tax-s provides t The Ta ubsidized Whe Wh he most c xile the resu pn ay accounts. In a only pla er R oe m lip e ln rehensive tf Act s in s that include Fi o n attem g f u 1re 9 data avail 92 7 p are sp a t to assess the com pplip e a ecific to th any stoc d a ble on t limi first th k are a on m e e assu we -order im al an ndat talyzed, h m o pf o tio Am ry pact of n i splans nvest m erie cn an ho e that tio m liminating c en nt euse of d o abo f fer h 40 ol com v 1( ds. eo , sim kmpany W )p c any ont eilar resu tr st ri acke stoc b oc utk id ons k in 401(k) lts are but info i n n rm o em tob G ati tain pl Ion C oy plans, sed er 1 Introduction I f st (al have rp o ock b rm o ei an g th .t T ramm wi e 1 ave h tih 992 s di r ed wa ag f , 19 a n f e o s a m ere e 95 fn w sub 31 to , and pe re m .8% rce r o o 19 odest n uftt98 t a in ge l he to th e acc ver (th oe sses) s m ou io e o n nt EBRI/ERF Retirem st r u of a bal ne dcen e a pr rnces i vari o t d posal ao ta nvest us cur by com Se reed ntly av e b n. B in n in t In co ata ico m ons rba ailab p m an r o e a B Pro f l y st e) m o su ix ock jnim ectio erv r ( ,eys an u D wh m n -C M guara ile th A) o d foun d te o e figure decrea l t nt im o ee d th sim pose a sepa s an e ud as late th follo sum w ses to e fin ra ing etd asset e: l ain 27.7% m ciial ta tion 15 32 40 Ibid. See This is imFigure portant6. because an ESOP is to be "primarily invested" in qualifying employer securities. See fo im of allo 1 r pact on pl catio 0 •% ans on t Th Ch fs h 401(k) account bala pl and rates at e p airm an ae asset lso i rcen an Thomas, Ran ntag cl so on ude f return e t of G he fam Im C . nce. s ailies . ndat kOnce ing o wit ry Me t i hh n m a p e i vb en e er Rangel, m stm fl nuence sion ent p of o lan f 4 t 0 who h 1 ee ( m i knve ) b h c ers o a ont v ste m ri d f th e b ent u fin e co t im o ens i d emmittee nu be n i n s qual e c fit ont .i cov I am fr yo in lelg rag e Jack em d fo e h pl r, t Van aoy s d he i er st e D creased m erh o pact ce k a i, a of n fro d faculty pl real m an 6 2.5 19 33 “Employee Stock Ownership Plans (Part II),” Journal of Pension Planning and Compliance (Winter 2000); John L. 33 size is less significant. property. member in the percen risk i t in 1992 nsura to 43 nce and hea .1 percen ltht in care 19 m 98 a, and th nagemee si nt at gn tih fe F ican oc xe of Scho 40 ol 1 o (k) f B -type p usines lans for s, Tem tho ple Uni se fa vm erisi lies ty, and Ibid. See the bottom two panels in Figure 6. 6.1 Simulation Results Utz; pages 1 -34. research The Econ d p I also illu i arect rticip o om rating of th ic Gro strate th in a p e Em wth e im p and eln os y p iee Ben Tax o act o n p Relief Reco lf an m salary on efit Research In ore th co an doub nciliatio mpan stitu led y sto n Act ,t fr e Fello co km o allo f 3 20 ws Program 1catio .6 01 p (EGTRR en rc for th ent in 199 . e sub A) exp 2 to set an o 64 d f t e.3 h de EB tp he e d rcRI/ICI en ivit in dend 19 d d a98 tab ed . u ase ction 34 34 Ibid. See the bottom two panels in Figure 7 16 for ESOPs to in for which we hav clud e th e e drequ ivide isite nds in pafo id on rmatio qun alifyin . For g em plan pls bo oyer th with securities h and witho eld by u an ESOP t GICs, there that, at th appears e electio to be an inve n of rse The simulation was performed for birth cohorts between 1936 and 1970, and the results indicate the overall gain • The percentage of family heads eligible to participate in a defined contribution plan who did so increased It should be noted that less than 5% of all ESOPs are in public companies. For an explanation of the 35 relatio part or lo ic ss in pfr s ah n om itp b s (p or eros tween bene pect fi t ci i hv ari e lev e)e ret s, a ee l of salary and r nt e:i 1 on ) o pay f ca obl me p tany di he rect p st ercen oc ly i k i nta cas ng 40 eh o 1( ;f 2) 401 k) pai pl(k ad n ) b t s o(as a tlan he op ce inv pl pan a osee d t nsted d odi co in GICs, althou stm ribut pany ed st in ock casb h gh en ing e th o le atn etr t irel han y from 73.8 percent in 1995 to 77.3 percent in 1998. Of those families choosing not to participate in a defined challenges that For recent EBRI/ICI researc stricter diversification rules h on may the c pres ontri ent t bution acti o private com vity of 401(k) pl pany ESOPs an, participa see Corey R nts, se osen, “ e Sara Sh houl Holde d n 8 Endnotes 1.1 Objectives of the Testimony relations 90 days aft hip is er th m e cl uch less significant