CAPTRUST Senior Director | Marketing
The Employee Retirement Income Security Act (ERISA) was born Monday, September 2, 1974, an unseasonably mild Labor Day in our nation’s capital. Recently inaugurated President Gerald Ford signed the act into law during a White House Rose Garden ceremony. Upon enactment, ERISA completely overhauled federal pension law with a goal to protect qualified retirement plan participants and their beneficiaries from abuses prevalent at the time and to create a more equitable retirement system. Born into a world of defined benefit plans, modified to address the demands of a fledgling defined contribution system, ERISA has seen a lot of change. As this seminal legislation approaches middle age at forty years old, it is interesting and instructive to look back at its origins, growth, and evolution while looking forward to potential changes.
Origins of ERISA
Of course, ERISA didn’t just appear on the legislative agenda in the summer of 1974; its history dates back much further. One could trace its origins back to 1875, when the American Express Company established the first private pension plan in the U.S. However, the modern history of ERISA began in 1961 when President John F. Kennedy created the President’s Committee on Corporate Pension Plans. At the time, committee members identified a number of pension plan abuses and causes for concern:
• Employees were losing anticipated retirement benefits because of strict vesting or service requirements.
• In some cases, plans were insufficiently funded and unable to pay benefits.
• Plans were terminated before assets were sufficiently accumulated to pay employees or their beneficiaries promised benefits.
The pension reform movement gained additional support in 1963 when Studebaker, America’s oldest automobile company at the time, closed down. Its pension plan was so poorly funded that it could not provide all beneficiaries with their pensions. The company created a program in which 3,600 retirement-age workers received full pension benefits, and 4,000 workers age forty to fifty-nine with ten years of service at Studebaker received lump sum payments valued at only 15 percent of the actuarial value of their pension benefits. The remaining 2,900 workers received no pension at all.1
Early attempts at pension reform faced resistance from business leaders and unions, but the movement gained momentum after a Peabody award-winning NBC News documentary called Pensions: The Broken Promise aired in September 1972. Millions of Tuesday-night TV viewers witnessed tales of workers losing all or most of their pensions through a variety of misfortunes: pre-retirement dismissals, company closings or mergers, and the collapse of pension funds because of mismanagement.2
The next two years witnessed a groundswell of support for pension reform, ultimately leading to President Ford’s signing of the “massive”3 and “extremely complicated piece of legislation”4 to provide “American workers a greater degree of certainty as they face retirement in the future.”5 ERISA established a new set of rules for retirement plan participation, added mandatory and quicker vesting schedules, fixed minimum funding standards, set standards of conduct for plan administration and handling of plan assets, and required disclosure of plan information. It also established a system for insuring the payment of pension benefits via the Pension Benefit Guaranty Corporation (PBGC).6
How We Got Here
In a 1974 speech to Congress endorsing ERISA, Senator Jacob Javits of New York, a longtime proponent of pension reform, stated, “Mr. President, we have reached the end of a very long road.”7 Reflecting on that quote today, Senator Javits’ time marked the beginning — not the end — of the road. ERISA and the regulation surrounding it have changed quite a bit since 1974. The past forty years have brought numerous amendments, court cases, regulatory actions, notices, and interpretations. Countless bits of legislation, large and small, have affected private pension plan management and participation, including the following partial list of notable developments:
• The Revenue Act of 1978 created the 401(k) plan and pre-tax employee contributions.
• The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) established top-heavy rules and amended rules to require distributions to begin no later than the tax year in which the participant turns seventy-and-a-half.
• The Deficit Reduction Act of 1984 (DEFRA) clarified and tightened nondiscrimination testing requirements.
• The Retirement Equity Act of 1984 (REA) added break-in-service rules and rules regarding qualified domestic relations orders, also known as QDROs.
• The Tax Reform Act of 1986 (TRA 86) introduced new nondiscrimination rules, reduced the annual limit for employee 401(k) contributions from $30,000 to $7,000, and capped defined benefit plan payments.
• The Omnibus Budget Reconciliation Act of 1986 (OBRA 86) required pension accruals for older workers and coverage for newly hired employees near retirement age.
• The Small Business Job Protection Act of 1986 (SBJPA) created a simplified retirement savings plan for businesses with fewer than 100 employees and added nondiscrimination testing safe harbors.
• In 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) established catch-up contributions for individuals age fifty and over.
• The Pension Protection Act of 2006 (PPA) expanded availability of fiduciary investment advice to participants, removed challenges to automatic enrollment through qualified default investment alternatives (QDIAs), and increased the transparency of pension plan funding.8
Along the way, the scope of responsibilities of the Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA), the part of the organization tasked with enforcing ERISA, has also grown and evolved. The list above merely scratches the surface of developments in the evolution of qualified retirement plans covered by ERISA during its adolescence and young adulthood. Perhaps bigger changes are yet to come.
