1 See Institute Memorandum to Pension Members No. 7-98, dated January 29, 1998.
[9635]
February 6, 1998
TO: PENSION COMMITTEE No. 3-98
RE: ADMINISTRATION DESCRIBES PENSION PROPOSALS IN PRESIDENT'S
BUDGET
______________________________________________________________________________
As you were previously informed,1 the Clinton Administration has included pension reform as
part of its 1998 budget proposal. Attached are descriptions of pension reform proposals from the
Department of Treasury's “General Explanations of the Administration’s Revenue Proposals.” The
proposals include the following items:
(1) Payroll Deduction IRAs. The President proposes to facilitate the availability of payroll
deduction IRA programs, by permitting contributions to an IRA made through payroll
deduction to be excluded from income and, thus, not be reported as income on an employee’s
W-2. The amounts would continue to be subject to employment taxes and would be reported as
a contribution to an IRA on the employee’s Form W-2.
(2) Start-up Tax Credit. The President proposes to induce small employers who currently do not
offer a retirement plan to their employees to do so with a start-up tax credit, which would be
available to employers of less than 100 employees if they establish an employer-sponsored
retirement plan on or before December 31, 2000. The tax credit would be available for three
years and cover 50 percent of the first $2,000 in administrative and education-related expenses
for the plan for the first year and 50 percent of the first $1,000 of these expenses in each of the
second and third years.
(3) Simplified Defined Benefit Plan For Small Employers. The President proposes to make
available a new simplified small business defined benefit pension plan, called the Secure Money
Annuity or Retirement Trust ("SMART") plan. The SMART plan is designed to reduce the need
for actuarial calculations typically associated with defined benefit plans. Additionally, such plans
would not be subject to nondiscrimination or top-heavy rules or the limitation on benefits under
Code section 415. The plan would be available to employers with no more than 100 employees
who received at least $5,000 in compensation in the prior year. It would not be available either
to “professional service employers” or employers who had maintained a defined benefit or
money purchase plan within the preceding five years.
The SMART plan would provide a fully funded minimum defined benefit based on an
annual contribution by the employer into individual accounts for each employee. The annual
employer contribution would be determined such that each employee would earn a minimum
annual benefit at retirement equal to 1 or 2 percent of compensation for that year. (For the first
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five years of the plan’s existence, the employer could provide a benefit equal to 3 percent of
compensation.) The maximum annual compensation taken into account under the plan,
however, would be $100,000.
Each year an employer would contribute an amount sufficient to provide the annual
benefit accrued for that year payable at age 65, using actuarial assumptions specified in the
statute, including a 5 percent annual interest rate assumption. In years in which a participant’s
account balance is less than the total past employer contributions credited with 5 percent interest
per year, the employer would be required to make up the shortfall with an additional
contribution. Similarly, each account balance must be sufficiently funded on an annual basis to
purchase a life annuity paying the minimum guaranteed benefit at retirement; the employer
would be responsible for this shortfall. On the other hand, where investment return exceeds the
5 percent assumption, the employee would be entitled to the excess return, which would
increase the value of the benefit produced at retirement. Plan assets would be invested in either
individual retirement annuities issued by an insurance company or through a trust, which could
invest in readily tradable securities and regulated insurance products.
Employees would be immediately 100 percent vested in their benefit. Benefits at
retirement would be subject to joint and survivor annuity rules, although the plan could make
available a lump sum payment at retirement. Distributions would be permitted only upon
attainment of age 65, death, disability, or where the account value of a terminated employee was
no more than $5,000. A 20-percent penalty tax would be imposed on distributions not meeting
these criteria. Where held in trust, rather than in individual retirement annuities, the benefits
would be guaranteed by the Pension Benefit Guaranty Corporation, to which the employer
would have to pay an annual insurance premium.
(4) Acceleration of the Vesting Schedule For 401(k) Plan Matches. The President would accelerate
vesting of 401(k) plan matching contributions to require an employee be fully vested either at
completion of three years of service or based on a six-year graduated schedule.
(5) Enhanced Disclosure Regarding Survivor Benefits and 401(k) Salary Deferral Election
Opportunities. Employers would be required to provide written explanations of survivor
benefits to spouses at the same time as provided to participants. Also, employers electing to use
a section 401(k) plan safe harbor design would be required during a 60-day period before the
beginning of the plan year to provide notice to participants informing them that they may elect
to contribute or modify prior elections to contribute to the plan. This 60-day notice is similar to
that required for SIMPLE plans.
(6) Modification of 401(k) Plan Safe Harbor Formulas. The design-based 401(k) safe harbor
formulas, which eliminate the need to perform annual ADP/ACP testing, would be modified.
In addition to current safe harbor contribution formulas under the safe harbors, employers
would be required to make an additional one percent of compensation contribution for each
eligible, nonhighly compensated employee.
(7) Revision of “Highly Compensated Employee” Definition. The definition of “Highly
Compensated Employee,” which is used in applying nondiscrimination tests, was simplified in
the Small Business Job Protection Act of 1996. The President proposes to eliminate the
optional election to use a “top 20 percent of employees” test when defining the "HCE” group.
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(8) Reforms Relating to Tax Treatment of Variable Annuities. Also included in the budget are
proposals that would modify the tax treatment of insurance contracts. Proposals would (1) tax
exchanges of insurance contracts with variable contracts, (2) treat each variable contract
investment in a separate account mutual fund or in an insurance company’s general account as a
separate contract, (3) reduce the “investment in the contract” amount for mortality and expense
charges on insurance contracts by modifying the manner in which basis is computed under Code
section 72, and (4) modify rules applied to corporate-owned life insurance (COLI). These items
are further described in the attachment.
Russell G. Galer
Associate Counsel
Attachment