in t ose of the plan year ih ne w form hich t er case. The he dividends ex are tent pai to d wh toich th th e pl is is du an; or e t 3)o pai non-p d to t articip he plan a ant-d ni drected eliminated immediately). The estimated gain of retaining company stock is 4.0% of 401(k) balances, assuming contribution plan, 40.3 percent were already participating in a defined benefit plan. and Jack VanDerhei, "Contribution Behavior of 401(k) Plan Participants,” EBRI Issue Brief n. 238, October 2001. ESOPs Be Subject to Stricter Diversification Rules?” (www.nceo.org/library/boxer_corzine_bill.html) 20 m reinv coa m tcp hi e lete in sted ng c io n d nt e qu pen ribut alifyin di eo nns m ce g em with aki p l n resp o gy up er securities. ect to th a larger e p pro ercent A 401 bability o age (k of ) p f an com lan w nual pan ith cy sto o a co ntric bm k u i tp in ons any sto a su fo brs l c equ k fu ower end n-tp t plan ai hd i at r and ndi egu vi 7 lar d .8 ul% al y s awai assu pays mtisn g My testimony today will focus on retirement security and defined contribution pension plans with special • Overall, “personal account plans” represented nearly one-half (49.5 percent) of all the financial assets for 36 17 35 So Altur ernat ce of c ivelo ynt , am ribount ution s (em subjp elc oty te or tver he s rius gh em t ofpl di oy ver ee) si can ficat be ion m maa tc yhed t be di ost fu rin but d ie nd fo fr rm om at t ion f he pl or an. a s See ubset of di furth vide er inv nds m estigatio ay cons ni.der designating a portion of the plan that includes the company stock fund to be an ESOP in perfect correlation. emphasis on 401(k) plans with company stock. This draws on the extensive research conducted by the Employee those families with a defined contribution plan account, IRA, or Keogh, in 1998. This was a significant 21 the data providers in our sample. Of those plans in the 2000 EBRI/ICI database for which the appropriate data are Everett T. Allen, Jr., Joseph J. Melone, Jerry S. Rosenbloom and Jack L. VanDerhei, Pension Planning: Pensions, order Fig tou t 1 re ake a 1 (b dva elow) ntage prov of t id hes the resu is deductiolts of th n. e simulation by gender and preretirement income, assuming complete Benefit Research Institute and on the EBRI/ICI 401(k) database. Portions of this testimony borrow heavily from a increase from 43.6 percent in 1992. The average total account balance in personal account plans for Portions of this testimony borrow heavily from Sarah Holden and Jack VanDerhei, "401(k) Plan Asset 41 Pro avaifit Sh lable, l aring ess t , an han d Ot 0.5h % e re r Def quierrred e em C plo oy mp er c eno sa nt tio rib n Plan utions t s (o 8 b th e e id nve ) (H sted i omewoo n com d, p IL: any R stioc chk. ard H D. owe Irwi ven r, m , Inc ost ., of 19 t 9h 7e ). At Enron, 57.73% of 401(k) plan assets were invested in company stock, which fell in value by 98.8% during i recent publication I ndependence. Prec ro etirem -authored with ent income Sa was ca rah Hol tego den rized of th as eith e Inveer h stmi eg nt Com h or low b pany Ins y simtitut ulatin e, “401(k) Plan Asset g the income in the year families with a plan in 1998 was $78,417, an increase of 54 percent in real terms over the 1992 balance of Allocation, Account Balances, and Loan Activity in 2000," EBRI Issue Brief n. 239, November 2001. 4.3 Distribution of Company Stock Allocations 22 plans with this feature are large, covering 6% of participants and 10% of plan assets in the subset. 18 2 p001 rior t . o Th retiremen e decrease in sh t and comare paring price and it with th even e m tue al b dian ank in rup com tcy e filin for pg of En articipants in ron resu thlted in e same hu big rth coho e financrt. ial l Males wou osses for ld Allocation, Account Balances, and Loan Activity in 2000," EBRI Issue Brief, November 2001. $50,914 (expressed in 1998 dollars). As a result, the impact of this change was de minimis during the significant market decline in the fall of 2 37 many of it “Th s 40e 1 Fu (k) pa ture of Priv rticipants ate Retiremen . This has prom t Plan pted seve s,” Dallas ral lS aws alisb uitu sr as y, ed we . EBRI ll as co Educa ngressi tion a onal a nd Res nd agearch Fund ency gain more t Seve han fem ral legi ales fro slative p m reten roposal tios nh of com ave calp le an d f y sto or ac nk a fo bsr bo olute th lev upper limit o els of relativ n th e salary. Particip e percentage of co an m ts in pan t y sto he lower ck 1997. See