Pensions: Are They Just a Toy For Congress to Play With?

In 1963, Studebaker, once a large and proud American auto maker closed its doors in the US for the last time. With that door closing, as legend has it, New York Senator Jacob Javitz had the idea that the retirement income promised to employees needed more security. So was born in his mind the law that in 1974 became the Employee Retirement Income Security Act (ERISA). While it did far more than take steps to make pensions more secure, that was purportedly its primary purpose.

ERISA provided a framework for corporate retirement plans. And, in 1974, before paragraph (k) had been added to Section 401 of the Internal Revenue Code, the predominant employer-provided retirement income came from defined benefit (DB) plans. Unions bargained for them, and what the unions got, management wanted. Also, back in 1974, it was not unusual that if there was a company that an employee worked for in their mid-to-late 20s that that employee would eventually retire from that company. If you, as an employer, promised that employee a pension, you could expect 30 or more years of loyalty from that employee.

So, ERISA set up a minimum funding regime regime for DB plans. If you were using what is known as an immediate gain (or loss) actuarial cost method (if you know what that means, you don't need an explanation and if you don't know what it means, you don't want an explanation), then your minimum funding requirement for the year was the sum of these elements:

• The normal cost or the actuarial present value of benefits accruing during the year
• Amortization over 30 (or 40) years of the unfunded liability remaining from inception of the plan or transition to ERISA
• Amortization over 30 years of the actuarial liability emerging due to changes in plan provisions, the thought likely being that you got 30 years of value from the amendment
• Amortization over 30 years of the actuarial liability emerging due to changes in actuarial assumptions
• Amortization over 15 years of the actuarial liability emerging due to actuarial gains and losses (deviations from the expected)
• A few other elements that rarely came up

By the mid-1980s, DB plans were generally pretty well funded, and most of those that were not yet fully funded were getting much closer than they had been. The exceptions, for the most part, were plans sponsored by companies in dire financial straits that often convinced their actuaries to use fairly aggressive actuarial assumptions, or companies that frequently provided large benefit increases that had not yet been funded.

In 1986, we were graced with the Tax Reform Act (TRA86), a massive and sweeping change to the entire Internal Revenue Code -- so massive, in fact, that the Code was renamed from the Internal Revenue Code of 1954 to the Internal Revenue Code of 1986, a moniker it keeps to this day. A not insignificant portion of TRA86 included changes to pension funding rules. Amortization periods were shortened. For the most part, this increased required contributions for underfunded plans, which in turn increased corporate tax deductions.

Those new rules were revamped quickly. Just a year later, embedded in the Omnibus Budget Reconciliation Act of 1987 (OBRA87) was the Pension Protection Act of 1987. OBRA87 was the annual budget bill. And, has become the trend, each powerful legislator had his own pet spending project. To pay for all that pork, either a revenue generator or a decrease in tax expenditures (a fancy name for deductions) was needed. OBRA87 found a useful tool in DB pension plans. How is that? Just change the funding rules to decrease required contributions and tax deductions will go down which in a backhanded sort of way increases revenue for the government. of course, this was thinly veiled in a complex set of new requirements that applied only to underfunded plans.

A star was born!

Congress needs a revenue raiser? Change the funding rules. Cut the maximum benefit limitations. Change required interest rates. 

With this new toy, Congress looked at changes in pension rules at least every other year. It created uncertainty for employers. Yes, they could plan and budget based on current rules, but they lived in fear that the rules would change. That's a tough way to run a business. Many of those plan sponsors froze their pension plans. Many of them wanted to terminate their plans, but interest rates were so low that the cost of terminating those plans was too high. 

Fast forward to 2006. Coming out of the economic malaise and stock market tumble at the beginning of the decade, many plans were underfunded on an accrued benefit basis using market-based discount rates. It was time to protect pensions yet again. Thus was born the Pension Protection Act of 2006 (PPA), the most sweeping change to corporate pensions since ERISA. It provided a regime that essentially ensured that underfunded plans would be fully funded within 7 years. Employees would get their pensions. 

But, those extra contributions from employers are tax deductible. That's an extra burden on the government. And, it was just one year later (falling from its October 11, 2007 peak) that the markets crashed yet again. Employers couldn't afford these new levels of required contributions. But. Congress had an agenda to help those employers and help themselves. 

Welcome pension smoothing in the form of several laws since then. PPA brought us 7-year funding based on "fair market" conditions and assumptions. Pension smoothing undid that and then undid it again and undid it again as Congress invoked its favorite toy at least 3 times in the period following the signing of PPA. Employers had funding relief. Congress had its decrease in tax expenditures. Employees in pension plans had less funded benefits and the rules got so complex that almost nobody wanted to sponsor a pension plan anymore.

And, the places that pension funding relief gets buried are just amusing. I think the 2014 relief is my favorite -- the Highway and Transportation Funding Act of 2014 (HATFA). That's right. Congress decided it was time to improve our roadway system, but new roads don't come for free. So, to help pay for this, Congress invoked its favorite tax toy, pension funding relief.

Shame on them!