Pension Plans: Put Small Business In First Class
BY Daniel Cronin
It's time Congress created retirement security for professionals and small companies.
As far as pension benefits are concerned, there are two classes of American citizens:
1. Members of Congress, employees of federal, state, and local governments, and employees of large corporations;
2. Everyone else -- independent businessmen, shopkeepers, accountants, lawyers, other professionals, and their employees.
The first group enjoys unique pension benefits. These "first-class" citizens have pensions that are:
1. Subsidized. Their employers make substantial contributions to the cost of their pensions.
2. Generous. Their pension benefits frequently represent a high percentage of their highest income.
3. Secure. Their employers enjoy great staying power. Whatever the vagaries of the market, their pensions are virtually guaranteed.
4. Tax sheltered. Dividends, interest, and capital gains earned by money invested in their pension funds are not taxed until the funds are withdrawn after retirement, when the recipient is usually in a lower tax bracket.
5. Indexed. Government employees' benefits are raised automatically as the Consumer Price Index rises. Large corporations offset increased pension funding liabilities by raising prices.
The rest of us, "second-class" citizens, have pensions in the form of savings and investments that are:
1.Unsubsidized. The beneficiary usually makes 100% of the retirement contribution from his earned after-tax income.
2. Modest. Because up to 100% of the contribution is made from wages, the retirement benefit is frequently modest and will represent a relatively small percentage of highest income.
3. Insecure. Often the small business or profession has a life span equal to the pensioner's work span. When he retires, the business or practice stops, is sold, or is continued by others who are often unable to assume pension liabilities for those who preceded them.
4. Taxed. Dividends, interest, and capital gains that accrue to the individual's savings or investment account for retirement are subject to federal and state taxes. Only recently, under Individual Retirement Accounts (IRAs) and Keogh Plans, has some income been exempted from taxes.
5. Depreciated by inflation. Retirement benefits are directly related to funds put aside by the beneficiary. If invested in stocks and bonds, for example, the purchasing power of the funds has eroded by 50% over the past 10 years. Inflation works to the cruel disadvantage of the independent beneficiary. The purchasing power of the income his investments yield will continue to decline in direct proportion to the rise in the rate of inflation.
To correct this inequitable situation, Congress should create an Indexed Individual Retirement Bond that would feature these characteristics:
1. Eligibility. Limited to "second-class" citizens, to the extent of IRA or Keogh eligibility. Double-dipping by retired first-class citizens would be prohibited.
2. Cost-deductibility. The purchase cost of the bonds would be deductible against income as are current IRA and Keogh investments.
3. Tax-free interest accumulation. Interest, paid by the government, would accrue annually at the prime rate. A $5,000 bond would have earned about 15% during 1980, or $750. That interest would accumulate tax-free.
4. Redemption price indexation. The bond's redemption price would be indexed to inflation, as determined by changes in the Consumer Price Index. The redemption value of the $5,000 bond purchased in 1979, for example, would be increased by the 1980 inflation rate of 13%, or by $650. Adjusted both for inflation and interest, the redemption value of the $5,000 bond at the end of 1980 would have been $6,400 ($750 in interest, from #3, above, plus the $650 inflation adjustment). If the prime rate for 1981 averages 16%, the bond would earn another $1,024 in untaxed interest; if 1981 inflation runs at 10%, the redemption value would increase by $640, and so on.
It will be argued that such a proposal cannot be considered because indexation is inflationary. Such an objection hardly holds water in light of the "first-class/second-class" facts of life outlined above. Congress has no business protecting some citizens, including its own members, from inflation while shifting the burden of that protection to other citizens unprotected from inflation. If we index for some, we must index for all; if not for all, then for none.
It should be pointed out that the Indexed Individual Retirement Bond is not subsidized. All of its costs are paid by the beneficiary. The difference between cost at time of purchase and value at the time of redemption will be absorbed by the government only to the extent that the government fails to control inflation. If the inflation rate is zero, the redemption price indexation factor would be zero as well.
Only 44% of those employed in the private sector work for companies that have any kind of pension plan. Less than half of those employees will actually receive pension benefits. Think of it! Only one out of every five employed in the private sector -- for the most part only those employed by large companies -- will receive any corporate pension benefit. Four out of five will be totally dependent upon Social Security and whatever inflation-depreciated personal savings they have accumulated over a lifetime. The Indexed Individual Retirement Bond then not only provides the needed supplementary retirement income needed by our second-class citizens, it also protects them against the failure of, or reduction of benefits from, Social Security. Indeed, it may well serve as an answer to the Social Security dilemma.