vesting (Figure 3) % of Employees Who Will Qualify for Benefits If Vesting Eligibility Is (Normal, early and vested) 15 yrs. service 55% (See Number e, Figure r) Age 40-10 yrs. service 58 (See Number 2, Figure r) Age + service = 50 66 (See Number 3, Figure a) to yrs. service 66 (See Numbers arid 5, Figure r) 5 yrs. service 84 (See Numbers 6 and 7, Figure a) Figure 2 indicates that 32 per cent of the work force will qualify for a benefit, even if there is no vesting before early retirement Figure ~ shows that the proportion of employees leaving employment with vested rights to either deferred or im- mediate benefits will range from a low of ~ to a high of 84% depending on the generosity of the vesting requirements. The incremental cost of vesting on the food chain's plan is shown in Figure 4. Additional Cost under Alternative Vesting Schedules (Figure 4) Vesting Mature Plan New Plan ~o%-t~ yrs. to too% 20 44.1% 24.9% (See Number i,Figure a) loo%-4o/lo 51.9 34.9 (See Number 2, Figure a) ~o%-Age/service = 50 52.5 35.3 (See Number 3, Figure a) io%-~ yrs. to ioo% 14 57.7 38.8 (See Nu,nber 4, Figure a) too%-io yrs. 58.3 39.3 (See Numbers, Figure a) ~o%-~ yrs. 64.8 46.6 (See Number 6, Figure a) too%-5 yrs. 72.1 52.8 (See Number 7, Figure a) Note that the percentages are related to the plan's present annual cost. Clearly... this company's costs would increase substantially. Under the Nolan formtila and all of the Bills currently pending in Congress, the increase would amount to more than fifty per cent for a mature plan. I have defined a mature plan, for the purpose of these illustrations, to be one that is fifteen years old and has been amortizing past service liabilities on a 30 year schedule. The last column of percentages illustrates the vesting cost for a completely new plan using the same benefit provisions and having the same employee population. 11 PAGENO="0165" 467 As you can see. . . even for existing legislative proposals. . . the extra cost would be more than one third. At this point, it should be underlined that the relative costs and other factors illustrated here will be inappropriate for companies whose patterns of turn- over and other actuarial factors differ from this one company's experience. Your own results may indicate a greater or lesser cost than those shown in the figures. The percentages in Figure 4 can also be used to estimate the cost of liberal- izing the vesting under a plan whirls already has a vested benefit. For example, if a mature plan is now providing vested benefits after i ~ years of service on a graded schedule and is compelled to give full vesting after ten years of service, its cost will increase by 1 1.585 9.9%~=---1.ooo Terminated Employees Since the whole purpose of vesting is to provide retirement protection for employ- ees who change jobs. . . we performed two other computations: To determine what percentage of employees would not receive at least some benefit under various vesting schedules, and 2. What percentage of the normal pension would be payable to an employee under the seven vesting schedules if he worked for four different employers during his career. In the first case, we applied the turnover rates of the retail company to each age group and established that from thirteen per cent to forty-two per cent of present employees would not qualify for benefits. . . either through working to retirement age. . . or having accrued benefits vested at the time of termination, as shown in Figure ~. Employees Terminating without Vested Rights (Figures) % of Employees not Qualifying for If Vesting Eligibility Is Vested Benefits 15 yrs. service 42% (See Number a, Figure a) Age 40-mo yrs. service 39 (See Number 2, Figure a) Age + service = 50 31 (See Number 3, Figure a) 10 yrs. service 31 (See Nu,nbers 4 and 5, Figure a) 5 yrs. service 13 (See Numbers 6 and 7, Figure a) Does this mean that all of these employees will be left out in the cold at retirement, which has been the chief accusation hurled at the private pension system? 12 PAGENO="0166" 468 The answer is an unequivocal: No! In our highly mobile work force, job hopping is a fact of life. An employee who leaves one job takes another. After all, he has to eat and pay the mortgage. So our second computation slsows the benefits accruing for a hypothetical employee who is assumed to Isave four employers in a career wlsich began at age 25. He was assumed to work five years (less one day) for the first employer; five years (less one day) for the second ensployer; ten years (plus one day) for the third ensployer; and to retire from Isis fourth employer at age 6q after twenty years (plus one day) of service. In each case, we assssmed that Isis salary progression was unaffected by his change of employment. In other words.. . he made a lateral employment shift. . . and continued with the same rate of salary increase that he would isave received from the former employer. We also calculated the benefit for an employee wlso stayed with one employer throughout his entire working lifetinse and retired under a typical private pension plan. The benefits eventually earned by the mobile employee under various vesting schedules were then compared with tlsose payable to the one-career to-year service employee, as sisown in Figure 6. Benefit Illustration for Mobile Employee (Figure 6) Total of %of Benefit Fester! Benefits from Earned by Vesting ~ Employers i-Job Employee yrs. to soo% 20 $14,899 ~o% (See Number i, Figure r) 1 oo%-40/so 18,035 61 (See Number 2, Figure r) so%-Age/Service = 50 17,250 q8 (See Nun, ber3. Figure z) so%-~ yrs. to ioo% 14 16,799 ~6 (See Number ~,Figure r) ioo%-so yrs. s8,o33 6i (See Numbers, Figure i) ~o%-~ yes. s8,o~~ 6s (See Nzz,n ber 6, Figure i) ioo%-~ yrs. 18,033 6i (See Number 7, Figure') These two sets of computations. . . shed a lot of liglst on the much publicized `one in nine" rule broadcast by critics of tlse private pension system. Under this tiseory, only one employee in nine who comes under a pension plan will ever have a vested benefit. Statements to a similar effect were recently made by Senators Williams and Javits in connection \viths tlse preliminary survey results released by their Committee. The figures given above show the logical error of such statements. They fail to recognize that an employee wlso leaves one employer witlsosit any vested rights does not drop out of the labor force. He goes to work for anotlser employer and 13 PAGENO="0167" 469 typically, in time, will settle