“Common” Sense?

By Nevin Adams, EBRI

Nevin Adams

Nevin Adams

At a time when the nation’s legislative wheels seem mired in partisanship, the last week of January turned out to be a busy one for retirement plan proposals.

First the president unveiled his myRA concept in the State of the Union (along with a reference to an automatic IRA proposal previously included in the White House’s annual budget), followed a day later by introduction of the Retirement Security Act of 2014, a bipartisan proposal by Sens. Bill Nelson (D-FL) and Susan Collins (R-ME). A day after that, Sen. Tom Harkin (D-IA), chairman of the Senate Health, Education, Labor, and Pensions (HELP) Committee, formally introduced the Universal, Secure, and Adaptable (USA) Retirement Funds Act of 2014, an updated version of his 2012 proposal.

All three were intended to expand and improve the retirement savings of Americans—although, as you might expect, the three take quite different approaches. Consider that the myRA calls for the development of a “new retirement savings security” to encourage savings in a kind of Roth IRA, while Sen. Harkin’s proposal would require employers above a certain size to offer a whole new type of retirement savings plan (and would impose some new threshold enrollment and withdrawal requirements on existing 401(k)s, as well). As for the Nelson/Collins proposal, it seems to be largely focused on lowering or removing certain current regulatory and administrative barriers to smaller employers offering retirement plans.

Despite their varied approaches to the commonly-stated goal of expanding retirement savings, all three do have one other key commonality: All look to leverage the success of the work place and systematic payroll deductions in fostering retirement savings. Of course, that’s a foundation whose worth previous EBRI research has documented:¹ the impact that eligibility for a work place retirement plan can have on retirement readiness,² as well as the additional help that automatic-enrollment designs can provide.

It remains to be seen whether the legislative proposals will go anywhere—and the potential impact of myRA on motivating new savers is also uncertain. Just this week, Senate Majority Leader Harry Reid (D-NV) introduced a proposal on defined benefit pension smoothing—not to provide any kind of help for retirement, but as a way to pay for a three-month extension of unemployment benefits.

But as America Saves Week nears, the activity on Capitol Hill serves as an additional reminder that a good place to start—any time, with or without the incentives of legislative change—is to Choose to Save. ®³

Notes

¹ The January EBRI Notes, “The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis,” is available online here.

² See “The Impact of Automatic Enrollment in 401(k) Plans on Future Retirement Accumulations: A Simulation Study Based on Plan Design Modifications of Large Plan Sponsors,” online here, and “Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation,” online here.

³ You can find a wide variety of tools and resources—including the popular and widely recommended Ballpark E$timate—at http://www.choosetosave.org/

“Upside” Potential

By Nevin Adams, EBRI

Adams

Adams

I once spent a very uncomfortable period of time stuck in one of those carnival rides that, for brief periods of time, spins riders in a circle as the cab you are in also twirls. As uncomfortable as the ride was, the “stuck” part came while my cab was high in the air—and turned upside down. In no time at all, it was obvious that this extended “upside down” state wasn’t contemplated by those who designed the seating compartment (nor, apparently, had they considered that my compartment “mate” would find it exciting to rock our stuck cab during our brief “internment”).

One of the comments you hear from time to time is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, those who perhaps don’t need the encouragement to save. And from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Indeed, if those “upside-down incentives” were the only forces at work, one might reasonably expect to find that the higher the individual’s salary, the higher the overall account balance would be, as a multiple of salary. However, drawing on the actual administrative data from the massive EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), those ratios hold relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000.

In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes—and not “upside down.”

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(click to enlarge)

As those who work with these programs know, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Secs. 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that—to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

And that’s why focusing only on the incentives—and not also on the limits—can leave you “stuck” with only part of the answer.

Impact “Ed”

By Nevin Adams, EBRI

Adams

Adams

Last month, the U.S. Senate Committee on Health, Education, Labor and Pensions (HELP) held a hearing titled “Pension Savings: Are Workers Saving Enough for Retirement?” The answer to that question is, of course, about as varied as the individual circumstances it contemplates, but certainly at a high level, the best answer is, “it depends.”

It depends on your definition of “enough,” for one thing—and it might well depend on your definition of retirement, certainly as to when retirement begins, not to mention your assumptions about saving and/or working during that period.(1) While those are individual choices (sometimes “choices” imposed on us), they can obviously make a big difference in terms of result.