Many of the changes affecting retirement plans covered under ERISA over the past several decades have been driven by the federal government’s need for revenue. Reduced contribution limits, minimum required distributions, and, in some ways, nondiscrimination testing all have the effect of eliminating savings “loopholes” and, therefore, generating tax revenues. Given the federal budget deficit’s present state, this trend is likely to continue. In fact, President Obama’s recently announced budget proposal includes provisions to reduce deductibility of pre-tax savings for high-income taxpayers and cap total qualified plan savings.9 While the President’s proposal is not likely to come to fruition in its present state, it is consistent with the trend and several other pension reform ideas floating around Washington. While they may get altered or diluted, these ideas very often resurface and ultimately find their way into legislation; the revenue opportunity is simply too large to ignore.
For some time now, we have heard rumblings about a potential amendment to the definition of the term fiduciary under ERISA’s Section 3(21). On October 21, 2010, EBSA issued proposed regulations expanding the circumstances under which individuals like consultants and advisors might be deemed to be fiduciaries. With this rule, EBSA aimed to eliminate technicalities that have allowed broker-dealers to avoid fiduciary responsibility and related liability when they deliver investment advice to retirement plans. Perhaps the most controversial aspect of the rule is the expansion of the definition of fiduciary to cover advice-based services for individual retirement accounts (IRAs), including rollovers and IRA-based small business retirement plans like Savings Incentive Match Plan for Employees (SIMPLE) and Simplified Employee Pension (SEP) plans.10
On September 19, 2011, the DOL announced that it had withdrawn its proposed rule and would re-propose it after further consideration. Two and a half years later, the proposal is still up in the air as the DOL and the Securities Exchange Commission (SEC) jointly study the issues and seek to address the concerns of Congress and the financial services industry. As of this writing, August 2014 is the earliest date by which we may see further guidance on this topic.11 Redefining one word may seem a small matter; however, doing so could have a dramatic effect on the financial services industry.
While the outcome is uncertain at this time, the debate surrounding delivery of unconflicted advice to retirement plan participants feels like a midlife crisis for ERISA and recognition of just how much our retirement system has changed. Both the IRA and the 401(k) came into being as a result of ERISA. In 1970, thirty million workers were covered by pension plans funded with $138 billion.12 Today, 68 percent of U.S. households (or eighty-two million households) report that they have employer-sponsored defined contribution plans, IRAs, or both, representing over $10 trillion of assets.13
Over the past forty years since ERISA’s enactment, we have shifted from a world of defined benefit plans with trustee-directed investments to one where participants control their own savings and investment destiny. Who could have known these savings vehicles, largely uncelebrated at their genesis, would grow to become the basis of the U.S. retirement system as we know it?
Happy 40th, ERISA!
1 Dan M. McGill, “Guaranty Fund for Private Pension Obligations,” Pension Research Council, University of Pennsylvania, accessed March 22, 2014, http://www.pensionresearchcouncil.org/publications/pdf/75-133131-index.old.pdf
2 NBC News, “Pensions: The Broken Promise,” transcript, accessed February 23, 2014, https://archives.nbclearn.com/portal/site/k-12/browse/?cuecard=57200
3 Remarks on Signing the Employee Retirement Income Security Act of 1974, The American Presidency Project, accessed March 22, 2014, http://www.presidency.ucsb.edu/ws/?pid=4678
6 History of EBSA and ERISA, U.S. Department of Labor, accessed March 22, 2014, http://www.dol.gov/ebsa/aboutebsa/history.html
7 Michael S. Sirkin, “The 20 Year History of ERISA,” St. John's Law Review: Vol. 68: Issue 2, Article 3, accessed March 22, 2014, available at http://scholarship.law.stjohns.edu/lawreview/vol68/iss2/3
8 Georgetown University Law Center, “A Timeline of the Evolution of Retirement in the United States,” accessed March 22, 2014, available at http://scholarship.law.georgetown.edu/legal/50
9 Jeanne Sahadi, “Obama's budget: Help for workers, taxes for the rich,” CNNMoney, March 4, 2014, http://money.cnn.com/2014/03/04/pf/taxes/obama-budget-taxes
10 Rich White, “Your ‘fiduciary IRA’ opportunity – an FAQ,” benefitspro, March 15, 2013, http://www.benefitspro.com/2013/04/15/your-fiduciary-ira-opportunity-an-faq
11 John Manganaro, “Reps. Petition DOL on Fiduciary Rule,” PLANSPONSOR.com, January 15, 2014, http://www.plansponsor.com/Reps_Petition_DOL_on_Fiduciary_Rule.aspx
12 President Ford Signing ERISA of 1974, Pension Benefit Guaranty Corporation, accessed March 22, 2014, http://www.pbgc.gov/about/who-we-are/pg/president-ford-signing-erisa-of-1974.html
13 Investment Company Institute, “Retirement and Education Savings,” 2013 Investment Company Fact Book, 53rd Edition, accessed March 22, 2104, http://www.icifactbook.org/fb_ch7.html#us.c