Pension Reform: The Pension Preservation and Savings Expansion Act of 2003

Pension Reform: The Pension Preservation and Savings Expansion Act of 2003

Order Code RS21531
May 28, 2003
CRS Report for Congress
Received through the CRS Web
Pension Reform: The Pension Preservation
and Savings Expansion Act of 2003
Patrick Purcell
Specialist in Social Legislation
Domestic Social Policy Division
Summary
H.R. 1776 (Portman/Cardin), the Pension Preservation and Savings Expansion Act
was introduced April 11, 2003. Provisions of the bill would make permanent the
pension provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA), which otherwise expire after 2010, and accelerate the scheduled increases
in contribution limits to individual retirement accounts and employer-sponsored plans
that were included in the EGTRRA of 2001. The bill also would expand and make
permanent a non-refundable tax credit for low- and moderate-income individuals who
contribute to a qualified retirement plan. It would replace the interest rate on 30-year
Treasury bonds as the rate used by defined benefit plans to calculate funding ratios and
lump-sum distribution amounts. It would allow retirees to use distributions from a
retirement plan to pay premiums for employer-based health insurance on a pre-tax basis,
and allow up to $2,000 of retirement annuity income to be free of income taxes. It
would raise from 70½ to 75 the age at which participants must begin to take
distributions from pension plans and individual retirement accounts and reduce the
excise tax for not taking required distributions. It would allow workers to diversify
company stock acquired through employer matching contributions after 3 years of
service and company stock acquired through other employer contributions after 5 years
of service. The bill would allow disabled persons to contribute unearned income to
retirement plans and to qualify for Supplemental Security Income (SSI) while holding
retirement assets of $75,000 or more.

This report will be updated periodically. For a section-by-section summary of the
bill see CRS Report RL31939, “Pensions and Retirement Savings Plans: Comparison
of H.R. 1776 with Current Law.”
Making Today’s Savings Opportunities Permanent. The Economic Growth
and Tax Relief Reconciliation Act of 2001 (“EGTRRA,” P.L. 107-16) provides that the
the Act shall not apply after December 31, 2010. H.R. 1776 would make permanent the
provisions of P.L. 107-16 relating to pensions and individual retirement arrangements.
Congressional Research Service ˜ The Library of Congress

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Preserving Retirement Assets. The Internal Revenue Code (I.R.C.) requires
plan participants and owners of traditional IRAs to begin taking distributions no later than
April of the year after reaching age 70½. An exception allows participants in
employer-sponsored plans who are still working at age 70½ to delay distributions until
April of the year after they have retired, unless they own 5% or more of the firm. If a
participant in a defined benefit plan retires after age 70½, the benefit must be increased
in an actuarially fair manner. Failure to take a required distribution results in a tax penalty
equal to 50% of the amount that should have been distributed. Under H.R. 1776, the
required beginning date for distributions would be increased from 70½ to 75 (see chart,
below). The excise tax for failure to take a required minimum distribution would be
reduced from 50% to 20% of the amount that should have been distributed.
Year
Required beginning date
2004-2005
December 31 of year person reaches age 72
2006-2007
December 31 of year person reaches age 73
2008-2009
December 31 of year person reaches age 74
2010 and later
December 31 of year person reaches age 75
As under current law, distributions could be delayed until retirement (if later) except
for traditional IRAs and 5% owners of a firm. Actuarial adjustment would continue to
be required for defined benefit plan participants who retire after age 70½.
Enhancing Fairness and Pension Portability. Under current law, a transfer
of IRA assets from the IRA owner to his or her spouse’s IRA is taxable except in cases
of divorce or death of the account owner. H.R. 1776 would provide that a transfer of IRA
assets between spouses’ IRAs would in most cases not be treated as a taxable distribution.
The I.R.C. requires employees to be fully vested in nonelective employer
contributions (i.e., contributions other than matching contributions) after no more than 5
years of service, or in increments of 20% beginning in the third year with full vesting after
7 years. Employees must be fully vested in employer matching contributions after no
more than 3 years of service, or in increments of 20% beginning in the second year with
full vesting after 6 years. Under H.R. 1776, vesting in nonelective employer contributions
would be the same as vesting in employer matching contributions. Employees would be
fully vested in nonelective employer contributions after no more than 3 years of service,
or in increments of 20% beginning in the second year with full vesting after 6 years.
Most distributions from retirement plans are taxed as ordinary income, whether they
are received as a lump-sum distribution or in the form of an annuity. (Any distribution
that represents repayment to the participant of amounts that he or she contributed to the
plan with after-tax dollars is excluded from taxable income.) H.R. 1776 would allow a
percentage of annuity payments from an employer-sponsored plan or an IRA to be
excluded from taxable income. For tax years 2004 to 2007, 5% of annuity payments up
to $20,000 could be excluded from income to a maximum exclusion of $1,000 per year.
In 2008 and later, 10% of annuity payments could be excluded. The $20,000 limit on
countable annuity payments would be indexed to inflation. The exclusion would be
phased out for single tax filers with adjusted gross income between $75,000 and $90,000
and for joint filers with AGI from $150,000 to $180,000.