For public policy purposes, EBRI has defined adequate retirement income as having the financial resources to cover basic expenses plus uninsured medical costs in retirement. Working from that definition as a starting point, along with an assumption that retirement represents the cessation of paid employment and begins at age 65, we have projected that approximately 44 percent of Baby Boomer and Gen-Xer households are simulated to be at risk of running short of money in retirement, assuming they retain any net housing equity until other financial resources are depleted. That’s a lot of households, to be sure, but as an EBRI report noted last year, it includes a wide range of personal circumstances, from individuals projected to run short by as little as a dollar to those projected to fall short by tens of thousands of dollars.(2)

However, the focus of the recent Senate HELP hearing quickly turned from an acknowledgement that many workers aren’t saving enough to what to do about it. In a recent response to questions posed at the hearing,(3) EBRI Research Director Jack VanDerhei compiled a list of alternatives that EBRI research has modeled in recent years, some mentioned at the hearing, along with the impact each is projected to have on that cumulative savings shortfall.

Specifically, the impacts quantified on retirement readiness included in EBRI’s response were:

  • The availability of defined benefit (pension) plans.
  • Future eligibility for a defined contribution (401(k)-type) plan.
  • Increasing the 401(k) default deferral rate to 6 percent.
  • Job changes and default deferral rate restarts.
  • 401(k0 Loans and pre-retirement withdrawals.

The impacts of these factors vary, of course. Consider that, overall, the presence of a defined benefit accrual at age 65 reduces the “at-risk” percentage by about 12 percentage points. On the other hand, merely being eligible for participation in a DC plan makes a big difference as well: Gen Xers with no future years of DC plan eligibility would run short of money in retirement 60.7 percent of the time, whereas fewer than 1 in 5 (18.2 percent) of those with 20 or more years of future eligibility are simulated to run short of money in retirement.(4)

Ultimately, if you’re looking to solve a problem, it helps to know what problem you’re trying to solve. And you don’t just want to know that a solution will make a difference, you want to know how much of a difference that solution will make.

Notes

(1) Many other projections overlook, implicitly or explicitly, uninsured medical costs in retirement, and many simply publish a projected average result that will be correct only 50 percent of the time, without acknowledging these limitations. Moreover, while various estimates have been put forth for the aggregate retirement income deficit number, when taking into account current Social Security retirement benefits and the assumption that net housing equity is utilized “as needed,” as well as uninsured health care costs, the EBRI Retirement Security Projection Model (RSPM) indicates the aggregate national retirement income deficit to be $4.3 trillion for all Baby Boomers and Gen.

(2) Nearly one-half (49.1 percent) of Gen Xers are projected to have at least 20 percent more than is simulated to be needed, for example, while about 1 in 5 (19.4 percent) are projected to have less than 80 percent of what is needed. See “All or Nothing? An Expanded Perspective on Retirement Readiness,” online here.

(3) The EBRI response to the Senate HELP hearing questions is available online here.

(4) See “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,” online here.

Missed Behaviors

By Nevin Adams, EBRI

Adams

Adams

As the nation continues to grapple with fiscal challenges, the subject of so-called “tax expenditures,” (the amount of tax breaks accorded various programs) has attracted a great deal of attention. Critics of the current tax preferences structure for work place retirement plans have questioned the efficacy of those preferences relative to the savings produced.

In that vein, a recent study¹ examined the experience of the Danish pension system to consider the relative impact of government retirement-savings tax preferences on savings behaviors, as well as the impacts on savings patterns of a mandate that required all Danish citizens to contribute 1 percent of their earnings to a retirement savings account from 1998 until 2003.

In explaining their rationale for drawing on the Danish pension experience, the study’s authors described that nation’s pension system as “broadly similar in structure” to that in the United States and other developed countries, in that it has individual accounts, employer-provided pensions, and a government-supported defined benefit (DB) retirement plan. However, while the components are similar, as a recent EBRI Notes article² points out, the Danish retirement system functions differently in several critical aspects.

The Danish Experience

Not surprisingly, the research on Danish workers noted a “sharp increase” in savings rates in 1998 (when the mandate took hold), and sharp reductions in total savings in 2004 (when the mandate lapsed). They also considered worker savings responses when, in 1999, the Danish government reduced the subsidy for contributing to capital pension accounts for individuals in the top income tax bracket, noting that while contributions fell sharply for individuals in the top bracket, they “remained virtually unchanged for individuals just below that bracket.” In other words, the individuals directly affected by changes in the incentives reacted, while those for whom the tax subsidy was unchanged did not.

They also found that the reduction in incentives also had a larger effect on Danish workers who make frequent changes to their pension contributions. In essence, Danish savers who were actively making decisions about their pension contributions were more likely to respond to the change in incentives than other individuals. This group the study authors classified as “active savers,” who, as it turns out, also have significantly higher wealth/income ratios and were more likely to be older than other Danish workers in the study.

