Pension plan declines likely to hit younger workers hardest

The EBRI study, released May 4, notes that there are several forces behind the erosion of defined benefit pension plans: financial, regulatory and accounting pressures for employers to either freeze or terminate the pension plans they sponsor, and the increasing tendency for workers to take their pension payouts in single lump-sum distributions, rather than as annuities that are guaranteed to last their lifetime.

This analysis, contained in the May EBRI Issue Brief, “ERISA At 30: The Decline of Private-Sector Defined Benefit Promises and Annuity Payments? What Will It Mean?” is an effort to anticipate what will happen if current trends continue involving the decline of “traditional” defined benefit pension plans.

Among other things, it concludes that:

• Freezing all defined benefit accruals starting in 2005 would reduce the expected average real dollar first year surplus (beyond basic expenses) of families between age 39-43 by almost $4,900 a year. For single males, the loss would be more than $2,750 a year and for single females the loss would be almost $1,700 a year.

• Terminating all cash balance retirement plans (defined benefit pensions that are converted to function more like a defined contribution plan) would reduce the expected average real dollar first-year surplus of many high-income couples born since 1945 by more than $1,000.

• If one assumes that all defined benefit participants take lump-sum distributions at retirement, the median percentage of additional compensation that must be saved annually until retirement for a 75 percent chance of covering simulated expenses, is 14.9 percent, whereas assuming that all individual accounts are annuitized at retirement has an impact twice as large but in the opposite direction (a 30 percent decrease in needed additional annual savings).

The EBRI report notes that between 1975, when the Employee Retirement Income Security Act became effective, and 2003, the number of private employer-sponsored defined benefits pension plans declined from more than 100,000 to less than 31,000. In addition, a number of recent studies have been documenting the continuing decline of pension plans in the United States. Recent data suggests that more than one in every three Americans older than 65 receives pension income, with a third of this group receiving payment from a public-sector pension plan.

The report was written by Temple University Professor and EBRI Fellow Jack VanDerhei and EBRI Senior Research Associate Craig Copeland. It expands on a new model first used in late 2003 to predict retirement income adequacy. Because the figures given are averages for all retirees and only a fraction of future retirees are expected to receive payments from defined benefit plans, the actual impact on individuals with such coverage probably would be significantly greater than the average numbers.

It notes that various reforms now being proposed could lead to the death of many defined benefit plans. One survey found that one-half of corporations are likely to seriously consider reducing pension benefits if these initiatives are adopted.

EBRI President and CEO Dallas Salisbury said the findings of the report underline the need for policymakers to take action sooner rather than later in order to create greater regulatory certainty for pension plan sponsors. Decisions are needed, he noted, on the status of cash balance pension plans, permanent funding rules and interest rates to be used in plan calculations, accounting treatment related to how investment returns and interest rates affect pension plan assets, and rules and premiums paid by plan sponsors to the Pension Benefit Guaranty Corporation, the agency that insures pension plans.

“Until these kinds of policy decisions are made, further erosion of the defined benefit system can be expected to continue,” Salisbury said. “While the decisions made could either slow or speed that erosion, they would at least create an environment in which individuals could better assess what they are likely to have as retirement assets and income, and plan to continue working, or to exit the work force, accordingly. A demographic time bomb is ticking, and the time to act is now.”

EBRI is a private, nonprofit public policy research organization based in Washington, DC. Founded in 1978, its mission is to contribute to, to encourage, and to enhance the development of sound employee benefit programs and sound public policy through objective research and education. EBRI does not lobby and does not take positions on legislative proposals. EBRI receives funding from individuals, employers of all types, unions, foundations, and government.

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