chapter 6 the cost of “choice” in a voluntary pension...
TRANSCRIPT
-
CHAPTER 6
The Cost of “Choice” in a Voluntary
Pension System
JONATHAN BARRY FORMAN
GEORGE A. (SANDY) MACKENZIE
Jon Forman is the Alfred P. Murrah Professor of Law at the University of Oklahoma
College of Law, 300 Timberdell Road, Norman, Oklahoma 73019; (405) 325-4779 (tel);
[email protected]. Professor Forman teaches courses on tax and pension law, and he has
more than 300 publications, including Making America Work (Urban Institute Press 2006).
Professor Forman was the Professor in Residence for the Internal Revenue Service Office
of Chief Counsel for the 2009–2010 academic year, and, prior to entering academia, it was
his privilege to serve in all three branches of the federal government, most recently as Tax
Counsel to the late Senator Daniel Patrick Moynihan (D-NY). Professor Forman is also a
fellow in the American College of Tax Counsel, a member of the National Academy on
Social Insurance, and a fellows program associate of the Employee Benefits Research
Institute. Professor Forman earned his law degree from the University of Michigan in
1978, and he has Master’s degrees in economics and psychology.
Sandy Mackenzie is an Oxford-educated consulting economist in Washington, D.C.,
and the editor of the Journal of Retirement; (202) 434-3909 (tel);
[email protected]. Mr. Mackenzie is the author of The Decline of the
Traditional Pension—A Comparative Study of Threats to Retirement Security (Cambridge
University Press 2010) and Annuity Markets and Pension Reform (Cambridge University
Press 2006), and he has years of experience at the International Monetary Fund (1978–2007)
and at the AARP Public Policy Institute (2008–2012). Mr. Mackenzie was educated at
Dalhousie University, B.A. 1970, and Oxford University, M.A. 1972, M.Phil. 1974 (Rhodes
Scholar).
Copyright © 2013, Jonathan Barry Forman and George A. (Sandy) Mackenzie. All
Rights Reserved. This paper is based on a presentation prepared for a symposium on “The
Regulation of Benefit Plans: The Most Consequential Subject to Which No One Pays
Enough Attention” sponsored by the University of Michigan School of Business, Ann
Arbor, Michigan, March 22, 2013.
6-1 (Rel. 2013-10/2013 Pub.1646)
0001 [ST: 6-1] [ED: 100000] [REL: 2013] (Beg Group) Composed: Mon Oct 7 16:41:51 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:desig, tr:ch/core:desig, desig_title, style_01xpath-> core:title, tr:ch/core:title, desig_title, style_01xpath-> core:title, tr:ch/core:title, desig_title, style_01xpath-> core:byline, core:byline, byline, style_03xpath-> core:byline, core:byline, byline, style_03xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:url, core:url, endmatter, style_01xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06xpath-> core:para, se:ch-scope/core:para, scope, style_06
-
Synopsis
§ 6.01 INTRODUCTION
§ 6.02 AN OVERVIEW OF THE U.S. RETIREMENT SYSTEM
[1] Social Security and Supplemental Security Income (SSI)
[2] The Private Pension System
[a] Retirement Savings are Tax-Favored
[b] Types of Pension Plans
[i] Defined Benefit Plans
[ii] Defined Contribution Plans
[iii] Hybrid Retirement Plans
[iv] Other Voluntary Savings Mechanisms
[c] The Regulation of Employment-based Plans
[d] The Dominance of Defined Contribution Plans
[e] Coverage and Retirement Income Adequacy
§ 6.03 THE COSTS OF THE CURRENT RETIREMENT SYSTEM
[1] The Costs of Social Security
[2] The Costs of Government Plans
[3] The Costs of Private Pensions
[a] The Cost of Choice
[b] Administrative and Compliance Costs
[i] Generally
[ii] All-in Cost Estimates
[iii] Form 5500 Annual Reports
[iv] International Comparisons
[v] Government Costs
[vi] Cost Trends
[vii] The Costs of Service Providers and Supporting Organizations
[c] Opportunity Costs
[i] Lost Investment Returns
[ii] Lost Savings Opportunities
[A] The Lost Opportunity to Save
[B] The Lost Opportunity to Buy Longevity Insurance
[C] The Cost of Leakage
§ 6.04 REDUCING COSTS
[1] Reducing Costs with a Universal, Second-Tier Pension System
[a] How Much Will Workers Need in Retirement?
[i] Sources of Income in Retirement
NYU REVIEW OF EMPLOYEE BENEFITS 6-2
(Rel. 2013-10/2013 Pub.1646)
0002 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:51 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:title, core:toc/core:title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secmain"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secmain"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secmain"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secmain"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secmain"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secmain"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub4"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub4"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub4"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub4"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub4"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub4"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secmain"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secmain"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01
-
[ii] Replacement Ratios
[b] Enhancing Retirement Income
[i] Expand the Social Security System
[ii] Strengthen the Private Pension System
[c] A Model Second-Tier Pension System
[i] A Simple System of Add-on Individual Accounts
[ii] The Cost of a Simple System of Add-on Individual Accounts
[2] Some More Modest Ways to Reduce the Costs Associated with America’s
Second-Tier Pension System
[a] Encouraging Default Investments
[b] Employer Retirement Savings Account (ERSAs)
[c] Multiple Employer Plans
[d] State Funds
[e] Other Options
§ 6.05 CONCLUSION
§ 6.01 INTRODUCTION
Unlike our mandatory universal Social Security system, America’s private pension
system is replete with choice: choices about the type of pension plan, choices about the
amount and timing of contributions, choices about investments, and choices about the
timing and nature of distributions. It takes time to make all these choices, and
sometimes employers and workers just throw up their hands and don’t make any
choices at all. This “choice overload” or “analysis paralysis” imposes significant costs
on employers, workers, and government; and this article recommends a variety of
ways to reduce those costs.
