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Pension Policy: the Search for Better Solutions Upjohn Press Upjohn Research home page 12-11-2009 Pension Policy: The Search for Better Solutions John A. Turner Pension Policy Center Follow this and additional works at: https://research.upjohn.org/up_press Part of the Labor Economics Commons Citation Turner, John A. 2010. Pension Policy: The Search for Better Solutions. Kalamazoo, MI: W.E. Upjohn Institute for Employment Research. https://doi.org/10.17848/9780880994781 This work is licensed under a Creative Commons Attribution-Noncommercial-Share Alike 4.0 License. This title is brought to you by the Upjohn Institute. For more information, please contact [email protected]. Pension Policy Pension Policy The Search for Better Solutions John A. Turner 2010 W.E. Upjohn Institute for Employment Research Kalamazoo, Michigan Library of Congress Cataloging-in-Publication Data Turner, John A. (John Andrew), 1949 July 9- Pension policy : the search for better solutions / John A. Turner. p. cm. Includes bibliographical references and index. ISBN-13: 978-0-88099-354-8 (pbk. : alk. paper) ISBN-10: 0-88099-354-5 (pbk. : alk. paper) ISBN-13: 978-0-88099-355-5 (hardcover : alk. paper) ISBN-10: 0-88099-355-3 (hardcover : alk. paper) 1. Pensions—Government policy. 2. Defined benefit pension plans. 3. Annuities. I. Title. HD7091.T86 2009 331.25'2—dc22 2009037585 © 2010 W.E. Upjohn Institute for Employment Research 300 S. Westnedge Avenue Kalamazoo, Michigan 49007-4686 The facts presented in this study and the observations and viewpoints expressed are the sole responsibility of the author. They do not necessarily represent positions of the W.E. Upjohn Institute for Employment Research. Cover design by Alcorn Publication Design. Index prepared by Diane Worden. Printed in the United States of America. Printed on recycled paper. Contents Acknowledgments ix 1 Introduction to Pension Policy 1 An Introduction to Pensions 2 Basic Issues in Pension Policy 4 An Overview of the Book 11 2 Mandates: Pathways to Expanding Private Sector Provision 21 Four Pathways to Pension Coverage—Degrees of Compulsion 22 Voluntary Carve-Out Accounts 25 Pension Privatization in OECD Countries 29 Conclusion 31 3 Extending Pension Coverage 33 Measures of Coverage 34 Policies to Encourage Employers to Provide Pension Plans 37 Policies to Encourage Workers to Participate 40 Conclusion 52 4 Labor Market Policy: Portability and Retirement 55 Portability 55 Retirement 73 Conclusion 81 5 Tax Policy: Influencing Coverage and the Structure of Pensions 83 Overview 84 Pension Tax Policy in OECD Countries 86 Tax Policy Analysis 87 Conclusion 98 6 Managing Pension Risk 101 Risk in Pension Plans 102 Risk in 401(k) Plans 104 Risk in Defined Benefit Plans 109 Conclusion 122 v 7 Hybrid Plans: The Best of Both Worlds? 125 Types of Hybrid Plans 125 Analysis of Risk-Bearing in Hybrid Plans 132 Conclusion 134 8 Financing Pensions for Adequacy and Security 137 Financing Issues Common to Defined Contribution and Defined 137 Benefit Plans Defined Contribution Financing Issues 141 Defined Benefit Financing Issues 154 Conclusion 163 9 Pension Benefit Policy:The Search for Lost Pensions and 165 Other Issues Defined Contribution Plans 165 Defined Benefit Plans 169 Issues Affecting Both Defined Contribution and Defined Benefit Plans 171 Conclusion 179 10 The Decline in Annuitization and How to Reverse It 181 Annuity Basics 182 Annuitizing 401(k) Plans 183 Annuity Options 194 Income Redistribution 197 Market Innovations: Longevity Insurance, Laddering, and Framing 199 Conclusion 200 11 Finding Better Solutions 203 Public Policy for 401(k) Plans 203 Public Policy for Defined Benefit Plans 206 Proposal: A New Type of Hybrid—the Life-Indexed DB 210 Conclusion 212 References 213 The Author 227 Index 229 About the Institute 243 vi Tables 3.1 Reasons Why Workers Who Are Eligible to Participate in a 48 Pension Plan Do Not Participate (%) 3.2 Reasons for Not Contributing to the Federal Thrift Savings 49 Plan (%) 5.1 Tax Treatment of Employee Pension Contributions 91 5.2 Net Tax Cost per Dollar Contributed to a Pension, Different 96 Countries, 2006 6.1 PBGC Single-Employer Trust Fund Financial Status, 2000–2007 115 7.1 Types of Hybrid Pension Plans 126 8.1 Mutual Fund Expenses, Selected Countries, 2002 (% assets) 153 10.1 Features of Annuities in Mandatory Individual Account 186 Systems in Sweden, Chile, and the United Kingdom 10.2 Comparison of Monthly Annuity Benefits for a $100,000 189 Account Balance with Unisex and Gender-Based Pricing, BenefitsTaken at Age 62, 2007 ($) 10.3 Comparison of a Unisex Annuity Provided through the Thrift 189 Savings Plan and a Gender-Based Annuity Provided to Individuals by the Same Insurance Company, 2007 vii Acknowledgments This book was inspired by an Upjohn Institute book that I coauthored with Noriyasu Watanabe while on a Fulbright at the Institut de Recherches Economique et Sociale in Paris. That book, Private Pension Policies in In- dustrialized Countries: A Comparative Analysis (Turner and Watanabe 1995), focuses primarily