dosvn and work long enough to establish his en title- ment to vested benefits. Consequently, the probability that an employee who serves several em- ployers, each providing coverage under a pension plan, will ultimately retire with vested rights from one or more of these employers is very much higher than the one-in-nine fallacy suggests. I cannot judge the political tactics by whirls such exaggerations are deemed necessary in order to galvanize public opinion aiid get support for legislative proposals. Nonetheless. . . it is regrettable to see intelligent men make such mis- leading use of statistical data. Reinsurance The third area of direct extra employer cost is reinsurance.. . a scheme for accumulating employer-paid premluills as a reserve against obligations of plans which terminate with insufficient assets. The Javits, Carney and Dent Bills each have reinsurance provisions, and the employer's premium is based on the unfunded vested liability. Despite premisim limits and various ameliorating clauses, the cost cosild he a significant addition to your annual expense. To illustrate the magnitudes, let us assume that a plan being newly established has an accrued liability equal to i a times its normal cost and a vested liability of 8 times its normal cost. If this plan has a six per cent investment return assumption and is amortizing past service liabilities over 20 years, reinsuranre prensicims (asssiming the six-tenths per cent maximum under the Dent Bill) would increase the annual funding require- ments by 2~ per cent. Under both the Dent and Carney Bills, a plan which had fully protected its vested benefit liabilities would pay no reinsurance prcumum. There are, however, rumors about that Senator Javits' staff is aware that large plans are fully funded and would pay relatively little, if any, reinsurance ~ They are said to be considering a mixed premium approach cinder which the prenhlum would be partly based on the sinfunded liabilities and Partly on a per capita tax which would continue indefinitely, regardless of the funding condition. Indirect Costs The indirect costs and administrative effects of portability proposals are also a matter of concern to every plan sponsor. The Dent Bill does not include any pro- vision for transferring assets out of a pension fund at the time an employee with vested rights terminates, but both Javits and Carney do. The costs associated with a portability provision are indirect and of two sorts: The assets transferred to a special fund would be invested in Government securities. Consequently tIle assuniecl investment return would be smaller than might be expected from a typical pension fund investment policy, and the pension fund would therefore give up a potential for investment return. 14 PAGENO="0168" 470 a. The requirement for transfer of assets into the special fund would increase the fund's liquidity requirements. This exposure could force a change of investment policy and unfavorably influence investment performance. Another significant incremental cost built into the various pension legislation pro- posals is the cost of complying with the reporting requirements. Elaborate reporting of investment transactions, actuarial and accounting data, and infor- mation about membership status is specified under all of the Bills. In addition, employees would have to be given a statement of vested rights and a summary of the annual reports filed with a government agency. Presumably these opera- tions could be routinized and would not have major cost consequences once the systems and procedures were established. Nonetheless, startup costs would no doubt be quite significant for many employers. In addition to knowing the economic implications of the various bills, plan sponsors need to be concerned about the new layers of control which they would grant the Federal government. In several areas, large elements of oppor- tunity for fuller control would be granted to the government. There is an implication in any minimum funding provision or reinsurance statute that a government authority will set the standards for valuing assets amid liabilities of pension funds. Considering the vast number of private pension plans, this can only imply a great deal of standardization which will disregard important and significant differences between individual plans, companies, groups of employees, investment policies, etc. Conclusion Finally, I suggest that all of us are challenged by the matters we discuss today. And I suggest that the most creative and constructive way to meet that challenge is by increased interaction between plan sponsors, their actuaries and their investment managers. This increased interaction is not merely a need of this moment, when pensions face a crisis, hut the sensible theme from this day forward. Change. . . and the need to adapt frequently and creatively. . . is now a way of life. `5 PAGENO="0169" 471 2. Options for Pension Plan Sponsors In the face of legislative threats to the autonomy of the private pension system every plan sponsor, every asset manager, and every actuary needs to consider ways of coping with the situation. VVe stressed earlier the importance of exam- ining earls plan's condition and its exposure to additional costs and administrative burdens. Now we want to deal with the options available to citizens and corporate employers. Even though you don't have complete control over your own destiny, there are several ways for you to influence and moderate the forces bearing on yotsr company, your employees and your shareholders. The opportunities fall into several categories: political, benefit design, cost-sharing and spreading, asset productivity, and acttiarial realism. Let's discuss each of them briefly. Legislative Action To be effective politically we must have knowledge. You need to know the content of the legislative proposals . . . and their cost effects on you and your employees. One useful source of information is the Association of Private Pension and Welfare Plans. Their mission is to see that all groups interested in pension and welfare plan topics know about activities its Washington. . . and have a channel for expressing their own views to Congress and the administration. You can also build understanding of tile scope and impact of proposed legis- lation through trade associations and tile U.S. Chamber of Commerce. I would also recommend an excellent monograph prepared in 1967 by the Financial Executives Institute