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I.R.C. §72(t), imposes a 10% penalty on distributions from an employer-sponsored
plan or IRA that occur before age 59½. There are several exceptions to the 10% penalty,
including distributions made as a series of substantially equal periodic payments that are
based on the life expectancy of the plan participant or the joint life expectancies of the
participant and his or her designated beneficiary. If the series of payments is terminated
or modified (except because of death or disability) before the later of age 59½ or the end
of a 5-year period beginning on the date of the first distribution, the entire series of
distributions is subject to the 10% penalty. IRS Revenue Ruling 2002-62 allows an
individual to elect a one-time change in the series of equal periodic payments without
incurring the tax penalty. The ruling specifies that either a nontaxable transfer of a
portion of the account balance to another retirement plan or a rollover of the amount
received by the taxpayer to another account will be treated as a modification of the series
of payments, resulting in all distributions being subject to the 10% tax penalty. The
interest rate used in calculating these payments may not exceed 120% of the federal mid-
term rate.
H.R. 1776 would amend I.R.C. §72(t) such that a change from one permissible
method of calculating substantially equal periodic payments to another permissible
method would not be subject to the 10% tax penalty if the change results initially in a
reduction in the amount of the payments. It would further provide that if amounts are
being received as a series of substantially equal periodic payments, and a transfer or
rollover is made into another tax-qualified retirement plan, the 10% tax penalty will not
be applied. It also would provide that any “reasonable” interest rate may be used in
determining whether distributions are substantially equal periodic payments.
The Supplemental Security Income (SSI) program is a means-tested, federally
administered income assistance program that provides monthly cash payments to needy
aged, blind, and disabled persons. The maximum SSI payment in 2003 is $552 per month
for a single person and $829 for a couple. The asset limit for SSI eligibility is $2,000 for
a single person and $3,000 for a couple. Under H.R. 1776, $75,000 or more in a qualified
retirement account would be excluded from assets in determining eligibility for SSI.
Beginning at age 60½, the Social Security Administration would count as monthly income
the annuity value of a retirement account balance and offset SSI benefits by that amount,
regardless of whether or not the individual has converted the account to an annuity.
Increasing Retirement Plan Participation and Savings. The EGTRRA of
2001 authorized a non-refundable tax credit equal to a percentage of the first $2,000
contributed annually to a qualified retirement plan by low- and moderate-income
individuals and families. The credit does not apply to years that begin after December 31,
2006. Under H.R. 1776, the non-refundable credit would be made permanent and would
be expanded for tax years after 2003 according to the following schedule:
Single return
Joint return
Credit
AGI<$15,000
AGI<$30,000
55%
15,001 to 20,000
30,001 to 40,000
25%
20,001 to 25,000
40,001 to 50,000
20%
25,001 to 30,000
50,001 to 60,000
10%

