New papers from the Social Science Research Network

SOCIAL SECURITY, PENSIONS & RETIREMENT INCOME eJOURNAL

"The Importance of Defined Benefit Plans for Retirement Income Adequacy"

EBRI Notes, Vol. 32, No. 8, August 2011

JACK VANDERHEI, Employee Benefit Research Institute (EBRI)
Email: vanderhei@ebri.org

According to EBRI estimates, the percentage of private-sector workers participating in an employment-based defined benefit plan decreased from 38 percent in 1979 to 15 percent in 2008. Although much of this decrease took place by 1997, there have been a number of recent developments that have made defined benefit sponsors in the private sector re-examine the costs and benefits of providing retirement benefits through the form of a tax-qualified defined benefit plan. However, these plans still cover millions of U.S. workers and have long been valued as an integral component of retirement income adequacy for their households. In this paper, EBRI's Retirement Security Projection Model (RSPM) is used to evaluate the importance of defined benefit plans for households, assuming they retire at age 65. The paper shows the tremendous importance of defined benefit plans in achieving retirement income adequacy for Baby Boomers and Gen Xers. Overall, the presence of a defined benefit accrual at age 65 reduces the "at-risk" percentage by 11.6 percentage points. The defined benefit plan advantage (as measured by the gap between the two at-risk percentages) is particularly valuable for the lowest-income quartile but also has a strong impact on the middle class (the reduction in the at-risk percentage for the second and third income quartiles combined is 9.7 percentage points). The analysis also provides additional information on how the relative value of the defined benefit accruals impact retirement income adequacy. It should be noted that this analysis does NOT attempt to do a comparison between the relative effectiveness of defined benefit vs. defined contribution plans in providing retirement income adequacy; however, it does show that when the value of a defined benefit plan is analyzed for those without any future eligibility in a defined contribution plan, the impact on the at-risk ratings increases to 23.6 percentage points. In other words, for those households without future years of defined contribution eligibility, the presence of a defined benefit accrual at age 65 is sufficient to save nearly 1 out of 4 of these households in the Baby Boom and Gen X cohorts from becoming "at risk" of running short of money in retirement for basic expenses and uninsured medical expenses.

The PDF for the above title, published in the August 2011 issue of EBRI Notes, also contains the fulltext of another August 2011 EBRI Notes article abstracted on SSRN: "The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare."

"Social Security Reform: Sovereign Wealth Funds as a Model for Increasing Trust Fund Returns"

Fordham International Law Journal, 2011

BEN TEMPLIN, Thomas Jefferson School of Law
Email: btemplin@tjsl.edu

This article addresses the question of whether foreign sovereign wealth funds (SWFs) should serve as a model for the United States in managing the Social Security Trust Fund. The last ten years has seen a significant shift in the way countries manage public pension and social insurance reserve funds. Rather than invest solely in government bonds, many countries now use modern portfolio techniques to diversify assets and earn higher rates of return for their reserve funds. Even after considering the losses incurred during the 2007-2009 financial crisis, some funds have managed competitive returns. Well-run funds include those found in Canada, New Zealand, Norway and Australia.

Curiously, the U.S. has not followed suit even though the long-term benefits of a diversified portfolio are well-known. The reason for this economically irrational behavior is likely rooted in political beliefs about the role of government as an owner of private enterprise. Institutional studies suggest that the rules constraining government investment are not likely to change rapidly given the constraints of path dependence theory.

However, the U.S. has seen incremental change in terms of attitudes towards government ownership of private enterprise. Many states run venture capital funds and government employee pension funds have been successful as apolitical state investment entities. Moreover, attitudes towards foreign SWFs have shifted from fear and anxiety over politically motivated investments to a greater acceptance of sovereign investors as wealth-maximizing entities. Crisis also drives change. The Social Security Trust Fund is now expected to be depleted by 2036. Diversifying the Trust Fund could eliminate as much as 30 percent of Social Security's funding deficit and do so without raising taxes or reducing benefits.

Foreign sovereign wealth funds that were created for the purpose of funding national pension systems provide a model for the U.S. to form an independent entity that is apolitical yet able to be held accountable for its actions. As politicians grasp for solutions to Social Security's funding problems that minimize tax increases and benefit cuts, they should consider adopting the successful diversification models employed by other countries.

"Longevity, Life-Cycle Behavior and Pension Reform"

PETER HAAN, DIW Berlin, German Institute for Economic Research, Institute for the Study of Labor (IZA)
Email: phaan@diw.de
VICTORIA L. PROWSE, Cornell University - Department of Economics, Institute for the Study of Labor (IZA)
Email: vlprowse@gmail.com

How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.

"A Modest Proposal to Enhance Reporting and Other Tax Compliance by Owner-Employees and Their Pension Plans"

Tax Management Weekly Report, Vol. 30, No. 35, p. 1033, August 29, 2011

ALBERT FEUER, Law Offices of Albert Feuer
Email: afeuer@aya.yale.edu

Owner-employees often establish and maintain pension plans, which cover only themselves and their spouses ("Owner-Employee Plans") to qualify for favorable treatment under the Internal Revenue Code of 1986, as amended (the "Code"). Qualified plans must have governing instruments satisfying the qualification requirements, must be operated pursuant to those instruments, and must file annual plan reports and annual individual reports of plan distributions. Many Owner-Employee Plans violate some or all of those requirements. Moreover, some recipients do not report benefit distributions.

Four modest changes would improve compliance with the Code requirements pertaining to (1) an Owner-Employee or his beneficiaries including a benefit distribution in his or her income; (2) an Owner-Employee older than 70 ½ receiving minimum distributions; (3) the governing instruments of an Owner-Employee Plan satisfying tax qualification requirements; and (4) an Owner-Employee Plan operating pursuant to its governing instruments.

First, individuals would be required to include on their Form 1040s the names of those pension plans, if any, whose contributions they deduct from their total income to determine exclude from their adjusted gross income.

Second, Owner-Employer Plan administrators would be required to include in their Form 5500-EZ the amount of the plan's distributions and the number of participants at least 70 ½.

Third, the instructions to the Form 5500-EZ would remind plan administrators of the Code requirements (1) to report individual benefit distributions to the Service and the recipient representative, (2) to make minimum distributions to participants older than 70 ½, and (3) to operate the plan pursuant to governing instruments that satisfy tax qualification requirements.

Fourth, the lenient compliance programs pertaining to violations of the annual plan filing or prohibited transaction rules would be extended to Owner-Employee Plans, the only qualified plans excluded from such programs. If the final change is not adopted, in many cases only imprudent Owner-Employee would file annual plan reports or include plan distributions in their income because such disclosures could make the Service aware of prior violations that the Owner-Employee, unlike other pension plan fiduciaries, may not be able to correct at minimal cost.