The United States and most other industrialized nations have multi-pillar retirement
systems that fit within the World Bank’s multi-pillar model for retirement savings
consisting of a first-tier public system, a second-tier employment-based pension
system, and a third-tier of supplemental voluntary savings.1 While in many countries
the second-tier employment-based pension is mandatory or quasi-mandatory, in the
1 WORLD BANK, AVERTING THE OLD AGE CRISIS: POLICIES TO PROTECT THE OLD AND PROMOTE
GROWTH (Oxford University Press, 1994) xiv; see also ROBERT HOLZMANN AND RICHARD HINZ,
OLD-AGE INCOME SUPPORT IN THE 21ST CENTURY: AN INTERNATIONAL PERSPECTIVE ON PENSION
SYSTEMS AND REFORM (World Bank, 2005), http://www.egm.org.tr/kutuphane/Old_Age_Income_
Support_Complete.pdf (suggesting an additional pillar for informal intrafamily or intergenerational
sources of both financial and nonfinancial support to the elderly, including access to health care and
housing); Lans Bovenberg & Casper van Ewijk, The Future of Multi-Pillar Pension Systems (Network for
Studies on Pensions, Aging and Retirement, Discussion Paper No. 09/2011-079, 2011), http://papers.
ssrn.com/sol3/papers.cfm?abstract_id=1935307.
6-3 CHOICE IN A PENSION SYSTEM § 6.01
(Rel. 2013-10/2013 Pub.1646)
0003 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:54 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub3"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub3"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub1"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub1"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secsub2"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secsub2"]/core:entry-title, synopsis, style_01xpath-> core:entry-num, core:toc-entry[@lev="secmain"]/core:entry-num, synopsis, style_01xpath-> core:entry-title, core:toc-entry[@lev="secmain"]/core:entry-title, synopsis, style_01xpath-> core:desig, 192, , xpath-> core:title, tr:secmain/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01
-
U.S., both the second-tier and third-tier retirement savings systems are voluntary.2
That is, employers are not required to offer pensions, and when they do, they have
considerable choice over the type of pension plan to have and over many of that plan’s
features. Moreover, when employers do offer a pension plan, it is probably a
401(k)-type plan that offers employees considerable choice about whether to partici-
pate, about how much to contribute, about how to invest those contributions (and prior
accumulations), and about the timing and nature of distributions.3 In short, unlike our
first-tier, mandatory Social Security system, America’s second-tier private pension
system is replete with choice: choices about the type of pension plan, choices about the
amount and timing of contributions, choices about investments, and choices about the
timing and nature of distributions.
To be sure, the availability of pension choices may be of value to employers and
individuals, but, on the whole, the costs of choice almost certainly exceed the benefits.
Pertinent here, one of the major problems with the current pension system is its
incredible complexity. That complexity imposes significant costs on individuals,
employers, and government, especially when compared to the relatively rigid, but
straightforward, Social Security system. As more fully discussed below, the adminis-
trative costs for Social Security’s retirement system are well under 1% of benefits
paid.4 Meanwhile, other than the cost for a payroll withholding service, employers
incur almost no costs because of Social Security; and almost the only choice that
workers face is the choice about when to take their benefits, at which point in time, a
costless and simple application5 leads to a lifetime of inflation-adjusted retirement
income.6
On the other hand, employers, individuals, and government all incur significant
costs in connection with the current pension system.7 Employers incur significant costs
in choosing, designing, administering, or even outsourcing their pensions; individuals
2 See, e.g., OECD, OECD PENSIONS OUTLOOK 2012, 205 tbl. A6 (2012), http://www.oecd-ilibrary.
org/finance-and-investment/oecd-pensions-outlook-2012_9789264169401-en (showing, inter alia, gross
pension replacement rates from voluntary and mandatory private pensions in OECD countries);
JONATHAN BARRY FORMAN, MAKING AMERICA WORK 214 (2006); Kathryn L. Moore, An Overview of
the U.S. Retirement Income Security System and the Principles and Values It Reflects, 33 COMPARATIVE
LABOR LAW & POLICY JOURNAL 5, 17 (2011).3 Outside of the public sector, 401(k)-type plans are the most common type of pension plan. See infra
§ 6.02[2].4 See infra § 6.03[1].5 Social Security Administration, Apply Online for Retirement Benefits (April 29, 2013), http://www.
ssa.gov/planners/about.htm.6 See infra § 6.02[1].7 See infra § 6.03[3].
§ 6.01 NYU REVIEW OF EMPLOYEE BENEFITS 6-4
(Rel. 2013-10/2013 Pub.1646)
0004 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:54 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
incur significant costs in connection with the management, investment, and distribu-
tion of their contributions and benefits; and the government incurs significant costs in
regulating thousands of disparate pension plans and millions of Individual Retirement
Accounts (IRAs). Also, because of the voluntary nature of our second-tier private
pension system, coverage, and participation rates are low, and retirement savings may
be inadequate for many retirees.8
All in all, this Article focuses on the costs of choice in America’s voluntary private
pension system. At the outset, § 6.02 of this Article provides an overview of the current
U.S. retirement system—both Social Security and private pensions. Next, § 6.03 of
this Article looks at the costs associated with the current Social Security and private
pension systems. Finally, § 6.04 of this Article outlines some ways to reduce the costs
associated with the private pension system. In particular, § 6.04[1] discusses how to
reduce costs by moving to a universal, second-tier pension system; and § 6.04[2]
discusses some more modest approaches for reducing the costs associated with the
current private pension system.
§ 6.02 AN OVERVIEW OF THE U.S. RETIREMENT SYSTEM
The U.S. retirement system consists of a universal Social Security system, avoluntary, employment-based pension system, and supplemental voluntary savings.These are discussed in turn.
[1] Social Security and Supplemental Security Income (SSI)
The U.S. retirement system consists of a universal Social Security system, a
voluntary, employment-based pension system, and supplemental voluntary savings.
These are discussed in turn.
The current Social Security system includes two programs that provide monthly
cash benefits to workers and their families.9 The Old-Age and Survivors Insurance
(OASI) program provides monthly cash benefits to retired workers and their
dependents and to survivors of insured workers; and the Disability Insurance (DI)
program provides monthly cash benefits for disabled workers under full retirement age
and their dependents. A worker builds protection under these programs by working in
employment covered by Social Security and paying the applicable payroll taxes. At
retirement, disability, or death, monthly Social Security benefits are paid to insured
workers and to their eligible dependents and survivors.