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The EGTRRA of 2001 increased the maximum annual employee contribution to
qualified retirement plans authorized under sections 401(k), 403(b), and 457(b) on a
phased-in schedule, with the maximum reaching $15,000 in 2006. H.R. 1776 would raise
the maximum annual employee contribution to a qualified retirement plan to $15,000 in
2004 and index this amount to inflation in $500 increments in later years. EGTRRA also
increased the maximum annual employee contribution to a Savings Incentive Match Plan
(SIMPLE) retirement plan, with the maximum reaching $10,000 in 2005. H.R. 1776
would raise the maximum annual employee contribution to a SIMPLE retirement plan to
$10,000 in 2004, indexed to inflation in $500 increments in later years.
The EGTRRA amended I.R.C. §414(v) to permit persons age 50 and older to make
additional contributions to retirement plans, according to the following schedule:
Year
401(k), 403(b), 457(b)
SIMPLE
2003
$2,000
$1,000
2004
3,000
1,500
2005
4,000
2,000
2006
5,000
2,500
Under H.R. 1776, the maximum additional contribution to plans under sections
401(k), 403(b), and 457(b) by individuals age 50 and older would be increased to $5,000
in 2004 and indexed to inflation in $500 increments in later years. The maximum
additional contribution to a SIMPLE plan by individuals age 50 and older would be
increased to $2,500 in 2004 and indexed to inflation in $500 increments in later years.
IRS rules allow firms to enroll employees automatically in salary reduction
retirement savings plans, provided that employees receive notice of the arrangement and
have the opportunity to choose not to participate. ERISA §404(c) provides that if an
employee can exercise control over the investment of the funds in a qualified retirement
plan, the employer will not be held liable for investment losses that the employee
experiences as a result of exercising that control. H.R. 1776 would amend ERISA
§404(c) to authorize “automatic contribution trust arrangements” under which the
employer could contribute a uniform percentage of employee pay to a retirement account
that is invested in accordance with regulations to be prescribed by the Secretary of Labor.
Employees must be notified of their right not to participate in the plan and also of the
assets in which the contributions to the plan will be invested in the absence of specific
directions by the employee. It would amend I.R.C. §514(b) to supersede any state laws
that otherwise would prohibit automatic enrollment in a qualified retirement savings plan.
Expanding Retirement Plan Coverage to Employees of Small
Businesses. As authorized by P.L. 104-188, an employer with 100 or fewer employees
can establish a SIMPLE plan. Under a SIMPLE plan, an employer must either (1) match
100% of employee salary deferrals up to 3% of pay (to a maximum match of $6,000 in
2003) for all participating employees or (2) make a nonelective employer contribution of
2% of pay (up to $4,000 in 2003) for all eligible employees. No other contributions are
permitted. Under H.R. 1776, an employer could choose to make an additional nonelective
contribution of a uniform percentage of pay up to 10% of total compensation for each
eligible employee, regardless of whether the employer also is making a matching
contribution. An employer that sponsors a SIMPLE 401(k) could make matching

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contributions of less than 3% of pay, provided that the contribution is at least 1% of pay
and the reduced contribution is not in effect for more than 2 years in a 5-year period
ending in the current year. A small employer that has not sponsored a retirement plan in
the previous 2 years, and that is otherwise eligible to sponsor a SIMPLE plan, could adopt
a SIMPLE plan funded entirely through employees’ elective deferrals with no employer
contributions. Employees could defer up to $5,000 per year, indexed to inflation. The
Secretary of the Treasury would be required to propose regulations that would permit an
employer to replace a SIMPLE plan with another tax-qualified plan in mid-year. The bill
would lower the tax penalty on distributions from a SIMPLE IRA during the first 2 years
of participation to 10% of the amount distributed, and it would allow individuals to roll
over balances from any other type of qualified retirement savings plan into a SIMPLE
IRA. Amounts held in a SIMPLE IRA could be rolled over into other qualified retirement
plans to the same extent as other IRAs.
Strengthening Individual Retirement Arrangements. The EGTRRA of
2001 increased the maximum annual contribution to an IRA. The maximum reaches
$5,000 in 2008. H.R. 1776 would increase the maximum annual contribution to an IRA
to $5,000 in 2004 and index it to inflation in $500 increments in later years. EGTRRA
allows individuals age 50 and older to make additional contributions of up to $500 to
IRAs through 2005, and $1,000 in 2006 and later years. Under H.R. 1776, the maximum
additional contribution to an IRA by persons age 50 and older would be increased to
$1,000 in 2004 and later years. IRA contributions are limited to the lesser of a specific
dollar amount (currently $3,000) or the individual’s earned income for the year. Under
H.R. 1776, disabled persons, as defined in I.R.C. §72(m)(7), could contribute to an IRA,
regardless of whether they had earned income for the year of the contribution, provided
that they had not yet reached age 70½.
Revitalizing Defined Benefit Plans. Most defined benefit plans in the private
sector are funded entirely by the employer. Any required employee contributions must
be made on an after-tax basis. In the public sector, most governmental defined benefit
plans require the employee to contribute to the plan, but governmental employers can
choose to take employee contributions on a pre-tax basis. Under H.R. 1776, private-
sector employers could treat employee contributions to defined benefit plans as pre-tax
dollars.
Under current law, the interest rate on 30-year U.S. Treasury Bonds must be used to
determine the funded status of a defined benefit plan, to calculate the amount of lump-
sum distributions to plan participants, and to determine maximum benefit amounts. The
Treasury Department no longer issues 30-year bonds. H.R. 1776 would replace the
interest rate on 30-year Treasury Bonds as the rate for determining the funded status of
defined benefit plans with an interest rate based on an index of high-quality, long-term
corporate bonds. For calculating lump-sum distributions, the corporate bond rate would
be phased in over 4 years beginning in 2006. For determining maximum benefit amounts,
the Treasury interest rate would be replaced by a rate of 5.5% beginning in 2004.
Restricting Excessive Remuneration. The tax code imposes an excise tax of
20% on certain payments to owners and officers of a corporation that are contingent on
a change in company ownership or control of assets. H.R. 1776 would impose an excise
tax of 50% on “excessive employee remuneration” (including nonqualified pension
benefits) that is paid during bankruptcy and the 2 years preceding a bankruptcy filing. In

