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2.

Retirement Versus Nonretirement Plans

RIPA attempts to improve retirement income security by ensuring that pension benefits are used to finance retirement, rather than pre-retirement needs. To achieve this end the bill distinguishes between "retirement plans," which must provide income during retirement, and "nonretirement plans," which are essentially savings plans that permit distributions at any time. Before an employer can maintain a nonretirement plan under RIPA, it must first maintain a retirement plan with a minimum level of benefits or contributions. An employer maintaining a defined contribution plan, for example, would have to contribute at least 3 percent of each of participant's pay annually to the retirement plan to be eligible to maintain a nonretirement plan. 5

5It should be emphasized that the 3 percent contribution requirement for employers with retirement plans exists only as a prerequisite to the establishment of a nonretirement plan; to be a qualified retirement plan, standing alone, contributions

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While, in theory, the distinction between retirement and savings plans is important in ensuring that workers' retirement needs come before short-term savings needs, in practice the distinction will be of little utility to small businesses which typically maintain only one benefit plan, if at all. Simply stated, small employers will not be able to take advantage of the flexibility permitted by RIPA to offer employees tax-deferred savings vehicles as well as retirement income

plans.

In addition, RIPA's prerequisite for establishing a savings plan may be difficult for small employers maintaining profit-sharing plans as primary retirement plans to meet. Because profit-sharing plans permit little or no contributions in years with lean profits, the tax-qualified status of a 6 nonretirement plan under RIPA may change in such years. As previously discussed, profit-sharing plans are the most prevalent form of retirement plan in small business.

"We recognize, of course, that employers with extremely unstable profits are not likely to establish a second plan to complement profit-sharing plans; however, the Committee should recognize the potential difficulty of meeting RIPA's

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3. Distribution Rules for Retirement Plans

To be a qualified retirement plan, RIPA requires benefits to be distributed in "retirement income" form. In general, this means that benefits must be payable in annuity form or that accrued benefits must be rolled over into an Individual Retirement Account (IRA) when a worker leaves the job prior to age 59 and 1/2. RIPA prohibits lump sum distributions of any amount to workers before they reach age 59 and 1/2.7 In addition, RIPA would increase the penalty on early withdrawal from IRAs from 10 to 20 percent.

RIPA's distribution rules would affect a significant number of small employer plans. Most small businesses with retirement plans have defined contribution vehicles which typically provide workers with lump sums on the termination of employment.

7RIPA would repeal employers' current ability to require employees to take lump sums of $3,500 or less. It would also repeal the current tax-favored treatment accorded lump sums,

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Small employers have found the lump sum feature of defined contribution plans very important because small firms

experience a relatively high turnover of labor and the lump sum distribution option relieves employers of administrative burdens when employees leave the job. RIPA would require these employers to notify workers before transferring vested account balances to IRAs that are either designated by the employee or established by the employer, if the employee fails to designate an account.

Understandably, the Committee is concerned with the pre-retirement use of funds that have received tax-favored treatment. The Administration's tax reform proposal, as well as the House-passed tax reform bill (H.R. 3838), also have evidenced this concern. Each of these tax reform measures would discourage pre-retirement use of tax-deferred monies by repealing favorable tax treatment of lump sums and by imposing a tax penalty on plan distributions prior to age 59 and 1/2.8

8The Administration's tax proposal (May 1985) would repeal the favorable tax treatment of lump sums and generally impose a 20 percent penalty on distributions on the separation of service prior to age 59 and 1/2. H.R. 3838 would also repeal the favorable tax treatment of lump sums received before age 59 and 1/2 and would impose a 15 percent penalty on

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I believe that the approach taken in the tax reform proposals is preferable to RIPA's distribution rules for two reasons. First, the requirement that the employer transfer the funds to an IRA will increase administrative costs. Second, these administrative burdens may prove unnecessary and unjustified because RIPA allows employees to withdraw the transferred amounts from the IRAS prior to retirement subject to a 20 percent penalty tax. If either of the tax reform bills are enacted, the result will be virtually the same for employees who want access to the funds prior to retirement and do not roll over lump sums into IRAs. Employers should not be required to carry the burden of transferring funds to IRAs if their efforts can be undermined by early withdrawal of the funds. Rather, employees should be motivated to transfer funds to IRAS; appropriate tax penalties would encourage workers to roll over lump sums and use the monies for retirement.9

9In reality, the repeal of favorable tax treatment of lump sums and the enactment of a penalty on early withdrawals may increase the likelihood that employees will exercise their rights to annuity payments of amounts exceeding $3,500. Some employees, however, may still prefer to roll over funds into IRAS because they can direct fund investment and access the