The Old-Age and Survivors Insurance program is by far the larger of these two
programs, and it is usually what people mean when they talk about Social Security.
Consequently, for the remainder of this Article, “Social Security retirement taxes” will
8 See infra § 6.02[2][e].9 See, e.g., Forman, supra note 2, at 184–190.
6-5 CHOICE IN A PENSION SYSTEM § 6.02[1]
(Rel. 2013-10/2013 Pub.1646)
0005 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:54 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:desig, 192, , xpath-> core:title, tr:secmain/core:title, desig_title, style_01xpath-> core:para, core:abstract/core:para, abstract, style_01xpath-> core:para, core:abstract/core:para, abstract, style_01xpath-> core:para, core:abstract/core:para, abstract, style_01xpath-> core:title, tr:secsub1/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
refer to OASI taxes, and “Social Security retirement benefits” will refer to OASI
benefits. Historically, “full retirement age” was age 65, but it is currently age 66, and
it is gradually increasing to age 67 for workers born after 1959 (who reach that age in
or after 2027).10 In April of 2013, OASI paid benefits to 37 million retired workers,
and the average monthly benefit paid to a retired worker was $1,266.81.11
Social Security retirement benefits are financed primarily through payroll taxes
imposed on individuals working in employment or self-employment that is covered by
the Social Security system. For 2013, employees and employers each pay a Social
Security retirement tax of 5.3% on up to $113,700 of wages, for a combined OASI rate
of 10.6%—the lion’s share of the total 15.3% collected for OASI, DI, and Medicare.12
Self-employed workers pay an equivalent OASI tax of 10.6% on up to $113,700 of net
earnings.13
Workers over the age of 62 generally are entitled to Social Security retirement
benefits if they have worked in covered employment for at least 10 years.14 Benefits
are based on a measure of the worker’s earnings history in covered employment. Of
note, however, the benefit formula is highly progressive,15 and, as a result, the Social
10 Social Security Administration, Retirement Planner: Full Retirement Age (April 22, 2013),
http://www.socialsecurity.gov/retire2/retirechart.htm.11 Social Security Administration, Monthly Statistical Snapshot, April 2013 (May 15, 2013),
http://www.ssa.gov/policy/docs/quickfacts/stat_snapshot. For estimates of the expected present value of
lifetime benefits, see C. Eugene Steuerle & Caleb Quakenbush, Social Security and Medicare Taxes and
Benefits over a Lifetime: 2012 Update (2012), http://www.urban.org/UploadedPDF/412660-Social-
Security-and-Medicare-Taxes-and-Benefits-Over-a-Lifetime.pdf (showing that a single man earning the
average-wage [$44,600 in 2012 dollars] who retired in 2010 at age 65 would have lifetime Social Security
benefits with a present value of $277,000 [$302,000 for a single woman]).12 Social Security Administration, 2013 Social Security Changes (2012), http://www.socialsecurity.
gov/pressoffice/factsheets/colafacts2013.pdf.13 Social Security Administration, 2013 Social Security Changes (2012), http://www.socialsecurity.
gov/pressoffice/factsheets/colafacts2013.pdf.14 42 USC §§ 402(a), 414(a)(2).15 For example, benefits for retired workers are based on a measure of the worker’s earnings history
in covered employment known as the average indexed monthly earnings (AIME). The starting point for
determining the worker’s AIME is to determine how much the worker earned each year through age 60.
Once those “benefit computation years” and covered earnings for those years have been identified, the
worker’s earnings are indexed for wage inflation, using the year the worker turns 60 to index the earnings
of prior years. The highest 35 years of earnings are then selected, and the other years are dropped out. The
AIME is then computed as the average earnings for the remaining 35 years (420 months). The AIME is
then linked by a progressive formula to the monthly retirement benefit payable to the worker at full
retirement age, a benefit known as the “primary insurance amount” (PIA). For a worker turning 62 in
2013, the PIA equals 90% of the first $791 of the worker’s AIME, plus 32% of the AIME over $791 and
through $4,768 (if any), plus 15% of the AIME over $4,768 (if any). Social Security Administration,
§ 6.02[1] NYU REVIEW OF EMPLOYEE BENEFITS 6-6
(Rel. 2013-10/2013 Pub.1646)
0006 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:55 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
Security retirement system favors workers with low lifetime earnings relative to
workers with higher lifetime earnings.16 For example, Figure 1 shows how a worker’s
initial retirement benefit compares to her final preretirement earnings.17 Of particular
note, these redistributive Social Security benefits play an important role in reducing
poverty among the elderly. For example, without Social Security benefits, 43.6% of
elderly Americans fell below the poverty line in 2011, but with Social Security
benefits, just 8.7% were poor that year.18
Social Security Benefit Amounts (October 16, 2012), http://www.ssa.gov/oact/cola/Benefits.html; Social
Security Administration, Primary Insurance Amount (October 16, 2012), http://www.ssa.gov/oact/cola/
piaformula.html.16 See, e.g., Michael Clingman, Kyle Burkhalter & Chris Chaplain, Money’s Worth Ratios Under the
OASDI Program for Hypothetical Workers (Social Security Administration, Office of the Chief Actuary,
Actuarial Note No. 2012.7, 2013), http://www.ssa.gov/OACT/NOTES/ran7/index.html.
To be sure the redistributive benefits of the progressive benefit formula are tempered by the relatively
longer life expectancies of high earners relative to low earners. See, e.g., Hilary Waldron, Trends in
Mortality Differentials and Life Expectancy for Male Social Security—Covered Workers, by Average
Relative Earnings (Social Security Administration, Office of Policy, Office of Research, Evaluation, and
Statistics, Working Paper No. 108, 2007), http://www.ssa.gov/policy/docs/workingpapers/wp108.pdf.
