The Pension Protection Act of 2006: is it too late to save traditional pension plans?

• Author: Eriksson, Emma Cecilia

"Nothing could be more clear than the message this bill sends Americans, and that is to save, save, save for your own retirement because hefty Social Security benefits and fat defined-benefit pensions are definitely yesteryear ...." (1)

1. INTRODUCTION

   In 2006, Larry Millette believed that if he continued to work at International Business Machine's (IBM) factory for another fifteen years, in addition to the sixteen years he worked at Digital Equipment Corporation, he would retire comfortably on the combined pension plans. (2) After working twelve-hour shifts at the IBM factory for eleven years, Larry Millette only has $30,000 in his pension account. (3) Instead of fulfilling his dream of retiring to spend time with his family and travel, Larry Millette is now planning to work until he is physically unable. (4)

   Most Americans believe that if they work for forty to forty-five years they are entitled to a luxurious retirement. (5) The common belief in "the Great American Retirement Dream" is problematic because comfortable retirements are perceived as guaranteed, as opposed to earned through a lifetime of active saving and planning. (6) Currently, most Americans are unprepared for retirement because of their failures to contribute to, and properly manage, their retirement accounts. (7)

   One-third of private sector employees in America partake in private defined-benefit pension plans. (8) Nevertheless, Americans are unprepared for retirement. (9) Older employees approaching retirement age often expect nonexistent pensions to support their anticipated luxurious retirements. (10) Conversely, younger employees, though not promised traditional defined-benefit pension plans, commonly fail to sufficiently contribute to their defined-contribution accounts such as 401(k) plans. (11) In February 2007, for the first time after the Great Depression, aggregate savings in the United States reached negative levels. (12)

   In response to this pension crisis, President George W. Bush signed H.R. 4, the Pension Protection Act of 2006 (Pension Act), (13) on August 17, 2006, referring to it as the first comprehensive transformation of retirement legislation since the Employment Retirement Security Act of 1974 (ERISA). (14) The Pension Act mandates employer discipline in fulfilling promises made to employees by adequately funding their defined-benefit pension plans. (15) The Pension Act, unfortunately, also recognizes the demise of employer-sponsored pension plans. (16) By offering employers more latitude in administering their defined-contribution plans (e.g., 401(k)s), the Pension Act acknowledges that private employer defined-benefit pensions are vestiges of the past as they are being rapidly replaced by defined-contribution retirement accounts. (17)

   This Note analyzes the demise of pension plans and the corresponding rise of defined-contribution savings plans in light of the Pension Act's recent enactment. (18) Part II reviews general retirement plan concepts and includes a discussion of the economic and sociological importance of saving for retirement. (19) This Part also surveys the historical and statutory development of ERISA and the Pension Act. (20) Part III then summarizes the immediate economic effects of the Pension Act, analyzes the recurring problems that the Pension Act attempts to resolve, and considers whether the social issues surrounding retirement education undermine the Pension Act's solutions. (21) Lastly, Part IV concludes that America's social and economic culture must stress saving for retirement in order for the benefits of the Pension Act to be fully realized. (22)

2. HISTORY

   1. Why Do We Retire?

      Pensions have existed in various forms for thousands of years. (23) Traditional pensions emerged in response to occupational hazards associated with industrialization in the United States. (24) The Grand Trunk Railway of Canada established the first formal pension plan in America on October 1, 1874, thereby starting a trend for other similar companies to slowly follow. (25) Beginning in the early twentieth century, major industrial companies established pension plans. (26) Even at the outset, employers faced significant funding hurdles that still exist today. (27)

      Defined-contribution plans, conversely, only recently emerged to complement traditional pension plans and encourage individual retirement savings. (28) For example, Congress added 401(k)s, a popular form of defined-contribution plans, to the Internal Revenue Code (IRC) in 1978. (29) Congress intended for 401(k)s to respond to the growing mobility of the modern workforce by offering alternative, and more portable, retirement plans. (30) Though originally designed to augment traditional pension plans and ease portability concerns, defined-contribution plans are now the norm because employers prefer for their employees to assume liability for their own retirement security. (31)