under the title `Private Pension Plans and the Public Interest". Another worthwhile Financial Executives Institute publication, "Retirement Income in the United States," develops a powerful argument for an active, socially responsible private pension system. By all means, communicate directly with your elected representatives. Legislators listen to voters and to taxpayers. They can be extremely responsive if you demonstrate your knowledge and concern about proposed legislation, and can deal in personal terms with its effect on you and your communities. Your influence can be radiated by building interest among other citizens and corporations in your communities. Ihave them make for themselves the same analyses and investigations that you do for your own companies. See that they become sensitized to the problem, and that they write or talk to their con- gressmen and senators. s6 PAGENO="0170" 472 Through all this, I would stress the need to be practical and rational. It is not persuasive. I believe, just to defy and oppose legislative change. New law is surely coming. Decide for yourselves what makes sense in terms of your people and your corporations . . and wliatyou can live with. My personal view is that it is better to endorse the acceptable and tolerable (and at the same time point out the weakness and pitfalls in other, less desirable proposals) than to make a blanket condenination of the purposes and specifics of legislation. Betiefit Liberalizations A second option . . altliouglt perhaps too idealistic an approach to influencing the legislative result is to change your beiiefit structure, if you have not already done so. Plans witlt inadequate vesting or other deficiencies can be brought into better alignnient with employees' economic security needs . . and svitli tIm national objectives which the private pension system tnust serve. If the corporations whose plaiis need updatmg act withuii the next year or two-which I think is all the time we have before legislation is passed-the private pension system will have denionstrated that it can of its own volition fully nieet its obligations and responsibilities to employees. Transmitting this increased sense of vitality to the Coiigress could have a beneficial effect oii the legislation and niiglit take some of die edge off the proposals which eventually beconie law. Improved communications with your own employees will also benefit you, both politically aiid as an employer. Employees are going to be very easily swayed by some of lie horror stories which are bound to appear as this subject gets more headline attention. If employees don't understand the structure of their own benefit plans and the extent of economic benefit security you have made available for them, they will over-react, usisinterpret and fuel the fires of discontent. Cost-Sharing aiid Spreading A third option is cost-sharing-a step backwards in a sense-because one of the important forms of pension liberalization in recent years has been the elimination of employee contributions from many plans. If legislation is passed and forces you to modify your plans in order to meet minimum funding and vesting requirements. . . or to cover the additional costs associated with reinsurance, portability or new reporting standards, the option of cutting benefits will be as unthinkable as it is impractical. Under the circumstances, many companies will consider the possibility of requiring employee contributions as a cOIiditiOn of future plan membership. This is an inefficient solution for several reasons: U The employee's contribution is not currently deductible from tax, mvhereas yours is. Consequently it costs tim enmployee more to pay a s/mare of time pension plan than it costs the employer. `7 PAGENO="0171" 473 U In addition, employee contributions are refundable upon death or terini- nation. This means that a substantial part of s/se nsossev is sscs'er used to pro side retirement benefits. U Furthermore, your employees are going to be concerned with lobe-home pay, ond if you impose o contribution re~juirensesst on theni some resentment is inevitable. The result may he dropouts frons the plan and employee conmplamts that your actions are harsh amsd unfair. Even if employees do osstnbute you may well find yourself increasing base pay to compensate for the mandatory contribution. Mr. Nolan of the Treasury-alone among the critics of our private pension systeni-has proposed that we follow the public policy in Canada and allow employees a tax deduction for contributions to their employers plan. I would certainly urge you to support such a measure, even if it did not have a major long-term impact on benefit plans. It would. nonetiseless, increase flexibility and the optiomss available to cns1)lovers. Cost spreading is amss)thier option, available to conspanies who have been funding past service liabilities on short schedules. By stretching out the past service funding program, you may l)C able to absorb extra costs witlsomst increasing the annual expense. / Improving In addition to the first three o1stions every plasm has options whmich can help Pension Cost Effectiveness improve time cost effectiveness of their pensioss programs: U Improving 1/se quality one1 productivity of pension fund imsvestment management, and LI Using realistic actuarial assssnmptious to c/eternmisme benefit levels, plasm liabilities, one) accountissg asic) fmsmmrhimmg requirenmemsls. Achieving these improvemnemsts will de1send mmpnsm a changed relasiomsshmip between p1~~ sponsors. actuaries ouch ismvestsuent managers. Historicusily pcnsioms plan sponsors have tended tsswarcl rallier passive relationships wills snvestmesst managers and actuaries. Too many assmmnsedl that all they had to do was appoint time money manager for their pension fund and then have little further involve- ment, other than to say grace over a recommended split between stocks and bonds. Similarly they assumed sisal the actuary's mysterious ways were beyond their comprehension. They waited to be told the actuary's results witimout any real understanching of tue elemmuenis of time actuarial basis, excepting possibly the investment return assumption-a concept that is closer to time training and ex- perience of financial officers. I believe that it is imss1serative ummucher amsy conditiomus-whuetluer or not legis- lation is passed-for earls bemiefit piamm sponsor to be msschm more actively involved in policy setting in the investment nsanagement