401(k) changes need rethinking


NEW YORK -- Congress is preparing to "simplify" 401(k) plans. Those are the tax-deferred retirement saving plans that many firms offer their employees. Small firms say that 401(k)s are burdensome to operate. If the rules were simpler, they say, more small firms would offer them.

But who will simplification help? Supporters say it will help the entire work force, by enlarging the number of tax-deferred retirement plans. Opponents say it will mainly help higher-paid workers and executives, at the expense of the lower-paid.

Both sides have a point. The issue is how to expand 401(k)s while being fair to all. Opponents worry about the negative incentives in the proposed new 401(k)s. They relate to the so-called "anti-discrimination" rules. These rules stop retirement plans from discriminating in favor of the highly paid.

Companies with 401(k)s are encouraged to make it attractive for the work force to join. The more that the rank-and-file contributes, the more the bosses can contribute for themselves (up to a ceiling of $9,240 this year and $9,500 next year).

In some 23 percent of plans today, high-earners are prevented from making the maximum contribution, because of low rank-and-file participation, according to Paul Yakoboski, research associate of the Employee Benefit Research Institute in Washington, D.C. (Generally, "high earners" are defined as those who own at least 5 percent of the company, earn more than $100,000 or earn more than $66,000 and are among the highest paid.)

For this reason, many companies court their rank-and-file, to get more of them into the plan. They run information programs about the 401(k), and get workers to join by matching the money they put in.

The overhaul Congress proposes, however, would turn that incentive inside out. The bosses could get their tax break even if the workers didn't join.

Opponents fear that would end the worker-information programs. The bosses would no longer care if the workers joined or not, says Karen Ferguson, director of the Pension Rights Center in Washington.

In return for improving the tax break for the better paid, Congress would require firms to pay something to other employees, too. For example, they might have to contribute a certain sum to the account of every worker in the 401(k). But this would discourage worker-education programs. The fewer the people who join the 401(k), the less money the company would have to pay, Ferguson says.

A parsimonious company might give employees a technical sheet about the plan with no explanation at all, hoping that they'd never get through the boilerplate.

Supporters of the plan, however, do have a point to make. A super-small company, they say, may consist of a couple of well-paid principals plus three or four modestly paid employees. Those employees probably can't afford a 401(k). If they do join, they won't contribute much.

Result: Under the anti-discrimination rules, the principals can't contribute much either. So they're prevented from making solid retirement contributions for themselves.

There's a way to harmonize these two needs. The bosses could be allowed the maximum tax deferral if they also contributed something for every single worker (even workers who didn't put anything into the plan). If the company president put in $9,000, say, and saved himself $3,600 in taxes, he'd have to spend something on pensions for his employees. That's tit for tat.

President Clinton has suggested that every worker get at least 1 percent of pay, plus more generous contributions for the workers who put their own money into the 401(k). But Congress isn't interested.

Many small companies may not be interested either, says Peter Elinsky, a tax partner of the consulting firm, KPMG Peat Marwick. They like the idea of getting rid of the anti-discrimination tests (which involve some paperwork), but don't want to pick up extra costs.

Bottom line: The current proposals could lead to the worst of both worlds. Small companies without plans might not be encouraged to start them. Those that do start 401(k)s (or have them already) might discourage the lower-paid from signing up.

This issue needs to be rethought.

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