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9. Effects of Nondiscrimination Rules on Pension Participation
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One of the central reasons policymakers provide tax subsidies for pensions is to raise pension coverage and benefit levels, especially among low- and moderate-income workers. 1 To achieve this goal, Congress has established and periodically revised nondiscrimination standards that pension plans must meet in order to qualify for tax subsidies. In broad terms, the nondiscrimination rules require that coverage and benefits for low-wage employees maintain at least minimal levels relative to what is available for highly compensated workers. The central policy question surrounding nondiscrimination rules is whether they are effective in raising coverage and benefits for low-wage workers. The rules may work as intended if, in the absence of such regulations, firms would choose to skew pension subsidies toward highly compensated workers. But the rules may also inadvertently reduce coverage for all workers in general and for low-income workers in particular, in either of two ways. First, the rules are complex and thus 259 Effects of Nondiscrimination Rules on Pension Participation robert l. clark, janemarie mulvey, and sylvester j. schieber 9 Robert Clark’s work on this paper was funded by grants from WorldatWork and the Shannon J. Schieber Retirement Policy Institute of the American Benefits Council. The authors wish to thank Annelise Li and Lex Miller of Watson Wyatt Worldwide for their help in developing the statistical analysis included in this paper. They thank Kyle Brown of Watson Wyatt Worldwide for his comments. A more detailed version of many of the results in the paper may be found in Clark, Mulvey, and Schieber (2000). 1. For an analysis of the size and distribution of pension tax expenditures, see Goodfellow and Schieber (1993) and Clark and Wolper (1997). 09-0238-8 chap9.qxd 3/9/04 10:57 AM Page 259 may raise the administrative burden of providing a pension, which could reduce overall coverage rates. This problem may especially affect small firms, which tend to disproportionately employ low-wage workers. 2 Second, the rules may bear more heavily on the cost of offering defined benefit plans than on the cost of offering defined contribution plans. Participation rates for low-wage workers are lower in defined contribution plans, where workers choose whether to participate , than in defined benefit plans, where employers determine participation. 3 To a large extent, the policy debate over nondiscrimination standards has proceeded without evidence. 4 This paper aims to fill that gap. Using twenty years of data from the Current Population Survey, we examine the effects of three changes in nondiscrimination rules in the 1980s and 1990s. The primary finding is that stricter nondiscrimination standards did not increase coverage rates of low-wage workers in absolute terms or relative to highly compensated employees . In addition, some of the findings suggest that the rules reduced coverage for low-wage workers relative to others. These results indicate that the nondiscrimination rules enacted in the past not only failed to meet their ostensible goal of helping low-wage workers, but appear to have been counterproductive, reducing participation rates for low-wage workers relative to others. The key policy implication from this research is that giving employers better incentives to sponsor plans, by simplifying the nondiscrimination rules and reducing administrative costs, would likely be more effective than current policy in raising pension coverage levels among low- and moderate-wage workers. Nondiscrimination Rules: A Primer Tax-qualified employer-sponsored retirement plans may not discriminate in favor of highly compensated employees in coverage, contributions, or benefits. This simple principle is the basis for an extremely complex set of rules and regulations. 5 General Provisions A “highly compensated employee” is defined as anyone who is a 5-percent owner, is paid more than $75,000 in compensation, is paid more than $50,000 260 Private Pensions and Public Policies 2. McGill and others (1996) provide a detailed discussion of these standards and the various tests that are required for plans to retain their tax-qualified status. 3. Clark and Schieber (1998) conclude that low-wage workers are less likely to make voluntary contributions to pension plans such as 401(k) plans. 4. For contributions using cross-sectional firm data, see Garrett (1995) and Carrington, McCue, and Pierce (2000). Bankman (1988) provides a conceptual analysis. 5. The seventh edition of Fundamentals of Private Pensions dedicates three full chapters to the description of current general rules and part of another chapter to the special provisions covering 401(k) plans (see McGill and others, 1996, chs. 3–5, 12). The discussion of...