Document: Testimony of Scott J. Macey on Behalf of The ERISA Industry Committee Before the Senate Committee on Health, Education, Labor and Pensions at a Hearing on "Protecting Pension Assets in Bankruptcy": ERIC

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Testimony of Scott J. Macey on Behalf of The ERISA Industry Committee Before the Senate Committee on Health, Education, Labor and Pensions at a Hearing on "Protecting Pension Assets in Bankruptcy"

TESTIMONY OF
SCOTT J. MACEY
THE ERISA INDUSTRY COMMITTEE
BEFORE THE
COMMITTEE ON HEALTH, EDUCATION, LABOR AND PENSIONS
UNITED STATES SENATE
HEARING ON
PROTECTING PENSION ASSETS IN BANKRUPTCY
APRIL 13, 2000

My name is Scott J. Macey. I am a member of the Board of Directors and a former Chairman of The ERISA Industry Committee (commonly known as "ERIC"), on whose behalf I appear today. I also serve as Senior Counsel of Actuarial Sciences Associates, which provides benefits advice and administration for AT&T.

ERIC is gratified that, in holding these hearings, the Senate Committee on Health, Education, Labor, and Pensions is seeking to protect the retirement benefits of American workers and their families. Protecting retirement benefits in bankruptcy is in accord with the purposes and requirements of the Employee Retirement Income Security Act (ERISA) and is consistent with sound bankruptcy policy as well.

ERIC, a nonprofit association, is the only organization in Washington, D.C. that represents exclusively the employee benefit plan interests of America's largest employers. ERIC's members provide comprehensive retirement, health care coverage, and other economic security benefits directly to some 25 million active and retired workers and their families. ERIC has a strong interest in proposals affecting its members' ability to deliver those benefits, their cost and effectiveness, and the role of those benefits in the American economy.

In my remarks today, I will address both the general issues of importance to employer-sponsored retirement plans and, as you requested, the particular issues faced by employer-sponsored defined benefit plans.

ERISA'S STRONG ANTI-ALIENATION PROVISIONS ARE INTEGRAL
TO A SOUND NATIONAL RETIREMENT POLICY
ERISA requires that "Each pension plan shall provide that benefits provided under the plan may not be assigned or alienated."1 Similarly, the Internal Revenue Code (IRC) states that a pension trust will not be qualified under its provisions unless "the plan of which such trust is a part provides that the benefits provided under the plan may not be assigned or alienated."2 The current ERISA and Internal Revenue Code anti-alienation provisions were preceded by similar Internal Revenue Code provisions dating back to 1938.3

ERISA's anti-alienation provisions are integral to the overarching purpose of this landmark reform law: to provide financial security for working American's by assuring that the pension benefits they earn actually will be available to them when they retire.

In enacting ERISA, Congress expressed an overriding concern that a pension plan participant's actual receipt of retirement benefits not be subjected to the whims of financial misfortune. This intent is expressly embodied in ERISA's vesting and funding requirements as well as in its anti-alienation provisions. The legislative history of ERISA states that: "To further ensure that the employee's accrued benefits are actually available for retirement purposes, the committee bill also contains a provision requiring the plan to provide that benefits may not be assigned or alienated."4

The ERISA and Internal Revenue Code anti-alienation protections apply equally to rank and file employees, highly compensated employees, and substantial owners, even though ERISA and the Code saw fit to distinguish among these classes for other purposes.

Congress has created only very narrow exceptions to the general prohibition against the alienation of retirement benefits. The Retirement Equity Act of 1984 amended ERISA and the Internal Revenue Code to permit the alienation of benefits under a qualified domestic relations order for spousal support and maintenance under very limited circumstances - an exception that is in concert with ERISA's purposes of providing retirement security and that is fundamentally contrary to proposals to permit creditors to claim all or a portion of an individual's retirement benefits in bankruptcy. Even a qualified domestic relations order is forbidden from requiring any type or form of benefit not provided for under the terms of the plan.

The Taxpayer Relief Act of 1997 also amended ERISA and the Internal Revenue Code to provide that an order or settlement agreement may provide that a participant's retirement benefit will be reduced to satisfy his or her liability to the retirement plan if (1) the participant has been convicted of a crime involving the plan, (2) the participant is subject to a civil judgment or consent order in connection with a violation of ERISA's fiduciary standards, or (3) the participant has entered into a settlement agreement with the Labor Department or the PBGC in connection with a violation of ERISA's fiduciary standards. This provision also protects the participant's spouse's right to a survivor annuity. As with the qualified domestic relations order exception, this provision promotes retirement security and is wholly inconsistent with any proposal to allow a third-party creditor to make a bankruptcy claim against an individual's retirement benefits.