Jack Van For this gro Derh up, th ei, “Th e pa erticip Impact o ant-d f ith rected e Oct p oo brtio er 198 n of 7 Sto the acc ck Market Declin ount balances re e on presen Pents 65 sion % Plan of th s," e to written tal th (Employee Benefit Research Institute, 2000) that an em in relativ vestig e salar ation ploy y s in lev ee will be to e t ls wou he relativ allowed to ld ste b and to enefits an hold i gain m d limita n o his re th oran tio he t n r 401(k) h seir of h the curren ighaccount. er paid counter t practice. Figure 8 of paIn add rts fo mr bo y itio Fe tn, th h bruary 13 gee nd practice of im ers. testimony po sing 2.3 Size And Importance Of 401(K) Plans account balances. testimony for U.S. House of Representatives, Committee on Ways and Means, Subcommittee on Oversight, July 2 Defined Benefit/Defined Contribution Trends “blackout” periods when the 401(k) sponsor changes administrators has recently been called into question in light of provides t 3he year-end 2000 company stock allocation for the EBRI/ICI universe of plans offering company stock. A T-134 1988. 38 Pro See Jack fit-shari VanDerh ng plans wi ei, “Th th cas e C h o or n de trov fer ersy redof Trad arrangem ition ent al v s (m s. Cash ore com Balan monly ce Plan referre s.” d t ACA J o as 4 our 01nal, (k) pl Van ol. 8, s) gre no. w 23 See figure 9 of VanDerhei, “The Role of Company Stock in 401(k) Plans” to the En tal of ro 48 n situ % of th atioe n.401(k) participants under age 40 in Fi th gu esre 1 e plans have more than 20% of their account balances More than a quarter-century ago, C 8 ongress enacted the landmark law that still governs employment-based i 4n ( n Fu our mb th er f 19 Qu ro arter m vi rt 199 ual 9) ly : no 7–16 pl. ans in 1983 to 265,251 by 1997 (the most recent year for which government data are The final version exempts from the 10% limits: (1) de minimis (i.e., as much as 1% of pay) mandatory Certainly, the 39 Enron situation has caused the retirement income policy community to focus increased attention invested in com Aver panage Gain From y stock. The pe Re rcen tention tage deof Com creases t po any St 47% for ock as a P participan ercentage ts in their 40s, 45 of 401(k) % fo Bala r tho nces , e in their 50s retirement plans in the United States. The Employee Retirement Income Security Act of 1974 (ERISA), after more See Scott Burns, “Examining Your Gift Horse,” Dallas Morning News, April 17, 2001, for an excellent currently available), accounting for 37% of qualified private retirement plans, 48% of active employees, and 65% of 4 investment provisions, (2) plan designs under which the Sec. 401(k) deferrals (regardless of amount) are part of an an to th d dro e de psirab s to For a d 41 iBy Ge lity o % efor tailed f cu nder pa rren rticipan an and Rel alysis of th t law an ts in th ad practices reg tive Pre ese trend eir 60s. -retirement Salar s fro ard m ing 1985 com to p 199 an y (Ass y sto 3, see K umi ck in ne 40 g lly O Complete 1(kl)sen plans, an I d Jack ndependence resultin Va g in nD m erh ) ue ch i, “D deb ef aite. ned than two decades of am 9 endments and regulatory embellishments, remains the basis of the federal government’s example of the tradeoff of risk between the S&P 500 Index and an individual stock. new contributions. Written Statement ESOP, and (3) plans in which the total assets of all defined contribution plans of the employer are not more than C Pres ontum ribut abl io yn , any Plan D reco om mim nance endat Gr ions t ows o m Acr odi oss fy Sect curro ent rs a pe nd nsi Eo m npl la oy w er Si woul zes, d atWhi temp le t t M o st ega rike Defi a bal ned a B nce ene bet fitw Pl een ans approach to retirement plan regulation. Widely praised for achieving its goal of greater retirement security for those As 40 of 1997, the most recent year for which published government data are currently available, there were 10% of the t See otalVan defi D ned erhe be i, “The nefit and Rolde e of fine Cd om cont pany rib St utio ocn k pl in 401 an asset (k) Pl s oan f th s” e em for pl de oy tails of th er. The l e sim imitu appl latioin es Re prot m ect ain in Stron g empl g: W oyees an here We Ar d not det e and Whe erring em re We Are ployers fr Going,” om offeri EBRI Speci ng employal Report er matches t SR o-33 401 and (k) pl EBR ans. I Iss So um e Brief e have no. American workers who have pension Prereti s, it is si reme mn ultan t salary eously criticized for contributing to the demise