A Futurist Past

Salisbury

Salisbury

By Dallas Salisbury, EBRI

At EBRI’s 35th anniversary policy forum last December, it occurred to me that one of the youngest minds in the room happened to belong to the oldest panelist we had invited. Arnold Brown, 87 when he spoke at our forum, was nationally renowned not only for his insightful observations about the future, but his often surprising predictions of how the American labor force—and the employment-based benefits on which they depend—might change in response. How fitting that the forum panel on which he participated was titled “The Road to Tomorrow.”¹

So I was especially saddened to hear of his recent passing, shortly before his 88th birthday. He died surrounded by family, who described him as “brilliant, witty, wise and generous.” Having followed him and his work closely in my own career, I would agree with all that and more.

At a time when news reports warn of the “technological divide” between the young and the old in this country, Brown’s specialty was using hard data to help us understand why and how technology is changing our lives. Ironically for a tech-head, he started out as an English major (he graduated with honors from UCLA), before going on to serve in the Navy.

Arnold Brown

Arnold Brown

His big break on the national stage came when he was vice-chairman of the American Council of Life Insurers, where in 1969 he created ACLI’s Trend Analysis Program. This was the first, and considered among the best, “environmental scanning programs” that focused on long-range business planning and strategy. In 1977, he formed his own company, Weiner, Edrich, Brown, Inc., consultants in strategic planning and the management of change, where many of the biggest companies in the world would become clients. Not surprisingly, he served as board chairman of the World Future Society.

Much of his recent work focused on the trend toward “deskilled workers,” as more and more employers turn to computers, software, and robots to replace both blue-collar and white-collar human employees. He pointed out the many ripple effects that is already having and will have going forward, especially on state and federal social insurance programs that depend on taxes drawn from employment payrolls to survive. As workers are increasingly replaced by robots, Brown asked at the EBRI forum, “Should we require employers of robots to pay Social Security for them?”

Among his other thought-provoking, data-driven points at the EBRI forum:

  • The prolonged recession has masked what he called a “profound transformation of the economy” driven by automation, one that has to do with the very nature of work and jobs as the nation moves into the future. In 2012, he noted, approximately 85 percent of robots were purchased were for manufacturing purposes, and within the next few years 30 percent or more of robots will be for non-manufacturing, white-collar use.
  • Part-time, contract, and temporary workers are becoming the norm worldwide. Brown noted that in France in 2012, 82 percent of the new jobs created were temporary, and in Germany, what are referred to as “mini jobs” (low-paid, short-term jobs) now comprise 20 percent of all jobs in that economy. Another aspect of this job trend: Of the 16-to-25-year-old cohort not currently in school, barely a third (36 percent) have full-time jobs, and a major reason for this is new technology (such as 3-D printing), he said.
  • The upshot is that “The old model of the contract between employer and employee is increasingly obsolete,” Brown said at the EBRI forum, and “more and more, we will need a new model of what the relationship will be between the employer and the employee.” Over the next 35 years, he predicted, there will evolve “an entirely different, unprecedented relationship in the workplace between employers and employees, and what the consequences of that will be are really very profound in terms of what your businesses will be facing.”

Professionally, I greatly admired his acute use of data to make highly informed analysis about the future. Personally, I deeply admired how someone almost in his 90s lived so much in the future.

In Washington, there is naturally great attention given to how federal law (particularly tax law) and regulation affect business and employee benefits. But Arnold Brown’s focus was elsewhere: How the economy—and the underlying technology and skills that drive it—affect not only the business world, but society as a whole, faster and far more powerfully than even government policy.

His keen mind and often accurate predictions will be missed.

Notes

¹ The complete report on the EBRI 35th anniversary policy forum, “Employee Benefits: Today, Tomorrow, and Yesterday,” is published in the July EBRI Issue Brief and is online here.

Myth Understandings

Nevin AdamsBy Nevin Adams, EBRI

A frequent criticism of the 401(k) design is that it was “never designed” to provide a full retirement benefit, unlike, as it’s often stated or implied, the defined benefit plan.

Moreover, while there is a very real tendency to focus on the CURRENT balance[i] in a defined contribution/401(k) plan and treat that as the ultimate outcome, for reasons I’ve never really been able to understand, people tend to think and talk about defined benefit (DB) plans in terms of the benefit they are capable of providing, rather than the actual benefits paid.

However, the data show that some of the common assumptions about defined benefit pensions are out of line with the realities, including:

Once upon a time, everybody had a pension.

“Coverage” is a hot topic among policymakers these days, or more accurately, the lack of it. One of the most frequently invoked criticisms of the current system is that so many American workers don’t have access to a retirement plan at work. But in 1979, only 28 percent of private-sector workers participated in a DB plan, with another 10 percent participating in both a DB and defined contribution (DC) plan. By any measure, that’s a long way from “everybody.”

