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By: Robert J. D’Anniballe, Jr.
The closure of the Studebaker-Packard Corporation car manufacturing plant in 1963 was a major catalyst leading into the enactment of the Employee Retirement Income Savings Act of 1974 (“ERISA”), which became effective on September 4, 1974. This pension plan had promised generous benefits for the participants, but the plan was severely underfunded and was not able to cover the benefits for many of the employees vested in the plan. The failure of the Studebaker pension plan, along with a high profile conviction of infamous Teamsters boss James Hoffa on pension fraud, drew the attention to pension plan corruption and mismanagement and spurred talk of reform and regulation in Washington, DC. Ryles, Eric (December 3, 2018). “The History of the Employee Retirement Income Savings Act (ERISA)”. Judy Diamond Associates, Inc. Retrieved May 3, 2022.
Just over a decade later, ERISA was codified in the United States Code.[1] Being in the year of its 50th anniversary date, it is appropriate to update this article that author Robert D’Anniballe previously authored.[2] This article, like the original article, is not intended to suggest that ERISA has been a complete failure. Like other laws, ERISA has limitations and lacks flexibility in achieving its intended goals. The decline of the number of American workers covered by defined benefit plans illustrates how this legislation that was intended to protect participants of defined benefit plans has instead reduced the continued availability and utilization of those plans in the industrial and manufacturing sector. Specifically, airline, steel, and trade & craft workers, among others, have faced significant challenges in the funding and perpetuation of benefits provided by these plans.
Defined benefit plans have become associated with being expensive and inflexible. The funding requirements on an annual basis are not predictable due to volatility experienced in market returns and changes in employee censuses of the plan sponsor. The funding requirements have increased in many employment sectors due to declining employment levels. That is, more participants have been transitioning to pay status as compared to the number of new entrants being hired. These plans incur actuarial costs associated with the annual filing of 5500 Schedule B Forms. The underfunded level of some of these plans becomes an obstacle in acquisitions, mergers, and other corporate transactions.
It is no surprise that in 1975, private defined benefit plans made up 37.1% of the U.S. retirement market by plan type, with approximately 185 billion dollars held in these plans.[3] By the end of 2023, total U.S. retirement assets were 38.4 trillion dollars; 3.2 trillion dollars, or 8.3% (down from 37.1% in 1975), of those assets, were in private sector defined benefit plans.[4]
In order to obtain predictability in regard to annual contributions, plan sponsors have elected to utilize defined contribution plans such as 401(k) plans to provide retirement benefits to their employees. Any matching contribution can be set by the plan sponsor and is predictable year after year. There is no need for a Form 5500 Schedule B to be filed annually, reducing the administrative costs associated with the plan. Most of the risks associated with funding for retirement are shifted to the employee instead of the plan sponsor. However, the benefits that an employee receives upon retirement are not defined but instead a function of how much is accumulated throughout their work life and reasonable withdrawal rates based on the market conditions during retirement.
Plan sponsors’ current-day preferability of private sector defined contribution plans over defined benefit plans can be illustrated by the numbers of employees in 401(k) and other defined contribution plans, which comprised only 19.4% of the U.S. retirement market by plan type in 1975 (with just under $100 billion in 401(k) and other defined contribution plans)[5], and increased to 27.6% of the U.S. retirement assets in 2023 (with just under $10.6 trillion in 401(k) and other defined contribution plans).[6]
Federal, state, and local employees have fared much better. Federal, state, and local government defined benefit plans comprised 31.1% of the U.S. retirement assets in 1975, which fell to 22.7% in 2023 – a reduction far less drastic than that seen with private defined benefit plans.[7]
So where does this leave us? We have fewer workers in the private sector covered by defined benefit plans that are funded at a level that will guarantee them a certain benefit month after month. The majority of the workforce is covered by 401(k) and other defined contribution plans that do not provide a predictable monthly benefit. Instead, retirees’ monthly retirement benefits are dependent upon the level of contributions made throughout their work life, the investment returns earned on their account balances, and the determination of a reasonable withdrawal rate given prevailing market returns during retirement. Unfortunately, in recent years, investment returns have been subject to volatility and less substantial than those enjoyed in earlier years. Participants of 401(k) and other defined contribution plans, unlike their defined benefit counterparts, are directly burdened with the costs of these plans through investment manager fees, fund management fees & expenses, and TPA-recordkeeping costs. Until recently, these costs were significant. They have been lessened to some extent following an explosion of breach of fiduciary duty claims against plan sponsors and DOL audits of the plans.