of the traditional Gender 265,251 401(k)-type plans with 34 million active participants holding $1.26 trillion in assets. Contributions for that 5 Employee Reaction When Employers Mandate Th for the at Matching Contributions Be Invested in prospectively with respect to acquisitions of employer stock. The investment of matching or other employer 1 ar 9gu 0 (Em ed th p 41 at i loyee Ben f Congre efit Research In ss were to regustitu late 401 te, Octo (k) p blean r 1 s t 997 oo ). heavily, plan sponsors might choose to decrease employer relative to median for 10 defined benefit corporate pensions that it was created to secure and encourage. The number of these traditional Ibid. The distributional results for this population are shown in Figure 14. year amounted to $115 billion, and $93 billion in benefits were distributed. By year-end 2000, it was estimated Company Stock 24 contributions continues to be exempt from any limits. See Louis T. Mazawey, “1997 Tax Law Changes Affecting contributions or not offer them at all. Previous research has shown that the availability and level of a company pension pl 5 ans has sharply declined, w age coho hile nert w forms of defined bene Male fit plans ha Female ve increased their position of 11 House Ways and Means Committee that approximately 42 million American workers held 401(k) plan accounts, with a total of $1.8 trillion in assets. 42 U.S. Department of Labor, Pension and Welfare Benefits Administration. “Abstract of 1997 Form 5500 2 3 Retirement Plan The com s,” Jou putations rnal of ass Pen um sio e a long-term n Planning an avera d Comp ge return liance o (W f 11 in % f ter 1 or998 bot)h : a 72 di -versi 86. For m fied po ore rtfo dleitail o o andn an th e match is a primary impetus for at least some employees to make contributions to their 401(k) account. Others have Typically, in a 401(k) plan, an employee contributes a portion of his or her salary to a plan account and dominance. These new plans include cash balance plans, which are technically defined benefit plans but are often Low 5.2%3.5% Annual Reports,” Private Pension Plan Bulletin No. 10 (Winter 2001). i ondi rigvi indual al pr o st poc osk al, see but a st Ann andar L Co d devi mbs, “Tak ation of in 19 g St .6% f ock of t or thh ee fBo orm xer com er Bill,” pare Financial Execut d to 65% for thie l vea (tJ te an./Feb. r. I have 19 ar 97) bi: trarily argued th at individuals should have the right to invest their money as they see fit. m determ ore readily unde ines how the rstood assets i by e n the acc mployees as a result ount are invested, choosing am of their use of “indivi ong i dn ual accounts” a vestment options m nd “lum ade availa p-sum ble by the High 5.0%1.6% 2.4 What Will The Future Hold? 6 assumed all nonequity investments earn an annual rate of return of 6%. 18 -20 . plan sponso The r (e rat mp el o of y ret er). u In rn m gea nerat ny pl ed ans by , t th he ese em pl plaoy ns er alalso so n m eeds ak to es a co be conside ntributio red for a c n to the p oa m rticip plete analysis of t ant’s account, he distributions,” and defined contribution plans, which are typified by the 401(k). While it is impossible to predict with certainty how future developments for legislative and regu 4 latory relative fi 43 nancial cash flow. generallyThe decl 20 matchinig n a e ip no trt radi ion tiof onal the em defined ploy be ee’s c nefiont t plri an bs has bee ution. So nm we e em ll-doc ploy um ers ent re equi d and re t h isat c t ont he em inuipl ng oy . Seve er ral Source: Simulations using the EBRI/ERF Retirement Income Pr ojection Model with modifications as described in This portion of the model does not currently provide simulations for cohorts born after 1970. 4 The Con Hewitt, cenSp tration of ecial Repo Co rt to mpan Cliey n tStock In 401(k s, July 2001, “Im)p Plans act of EGTRRA on Employer Plans.” 36 constraints and opportunities as well as plan sponsor and participant decisions will translate into future defined contribution be invested in company stock rather than as directed by the participant. Participants in these plans reasons fo 7 r the decline of defined benefit plans have been suggested: the change in the industrial patterns of author's February 13, 2002, written testimony to the House Education and Workforce Committee's Subcommittee on www.hewitt.com/hewitt/resource/wsr/2001/egtrra.pdf) Craig Copeland and Jack VanDerhei, “Personal Hearing on Account Re tirement Plans: An Analysis of the Survey of benefit/defined contribution trends, Craig Copeland of EBRI and I modeled the likely financial consequences of 4.1 Percentage of 401(K) Plans and Participants With Company Stock t em end t ploym o inent vest i a n Am high eri erca fav perceo nr ta ing t ge of he sm theial r sel l servi f-dir ce i ectn ed du ba stry lan ; adm ces in ini co stm rat pian ve cost y stoc s k o t fh ope an particip rating defi ants i ned n b plan enefi s with t plans, out Employer-Employee Relations. 