and actuarial areas. u8 PAGENO="0172" 474 i-ic should see that he is regularly informed ahout the funds progress and about tile results and significance of tile acillary's calculations. Jnlestrncnt I'lIanagenlent Audit Your first need, if ou have not already done so, is to perform an investment management audit of your fund. The components of this process are: Measure earnings performance on each flInci segment for the past five years or more. Compare results with otl1er funds of similar status and investment objectives. Compare witll bencllnlarks of general market performance. For common stocks prefer the Staliciard & Poor's 500 Stock Index. Test results against your performance goals, if you have any. a. Determining liquidity requirements is also an important factor, because the need to lnamn tam high liquidi tv for bellefit payo ts can restrict the fund's earnings capabilities. With most funds liquidity is not a problem. Even though annual benefit payments have quadrupled in the past ten years, in 1969 overall they eclualled only about forty per cent of contributions and investment income, not including capital gains. If, however, the investment management audit shows that a thinly funded or niature ~ will have liquidity problc'lns, the asset manager can then recom- mend remedial action. lBs advice might suggest a greater use of mortgages, other instruments that regularly refllllch ca1n al, or programmed maturities of short term bonds. By colnbining knowledge of yollrhlistorical performalice, future plan liquidity requirelnents and anticipated investment and economic prospects, you can evaluate tile past investment mix and strategy and define a more productive investment policy. You sllollhcl also examine tile quality and content of relation- shi1)5 \vithl your investment managers and initiate changes if they are appro~)riate. Determine tile effect of expectations from your new or restated investment policy on actuarial assumptions, benefit levels and cost accruals. q. Review the avaiiab)le sources of investlnent advice and select suitable invest- ment managers, if cilanges are necessary, and 6. Estabhishl agreed upon Inc1 reahizab)le investment performance goals. I would recommelld thlat perforluance goals be relative to tile general market and possibly be different for bull and bear markets. Under tile six step audit process silown in Figure 1 plan sponsors have an opportunity not only to bring the management of their pension fllnd assets under greater control, but also to increase their cilances of getting a significantly 19 PAGENO="0173" 475 ~tStO~ Plan Sponsor Trust Fund Accounting Statements S I; Establish Measure/Compare Performance \~ Past Performance Goals / Forecast Select Investment Cash Flow Adviser /1 / S 7' ~ / / Review Actuarial Define Investment Assumptions Policy The Investment Management Audit Program (Figure i) PAGENO="0174" 476 better rate of return. Most of you know that a one per cent gain in performance achieved over the life of a pension fund can 1sroduce 15 to 25 per cent more benefits or reduced contributions. I'm equally sure that everyone woiiid welcome such a gain. And, if higher minimum pension costs arc going to Ise legislated, improving investment performance will become essential. Reviewing Actuarial Assumptions Every plan sponsor needs to recognize the importance and utility of establishing a practical degree of realism in each actuarial assumption. If each other assumption can stand on its own feet, the investment return assumption will no longer be needed as a buffer for the inadequacy of other assumptions. The investment return assumml)tisn camu then he selected as a direct function of basic investment policy. amid lie relative degree of risk you are willing to assume in order to reach your goals. The pursslit of an improved techumuiquue for selecting the investment return assumption has led us to tile formula shown in Figure 2. Selecting the Investnsent Return Assumption--Basic formula: (Figure a) Investnsent return assumption = Mix x Return x (i.oo ± Margin i)-Margin a Bond/Stock Bond/Stock Expected Margin Policy Mix Return r 2 Conservative go/6o 5.5%/9% -lo%/-2o% 2.5% inflation Intermediate 50/70 5.5%/9% 0 2% inflation Aggressive i~/8q 5.5%/9% +lo%/+25% o Mix, as used in this formula, is siniply the proportion of the fund invested in a particular class of securities. Return is the average total investment return on a class of securities. Margin One adjusts the average rate uuf return on a class of securities and Margin Two corrects for the effect of inflation. As you can see the formula allows for setting your assumption at any desired degree of conservatism or aggressiveness. You can set a conservative or liberal niix of securities in the portfolio. 2. You can assign a negative value to Margin One if you wish to minimize the risk of rising pension costs, since the investment manager may not achieve your performance goals. or can use a positive value if your investment policy or the skill of the money manager are expected to outperform the market in general. PAGENO="0175" 477 ~. You can allow for future inflation through Margin Two-and plans with salary progressions that do not include fully the effects of inflation must do so. The Figure illustrates tile factors that might be used for three different kinds of investment return assumptions: conservative, intermediate, and aggressive. Notice that under a conservative policy the portfolio is assumed to have only 6o per cent invested in equity securities with the balance in lower yield, but more secure investments. Notice also that Margin One reflects tile expectation that con- servative investment policies will result in a return ten per cent below the average return on bonds and twenty per cent below the average for stocks. Because the plan is assumed to make no actuarial allowance for the influence of inflation on salary progressions, Margin Two reduces the net return on investments by 2.5 per cent. The composite result is an investment return assumption of 3 per cent as shown in Figure 3. Investment Return Assumption-Conservative Policy (Figure 3) Expected Mix Return Margin I .40 X ~ X .90 = 1.98% .6o x g X .8o = 4.32 Margin 2 = -2.50 3.80% Investment Return Assumption-Internsediate Policy (Figure 4) Expected Mix Return Margin i .30 X 5.5% X 1.00 = .70 X 9 X 1.00 = 6.30 Margin 2 = -2.00 Turning to an intermediate policy, as shown in Figure ~, the equity portion of the portfolio is 70 per cent instead of Go per cent, and it is assumed that the fund will equal overall market performance. After a two per rent inflation reduction, tile investment return assumption emerges as 5.95 per cent. An aggressive policy might presume the equity portion of the portfolio to be 8~ per cent. . . and anticipate that the portfolio would be managed well enough to outperform the bond marketby ten per cent and the stock market by 25 per cent, or have an investment policy likely to generate such long term results. PAGENO="0176" 478 If we assume that the actuarys salary projection is completely realistic, a i\'largin Two iilllatiuii adjustment becomes unnecessary and inappropriate. Figure ~ illustrates that the investment return assumption under this combi- nation of elenien ts would be 10.47 per cent. Investment Return Assumption-Aggressive Policy (Figure 5) Expected Ihlix Return Margin i .15 X ~ X 1.10 = .91% .8~ X 9 x 1.25 g.