Also, because high-earners are more likely to be married than low-earners, high-earners receive a
disproportionate share of the Social Security system’s rather generous spousal benefits. In 2010 for
example, 78.4% of households in the top 20% of households income were married-couple families, but
only17.0% of households in the bottom 20% were married-couple families. Mark J. Perry, Income
inequality can be explained by household demographics (American Enterprise Institute, AEIdeas blog,
2011), http://www.aei-ideas.org/2011/10/income-inequality-can-be-explained-by-household-
demographics/#print.17 Virginia Reno & Elisa Walker, Social Security Benefits, Finances, and Policy Options: A Primer
6 (2012), http://www.nasi.org/research/2012/social-security-benefits-finances-policy-options-primer.18 Paul N. Van de Water & Arloc Sherman, Social Security Keeps 21 Million Americans Out of
Poverty: A State-by-State Analysis (October 16, 2012), http://www.cbpp.org/files/10-16-12ss.pdf. Social
Security benefits lifted 14,480,000 elderly Americans out of poverty in 2011. Id. In 2013, the poverty
level for a single individual is $11,490, and the poverty level for a married couple is $15,510. Annual
Update of the HHS Poverty Guidelines, 78 Federal Register 5,182 (January 24, 2013).
6-7 CHOICE IN A PENSION SYSTEM § 6.02[1]
(Rel. 2013-10/2013 Pub.1646)
0007 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:55 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> foots, Default, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01
-
Source: Virginia Reno & Elisa Walker, Social Security Benefits, Finances, and Policy Options:
A Primer 6 (2012), http://www.nasi.org/research/2012/social-security-benefits-finances-policy-
options-primer.
Similarly, Figure 2 shows the initial Social Security retirement benefits that workers
born in the 1970s are scheduled to receive when they get to age 65 (in and after
2035).19 All in all, Social Security’s replacement rate is high when incomes are low,
but may not be high enough to keep recipients above the poverty line, and it drops off
substantially as earnings rise.
19 Congressional Budget Office, Supplemental Data for CBO’s 2012 Long-Term Projections for
Social Security Exhibit 10 (2012), http://www.cbo.gov/publication/43653; see also Peter Brady, Kimberly
Burham & Sarah Holden, The Success of the U.S. Retirement System 17-20 (Investment Company
Institute, 2012), http://www.ici.org/pdf/ppr_12_success_retirement.pdf. Of note, future retirees are
projected to receive somewhat higher Social Security retirement benefits than today’s beneficiaries. See,
e.g., Congressional Budget Office, The 2012 Long-Term Projections for Social Security: Additional
Information (2012), http://www.cbo.gov/sites/default/files/cbofiles/attachments/43648-SocialSecurity.
pdf. However, future retirees will have to wait longer to reach full-retirement age, they are projected to
face higher Medicare Part B premiums, and a greater portion of their Social Security retirement benefits
will be subject to income taxation. Alicia H. Munnell, Anthony Webb & Francesca Golub-Sass, The
National Retirement Risk Index After the Crash 2 fig. 1 (Boston College Center for Retirement Research,
Issue in Brief 9-22, 2009), http://crr.bc.edu/wp-content/uploads/2009/10/IB_9-22.pdf.
§ 6.02[1] NYU REVIEW OF EMPLOYEE BENEFITS 6-8
(Rel. 2013-10/2013 Pub.1646)
0008 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:55 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
core:ext-obj, core:ext-obj, figure, style_01
xpath-> core:para, core:caption/core:para, figure, style_01xpath-> core:para, core:caption/core:para, figure, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01 core:ext-obj, core:image-alt/core:ext-obj, figure, style_01
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01
-
Source: Congressional Budget Office, Supplemental Data for CBO’s 2012 Long-Term Projec-
tions for Social Security Exhibit 10 (2012), http://www.cbo.gov/sites/default/files/cbofiles/
attachments/43648-SocialSecurity.pdf.
Note: The average initial replacement rate is a worker’s initial benefit as a percentage of a
worker’s average annual lifetime earnings.
Benefits may be increased or decreased for several reasons. Most importantly, the
real (inflation-adjusted) value of retiree benefits is kept constant by an annual
adjustment of nominal benefits to compensate for consumer price inflation.20 Also, the
“retirement earnings test” can reduce the monthly benefits of individuals who have not
yet reached full retirement age but who continue to work after starting to draw Social
Security retirement benefits.21
In addition, workers who retire before their full retirement age have their benefits
20 See, e.g., Social Security Administration, 2013 Social Security Changes (October 16, 2012),
http://www.ssa.gov/pressoffice/factsheets/colafacts2013.htm (announcing a 1.7% cost-of-living adjust-
ment [COLA] for 2013).21 42 USC § 403(f).
6-9 CHOICE IN A PENSION SYSTEM § 6.02[1]
(Rel. 2013-10/2013 Pub.1646)
0009 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:55 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
core:ext-obj, core:ext-obj, figure, style_01
xpath-> core:para, core:caption/core:para, figure, style_01xpath-> core:para, core:caption/core:para, figure, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:para, core:caption/core:para, figure, style_01xpath-> core:para, core:caption/core:para, figure, style_01 core:ext-obj, core:image-alt/core:ext-obj, figure, style_01
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
actuarially reduced.22 On the other hand, benefits payable to workers who choose to
retire after their full retirement age are actuarially increased (but only up to age 70).23
In effect, beneficiaries can buy additional annuity protection by delaying retirement.24
For example, consider a worker who reached age 62 in January of 2013 and earned the
maximum taxable amount under Social Security for every year of her working life. If
she claims her Social Security benefits at 62, she will get $1,923 per month.25 If she
instead waits until she is 65, she will get $2,414 per month, and if she waits until age
70, she will get $3,350 per month—and any additional years of work may boost the
measure of lifetime earnings that is used to determine monthly benefits.26
Spouses, dependents, and survivors of the worker may also receive additional
monthly benefits which are based on the worker’s benefits.27 For example, a
retirement-age wife or husband of a retired worker is typically entitled to a monthly
spousal benefit equal to 50% of the worker’s benefit.28 Also, a retirement-age widow
or widower of the worker is entitled to a monthly surviving spouse benefit equal to
100% of the worker’s benefit.29
In addition, the means-tested Supplemental Security Income (SSI) program pro-
vides monthly cash benefits to certain low-income elderly, disabled, or blind
Americans. In 2013, the maximum federal benefit for a single individual is $710 per
22 42 USC § 402(q).23 42 USC § 402(q).24 See, e.g., Kenn Beam Tacchino, David A. Littell & Bruce D. Schobel, A Decision Framework for
Optimizing the Social Security Claiming Age, 28(2) BENEFITS QUARTERLY 40 (2nd Q. 2012); Mary Beth
Franklin, 5 Steps to a Secure Retirement, KIPLINGER’S PERSONAL FINANCE (October 2011), http://www.
kiplinger.com/magazine/archives/5-steps-to-a-secure-retirement.html; C. Eugene Steuerle & Richard B.