Combining all these results, the authors arrive at two top-line conclusions about the saving behavior of Danish workers. First, that only 15 percent of those individuals are “active” savers, that only those active savers respond to tax incentive changes, and then largely only by reallocating savings between their tax-deferred pension accounts and taxable savings accounts. Second, for these active savers, a $1 of tax expenditure by the government on subsidies for retirement savings raises total savings by only about 1 cent, on average. Not surprisingly, these conclusions have drawn the attention of those who question the efficacy of the current retirement savings tax incentives in the U.S. But is this Danish experience relevant to the United States?

For the most part, the U.S. private sector relies on a voluntary retirement system—both on the part of workers to participate and save, and, significantly, on the part of employers to not only sponsor but also encourage participation with education, payroll deduction, and matching contributions. Furthermore, while U.S. employers sponsor these programs to attract and retain workers, they are encouraged to do so by certain tax preferences, conditional on administering the plan in accordance with various “nondiscrimination” standards. However, if the tax-deferred status of pension savings accounts were altered, previous surveys have shown these ties would almost certainly be weakened, if not entirely broken.³

Ultimately, the study of Danish worker savings behaviors was just that, and—as a study of individual savings behaviors in that environment—it has merit. It did not, however, consider the reaction of employers to these kind of changes. Those who would draw lessons from that experience should consider that the “success” of defined contribution work place retirement plans in the United States currently depends on the behavior of TWO parties: workers who voluntarily elect to defer compensation, and employers that choose to sponsor and, in many cases, contribute to them.

Notes

¹ See Chetty, Raj, John N. Friedman, Soren Leth-Petersen, Torben Heien Nielsen, and Tore Olsen, “Active vs. Passive Decisions and Crowd-Out in Retirement Savings Accounts: Evidence from Denmark,” NBER Working Paper # 18565, November 2012, online here.

² See “Tax Preferences and Mandates: Is the Danish Savings Experience Applicable to the United States?”

³ A survey conducted on behalf of The Principal Financial Group in 2011 determined that if workers’ ability to deduct any amount of the 401(k) contribution from taxable income was eliminated, 65 percent of the plan sponsor respondents would have less desire to continue offering their 401(k) plan. A separate survey of plan sponsors by AllianceBernstein that same year found that small plan sponsors were more likely to respond negatively to a proposed change in the deductibility of contributions by employees than larger employers—the impact of the loss of access to plans, and to the matching contributions often associated with those plans, was documented in previous EBRI research. See “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances,” online here.

“Churn” Factors

By Nevin Adams, EBRI

Adams

Adams

British Statesman and Philosopher Edmund Burke famously commented that “”Those who don’t know history are destined to repeat it.”(1) Indeed, those with experience working with employee benefit plans, can attest to a certain déjà vu-esque quality amidst the recent discussions about tax reform, limiting deductions, and “capping” contributions. These, are, in many ways, old “solutions,”(2) albeit these days arguably applied to a new (or at least different) set of circumstances.

As the 113th Congress begins its work, and the Obama administration readies for a second term, it is perhaps not surprising that the nuances of employee benefit plans and their tax treatment might not be an area of expertise for many on Capitol Hill. However, for all the longevity in tenure frequently assumed regarding those in Congress, a review of the data shows just how much turnover has taken place.

For example, you might not be surprised to learn that no member of the current Senate was in office when Medicare, or even ERISA was signed into law. But, as EBRI President and CEO Dallas Salisbury noted recently for the EBRI Board of Trustees, just three of the current 100 members of the Senate were there when Sec. 401(k) became law, and only 10 were there when the Tax Reform Act of 1986 became a reality. Fewer than half of the Senate were in their current office when the Pension Protection Act of 2006 passed.(3)

The implications for policy making in the midst of that kind of turnover are significant for employers and employees alike. Moreover, in an environment where expanding the transferability of Roth 401(k) balances is positioned as a revenue-generating mechanism to stave off sequestration, it seems increasingly obvious that every item of potential revenue or cost savings will be viewed through a new prism of scrutiny, where the short-term cost of the benefit may well trump the long-term value. And, as the data above suggests, by many who come to these deliberations without the full understanding and appreciation that experience in these complicated matters—a “history”—can provide.

One of EBRI’s founding principles in 1978(4) was the acknowledgement that “an ongoing need exists for objective, unbiased information regarding the employee benefit system, so that decisions affecting the system may be made based on verifiable facts.” And, as EBRI approaches its 35th anniversary, it’s clear that that need for information, and its critical role in making thoughtful decisions, remains undiminished.

Senate.Turnover

BensPolicyEd

Notes

(1) A century later George Santayana would write in his “Reason in Common Sense, The Life of Reason, Vol.1,” that “Those who cannot remember the past are condemned to repeat it.”