~6 10.47% Monitoring The final step in the investment management audit process is to establish a system Investment Performance for periodically monitoring perforniance, as shown in Figure 6. Plan sponsors should not exl)ect to nsake a decision about investment policy or to hire an invest- ment manager and then just sit back for several years waiting to see how the decisions work out. Investment results nsust be regularly recorded and continuously rnomtored by the same standards used in measuring historical performance, establishing standards and selecting portfolio managers. In this manner, the sponsor has continual awareness of what's happening within the fund, can form judgrnellts as to tile appropriateness of the selected policies and will be kept informed about tile staff, investment techniques, internal organization, and other attributes of his fund's asset manager. Monitoring Investment Performance (Figure 6) Supervision and Accountability o Establish management information system. 0 Compute/compare investment performance. 0 Update investment policy. 0 Review investment adviser operations. While improving investment performance is one of the most important options to be considered, you should be conscious of the llazard that performance objectives may be set so high as to be effectively unattainable, thereby creating an incentive for tise manager to take investment risks in selecting individual issues whicls are greater than a prudent man shsould be willing to accept. 25 PAGENO="0177" 479 Performance objectives should be challenging enough to discipline the portfolio manager and represent realistically a good return for the fund, without being so high as to encourage unwise or imprudent investment decisions. Plan sponsors must avoid exposure to the threat that a manager with weak early performance will be tempted to play catch-up ball and further damage the fund's performance. There is no question in my mind that effective money management can enable a pension fund to outperform the market. Studies performed last year under my direction for A. S. Hansen Inc. showed that over the period i 965- 1969 a majority of bank commingled equity funds, insurance company pooled equity accounts and mutual funds outperformed the Standard and Poor's 500 Stock Index. They also showed that many funds performed below the index. Another intriguing inference from these studies was a suggestion that the odds of a pension fund having, over a long period of years, an equity invest- ment performance which exceeds the general market by as much as qo per cent are long-only about i in 7. Conclusion We have considered five options: El Political Action El Benefit Design El Cost Sharing and Spreading El Asset Productivity and El Actuarial Realism I strongly recommend that you use them as fully and imaginatively as possible. You just might temper the severity of the legislation ultimately enacted, and you surely will strengthen your pension funds and benefit both your employees and your stockholders. Thank you. 78-202 0 - 72 - pt. 2 - 12 PAGENO="0178" 480 STATEMENT OF WILLL&M A. DREHER, PRESIDENT, WILLIAM A. DREHER & ASSOCIATES, INC. Mister Chairman and members of the Committee: My name is William A. Dreher. I am a consulting actuary and president of William A. Dreher & Associates, Inc. Our clients include corporations, joint labor-management trust funds and state and local governments. My testimony reflects 18 years of experience with the design, funding and administration of pension, profit sharing, stock bonus, thrift and savings plans, including funds wholly funded by employers and those partially and fully financed `by employees. I am a member of the American Academy of Actuaries, a Fellow of `the Society of Actuaries and the Conference of Actuaries in Public Practice. I am currently a member of the Board of Governors of the Society of Actuaries and a member of its Committee on Continuing Education, with responsibility for its Subcom- mittee on Retirement Plans. I `belong to the American Pension Conference and am currently a member of i'ts Steering Committee. I am in favor of the stated objectives of H.R. 12272: to provide minimum standards of `participation in the benefits offered by an employer-sponsored retirement plan and to offer greater tax benefits to individuals whose c'hoose to inves't in a retire- ment savings plan. However, I do not `believe `that the bill moves far enough or fast enough toward the accomplishment of these objectives, nor is it responsive to ano'ther need that should be promoted by retirement plan legislation: to encourage adequate funding of private retirement plans. SCOPE OF LEGISLATION HR. 12272 applies to pension and profit sharing plans, but appears to exclude stock bonus, thrift and savings plans. These plans are qualified under the same section of the Internal Revenue Code that applies to profit sharing plans, and in my opinion should be treated similarly to profit sharing plans under any new legislation affecting private retirement programs. Many employers have structured their private retirement programs to include both a pension `plan and a profit sharing, thrift or savings plan. Typically, the vesting provisions of the pension plan w-ill `be less liberal than `the vesting pro- visions of the profit sharing, thrift or savings plan. If the vested rights of par- ticipating employees under all employer-sponsored plans are considered together. the employee's total economic interest will often exceed the minimum vesting requirements of H.R. 12272 (or of other proposed