Fisher, Social Security as a Source of Annuities: A Simplified Social Security Option (Paper presented at
the Pension Rights Center conference on Re-Imagining Pensions, Washington, DC, 2012), http://www.
pensionrights.org/what-we-do/events/re-imagining-pensions/social-security-annuities; Anthony Webb,
Making Your Nest Egg Last a Lifetime (AARP Public Policy Institute, Insight on the Issues No. 132,
2009), http://assets.aarp.org/rgcenter/ppi/econ-sec/i32.pdf.25 Social Security Administration, Automatic Determinations: Workers with Maximum-Taxable
Earnings (October 18, 2012), http://www.ssa.gov/oact/COLA/examplemax.html.26 See supra note 15; and see Laurence Kotlikoff, Inside Social Security’s Obscure Incentive to Keep
Americans Working (February 4, 2013), http://finance.yahoo.com/blogs/the-exchange/inside-social-
security-obscure-incentive-keep-americans-working-224727054.html.27 42 USC §§ 402(b) (wife), (c) (husband), (d) (child), (e) (widow), (f) (widower), (g) (mother and
father), and (h) (parents).28 42 USC § 402(b)(2).29 42 USC § 402(e), (f).
§ 6.02[1] NYU REVIEW OF EMPLOYEE BENEFITS 6-10
(Rel. 2013-10/2013 Pub.1646)
0010 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:55 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
month, and the maximum for a couple is $1,066 per month.30 In April of 2013, 2.1
million elderly Americans received SSI benefits from the federal government, and the
average monthly benefit was $423.02.31
[2] The Private Pension System
[a] Retirement Savings are Tax-Favored
As already mentioned, the U.S. has a voluntary pension system, and employers have
considerable choice about whether and how to provide pension benefits to their
employees. However, when employers decide to provide a pension, those pensions are
typically subject to regulation under the Employee Retirement Income Security Act of
1974 (ERISA).32
Most pension plans qualify for favorable tax treatment. Basically, an employer’s
contributions to a tax-qualified retirement plan on behalf of an employee are not
taxable to the employee.33 Moreover, the pension fund’s earnings on those contribu-
tions are tax-exempt.34 Workers pay tax only when they receive distributions of their
pension benefits.35 Nevertheless, the employer is allowed a current deduction for its
30 Social Security Administration, SSI Federal Payments for 2013 (2012), http://www.ssa.gov/oact/
cola/SSI.html.31 Social Security Administration, supra note 11.32 Pub L No 93-406, 88 Stat 864. See generally Joint Committee on Taxation, Present Law and
Background Relating to the Tax Treatment of Retirement Savings (JCX-32-12, April 13, 2012),
https://www.jct.gov/publications.html?func=startdown&id=4418.33 IRC § 402.34 IRC § 501(a).35 IRC §§ 72, 402. Pension benefits or annuity payments may be fully taxable or partially taxable. For
example, a participant’s pension benefits will be fully taxable if the participant’s employer contributed all
of the cost for the pension without any of the contributions being included in the employee’s taxable
wages. Pension benefits would also be fully taxable if the participant has already received all of her
previously taxed contributions tax-free in previous years. See generally Internal Revenue Service,
Pension and Annuity Income (Publication No. 575, January 7, 2013), http://www.irs.gov/pub/irs-pdf/
p575.pdf.
On the other hand, if an individual made after-tax contributions to a pension or annuity, she can exclude
part of her pension or annuity distributions from income. Under IRC §§ 72 and 402, the individual can
exclude a fraction of each benefit payment from income. That fraction (the “exclusion ratio”) is based on
the amount of premiums or other after-tax contributions made by the individual. The exclusion ratio
enables the individual to recover her own after-tax contributions tax-free and to pay tax only on the
remaining portion of benefits which represents income.
Taxpayers who begin receiving annuity payments from a qualified retirement plan after November 18,
1996, generally can use the so-called Simplified Method to figure the tax-free part of their benefits. Under
the Simplified Method, the Code provides a table with a fixed number of anticipated payments that
depends upon the annuitant’s age as of the annuity starting date. The taxpayer then divides the total cost
6-11 CHOICE IN A PENSION SYSTEM § 6.02[2][a]
(Rel. 2013-10/2013 Pub.1646)
0011 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:56 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:title, tr:secsub1/core:title, desig_title, style_01xpath-> core:desig, tr:secsub2/core:desig, desig_title, style_01xpath-> core:title, tr:secsub2/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
contributions (within limits).36
Favorable tax rules are also available for individual retirement accounts (IRAs).37
Almost any worker can set up an IRA with a bank or other financial institution. In
2013, individuals without pension plans can contribute and deduct up to $5,500 to an
IRA, although individuals over age 50 can contribute and deduct another $1,000 (for
a total of up to $6,500); and spouses can contribute and deduct similar amounts.38 If
a worker is covered by another retirement plan, however, the deduction may be
reduced or eliminated if the worker’s income exceeds $59,000 for a single individual
or $95,000 for a married couple.39 Like private pensions, IRA earnings are tax-exempt,
and distributions are taxable.40
Also, since 1998, individuals have been permitted to set up Roth IRAs.41 Unlike
regular IRAs, contributions to Roth IRAs are not deductible. Instead, withdrawals are
tax-free. Like regular IRAs, however, Roth IRA earnings are tax-exempt.