PROTECTING RETIREMENT ASSETS IN BANKRUPTCY
IS IN ACCORD WITH SOUND BANKRUPTCY POLICY

Historically, the first and most basic policy of bankruptcy is to provide debtors who have not defrauded creditors with a "fresh start."
Alienation would make a "fresh start" unattainable. Federal Reserve Chairman Alan Greenspan stated on March 27, 2000, before the Senate Special Committee on Aging: "Any sustainable retirement system - public or private - requires that sufficient resources be set aside over a lifetime of work to fund an adequate level of retirement consumption." Allowing the alienation of retirement assets in bankruptcy would in one stroke eviscerate the ability of an individual to accumulate the resources necessary to be self-supporting when he or she can no longer work. It would force the individual to rely in retirement on public aid funds - a result contrary to both retirement policy and bankruptcy policy.

Qualified retirement plans cannot be used to defraud creditors. It is important to remember also that, because of their design and because of the limits that the internal revenue code imposes on them, qualified retirement plans simply cannot be used as part of a scheme to divert assets prior to a bankruptcy. As this Committee is aware, the amount of money an individual can set aside in a retirement plan is strictly limited by numerous limits imposed by the Internal Revenue Code. Excise taxes and other penalties are applied if contributions exceed allowable limits.

It is particularly absurd to view defined benefit plans as a vehicle for asset diversion prior to bankruptcy. Under these plans, contributions are both required and limited by Internal Revenue Code restrictions. Individual participants in defined benefit plans do not have discretion regarding contributions to the plan. Contributions instead are made by the employer sponsoring the plan in accordance with the funding requirements of the law and are deposited in a trust fund.

Thus, protecting retirement plan assets in bankruptcy is fully in accord with sound bankruptcy policy for two reasons: (1) preserving an individual's retirement benefits enables the individual to make a fresh start after bankruptcy and (2) the stringent legal restrictions on retirement plans prevent individuals from using retirement plans to evade their obligations to creditors.

THE PROTECTION OF RETIREMENT BENEFITS FROM BANKRUPTCY CLAIMS
HAS BEEN AFFIRMED BY THE SUPREME COURT
AND SHOULD BE EXTENDED

In the 1980s, the harmony between retirement policy and bankruptcy policy was threatened as creditors frequently attempted to divert retirement benefits. By 1991, one member of the U.S. Chamber of Commerce who maintained a qualified retirement plan was facing 85 bankruptcy cases in which creditors of plan participants were seeking to recover retirement plan benefits.5 This unfortunate and costly situation was remedied for ERISA plans by the unanimous decision of the Supreme Court in Patterson v. Shumate, which affirmed the exclusion of qualified retirement benefits assets from the bankruptcy estate.
Because the holding in Patterson v. Shumate is limited to plans subject to ERISA §206(d)(1), the status of benefits provided by certain other tax-qualified savings vehicles (such as individual retirement accounts, church plans, and government plans) remain exposed to the confusion spawned by continued claims by creditors.

The bankruptcy reform legislation (S.625 §224) approved by the Senate (with similar provisions also included in the House-passed bankruptcy reform bill H.R.833 §203) wisely closes the gap in federal bankruptcy law by providing a federal exemption under 11 USC §522 for all tax-qualified retirement funds and accounts. The exemption would be available under both the default exemption scheme and the state opt-out scheme.

6 §303(c) of S.625 should be removed. Without public debate or discussion, however, a provision also has been included in the Senate bankruptcy bill that would, in practice, vitiate the clear intent of the provisions in the House and Senate bills that establish a new federal exemption for retirement benefits. This provision, §303(c) of S.625, would permit unsecured creditors to enforce a waiver executed by an individual with respect to the retirement plan exemption available under the state opt-out scheme.

As a practical matter, this encourages potential creditors to include such a waiver in the small print of any credit card application or other similar document. Thousands of individuals will unwittingly subject their retirement security to the whims of financial misfortune. Less sophisticated individuals will be particularly vulnerable to the disastrous effects such waivers could have on their retirement security. We can say that individuals should read -- and understand -- all the fine print that accompanies credit applications - but you and I both know that is not going to happen. The result will be the bankruptcy of retirement protection - and, we submit, the undermining of the basic tenet of national bankruptcy policy to provide a way for individuals to settle their debts and restart their lives.

For these and all the other reasons outlined below, we strongly urge Senators to remove §303(c) from any Conference bill.

THE CONSEQUENCES OF CREDITOR ATTEMPTS TO CAPTURE RETIREMENT BENEFITS
ARE SEVERE AND EXCEED ANY IMMEDIATE GAIN TO THE CREDITOR.

ERISA and the Internal Revenue Code unequivocally prohibit plans from allowing the alienation of benefits to creditors.
Fiduciary violations and plan disqualification. If a plan allows or makes payments to third-party creditors, the plan administrator will be subject to penalties and to suit for violating ERISA's fiduciary standards and a tax-qualified plan will be subject to disqualification under the Internal Revenue Code.