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the case of company payments made to cover an employee’s income taxes on such
remuneration, the excise tax would be 100%.
Defined Contribution Plan Protections. H.R. 1776 would require all defined
contribution plans to provide quarterly “investment education notices” that would include
an explanation of generally accepted investment principles, including principles of risk
management and diversification, and a discussion of the risk of holding substantial
portions of a portfolio in the security of any one entity, such as employer securities. The
Sarbanes-Oxley Act of 2002 (P.L. 107-204) allows the Secretary of Labor to assess a civil
penalty of up to $100 per participant per day on a plan that fails to notify participants 30
days in advance of any period of 3 or more days during which 50% or more of a plan’s
participants would be unable to trade the employer’s securities. H.R. 1776 would levy
an excise tax of $100 per participant on any non-ERISA plan that fails to provide notice
30 days in advance of any period of 3 or more days during which 50% or more of a plan’s
participants would be unable to trade the employer’s securities.
Employers sometimes make contributions to defined contribution plans with shares
of the employer’s stock. They sometimes require employees to hold this stock until
separation or until age 50 or 55. Under H.R. 1776, employers could not require
employees to purchase company stock with their own salary deferrals. Employees could
sell company stock acquired through employer matching contributions after 3 years of
service and company stock acquired through other employer contributions after 5 years
of service. The diversification requirement would be phased in from 2004 to 2008. It
would not apply to (1) employee stock ownership plans (ESOPs) that hold neither
employer salary deferrals nor employer matching contributions or (2) plans that do not
hold company stock that is readily traded on a public stock exchange.
Other Elements of Retirement Security. Retired employees who purchase
health insurance through a former employer pay the premiums with after-tax income.
H.R. 1776 would allow retirees to pay for health insurance purchased though a former
employer with pre-tax income, provided that the premium is paid in whole or in part with
distributions from an employer-sponsored plan. Prior to 2010, the limit on plan
distributions used for pre-tax payment of health insurance premiums would be $500 in
2004 and 2005, $1,000 in 2006 and 2007, and $2,000 in 2008 and 2009.
Financial accounting standards require public corporations to report on their financial
statements any unfunded obligation for retiree health insurance benefits. Employers are
not required to pre-fund these obligations. Under I.R.C. §401(h), an account maintained
as part of a defined benefit plan or money purchase plan can be used to pre-fund some
retiree health benefits. H.R. 1776 would amend I.R.C. §401(h) so that accounts to pre-
fund retiree health benefits also could be maintained under profit-sharing or stock bonus
plans. Employer contributions to the 401(h) account would be limited to 25% of the
employer’s total contributions to the plan, as under current law, except that for profit-
sharing and stock bonus plans the limit would be 5% in 2004 and 2005, 10% in 2006 and
2007, and 20% in 2008 and 2009.