Also, since 2002, certain low- and moderate-income individuals have been able to
claim a tax credit of up to $1,000 for certain qualified retirement savings contribu-
tions.42 Finally, qualified small firms may claim a nonrefundable tax credit of up to
$500 for certain costs incurred in setting up a new retirement plan for employees.43
over the applicable number of anticipated payments and excludes the amount so determined each year.
Internal Revenue Service, supra, at 12–14.36 IRC § 404.37 IRC § 219.38 Internal Revenue Service, IRS Announces 2013 Pension Plan Limitations: Taxpayers May
Contribute up to $17,500 to their 401(k) plans in 2013 (IR-2012-77, October 18, 2012), http://www.irs.
gov/pub/irs-news/IR-12-077.pdf.39 Internal Revenue Service, IRS Announces 2013 Pension Plan Limitations: Taxpayers May
Contribute up to $17,500 to their 401(k) plans in 2013 (IR-2012-77, October 18, 2012), http://www.irs.
gov/pub/irs-news/IR-12-077.pdf.40 Also, so-called “Keogh plans” give self-employed workers an ability to save for retirement that is
similar to plans that employers sponsor, and Keogh plans allow self-employed workers to contribute more
than they could otherwise contribute to a regular IRA. Internal Revenue Service, Retirement Plans for
Small Business (SEP, Simple, and Qualified Plans) 2, 12 (Publication No. 560, January 14, 2013),
http://www.irs.gov/pub/irs-pdf/p560.pdf.41 IRC § 408A.42 IRC § 25B. The credit equals a percentage (50%, 20%, or 10%) of up to $2,000 of contributions.
In effect, the credit acts like an employer match: the government matches a portion of the employee’s
contributions. Employer matches encourage workers to contribute, at least up to the match level, and the
saver’s tax credit seems to have similar pro-savings effects. See, e.g., Lisa Southwirth & John Gist, The
Saver’s Credit: What Does It Do For Saving? (AARP Public Policy Institute, Insight on the Issues Paper,
2008), http://assets.aarp.org/rgcenter/econ/i1_credit.pdf.43 IRC § 45E. The credit is equal to 50% of up to $1,000 in eligible costs incurred in each of the first
§ 6.02[2][a] NYU REVIEW OF EMPLOYEE BENEFITS 6-12
(Rel. 2013-10/2013 Pub.1646)
0012 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:56 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> foots, Default, footnote, style_01xpath-> foots, Default, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
[b] Types of Pension Plans
[i] Defined Benefit Plans
Pension plans generally fall into two broad categories based on the nature of the
benefits provided: defined benefit plans and defined contribution plans.
In a defined benefit plan, an employer promises employees a specific benefit at
retirement. To provide that benefit, the employer typically makes payments into a trust
fund, contributed funds grow with investment returns, and eventually the employer
withdraws funds from the trust fund to pay the promised benefits. Employer
contributions are based on actuarial valuations, and the employer bears all of the
investment risks and responsibilities.
Defined benefit plans often provide each worker with a specific annual retirement
benefit tied to the worker’s final average compensation and number of years of service.
For example, a plan might provide that a worker’s annual retirement benefit (B) is
equal to 2% times the number of years of service (yos) times final average
compensation (fac) (B = 2% × yos × fac). Under this final-average-pay formula, a
worker who retires after 30 years of service with final average compensation of
$50,000 would receive a pension of $30,000 a year for life ($30,000 = 2% × 30 yos
× $50,000 fac). Final average compensation is often computed by averaging the
worker’s salary over the last three or five years prior to retirement.44 While many
defined benefit plans allow for lump sum distributions, the default benefit for defined
benefit plans is a retirement income stream in the form of an annuity for life.45
[ii] Defined Contribution Plans
Under a typical defined contribution plan, the employer typically withholds a
specified percentage of the worker’s compensation which it contributes to an
individual investment account for the worker. For example, contributions might be set
at 10% of annual compensation. Under such a plan, a worker who earned $50,000 in
a given year would have $5,000 contributed to an individual investment account for
her ($5,000 = 10% × $50,000). Her benefit at retirement would be based on all such
contributions plus investment earnings.46
three years of the plan’s existence. See, e.g., Gary Guenther, Small Business Tax Benefits: Overview and
Economic Rationales 17 (Congressional Research Service, Paper No. RL32254, 2008), http://royce.
house.gov/uploadedfiles/small%20business%20tax%20benefits.pdf.44 Alternatively, some plans use career-average compensation instead of final-average compensation.
Under a career earnings formula, benefits are based on a percentage of an average of career earnings for
every year of service by the employee.45 Defined benefit plans are generally designed to provide annuities, i.e., “definitely determinable
benefits . . . over a period of years, usually for life after retirement.” Treas Reg § 1.401-1(b)(1).46 Defined contribution plans are also known as “individual account” plans because each worker has
6-13 CHOICE IN A PENSION SYSTEM § 6.02[2][b]
(Rel. 2013-10/2013 Pub.1646)
0013 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:56 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:desig, tr:secsub2/core:desig, desig_title, style_01xpath-> core:title, tr:secsub2/core:title, desig_title, style_01xpath-> core:desig, tr:secsub3/core:desig, desig_title, style_01xpath-> core:title, tr:secsub3/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:desig, tr:secsub3/core:desig, desig_title, style_01xpath-> core:title, tr:secsub3/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> foots, Default, footnote, style_01xpath-> foots, Default, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
Unlike traditional defined benefit plans, defined contribution plans usually make
distributions in the form of lump sum or periodic distributions rather than life
annuities. Indeed, relatively few defined contribution plans even offer annuity options,
and, in any event, relatively few participants elect those annuity options.47
There are a variety of different types of defined contribution plans, including money
purchase pension plans, target benefit plans, profit-sharing plans, stock bonus plans,
and employee stock ownership plans (“ESOPs”).48 Of particular note, profit-sharing
and stock bonus plans often include a feature that allows workers to choose between
receiving cash currently or deferring taxation by placing the money in a retirement
account according to IRC § 401(k). Consequently, these plans are often called “401(k)
plans,” and they are the most popular type of retirement plan.49 The maximum annual
amount of such elective deferrals that can be made by an individual in 2013 is $17,500,
although workers over the age of 50 can contribute another $5,500 (for a total of up
to $23,000).50 Also, since 2006, employers have been permitted to set up Roth 401(k)
her own account, as opposed to defined benefit plans, where the plan’s assets are pooled for the benefit
of all of the employees.47 See, e.g., Beverly I. Orth, Approaches for Promoting Voluntary Annuitization, SOCIETY OF
ACTUARIES, 2008 RETIREMENT 20/20 CONFERENCE (Monograph No. M-RS08-1, 2009), http://www.soa.