on voluntarily provided defined benefit plans. The pension world has changed considerably since that book was published, with defined contribution pensions playing an increasingly dominant role. The current book examines a broad range of pension policy issues in the new environment. I have greatly benefited from collaboration over many years with distin- guished coauthors whose work with me I have cited, and to whom I express gratitude: Clive Bailey, Daniel Beller, David Blake, Ellen Bruce, Richard Burkhauser, Yung-Ping Chen, Lorna Dailey, Philip DeJong, William Even, Colin Gillion, Teresa Ghilarducci, Roy Guenther, Richard Hinz, Gerard Hughes, Mark Iwry, Sophie Korczyk, Denis Latulippe, Jules Lichtenstein, David McCarthy, Olivia Mitchell, Dana Muir, Leslie Muller, David Rajnes, Patricia Reagan, Martin Rein, Amy Shannon, Satyendra Verma, Noriyasu Watanabe, and Hazel Witte. I wish to thank members of the DB+ Initiative, and especially Karen Ferguson, with whom I worked to develop reforms to improve the U.S. pension system. I also wish to thank my wife, Kathy, and daughter, Sarah, for supporting my absences to write, attend conferences, and work abroad, and to thank my parents, Henry and Mary, for ultimately making everything possible. ix 1 Introduction to Pension Policy The U.S. pension system needs fixing. While some of its problems are longstanding, the system overall is in decline. Projections of the future are not certainties, and some analysts differ, but it appears likely that the financial security of current workers when they retire will be less than that of current retirees. For workers relying on 401(k) plans (which were named after the Internal Revenue Code section that enabled them), dramatic declines in the financial markets around the world in 2008 turned retirement security formerly provided to long-tenure work- ers by defined benefit plans into a system of retirement roulette. Work- ers in 401(k) plans are gambling that they will not be retiring in a period of dramatic stock market declines, such as experienced in 2008. By international standards, the U.S. pension system performs poorly. When measured in a comparable fashion, the U.S. poverty rate for peo- ple age 65 and older is more than twice as high as in other high-income countries (Pension Rights Center 2007). The move toward 401(k) plans has reduced the extent to which the pension system provides annui- ties and survivors benefits, reducing retirement income security. People who work for employers that offer 401(k) plans often do not participate, and when they do they tend to make poor financial decisions. Employ- ers are abandoning defined benefit plans for workers while maintain- ing generous pensions for executives. People in defined benefit plans who are laid off suffer portability losses, while their employers’ plans receive corresponding actuarial bonuses. Long-lived retirees in defined benefit plans have the real value of their benefits decimated by inflation, while long-lived retirees in defined contribution plans risk running out of money because of not having annuitized their account balances. The pension system is supposed to provide secure and adequate retirement income. In both respects, the U.S. system needs better solu- tions. With the decline in defined benefit plans and the increasing reli- ance on 401(k) plans, future retirees will have less secure and less adequate retirement income than current retirees. While that outcome would not occur if all workers covered by 401(k) plans contributed to their plans consistently and made wise investment decisions, research 1 2 Turner shows that many people do not contribute consistently and some do a poor job of managing their 401(k) plans. Pension policy is complex. It involves issues relating to taxation, labor economics, finance and behavioral finance, law, actuarial science, business administration, and accounting. Drawing on these disciplines, but taking an economist’s perspective, this book discusses pension pol- icy for U.S. private sector employer-provided pension plans. In analyz- ing pension policy, it addresses two questions: 1) What is the pension policy problem? and 2) What are the possible solutions? The book’s focus is the search for better solutions for pension policy. The United States has a federal system of government, where states play an important role in the development of policies in some areas. The 50 states provide the opportunity for social experimentation on policy innovations at a smaller level than the national level. That pos- sibility for experimentation, however, is not available in the pension system because federal law preempts state law on pension issues. For this reason, international experience is particularly important in study- ing innovations in pension policy. Thus, this book presents lessons for U.S. policy from the experience of other countries. AN INTRODUCTION TO PENSIONS The two main types of pension plans are defined benefit plans and defined contribution plans. Hybrid plans combine features of both.
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