pension legislation now before the Congress), even though `the vested interest in the pension plan alone may be less than the minimum standard. This point is illustrated by the Exhibit 1 to my testimony. The exhibit displays the accumulation of retirement benefits and vested interests for an employee of an oil company with a two tier retirement program. This company's program is representative of `plans provided throughout the petroleum industry. The ex- hibit indicates `that an employee terminating after ten years of service with a salary of approximately $10,000 would have a vested right to a $2,000 annual pension under the employer's two programs. An employee terminating after 15 years of service with a salary of approximately $12,500 would have a vested right in `a $4300 pension; an employee terminating after 20 years of service with a final salary of $15,000 would have a vested right in a $7,300 pension. These vested pensions are in addition to benefits provi'ded by `the employee's own contributions. These amounts are certainly substantial and indicate a progressive program. Yet. under the mand'atory vesting provisions specified in H.R. 12272, the employer w'ould be obliged to increase his vesting formula under the pension plan and provide, under the example being cited, an additional $000 pension to an employee terminating after 15 years of service. I suggest that HR. 12272 be amended to permit an employer to have a lesser degree of vesting under a single plan, if he can demonstrate to the satisfaction of the Secretary that the combined vested rights under all plans qualified under Section 401 of the Internal Revenue Code comply with the "rule of fifty" require- ments. PAGENO="0179" 481 TilE FORMULA FOR VESTING I subscribe to the "rule of fifty" concept expressed in HR. 12272. However, its application has several significant defects which should be remedied, if em- ployees, particularly older employees with long service under existing plans, are to have a greater measure of retirement security within a reasonable time, while at the same time preserving, to the greatest extent feasible, an employer's flexi- bility in designing retirement plans suited to his industry, work force and finan- cial capabilities. The minimum vesting standards of H.R. 12272 would not apply to benefits accrued in any plan year beginning January 1, 1974 or to benefits accrued during any plan year beginning before the termination date of a bargaining agreement in effect on November 30, 1971. This makes HR. 12272 an empty promise for most older and long service employees presently covered under plans which do not al- ready have a reasonable degree of vesting. It permits, for all practical purposes, continuation of the situations which are being dramatically cited in newspapers and periodicals across the country as evidence of the weakness of the private retirement system. For example, if an employer's plan presently provides no vesting until a man reaches age 55 and has 25 years of service, H.R. 12272 would now require that an employer will apply the "rule of fifty" with respect to benefits accruing after 1973. Under these cir- cumstances, an employee terminating after many years of service, but before age 55 would have little if any vesting for many years. He would be 100% vested, but only in benefits accruing after 1973. I believe that any meaningful minimum requirement must apply to all years of participation under a plan. However, I do not believe that there is a social necessity for the entire pension to be subject to a minimum vesting standard. The greater need relates to lower paid employees. Also, I do not believe that it is equi- table to insist that the employer who establisl1es a generous program should be forced to adopt the same minimum standard with respect to the total benefit un- der his program that applies to the benefits granted by another employer with a less generous benefit program. I would, therefore, suggest that the "rule of fifty" concept apply to all years of participation under all plans qualified under Section 401 of the Internal Revenue Code, but that the benefit to which the vesting percentage is applied be (i) the accrued benefits under the program or (ii) $5.00 of monthly benefit for each year of participation in the plan, whichever is less. In order to provide a transition period for corporate employers and union ne- gotiated plans, plan sponsors should be given a grace period before implementing the minimum vesting standard. Deferring implementation until the plan year beginning in 1974 or until the termination of any collective bargaining agreement still in effect on January 1, 1974, would give adequate time for transition. EFFECT OF EMPLOYEE CONTRIBUTIONS ON MINIMUM VESTING STANDARD Many plans today require employee contributions. There has been a trend away from this type of program in recent years, but the tax incentives provided by H.R. 12272 will undoubtedly stimulate the introduction of employee cost sharing in newly established retirement plans and, through amendment, into existing re- tirement plans. The definition of minimum vested rights under H.R. 12272 does not distinguish between benefits funded through employee contributions and those provided by employer contributions. There are many combinations of age, service and salary under which an employee's contribution into a retirement plan could provide more than 50% of the benefits accrued up to the date of his employment termina- tion. Consequently, the practical effect of the "rule of fifty" as specified in H.R. 12272 may be to guarantee vested rights which are less than the amounts which could be funded with an employee's contribution to a plan. I suggest that the vesting percentages which apply under the "rule of fifty" should relate to the employer-provided portion of the plan benefit, subject to the $5 per month limitation cited in the preceding section. The employee should always have a fully vested right in benefits provided by his own contributions. Most retirement plans with a requirement for employee contributions provide that vested rights in the employer-provided benefit are conditional upon a ter- PAGENO="0180" 482 minating employee's agreement to leave his contributions in the plan. I believe that this is a reasonable restriction to impose on any employee, but would suggest that all such plans include an option to receive, at any time after an employee reaches age 55, a reduced benefit which is