      The concept of retirement is equivocal. (32) Traditionally, retirement is considered a "[v]oluntary termination of one's own employment or career," (33) although the term commonly refers to the age at which an individual is eligible to accept pension benefits. (34) Given the varying interpretations of the term, the meaning, implications, and motivations for retiring and receiving pension benefits differ. (35)

      Due to the decline of personal savings, Americans rely on various forms of pension plans to provide economic stability during retirement. (36) In theory, a capitalist economy depends on citizens assuming personal responsibility for their individual retirement security. (37)

      Americans tend to believe that somewhere in their early to mid-sixties they will retire. Retiring before age fifty-five ... would be seen by most as retiring early, and working much past sixty-five would be seen as a stubborn and somewhat odd clinging to work (Supreme Court justices excepted). The idea that retirement can be expected as a stage in one's life is relatively new. (38) Since their origin, pensions have served dual roles by recognizing service and loyalty of employees while operating as inducements for older employees to stop working. (39) The concepts of retirement and pensions have differing meaning and significance to employers and employees. (40) From the employer's perspective, retirement plans serve wholly economic objectives. (41) Pensions offer employers the opportunity to maintain optimal employee productivity without restraining their ability to replace aging employees. (42) Although pension plans may be costly burdens for employers, they are less expensive than retaining older, and presumably more inefficient, employees. (43)

      Conversely, employees view pension plans as providing post-retirement economic security. (44) The employee's decision to retire, however, entails more than just financial considerations, like escaping work-related conflicts and spending more time with family. (45) A life beyond a working career appears more "attractive" to employees. (46)

   2. Basic Definitions and Concepts

      Depending on the employer and the objectives sought, employee welfare benefit plans assume a variety of models. (47) An employee welfare benefit plan, as originally defined by ERISA, is "any plan, fund, or program ... [offered] by an employer or by an employee organization ... [with] the purpose of providing [economic security] for its participants or their beneficiaries." (48) Specifically, all employee welfare benefit plans are conceptualized as "pensions," but are distinguished into two distinct categories--a defined-benefit or a defined-contribution plan. (49)

      A defined-benefit pension plan is an account into which employers directly deposit funds to provide employees with remuneration upon death, retirement, or early separation from employment due to disability. (50) Typically, a defined-benefit pension is distributed in the form of an annuity, namely, regular payments over a period of time from the point of retirement, or early employment termination, until death. (51) The pension's value is generally, but with substantial variation, calculated by considering factors including an employee's salary and his years of employment with the company. (52)

      Conversely, defined-contribution plans, like 401(k)s, "provide for an individual account for each participant and for benefits based solely upon the amount contributed to the participant's account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant's account." (53) An employee, and possibly her employer, allocates contributions to a trust account and the benefit is valued as the aggregate of contributions and investment performance. (54) As opposed to a defined-benefit plan where the employer's responsibility is to duly contribute to, and manage, the fund, the employer sponsoring a defined-contribution plan is only obligated to make any promised contributions. (55) Accordingly, employees personally assume the hazards of investment volatility in defined-contribution plans while employers, due to ERISA requirements, assume the investment management and contribution risks in defined-benefit plans. (56)

      A defined-contribution plan is considered a transferable benefit. (57) Upon early termination of employment, an employee may, depending on plan rules, exercise one of the following four options: transfer the assets from the plan to a new employer's plan and maintain the tax-qualified status of the contributions; roll over the assets into an IRA; make a withdrawal by paying taxes on the pre-tax contributions and, depending on the circumstances surrounding the withdrawal and the age of the participant, possibly an early withdrawal fee; or leave the money with the employer's plan until retirement. (58) On the contrary, defined-benefit plans are less portable and tend to induce employees to remain with a single employer throughout their career. (59)

   3. Recent...