The results of disqualification are catastrophic. If a plan is disqualified, the employer may lose its deductions for contributions to the plan, plan participants may be taxed immediately on the value of their funded vested benefits, and earnings on the plan trust become taxable. Even if the IRS does not impose this draconian penalty, the employer may be required to restore funds to the plan and may face stiff financial penalties.

Litigation. Since it is very clear that a plan cannot allow alienation to occur, there is no choice but to engage in costly litigation over creditors' claims. Thus, the chief result of the waiver provision we are discussing today will be increased litigation. In fostering an increasingly confused legal climate, it is likely that plans currently protected by Patterson v. Shumate will again become targets of creditor claims as well.

Discouragement of retirement plans. Besides the up-front cost of this wrongheaded approach, the potential for litigation, if widespread, will deter employers from establishing and maintaining retirement plans. Thus, the waiver provision not only undermines the retirement security of individuals, it also undermines this Congress's and this Committee's commitment to encourage and expand our voluntary employer-sponsored retirement system.

Excessive penalties for plan participants. If the plan distributed all or a portion of a participant's benefit contrary to the requirements of ERISA, the Internal Revenue Code, and the plan's provisions, the employee could be subjected to income and excise taxes on the distribution.

Defined benefit plans unduly burdened. The prospect of allowing the alienation of benefits in defined benefit plans is particularly disturbing for several reasons. First, under a defined benefit plan, the employee does not have any assets to alienate. Under these plans, the employee accrues a benefit over his or her entire career with the employer that sponsors the defined benefit plan. The employer promises to pay this benefit and holds assets in a trust in order to insure that money will be there to pay benefits when they are due regardless of the fortunes of the employer at that time. This trust assets are the property of the plan, not of the employee.

Second, benefits typically may not be paid from a defined benefit plan until the employee retires. In many cases this could be decades after the employee has passed through his or her bankruptcy event. A defined benefit plan simply is not a realistic source of money for a creditor.

Third, many defined benefit plans do not provide for lump-sum distributions of accrued benefits. Many plans provide payments only in annuity form. Thus, the benefits under a defined benefit plan often do not translate into a value that a creditor can immediately access.

Fourth, because the benefit under a defined benefit plan does not become fixed until after the employee retires, it is difficult to identify the benefit to which a creditor's claim would apply. Even the present value of the benefit at any given time is dependent on current interest rates. Future changes in interest rates will change the value of the benefit.

Fifth, the joint and survivor annuity requirements of defined benefit plans ensure that benefits are available for elderly surviving, creating an important resource against one of our most pressing retirement policy problems - providing retirement income for older women. Creditor claims against a worker's benefit would in many cases exacerbate this pressing national concern.

Reduced pension portability. Finally, Mr. Chairman, how this Congress chooses to address creditor claims against retirement benefits will either enhance or undermine one of today's most sought-after policy goals: increasing pension portability. ERIC applauds the leadership you and this Committee have exercised in considering legislation to increase the ability of an individual to transfer his or her retirement assets from one qualified plan to another of a same or a different type. Key legislation under consideration in the Senate that would substantially increase pension portability includes: The Retirement Account Portability Act of 1999 (S.1357) by Senator Jeffords and the pension reform amendments that were included in the Senate bankruptcy reform bill (S.625). In addition, the Pension Coverage and Portability Act (S.741) by Senator Graham of Florida, Senator Grassley, and several cosponsors, and the Income Security Enhancement Act of 1999 (S.8) by Senator Daschle and several cosponsors include similar and important portability initiatives.

Because of the potential inconsistent treatment in bankruptcy of funds held in different tax-qualified vehicles, however, individuals may unwittingly expose their retirement assets to claims by creditors when they roll their benefits from an ERISA-governed plan into a more vulnerable vehicle. Anyone aware of this potential danger will be loathe to transfer his or her benefits even though that might otherwise be the best decision for the individual. Unless Congress enacts legislation that (1) enacts a federal exemption under bankruptcy for all tax-qualified retirement benefits and (2) removes the waiver provision in §303 of the Senate bill, Congress's portability goals will be undermined.

Mr. Chairman, I thank you for the opportunity to present our views to this Committee. I will be pleased to address any questions you and the Members of the Committee may have.

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1. ERISA §206(d)(1).
2. IRC §401(a)(13).

3.P.L. 75-554, §165.

4. H. Rept. 807, 93rd Cong., 2nd Session, 68 (1974).

5. Cited in The Chamber of Commerce of the United States of America as amicus curiae supporting respondent in Patterson v. Shumate, U.S. Supreme Court, No. 91-913, pages 25-26.

6. 11 USC §522(d) and §522(b)(2), respectively

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