org/library/monographs/retirement-systems/retirement2020/2008/november/mono-2008-m-rs08-01-orth.
pdf; Paul Yakoboski, Retirees, Annuitization and Defined Contribution Plans 3, 5 (TIAA-CREF Institute,
Trends and Issues, April 2010), http://www.tiaa-crefinstitute.org/ucm/groups/content/@ap_ucm_p_tcp_
docs/documents/document/tiaa02029462.pdf (finding that only around 19% of retirees with significant
defined contribution plan assets but little defined benefit pension income annuitized a portion of their
retirement savings); David L. Wray, Testimony before the ERISA Advisory Council Working Group on
Spend Down of Defined Contribution Assets as Retirement 5 (July 16, 2008), http://www.psca.org/psca-
president-testified-july-16-2008-before-the-erisa-advisory-council-on-the-spend-down-of-defined-
contribution-assets-at-retirement (noting that only about 20% of defined contribution plans offer annuities,
and these are hardly ever utilized); GEORGE A. (SANDY) MACKENZIE, ANNUITY MARKETS AND PENSION
REFORM Chapter 1 (2006). All in all, people rarely choose to buy annuities voluntarily, even though
purchasing annuities could rationally help maximize their expected retirement incomes. That is, the
demand for annuities is lower than expected, and this shortfall has come to be known as the “annuity
puzzle.” See, e.g., Manahem E. Yaari, Uncertain Lifetime, Life Insurance, and the Theory of the
Consumer, 32(2) REVIEW OF ECONOMIC STUDIES 137 (1965); Franco Modigliani, Life Cycle, Individual
Thrift, and the Wealth of Nations, 76(3) AMERICAN ECONOMIC REVIEW 297 (1986); Shlomo Benartzi,
Alessandro Previtero & Richard H. Thaler, Annuitization Puzzles, 25(4) JOURNAL OF ECONOMIC
PERSPECTIVES 143 (Fall 2011).48 See, e.g., U.S. Department of Labor, Bureau of Labor Statistics, Six Ways to Save for Retirement,
3(3) PROGRAM PERSPECTIVES 1, 2 (2011), http://www.bls.gov/opub/perspectives/program_perspectives_
vol3_issue3.pdf.49 See, e.g., U.S. Department of Labor, Bureau of Labor Statistics, BLS examines popular 401(k)
retirement plans 2(6) PROGRAM PERSPECTIVES 1 (2006), http://www.bls.gov/opub/perspectives/program_
perspectives_vol2_issue6.pdf.50 Internal Revenue Service, supra note 38.
§ 6.02[2][b] NYU REVIEW OF EMPLOYEE BENEFITS 6-14
(Rel. 2013-10/2013 Pub.1646)
0014 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:56 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> foots, Default, footnote, style_01xpath-> foots, Default, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
plans that operate in a similar fashion.51
[iii] Hybrid Retirement Plans
So-called “hybrid” retirement plans mix the features of defined benefit and defined
contribution plans. For example, a cash balance plan is a defined benefit plan that looks
like a defined contribution plan.52 Like other defined benefit plans, employer
contributions are based on actuarial valuations, and the employer bears all of the
investment risks and responsibilities. Like defined contribution plans, however, cash
balance plans provide workers with individual accounts (albeit hypothetical).53 A
simple cash balance plan might allocate 10% of salary to each worker’s account each
year and credit the account with 5% interest on the balance in the account. Under such
a plan, a worker who earned $50,000 in a given year would get an annual cash balance
credit of $5,000 ($5,000 = 10% × $50,000), plus an interest credit equal to 5% of the
balance in her hypothetical account as of the beginning of the year. The interest credit
on a cash balance plan may also be tied to a market rate, like the long-term interest
rate, in which case the plan participant bears some interest risk.
[iv] Other Voluntary Savings Mechanisms
In addition to voluntary saving through 401(k) elections and IRAs, individuals can
also save money outside of the retirement system. Investment income is generally
subject to personal federal income tax rates of up to 39.6% in 2013;54 however,
dividend income and capital gains are generally taxed at no more than 20%.55 Also,
there are various tax advantages associated with investments in homes,56 state and
local bonds,57 annuities,58 and life insurance.59
[c] The Regulation of Employment-based Plans
In the almost 40 years since it was enacted, the Employee Retirement Income
Security Act has been amended numerous times, and a whole regulatory system has
grown up to enforce its provisions. The key agencies charged with the administration
51 IRC § 402A.52 See, e.g., Jonathan Barry Forman & Amy Nixon, Cash Balance Pension Plan Conversions,
25(1&2) OKLAHOMA CITY UNIVERSITY LAW REVIEW 379 (2000).53 Sometimes, these hypothetical accounts are referred to as “notional accounts.”54 IRC § 1; Rev Proc 2013-15, 2013-5 IRB 444 INTERNAL REVENUE BULLETIN.55 IRC § 1(h).56 For example, home mortgage interest is generally deductible, and gains from the sale of a personal
residence are often excludable. IRC §§ 163(a), 121.57 IRC § 103 (interest exclusion).58 IRC § 72; and see the discussion in note 35 supra.59 IRC § 101(a) (exclusion for insurance proceeds paid by reason of the death of the insured).