12 Consumer Finances,” EBRI Issue Brief no. 223 (Employee Benefit Research Institute, July 2000). 21 continuing the status quo. Our preliminary findings from the EBRI/ERF R etirement Income Projection Model an employer- Wd aitso rect n ed c Wyo att ntri Wo burl tid on. wid C e, "Retire ompany st men ock t Plan represe Prov ntision s 33% s: o Wh f th at, e part Whien cip an and How Mu t-directed acc ch?ou " (Wash nt bala in nces gton i, n which have been especially burdensome for small and medium-size plans; competition from 401(k) salary deferral In Figure 1 of my February 13, 2002, hearing testimony before the House Education and Workforce 8 37 were presented at the National Academy of Social Insurance 13th Annual Conference on The Future of Social DC: Watson Wyatt Worldwid Retire e, 2 ment Security an 001). d Defined Contribution Pension Plans pl plans ans, wi whic thA em h are easier lth pl oug oyh cash or er-directed cont for em deployees t ferre ributions d aro ran understand a g,em com ents h pared ave ex nd with 22% which cam isted sinof account bala c e along just as t e the 1950’s, th nces i h e Rev e co nst e plans and nue A co offe cm t o p ring flex 197 ity o com 8 en fp acted any 25 26 7 What Would Happen If a Minimum Rate of Return Were Guaranteed for 401(k) Participants? Committee’s Subcommittee on Employer-Employee Relations, I show that for the 1996 version of the EBRI/ICI 38 Insurance: Incremental Action or Fundamental Reform? sto perm ck as an anent invest provision men s tg o op vtion bu erning th t no em t r b equ y add irinig th ng Sec. at em 4p 01(k loyer ) to co tn hte In ribu ternal Rev tions be inv enu ested e Co id ne co . Wh mpan ile th y stock is was effectiv . e defined be 22nefit plans began to skyrocket; and tax policy that has restricted funding of defined benefit plans. database, onl “Enron y 2.9% of Deb a th cle e 4W 01ill Force (k) plans Clean include Up d o co f C mo pm any pan sty Sto ock (c 1k .4 Use i % ofn t DC he pl Plan ans ha s,” d Ic O oMA mpany ’s D st Coc Plan I k butn n vesti o ng, Proposals have been suggested recently that would attempt to transfer part or all of the investment risk Results of the model are compared by gender for cohorts born between 1936 and 1964 in order to estimate for plan years Whenb t eo gtal acco inning after 19 unt balan 79 ces , thare co e propo nssed idered regu , th latio e ons verall exp were no ots released ure to equ un ity secu til Nove rities thro mber 1981 ugh . co See mp Jack any 27 February 26, 2002 gua Dec. 11 ranteed i , 2001 nv , p estm . 1.e nt contracts (GICs) while 1.5% of the plans had both company stock and GICs). However, inherent in defined contribution plans from the employee to another entity. Although the party initially exposed to 5 the percentage of retirees’ retirement wealth that will be derived from DB plans versus DC plans and IRAs over the st Van ock D an erhei d p a ool nded i Kel nl vest y Ol m se ent n, “ s i S sect sig ion nifi4 cant 01(k) ly hi Plg ans her (C foas r pa h or rti De cipfer antrsed in A pl rra ans ngem with e em nts) a plo ny de Thri r-dirft ect Pl ed c anso ,” nt H riand buti boo ons. k 2.1 The Relative growth of Defined Contribution Plans From 1978 to 1997 the plans that do have company stock are generally quite large and represented 42% of the 401(k) participants in the said risk 23 varies among the proposals, the likely targets would be the employer, a government agency (perhaps the next three decades. Under the model’s baseline assumptions, both males and females are found to have an For of Empl exam oyee Benefits, pl C e, i urnve renst tly m , t e 5t h nt er h E s i e i nd com s. n , Jer o st p rany y at S. ut st R oroc y o or sk e,nbl re eqgul oom uity at f , ed. ou rn yd l ( s, iH m and om it on t ewoo the e he l d, qe ui ngt IL: ty po h Do of rt w J t io im n oe of nes- du bal ri Ir n a w g nced i whi n, 20 f cu h 0nds 1 part ). re icp ip resent ants ca 82 n % be 