actuarially equivalent to his vested pension commencing at the plan's normal retirement date. To avoid undue complications in determining the portion of the total benefit which is attributable to employee contributions, I would recommend that the Treasury issue a regulation similar to those which are now used to compute the cost of taxable group life insurance or the cost of insurance under individual policy retirement plans. This regulation would stipulate uniform annuity values for converting an employee's accumulated contributions into an equivalent amount of retirement income commencing at the plan's normal retirement date. COST OF VESTING Much of the argument against introducing minimum vesting standards relates to the incremental costs imposed upon employers and the prospect that employers would reduce future benefit accruals or, if they presently have no plan, defer the establishment of one. I believe that an analysis of the cost of vesting must consider its effect on the retirement plans, on total labor cost, and on the productivity of the Ameri- can economy. The apparent cost of a minimum vesting standard will be small for many employers; either because their plans already provide more generous vesting or because the actuarial assumptions used to estimate the plan's cost anticipate fewer employment terminations than will actually occur. Consequently, the incremental cost of any minimum vesting standard is understated. The actual additional cost of a minimum vesting standard, as measured by additional employer contributions into the related trust fund, must be based upon realistic actuarial assumptions. As so computed, these costs can be very significant, particularly if the plan has previously provided no vested rights until employees qualify for early or normal retirement benefits. An illustration of vesting costs under various alternative vesting schedules is provided on pages 8 through 14 of Exhibit 2, a booklet entitled, "Private Pension Plans: Hazards and Options for the 70's," which was published last year by my firm. It illustrates the incremental costs of improving the vesting schedule of a major food chain's retirement plan and includes the impact of the "rule of fifty" incorporated in H.R. 12272. The illustrations in the booklet indicate that incremental costs of "rule of fifty" vesting-if applied to all accrued benefits under a Plan-increase the costs for this type of employer by at least 35%. It should be recognized, of course, that termination rates among food chain employees-even after completion of three years of service and attainment of age 30-are higher than in many other in- dustries. Consequently, the impact of a minimum vesting standard would be greater for this type of employer than for many others. Increasing a retirement plan's total cost is only one of the consequences of mandatory vesting. Consider some of these possibilities: The employer can offset the cost of vesting by lowering cash wage in- creases or by postponing the addition of other features to his employee bene- fit program. An employee contribution requirement can be added to the retirement plan. Funding of past service benefits can be spread over a greater number of years. Employees who do terminate and receive vested rights will be replaced by employees at a lower salary. Many employers have unproductive employees who are kept on the payroll because the employer knows they cannot get any other meaningful employ- ment and the retirement plan does not provide even minimal benefits. Faced with the necessity of providing vested rights, many employers in this situation will terminate employees and not replace them, thereby sav- ing an annual salary. Employees, knowing that vested rights are accumulating under a retire- ment plan, will more readily change jobs if favorable opportunities present themselves. This obviously represents a threat to productive efficiency if capable employees are attracted to other companies. PAGENO="0181" 483 The reverse side of that coin suggests that employees will recognize that the employer has the option of terminating their services, and will be more likely to do so if vested rights under the retirement plan provide a source of income. This should encourage employees to be more productive workers. The greater likelihood that the employer will exercise his option if the employee fails to fill the requirements of his job should stimulate greater self-discipline and efficiency from workers who might otherwise be lulled into the assumption that their jobs are secure until normal retirement date. On balance, it is my opinion that the aggregate effect of mandatory vesting on the American economic system is substantially less than the direct cost on private pension plans. Apart from the obvious social benefits, in terms of increasing the security of pension expectations, minimumi vesting could in time increase corpo- rate profits by stimulating employees to achieve a higher degree of their economic potential if they are held more fully accountable for their job performance. MINIMUM ELIGIBILITY STANDARDS I am in favor of all three minimum requirements for participation in a retire- most plan qualified under Section 401. DEDUCTIBILITY OF EMPLOYEE- ~ONTRIBIJTIONS Granting a tax deduction for employee contributions to an individual retire- ment plan or to an employer-sponsored plan is a sound idea. The 20% limitation, however, is excessive. If the objective of the Bill is to enable the employee to supplement Social Security benefits and maintain his standard of living after retirement, 6% of wages, if systematically accumulated in a tax free trust, should be more than adequate to achieve this purpose for most employees. The requirements for offsetting the employer's cost to an IRS qualified plan against the permissible limit has a practical effect of denying any tax benefit to an employee with earnings in excess of approximately $21,000-even if he is required to contribute to his employer's plan. A more reasonable rule for determining the limit on deductible employee con- tributions would be: 6% of current annual earnings, but not in excess of $1,500. This limit would not be affected by employer contributions to a qualified retirement plan. An employee who withdraws funds from a voluntary retirement account would be obliged to pay current tax on the total distribution. Even with the benefit of income averaging, he would then be obliged to pay a greater total tax than would have