6-15 CHOICE IN A PENSION SYSTEM § 6.02[2][c]
(Rel. 2013-10/2013 Pub.1646)
0015 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:56 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:desig, tr:secsub3/core:desig, desig_title, style_01xpath-> core:title, tr:secsub3/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:desig, tr:secsub3/core:desig, desig_title, style_01xpath-> core:title, tr:secsub3/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:desig, tr:secsub2/core:desig, desig_title, style_01xpath-> core:title, tr:secsub2/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
of ERISA are the U.S. Department of Labor, the Internal Revenue Service (IRS), and
the Pension Benefit Guaranty Corporation (PBGC).60 The IRS and the Department of
Labor also have significant responsibilities with respect to IRAs and Roth IRAs.
Pension plans must be operated for the exclusive benefit of employees or their
beneficiaries, and plan assets generally must be held in a trust.61 To protect the
interests of plan participants, ERISA requires significant reporting and disclosure in
the administration and operation of employee benefit plans.62 ERISA also imposes
extensive fiduciary responsibilities on employers and administrators of employee
benefit plans.63 In addition, prohibited transaction rules prevent parties in interest from
engaging in certain transactions with an employee benefit plan.64 For example, an
employer usually cannot sell, exchange, or lease any property to the plan.
ERISA and the Internal Revenue Code also impose many other requirements on
retirement plans, including rules governing participation,65 coverage,66 vesting,67
benefit accrual,68 contribution and benefits,69 nondiscrimination,70 and funding.71
[d] The Dominance of Defined Contribution Plans
In recent years, defined contribution plans have come to dominate the pension
landscape. For example, 50% of full-time private industry workers in the U.S.
participated in defined contribution plans in 2011, up from 40% in 1989–90;
meanwhile, participation in defined benefit plans fell from 42% in 1989–90 to just 22%
in 2011.72 Also of note, a recent study estimated that 92% of the new pension plans
60 See, e.g., Internal Revenue Service, Tax Information for Retirement Plans Community (May 2,
2013); http://www.irs.gov/Retirement-Plans; U.S. Department of Labor, Employee Benefits Security
Administration, About the Employee Benefits Security Administration, http://www.dol.gov/ebsa/
aboutebsa/main.html (accessed May 22, 2013); Pension Benefit Guaranty Corporation, About PBGC,
http://www.pbgc.gov/about (accessed May 22, 2013).61 IRC § 401(a); ERISA §§ 403(a), 404(a)(1)(A).62 See, e.g., ERISA § 101(a) et seq.63 IRC § 401(a); ERISA § 404.64 IRC § 4975; ERISA § 406.65 IRC § 410(a); ERISA § 202.66 IRC § 410(b).67 IRC § 411(a); ERISA § 203.68 IRC § 411(b); ERISA § 204.69 IRC § 415.70 IRC § 401(a)(4).71 IRC § 412; ERISA § 302.72 William J. Wiatrowski, Changing Landscape of Employment-based Retirement Benefits, COMPEN-
SATION AND WORKING CONDITIONS ONLINE (U.S. Department of Labor, Bureau of Labor Statistics,
§ 6.02[2][d] NYU REVIEW OF EMPLOYEE BENEFITS 6-16
(Rel. 2013-10/2013 Pub.1646)
0016 [ST: 6-1] [ED: 100000] [REL: 2013] Composed: Mon Oct 7 16:41:57 EDT 2013XPP 8.4C.1 SP #2 SC_01125 llp 1646 [PW=500pt PD=684pt TW=380pt TD=528pt]
VER: [SC_01125-Master:04 Sep 13 02:10][MX-SECNDARY: 28 May 13 07:54][TT-: 23 Sep 11 07:01 loc=usa unit=ch0006v2013] 0
xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:desig, tr:secsub2/core:desig, desig_title, style_01xpath-> core:title, tr:secsub2/core:title, desig_title, style_01xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> core:para, Default, para-list, style_02xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> core:url, core:url, endmatter, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01xpath-> fn:para, fn:footnote/fn:para, footnote, style_01
-
formed from 2003–2007 were defined contribution plans, as opposed to defined benefit
plans.73
Pertinent here, employers may be responding to the relatively higher costs of
providing a defined benefit plan as opposed to a defined contribution plan. For
example, according to the Bureau of Labor Statistics, in March 2012, it cost an average
of $2.53 an hour to provide each participating worker with a defined benefit plan,
compared with just $1.46 per hour for defined contribution plan participants.74 That
said, defined benefit plans incur investment fees and other charges that DC plans do
not incur or can pass on to their participants. All in all, however, the era of the
traditional defined benefit plan is largely behind us.75
[e] Coverage and Retirement Income Adequacy
To encourage Americans to save for retirement in our voluntary pension system, the
government relies on two major approaches. First, most pension plans qualify for
September 29, 2011), http://www.bls.gov/opub/cwc/cm20110927ar01p1.htm; see also William J. Wia-
trowski, The last private industry pension plans: a visual essay, 135(12) MONTHLY LABOR REVIEW 3
(2012), http://www.bls.gov/opub/mlr/2012/12/art1full.pdf; TOWERS WATSON, GLOBAL PENSION ASSET
STUDY 2013 8, 34-37 (2012), http://www.towerswatson.com/en-ZA/Insights/IC-Types/Survey-Research-
Results/2013/01/Global-Pensions-Asset-Study-2013 (finding that defined contribution plans held 58% of
pension assets in the U.S. in 2012).
More specifically, there were 701,012 private pension plans in 2010. U.S. DEPARTMENT OF LABOR,
EMPLOYEE BENEFITS ADMINISTRATION, PRIVATE PENSION PLAN BULLETIN 3 tbl. A1 (2012), http://
www.dol.gov/ebsa/PDF/2010pensionplanbulletin.PDF. These are ERISA-covered plans and do not
include non-ERISA plans such as IRAs and Roth IRAs. Of these, just 46,543 were defined benefit plans
(with 41.4 million participants and $2.5 trillion in assets), while 654,469 were defined contribution plans
(with 88.3 million participants and $3.8 trillion in assets). Id.