28 In 1978, the first year detailed data were collected after ERISA, there was a total of 442,998 private database that year (17% of the participants had company stock but no GICS, while 25% had both options). In Pension Benefit Guaranty Corporation) and/or a private insurance company. While the cost of the guarantees and/or appreciable drop in the percentage of private retirement income that is attributable to defined benefit plans (other of the t blocked o f tal account rom reallocat balances ing as sfor pa ets or co rticipants nducting in pla other ns tw ran ith e sact m iployer-direct ons in a 401(ed c k) pl ont an.ribu See tions, c Patrick J. omp P ared urcel with 74% l, “The of 9 pension plans, 29 percent of which were of the defined benefit variety. By 1997, the most recent year for which terms of acco U.S. unDe t bal part ances, ment pl oans f Lawi botrh , P co ensi mpo any n a st nd oc We k acc lfare B ounte nefi for 59% ts Adm of ithe unive nistrationr.se “A (23% bstract of t ofh 19 e ass 97e F ts were orm 55 hel 00 d financial uncertainty inherent in such an arrangement may be borne by the employer at least initially, it is unlikely than cash balance plans). In addition, results show a clear increase in the income retirees will receive that will have th Enr e to on B tal acco ankru up nttcy b and alances Emfor ploy per St articip oc an k i ts in n Re ptl ian rem s withou ent Plan t em s,” CR ploy S Re er-dpor irect t for Congress ed contributio (Jan. 22, 2002) ns. This higher : 5. allocation 29 detailed data are available, the number of plans had increased to 720,041 but the relative share of defined benefit in plans that had company stock but no GICS, while 36% of the assets were held in plans that had both options). A thnnu at, in al Repo the long rts,” -term Priva , su te Pensio ch a shift in risk n Plan Bu -bearing lletin No wou . 10 ld not so (Winter m2001). For a ehow alter threvie e prov wisions of of the academ the exic lite istingrature defin ed to be managed by the retiree. This makes the risk of longevity more central to retirees’ expenditure decisions. to equity securities holds across all age groups. 24 plans had decreased to 8 percent. Even though defined benefit plans have always been in the minority, they tend to an The fact alyzing that pl t Jack hese trend ans with VanD s, see erc ho em i and Willia pany Cm r stoc ai Gale, Leslie Papk g C k ha opel d higher and, "A ave Be, e rhavi age and Jack VanDerhei, “Un account bala oral Model fo nces r Pre wa dis c no td ing Em ers doubt pa tand pl ing oyrtially th ee C e Sh ont due ift rib Toward to the utions bull t o contribution plans. 1 be sponsored by large employers and accounted for 65 percent of the 44.7 million active participants in 1978. The market preceding this time period, but may also be a function of the plan’s generosity parameters and average tenure 4 Defi 01(ned k) Plan C It is obv ont s," riN but o iou rt io h n Pl sly Ameri ians mp,c o ” i a ssib nn Act A F le to uari ramewor ma old Jeo l th urn k For e fin al ( Ev F an irc aluating Pe st Quar ial conter seq , 20 unsion Ref en 01) ces . of su orm ch pro (Brook posings In als until ad stitutio dition n/TIAA- al detail is The Role of Company Stock in 401(k) Plans 3 Background on Company Stock number of active participants increased to 70.7 million in 1997, but the relative share of defined benefit plans fell to of the em 6 CREF/ Wha Stanf ployees. t Would ord UnivHapp ersity), en to E forthcom mplo ing. ( yees If www.b Company rook.edu/e Stock Were No s/erisa/99papers/eri t Permitte sa2.pdf) d in 401(K) Plans? provided; however, a highly stylized example of one method of achieving this objective can be readily simulated. 25 See Jack L. VanDerhei, “The Role of Company Stock in 401(k) Plans,” hearing testimony before the 32 percent. Assume a proposal that would require the employer to ensure that participants receive an account balance no less 10 Although the topic of company stock investment in 401(k) plans has recently been the focus of by Hous Wel e Edu l be U. catio fo S. re t n and De he pl part Work im ght ent o force Co o f En f La rob no 4 mm r,0 P 1e it (k nsi tee ) pa o Sub n a rtin cc i d o pWe mmittee ants l fha are B d m on ea Em nefi de tt p h sle o Adm hea yer-Em d ini lin st e prat s lo , p yee Rela io en rs , “A onal bst fi tio r na n act snce a , “Enro of 19 nd9 i n7 an n F vest o d Beyon rm m 5 ent 50 0 d : A total of $377 billion of private pension assets existed in 1978. This number grew to $3.55 billion in the than what would have been obtained under a minimum rate of return. While some employers may choose to 39 considerable interest, the concept of preferred status for employee ownership has been part of the U.S. tax code for advi A Enh nnu a sn o al Repo c r4.2 s in had g Work lro tCompan s,” nger Retirem t Priva outed t te Pensio y Stock as a Per he en bt Security,” Feb enefi n Plan ts of di Bu ver lletin centage o s.i f 13 i No cat , 20 i. 10 on. 02f (Win . Total 401 While th ter 2001 e trad (K) Balances ). e-off of a diversified portfolio of equities for following 20 years. 