The Cost of “Choice” in a Voluntary Pension SystemProf. Jon Forman & Sandy Mackenzie

for the Tax Economist Forum

Washington, DCThird Way, 1025 Connecticut Ave., NW

May 15, 2013

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Figure 1. How Benefits Compare to Earnings(2012 dollars & percentage of final wages)

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"low" "medium" "high" "maximum"

$19,400

$43,000

$68,800

$106,800

$10,600$17,500

$23,300$27,800

Past wages

Benefits

Retired worker age 65, 2012

57%42%

35%25%

Figure 2. Initial Social Security Replacement Rates for Retired Workers

(1970s birth cohort, percent)

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Lowest Second Middle Fourth Highest

70

5042

3726

Lifetime Earnings

Table 1. Share of Workers Participating in the Pension Plans, 2011 (percent)

Worker characteristic Sponsorship rate

Percentage participating

Employer size     Fewer than 10 employees 13.8 11.3 10–49 employees 29.6 23.0 50–99 employees 43.4 33.4 100–499 employees 54.5 42.5 500–999 employees 60.6 47.8 1,000 or more employees 65.3 51.4 Public sector 79.3 70.6

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Table 2. Social Security: Administrative Outlays as a Percent of Trust Fund Income

and Benefit Payments, FY 2013

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  Percent of Income

Percent of Benefit Payments

OASI 0.3% 0.4%DI 2.7% 2.1%OASDI (combined)

0.7% 0.7%

SSI (Federal and State

n/a 0.7%

TOTAL SSA

1.4%

COSTS OF PRIVATE PENSIONS

• The Cost of Choice• Administrative and Compliance Costs– median participant’s all-in fee (ICI) was

0.78% of assets ($248 per year)• Opportunity Costs– Lost investment returns– Lost savings opportunities– Lost opportunity to buy longevity insurance– Leakage

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Table 3. Form 5500 Income Statement of Pension Plans by type of plan, 2010

(amounts in millions)

Income and Expenses Defined Benefit Defined Contribution

Income    Employer contributions $127,443 $118,056 Participant contributions 760 175,787 Other income 283,576 410,020

Expenses    Total benefit payments 169,645 287,282 Administrative expenses 9,769 4,011

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Yields Administrative Expenses:• For defined benefit plans– 7.5% of contributions– 2.4% of total income– 5.8% of total benefit payments – 0.4% of assets

• For defined contribution plans– 1.3% of contributions– 0.6% of total income– 1.4% of total benefit payments– 0.1% of assets

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Regulatory Costs Are Not Substantial

• IRS $110 million• EBSA $183 million• PBGC $6.5 billion

• The total of $6.8 billion is a very small fraction of the value of retirement assets, $18.9 trillion.

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Figure 3. Pension funds’ operating expenses as a share of total investment in selected OECD countries, 2009 (percent)

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84.3%

2.9%

1.8%2.4% 7.0% 1.6%

Social Security Pensions Asset income EarningsCash public assistance Other

Figure 4. Shares of aggregate income for the lowest and highest income quin-tiles, by source, 2010

Highest quintileLowest quintile

17.3%

19.1%

16.1%

44.9%

0.1% 2.4%

Table 4. 2008 Replacement Ratios (married couple, ages 65/62, one working)

 Pre-

retirement income

Replacement RatiosFrom Social

Security

From private

and employer sources

Total

$20,000 69% 25% 94%$30,000 59% 31% 90%$40,000 54% 31% 85%$50,000 51% 30% 81%$60,000 46% 32% 78%$70,000 42% 35% 77%$80,000 39% 38% 77%$90,000 36% 42% 78%

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Table 5. Lump Sum Amounts Needed at Retirement from Private and Employer

Sources as a Multiple of Final Pay  

Pre-retirement

income

Baseline replacement rate needed (% of final

pay)

Equivalent Lump Sum Needed

(as a multiple of final pay)

Male Female

$20,000 25% 4.4 4.5$30,000 31% 5.0 5.5$40,000 31% 5.0 5.5$50,000 30% 4.8 5.4$60,000 32% 5.2 5.7$70,000 35% 5.6 6.3$80,000 38% 6.1 6.8$90,000 42% 6.8 7.5

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Reducing Costs

• A Universal, Second-Tier Pension System– Expand Social Security; or– Strengthen the Private Pension System with a

Simple System of Add-on Accounts• More Modest Approaches– Encourage Default Investments– Employer Retirement Savings Accounts–Multiple Employer Plans– State Funds

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Two approaches to reform: 1. The blank slate

• Assume a blank slate, or tabula rasa– Ask what the second tier would look like if

policy had a free hand– A case can be made for heavy government

involvement– Social Security is a natural platform for a

second tier; it can funnel savings at little cost to providers of retirement savings vehicles

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The blank slate, cont’d

– Employers above a certain size not offering their own plan could be required to as a conduit for a government plan, or private sector savings vehicles.

– Social Security can also act as a low-cost intermediary for the purchase of annuities and other lifetime income products.

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The blank slate, cont’d

– Because the SSA is already providing annuities (which are indexed), it could conceivably provide an additional annuity piggy-backed on the first tier.

– In one version of this reform, the government simply acts as a conduit, although its role is mandated. In the more radical version, it becomes the provider of retirement savings vehicles and longevity insurance.

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2. Incremental reform• Woodrow Wilson—work with the system

as it is, do not assume a tabula rasa.– Increase the second tier’s coverage by

requiring the use of defaults: employees participate automatically unless they explicitly opt out,

– Require more appropriate default investments (e.g. TDFs).

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2. Incremental reform, suite et fin– Reduce liability concerns of providers over

provision of annuities and other lifetime income products by enacting appropriate safe harbors.

–Make a concerned effort to improve financial education.

– Replicate California’s experiment with a state fund.

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