The Great American Retirement Fraud

Data “Points” had an article this weekend criticizing a recent paper that alleges a “conspiracy…….between employers, investment management firms, advisors and those that support their interests” to do the defrauding.

Both articles are worth a read but here is what I got out of the Michael Doran paper which is the only place I have ever see “cross-testing” referenced as a bad thing and is worth debating.

The retirement-reform project of the past twenty-five years has been and continues to be a policy scam. Neither the aim nor the effect of the legislative changes has been to increase retirement security for the great majority of American workers. Instead, the heart and soul of the retirement-reform project has been to increase tax subsidies for the affluent – managers, professionals, entrepreneurs, financiers, and consultants – who have both the means and the disposition to save for retirement whether or not federal law provides retirement-savings incentives. Since 1996, Congress has steadily increased the amounts that higher-income earners may contribute to tax-exempt retirement plans and IRAs, and it has steadily delayed the time when higher-income earners must remove their savings from those tax-exempt accounts – all at great cost to the federal treasury. Clever lobbyists and pliable lawmakers sell the legislative packages as promoting general retirement security, but only the affluent are in a position to make use of the new rules. (pages 1-2)

But everything changed in 1996. That year, two junior but ambitious and enterprising members of the House Ways and Means Committee – Rob Portman, a Republican from Ohio, and Ben Cardin, a Democrat from Maryland – pushed through a package of reform proposals that loosened the regulation of retirement plans and increased retirement-savings subsidies. Neither Portman nor Cardin had any particular expertise in retirement policy; instead, they followed the lead of lobbyists representing employers and the financial-services industry. Portman and Cardin’s bill – later known as “Portman-Cardin I” – was enacted as part of the Small Business Job Protection Act of 1996.10 It was the first major relaxation of federal retirement policy in decades. (page 5)

Since the early 1940s, Congress has imposed a set of non-discrimination rules on retirement plans. The core rules are statutory, but the real work is done by a set of a detailed and intricate regulations. The basic statutory non-discrimination provision says that “the contributions or benefits” provided under a retirement plan may “not discriminate in favor of highly compensated employees.” A separate rule defines a “highly compensated employee” as someone making more than $135,000 per year (indexed for inflation). It is a requirement of federal law, then, that the contributions to an employer’s retirement plan and the benefits paid by an employer’s retirement plan not discriminate in favor of employees who earn more than $135,000. Failure to meet this requirement triggers the denial of the retirement-savings subsidies. (pages 22-3)

Consider one common dodge allowed by the rules – a practice known as “cross-testing.” Like many of the other retirement-plan rules, the non-discrimination rules distinguish between defined-benefit plans (retirement plans that promise a specific benefit, usually expressed as an annuity beginning at retirement age) and defined-contribution plans (retirement plans that promise a specific contribution but not a specific benefit). Cross-testing allows a defined-contribution plan to pass the non-discrimination rules on the basis of the benefits paid out and a defined-benefit plan to pass the non-discrimination rules on the basis of the contributions paid in. It sounds innocuous enough, but it really is not. Cross-testing seriously undermines the objectives behind the non-discrimination rules, making the whole matter look like an elaborate policy joke. (pages 25-6)

Beginning with Portman-Cardin I in 1996 and continuing to the present Congress has weakened the statutory non-discrimination rules – which were already weak to begin with – so that the increased retirement savings for higher-income earners now allow decreased retirement savings for lower-income and middle-income earners. Among the more salient changes, Congress enacted a non-discrimination “safe harbor” for 401(k) plans. The safe harbor works as an option alongside the traditional quantitative non-discrimination test for 401(k) plans, and as such, it has strongest appeal to employers for which the traditional non-discrimination test would require larger contributions for non-highly compensated employees. The general effect is to permit more discrimination in favor of highly compensated employees. (pages 38-9)

Government, Voltaire observed, is the organized means of taking money from one person and giving it to another, and the retirement-reform project has taken hundreds of billions of dollars from some and given it to others. Who are the winners, and who are the losers? Stated most simply, the retirement-reform project has effected a massive transfer of wealth from individuals who do not have tax-subsidized retirement savings to individuals who do have tax-subsidized retirement savings. (page 62)

There is a better path forward. As I intend to show in future work, genuine reform of retirement policy, structured around longstanding insights about tax subsidies, would look very different from the type of limit-increasing, deferral-extending, and discrimination-facilitating reform pursued over the past twenty-five years. Genuine reform would curtail retirement-savings subsidies for higher-income earners, who do not need those subsidies as incentives for retirement savings. Genuine reform would convert tax deductions, tax exclusions, and non-refundable tax credits for lower-income earners into direct, government-funded enhancements of retirement security – preferably through Social Security but otherwise through private retirement accounts. And genuine reform would leave the status quo in place for middle-income earners, who respond as expected to the marginal incentives of retirement-savings subsidies and who likely would not save in the absence of those subsidies. (page 82)

One response to this post.

  1. Posted by Michael Waldmeier on January 17, 2022 at 1:02 pm

    Regardless of the pension type, if the Fed prints money and causes inflation then the value of the pension drops. At the current rate of inflation will the pensioners be able to live off of their pensions?


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