13 Although defined benefit plans represented 72 percent of the total in 1978, it fell to only 49 voluntarily assume the additional cost of this arrangement, others may wish to re-think the investment options more than 80 years. When the ERISA was passed in 1974, it required fiduciaries to diversify plan investments for an individual stock may be of limited advantage for employees, what many of the commentators in this field have 26 11 percent in 1997. If the latest numbers are any in Jack L. VanDerhei, Ph.D., CEBS dication, it would appear that this financial trend will not reverse any The overall percentage of 401(k) account balances in company stock has remained consistently in the provided to th Ho Read e em lden ers sh an plod Van y ou ees and ld b D eerh cau pr eov tio i (N id ned ove e little o th m at wh berr, no 20 ile th 01 pa), rticip e p EBRI/ICI . 3an . t directio database a n. In fact, an ppears t easy o be way of m very repres itig ent ati an tig th ve of t e ne hw e defined benefit plans and some types of defined contribution plans. However, ERISA includes an exception for disregarded is the potentially beneficial attendant shift in asset allocation resulting from the inclusion and/or 30 time soon. In 1978, net contributions (the difference between contributions and be 14 nefits disbursed) amounted to 18 est risk i - im 19% m atpose ed uni ran dg v b e e y fr rse tom he m of 199 4 inim 06 t 1(k u o) m 2 pl g 0ans 0 u0 ara ., tn Th hte ee rTemple University and EBRI Fellow e e ag wo has cu u e ld be dirre str t i nt bu ol y ftio o bee rce n fo na l r year no l cont atte -ri e m n but p dt 200 t io ons de 0 is so (w vel het op e m her c ex w trh a oat pol ntof riat but an ioed n inv wei by er t g ted h he e ts t “U m o m ” sh ploy atap cee or h up e, "eligible ind 12 ividual account plans" that invest in "qualifying employer securities." An Employee Stock Ownership mandate of The com res pany ult st s we ock, re e gene speci rat ale ly d fo pri r y or t ou on tg h em e co pl nt oy ribut ees, w ion m ho odi othe ficat rwi ions e se exhi nact bited ex as trepart mel y of ri The sk-ave Eco rsnom e beha ic vior $29.4 billion for all private plans, and 68 percent of this was from defined ben 15 efit plans. By 1997, net contributions with t th hese pl e em youn pans wi loy ger) i er an th n d o to th a relativ ose lde r p repo articip rt ely risk-free i ed on ants ho the Fo ldn irm n vg slig e st 55 m 0e h 0n tly less th . t. See H While th olan den is is p a an rticip d Va unlik an nD ely t ts i erhei no th bei e (N p r opu 4 o0 vs em (where th lar ber 20 with yo 01 e v ung ), p al . em 6 f ue peak o pr lo m ys at ees an ore d Philadelphia, PA Plan (ESOP) normally qualifies for this exception, as do profit-sharing plans. in the determination of equity concentration for their 401(k) portfolio. Growth and Tax Relief Reconciliation Act of 2001" (EGTRRA). The model is currently being modified to allow for 31 had fallen to a negative $54.5 billion. Although defined contribution plans contributed a positive $12.8 billion, 19 d ot ehe tail. .7r %). part icipants desiring high long-term expected returns, it would minimize the new risks shifted to the employer. The concept of legislating diversification for qualified retirement plan investments in company stock was 6 the ne Wh w at EGTR I will atte RA pm rovi pt to sions de.m onstrate in the following section is that although forcing the employer match into defined benefit plans had a negative net contribution of $67.4 billion. 