Employer Stock in Pension Plans: Economic and Tax Issues

Publication Date: September 2002

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Labor

Type:

Abstract:

The loss of retirement assets held in Enron stock by Enron employees has stimulated proposals to restrict the holding of employer stock in retirement plans, and other proposals to regulate these plans. Stock in the Enron plan came from firm contributions in the form of stock that was not allowed to be sold and from voluntary investment by employees. This report focuses on rationales for providing employer retirement plans and for holding (or not holding) employer stock in these plans, both from the perspective of the private sector and of government policy.

Retirement plans fall into two types: defined benefit plans, where a pension based on earnings and years of service is provided; and defined contribution plans, where individuals receive benefits based on accumulated principal and interest. Either plan can hold employer stock, but holdings are limited to 10% of assets in the case of defined benefit plans. These plans receive tax subsidies, as do employee stock purchase plans and certain types of stock options.

The analysis suggests that there are economic reasons that firms and employees may engage in pension and profit sharing (or stock ownership) plans even in the absence of tax subsidies. Pension plans, primarily defined benefit plans, may be attractive for administrative and risk-reduction reasons, for dealing with inadequate investment in on-the-job training, and for smoothing the retirement of older workers. Stock options and stock ownership plans may be useful for addressing inconsistency in objectives between shareholders and managers and worker monitoring problems, although these benefits are not likely to accrue to stock ownership by the rank and file of large companies. These employee stock ownership plans may also deter hostile takeovers, which may undermine economic efficiency and stockholder interests. Stock contributions are also popular because they do not reduce cash flow, which has both benefits and costs from an economic efficiency perspective.

Government subsidies to plans may be justified to increase retirement incomes and access to annuities because of a shortfall in optimal savings and certain economic problems with self selection in purchasing annuities. These objectives also underlie the justification of Social Security. Pursuing these goals may actually conflict with another worthy objective, on-the-job training. However, objectives that are addressed via employee stock ownership do not appear important in shaping the nature of large, broadly-based, retirement plans. Diversification of plan assets and prudent investment portfolios do appear consistent with rationales for government intervention.

Attempts to address this issue might take several forms: restrictions on shares of employer stock in plans, prohibiting employer stock contributions or lifting restrictions on sale, denying a tax deduction on employer contributions until they could be sold, and requiring independent investment advice. The last proposal is not costless and could undermine participation for small firms. For administrative and other reasons, it may be rational to impose share restrictions on allocations of contributions, rather than on assets. There are no plans to update this report.