As if the foregoing is not enough to illustrate the unpopularity of defined benefit plans, the proliferation of the amount of defined benefit assets involved in – and participants impacted by – pension risk transfers (“PRT”) is contributing to the decline of defined benefit plans even further. PRTs put defined benefit plan sponsors at risk to the financial solvency of the life insurance and annuity company involved, and strip away the Pension Benefit Guaranty Corporation’s guarantees.
Congress, through enacting ERISA, unintentionally facilitated this unintended adverse impact on the retirement income of working men and women in the private sector. Interestingly, Congressional retirement benefits largely remain unaffected. For Members of Congress covered by FERS (defined benefit plan) after December 31, 2012, the accrual rate for congressional service covered by FERS is 1.0% per year of service, or, if the Member has at least 20 years of service and serves until at least the age of 62, the benefit accrual rate is 1.1% per year of service. Senior members with 32 years in office can earn 80% of their $174,000 final salary, or about $139,200 a year. The smallest starting pension for congressional members is 12.5% of high-3 salary for a member with five years of service. Pensions based on less than ten years of service cannot begin before age 62. “Retirement Benefits for Members of Congress” Congressional Research Service, dated July 25, 2023. Figures from the nonpartisan Congressional Research Service show that in approximately 2013, there were 617 former members of Congress collecting pensions worth an average of $60,250 a year, or about $5,000 a month. The total cost of those pensions comes to $37.2 million a year. Isidore, Chris (November 6, 2014). “Fat pensions for outgoing lawmakers”. CNN Money. Retrieved May 3, 2022.
Compare congressional retirement benefits with the fact that the average 401(k) account balance in 2020 was $87,040;.[8] Assuming a conservative withdrawal rate during retirement of 3%, an employee would receive approximately $220 per month.
What are the solutions? Legislation that encourages further contributions to pension and retirement plans through tax credits instead of tax deductions. Increasing the amounts that plan sponsors may contribute to defined benefit plans and that plan sponsors and participants can contribute to defined contribution plans. Enact changes to the incidental death benefit rule that would permit the inclusion of significantly more life insurance in retirement plans. The latter would provide more stable annualized returns, more predictable withdrawal rates, and death benefits in the event of the participant’s untimely demise, ultimately benefitting his or her beneficiaries. Also, individuals must examine alternatives, other than qualified plans, to fund their retirement needs.
With every solution comes risk. In a divided Congress, getting the legislative changes listed above will not be easy. Today, utilizing insurance products in a qualified plan or outside of a plan requires significant due diligence in regard to the company standing behind the life insurance benefits or annuity payments. That is, today, there is much talk about the risks associated with private equity firms’ investments in life and annuity insurance companies. Appelbaum, Eileen (January 13, 2022). “Beware of Private Equity Gobbling Up Life Insurance and Annuity Companies”. Center for Economic and Policy Research. Retrieved May 3, 2022. There are tools that will assist in this due diligence process.
Seeking orderly change is not enough. Working men and women, labor organizations, and plan sponsors – particularly small businesses – need to become activists. Change must be demanded, instead of requested, so that all Americans have access to a retirement system that generates benefits comparable to those enjoyed by the members they elect to Congress. You have earned it throughout your life. It will determine your ability to enjoy a comfortable retirement. You deserve nothing less.
Contact the author about solutions for you, and to join the cause.
The author, Robert J. D’Anniballe, Jr., is a partner in the law firm of Pietragallo Gordon Alfano Bosick & Raspanti, LLP and principal consultant / founder of Fidant Solutions, LLC.
[1] 29 U.S. Code Chapter 18
[2] ERISA: A Journey from a Promise of Protection to a Retirement Crisis
(June 8, 2022)
[3] “Beware of Private Equity Gobbling Up Life Insurance and Annuity Companies”. Center for Economic and Policy Research. Published January 13, 2022.
[4] Source: Investment Company Institute, “Retirement Assets Total $38.4 Trillion in Fourth Quarter 2023,” published March 14, 2024, at page 1.
[5] “Beware of Private Equity Gobbling Up Life Insurance and Annuity Companies”. Center for Economic and Policy Research. Published January 13, 2022.
[6] Source: Investment Company Institute, “Retirement Assets Total $38.4 Trillion in Fourth Quarter 2023,” published March 14, 2024, at page 1.
[7] Source: Investment Company Institute, “Retirement Assets Total $38.4 Trillion in Fourth Quarter 2023,” published March 14, 2024, at page 1.
[8] Source: Investment Company Institute, “Ten Important Facts About 401(k) Plans,” published October 2023, at page 6.