16 Al Fig th uo re u g 2h sho oftw en s th quot e ex ed p, t ected his fi resu gure i lts of s som runn ewhat ing on mie slsu eadi ch ng pro gi pve osal t n th hat ro a si ugh th zeabl e EBRI e perce /ERF Retir ntage of te hm e en 40t 1(k) 27 first applied to ESOPs via a provision enacted as part of the Tax Reform Act of 1986. Employees who are at least company stock obviously increases the standard deviation of expected results relative to a diversified equity Guaranteed investment contracts (GICs) are 610-525-6139 insurance company products that guarantee a specific rate of 13 p Inc articip ome Pro ants are in jection M smo all p del.l an Ins st th ead o at do f al no lo t wi generally in ng employ cl ees t ude o com direct pany th st eioc r ok w in c n th ont e iri nb vest utions ment an m d eper nu. ha The ps t ave hose rage of t he The first stock bonus plans were granted tax-exempt status under the Revenue Act of 1921. See Robert age 55 and who have completed at least 10 years of participation must be given the opportunity to diversify their po retu rtrn fo lon io, f th oe inv r each of ested cap the la ital st fi ove ver t year he life s theo EB f thR e co I/IC nI tract. data base has dem onstrated that, left to their own choices, the 32 17 2.2 The Increasing Importance Of Defined Contribution Plans For Family Retirement asset allo W. employer, as Smiley catio , Jr. sume e n in and co G m m rployers ep gan ory y sto Kare forced to . B ck is: rown, “Em guara ployee St ntee a m ock iO nim wne um rs rate of return hip Plans (ESO of Ps five ),” pe Handbook rcent nom of inal Employee and they are investments by transferring from the employer stock fund to one or more of three other investment funds. The employee’s asset allocation would have lower concentrations in equity (defined as diversified equity plus company 28 42 Security able to find a GIC (or its synthetic equivalent) that will provide that return in perpetuity. If all existing balances Benefits. 5t • See h E Less df., igu Jer th re an r y 2 S. 1 of % R VanD fo osr enbl plerh an oom s with ei, “Th , ed. fewer e ( R Ho om le of th ewo an C 5 oo 0 dm 0 , p IL pan a:rticip Do y Sto w J an ck o ts, nes- in 401 Irwi (kn, ) Plans” 2001). right to diversify need be granted only for a 90-day window period following the close of the plan year in which the stock plus 60% in balanced funds) and therefore have a lower expected rate of return. and future 401(k) contributions were required to be invested in this single investment option, the average expected Although the • 3.8% for pl precedi th ans wi ntg section h 501 -1,000 docum particip ented an the inc ts, reasing importance of defined contribution plans with employee first 29 14 becomes eligible to diversify and following the close of each of the next five plan years. This right is In my February 13 testimony, I start with some stylized examples of how the inclusion of company stock may The ERIS Ibid. See views expresse A Sec. Figure 40 d in this st 7( 3. b)(1). atement are solely those of Jack VanDerhei and should not be attributed to 18 reduction in 401(k) account balances at retirement would decrease between 25 and 35 percent for participants born respect to plan aggregate data, for purposes of this testimony it may be even more important to consider how the limited to shares acquired after 1986 and is further limited to 25% of such shares until the last window period, • 8.7% for plans with 1,001 -5000 participants, and work to the benefit of employees in general and expand the analysis by simulating the expected change in 401(k) Temple University o 43 r the Employee Benefit Research Institute, its officers, trustees, sponsors, or other staff. 30 between 1956 and 1970. relative val Ibid. See ue of these Figure plans 4. has changed from the standpoint of the family’s retirement security. Craig Copeland when up to 50% of such shares may be eligible for diversification. • 25.6% for plans with more than 5,000 participants. account balances if company stock were prospectively eliminated from 401(k) plans for birth cohorts from 7 and I analyzed data from the Federal Reserve Board’s triennial Survey of Consumer Finances (SCF), which 31 1936 -1970. These results may be useful in analyzing previous charges that company stock should not be used in Ibid. See Figure 5. 4 5 2 3 6 9 8 7 Figure 2: Expected change in average 401(k) account balances if all participants were to prospectively change to a guaranteed investment yielding 5 percent nominal, by gender and year of birth (see text for assumptions of asset allocation under status quo) 5.00% 0.00% 1936-40 1941-45 1946-50 1951-55 1956-60 1961-65 1966-70 -5.00% -10.00% -15.00% male female -20.00% -25.00% -30.00% -35.00% -40.00%