(2) In fact, a 1993 EBRI Issue Brief titled “Pension Tax Expenditures: Are They Worth the Cost?” cites a 1991 National Tax Journal article that observed, “Whereas the case for employer-sponsored pensions as an institution is strong, the case for a major tax expenditure is weak…given the demands on the budget, eliminating a tax expenditure that benefits a declining and privileged proportion of the population should be given serious consideration.“ See “Pension Tax Expenditures: Are They Worth the Cost?” online here. 

(3) See chart below, which tracks Senate turnover, by party, since 1975.

(4) See Facts about EBRI, online here. 

Most Workers Would Look for Alternatives if Health Benefits Are Taxed

What if Congress decides to start taxing workers’ health benefits as a means to raise revenue as part of an effort to rein in the federal deficit? More than half of American workers would either switch to a less costly plan, shop around, or drop coverage, according to new research from EBRI.

The 2012 EBRI/MGA Health Confidence Survey (HCS) finds that if current tax preferences were to change and employment-based coverage became taxable to workers, 26 percent would want to switch to a less costly plan, 21 percent say they would want to shop for coverage directly from insurers, and 9 percent say they would want to drop coverage altogether.  However, nearly 4 in 10 (39 percent) individuals say they would continue with their current level of coverage, up 10 percentage points from last year’s HCS findings.

While changes resulting from the Patient Protection and Affordable Care Act (PPACA) have raised concerns as to whether employers will continue to offer health coverage in the future, the 2012 HCS finds that health benefits remain a key a factor for workers in choosing a job, and health insurance in particular continues to be—by far—the most important employee benefit to workers.

“Most Americans are satisfied with the health benefits they have now and prefer not to change the mix of benefits and wages,” said Paul Fronstin, director of EBRI’s health Research and Education Program and author of the report. “About three-quarters say they are satisfied with the health benefits they currently receive, while 15 percent say they would trade wages to get more health benefits, and 9 percent say they would surrender health benefits for higher wages.”

Full results of the 2012 Health Confidence Survey are published in the December 2012 EBRI Notes, “Views on Employment-Based Health Benefits: Findings from the 2012 Health Confidence Survey,” online at www.ebri.org

The HCS examines a broad spectrum of health care issues, including Americans’ satisfaction with health care, confidence in the future of the nation’s health care system and the Medicare program, as well as their attitudes toward certain aspects of health care reform.

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“Next” Step

By Nevin Adams, EBRI

Adams

Adams

On December 13, EBRI will hold its 71st biannual policy forum, “’Post’ Script: What’s Next for Employment-Based Health Benefits?” It is a question that has been on the mind of employers, lawmakers and policymakers alike for some time now. It predates the time that the structure for the Patient Protection and Affordable Care Act (PPACA) was put in place, has evolved, but not been resolved, as regulations were, and continue to be issued subsequent to its passage. It has remained on the minds of employers, providers, and policymakers following the various courts’ assessment of the various challenges to the constitutionality of the law, and even as the nation went to the polls last month.

Today we know more than we once did about certain aspects of the law, its provisions and applications.¹And yet there is much yet to know about its broader implementation: How the insurance exchanges might work,² for example, or how their presence might affect or influence cost, access, or employer plan designs. Will employers step away from their traditional role in providing these benefits, or will these changes lead to an environment in which employers find them to be of even greater value to their retention programs and strategies? In addition, an overarching concern at present—not just for health benefits, but workplace benefits overall—is the potential impact that changes in tax policy³ could have on these programs, both direct and indirect.

Our next policy forum will bring together a wide range of national experts on U.S. healthcare policy to share a post-election perspective on fiscal impacts from the federal budget, findings from the EBRI Center for Research on Health Benefits Innovation, and a sense of how employment-based health benefits might evolve as a result of the changes set to come.

In a field as complex and sensitive as healthcare policy, we may not always know “what’s next”—but it’s our hope that the information, and interaction, at the EBRI policy forum will provide insights and clarity that can help.

EBRI’s 71st biannual Policy Forum will be held on Thursday, Dec. 13, from 9:00 a.m.–12:30 p.m. at the Henry J. Kaiser Family Foundation, 1330 G Street NW, Washington, DC 20005. The agenda and registration information are available online here. For those not able to attend in person, a free live webcast of the policy forum will be provided by the International Foundation of Employee Benefit Plans, online here.

Notes

¹ A summary of EBRI Research on PPACA and its Potential Impact on Private-Sector Health Benefits is available online here.  Of specific topical interest are:

² For insights on the topic of health insurance exchanges, see “Private Health Insurance Exchanges and Defined Contribution Health Plans: Is It Déjà Vu All Over Again?” online here.

³ See “Employment-Based Health Benefits and Taxation: Implications of Efforts to Reduce the Deficit and National Debt,” online here.