been due had the contribution not been deductible in the first place. This should be a sufficient penalty to inhibit early withdrawals. The same considerations apply to withdrawal of employee contributions from an employer- sponsored plan. In addition to paying a higher tax on the premature distribution, the employee would lose his vested interest in the employer-provided benefit. I suggest that the 30% penalty for premature distributions is excessive and recommend that it be eliminated from the Bill. MINIMUM FUNDING STANDARDS Existing Internal Revenue Service regulations offer a plan sponsor considerable flexibility in funding the obligations of a retirement plan. The current cost of a pension fund can be substantially affected by his choice of: Actuarial cost method, actuarial assumptions, asset valuation method, period for amortization of past service liabilities, and treatment of actuarial gains and losses. As general principle, I believe it is desirable to maintain flexibility in fund- ing. A pension plan is a long term arrangement under which individual employees typically receive monthly benefits extending over their retired lifetimes. Conse- quently, it is necessary that a pension fund accumulate assets equal to the total value of a pension before the employee's retirement. Also, funding flexibility gives an employer the opportunity to tailor a program to the circumstances of his work force, his industry and his company's particular financial circumstances. To impose a narrowly defined set of minimum funding standards would unreasonably restrict a great many responsible companies and would have the practical effect of discouraging benefit improvements and the expansion of the private pension system to cover employees whose employers have not yet established private plans. PAGENO="0182" 484 This generalizatron is valid, in my opinion, as long as the funding calculations are based upon reasonable actuarial assumptions. Unfortunately, some plans use actuarial assumptions which inadequately anticipate a plan's liabilities, thereby understating current costs. This condition is exacerbated if actuarial losses are not fairly promptly reflected in future pension costs. A~t first glance, this would seem to demand minimum requirements for actuarial assumptions and amortiza- tion of unfunded liabilities. In my opinion, this would unduly restrict the fund- ing practices of employers whose pension costs are based upon reasonable actu- arial assumptions. One practical means of avoiding abuse, without restricting all employers, would be to require that actuarial losses occurring after the effective date of H.R. 12272 (or after any grace period provided under the Bill) must be amor- tized over the future service lifetimes of covered employees or, alternatively, over 15 years from the date of the most recent actuarial valuation. Actuarial gains arising in the future could be directly offset against the accumulation of un- amortized actuarial losses. The practical effect of this step would be to accelerate funding for employers whose assumptions are shown to be inadequate, while retaining the funding flexibility for employers who have used realistic or conservative actuarial as- sumptions. I believe that this requirement would be consistent with the prin~- pies underlying Opinon No. 8 of the Accounting Principles Board of the Ameri- can Institute of Certified Public Accountants and that the technical problems of implementing this requirement would not be an undue burden upon employers, including those whose plans are insured and those which are trusted. At the re- quest of your Committee, I would be pleased to provide a supplemental memo- randum elaborating on this suggestion. FUNDING OF PAST SERVICE LIABILITIES Section 404 of the Internal Revenue Code permits an employer who elects an actuarial cost method involving a computation of past service liabilities to fund such liabilities by an annual payment of up to 10% of such amount, subject to various technical adjustments to reflect changes in the plan's liabilities. During the 1940's and 1950's, when actuaries were typically using investment assumptions between .21/2% and 3%, the 10% annual past service contribution permitted an employer to amortize these liabilities over approximately 12 years. In recent years, actuaries have been raising their investment assumptions. A survey we conducted last year indicated that over 50% of pension plans now use assumptions of 5% or higher, with some as high as 71/2% or 8%. If any employer uses a 6% investment return assumption and makes a 10% annual payment to- ward funding of past service liabilities, it will be approximately 16 years before* they are funded. I believe that the historic policy of permitting an employer to amortize past service liabilities in 12 years should be preserved. In order to do so, it would be advisable that the 10% annual limit on past service funding be increased to 12%. CARRYOVER OF LIMITATIONS ON FUNDING PAST SERVICE LIABILITIES Presentiy an employer who does not make the full 10% payment toward past service funding in a particular year cannot carry over the difference between his current contribution and the 10% limit tO another taxable year. Within limits we believe that this would be a desirable liberalization of the tax deductible limits. There is a useful parallel in the structure of deductible limitations for profit sharing plans. (The basic limit on deductions for profit sharing contributions is 15% of covered compensation. An employer who has not in the past made the full 15% contribution may make additional current contributions subject to a cumulative test that the deductions have not exceeded 15% of compensation since the plan was established. This carryover provision is limited to a total deduction of 30% of covered compensation.) This carryover concept could be applied to pension palns. An employer who has not in the past made the full 10% contribution could carry forward the difference between his actual contribution and the 10% limit, subject to an over- all limitation of 20% in any one year. (If the suggestion outlined in the preced- ing section is adopted, these percentages would be 12% and 24%, respectively.) Thank you for the opportunity to present my views. PAGENO="0183" 485 ~ ~L~49 a~ooo~c~ .~ ~ J>c~ I ~ cc J~ I I Li I >~R~ - - ~ EN~ 2 .2 0 ~, ~, ==~~ ~ 0 0 ~C) cfl C~ cc~ct) ~ ~ c~J ~ c~ >- 2 =5 C-) 0 -~ ~ >~- - I- ~ ~ I ui ~ ~H~H~HHHHHH *-~E"~ ~E~E -~ EV)W