The reality is that more private-sector workers are participating in a workplace retirement plan today than in 1979.

People used to work for the same employer their whole careers.

My kids think their generation is the first to anticipate having many employers during their careers, but the reality is that American workers, certainly in the private sector, have long been relatively mobile in the workforce. Median job tenure of the total workforce has hovered at about five years since the early 1950s (in fact, as EBRI’s latest research points out, the average median job tenure has now risen, to 5.4 years).[ii] The data on employee tenure—the amount of time an individual has been with his or her current employer—show that career jobs never existed for most workers and have continued not to exist for most workers.

And that has implications for pension benefits.

Everybody who had a pension got a full benefit.

Those who know how defined benefit plan accrual formulas work understand that the actual benefit is a function of some definition of average pay and years of service. Moreover, prior to the mid-1980s, 10-year cliff vesting schedules were common for DB plans. What that meant was that if you worked for an employer fewer than 10 years, you’d be entitled to a pension of … $0.00.

As noted above, the American workforce has, since the end of World War II, been relatively, and consistently, mobile. Between 1987 and 2012, among private-sector workers, fewer than 1 in 5 have spent 25 years or more with one employer. Under pension accrual formulas, those kinds of numbers meant that, even among the workers who were covered by a traditional pension, many would actually receive little or nothing from that plan design.

And that’s for those who were covered in the first place[iii].

People used to get more retirement income from pensions than they do today.

There are undoubtedly different challenges ahead for retirees than for prior generations – longer lives, higher health care costs, the pressures of affording long-term care – but when it comes to sources of retirement income for those over the age of 65, there has been remarkably little change over the past several decades.

Social Security is and has been a consistent source, representing somewhere between 40 and 45 percent of aggregate income (excluding non-periodic distributions from DC plans and IRAs) during most of that time, and into the current time, according to data from the Census Bureau. Pension annuity income, which constituted about 16 percent of aggregate income in 1976, rose to as high as 21 percent in the early ’90s – about where it stands today.

There’s no question that some Americans in the private sector have derived, and will continue to derive, significant retirement income from DB plans, and DB plans did and can deliver for the portion of the population that does stay with one employer/plan for a full career[iv].

The data show, however, that many Americans were not covered by those plans, even in the “good old days,” and that even many of those who were covered, for a time anyway, were not likely to receive the full benefit that the design was capable of delivering because they didn’t have, or take advantage of, the opportunity.

Sound familiar?

Notes

[i] Worse, that 401(k) balance is frequently an AVERAGE 401(k) balance, which includes the relatively small balances of those who have just started saving with those who have had a full career to save. That’s why reports from the EBRI/ICI 401(k) database have long differentiated average and median balances by age and tenure. See “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2012.”

[ii] See “Employee Tenure Trends, 1983–2012.”

[iii] Expectations for pension benefits appear to exceed the reality, even among workers. The 2014 Retirement Confidence Survey found that while 56 percent of workers expect to receive benefits from a defined benefit plan in retirement, only 31 percent report that they and/or their spouse currently have such a benefit with a current or previous employer. See here

 [iv] For an analysis of possible outcomes from DB and 401(k) plans, see “Reality Checks: A Comparative Analysis of Future Benefits from Private-Sector, Voluntary-Enrollment 401(k) Plans vs. Stylized, Final-Average-Pay Defined Benefit and Cash Balance Plans.”

 

Safety “Net”

By Nevin Adams, EBRI

Nevin Adams

Nevin Adams

I’m one of those travelers who absolutely dreads cutting it to the last minute. Not that I haven’t been forced to do so, from time to time, but I’m generally the one chomping at the bit to get to the airport, or to hit the highway an hour before anyone else. In my defense, on more than one occasion that “cushion” has been the difference between catching a flight or not. Planning that only considers a “best” or “normal” scenario too often overlooks the unexpected—and sometimes that margin of error is all you have.

For over a decade EBRI has modeled the nation’s potential retirement savings shortfall, and the EBRI Retirement Readiness Ratings™ provide an assessment of how many Americans are at risk of running short of money for needed expenses in retirement. In contemplating expenses, that model considers the regular expenses of living in retirement, as well as uninsured medical expenses, and the potential costs of nursing home care.

However, we have also documented and quantified the role of Social Security, defined benefit and private retirement accounts on retirement income adequacy for Baby Boomers and Gen Xers with an eye toward replacing their preretirement wages and income. While this more traditional focus on income replacement may misstate an individual’s actual post-retirement financial situation, many financial planners work with this goal as a starting point, and it can provide valuable insights particularly when—as is the case with EBRI’s projections—it is able to leverage actual 401(k) data from the unique EBRI/ICI 401(k) database, the largest such repository in the world.

Indeed, based on a recent EBRI analysis, between 83 and 86 percent of workers with more than 30 years of eligibility in a voluntary enrollment 401(k) plan are simulated to have sufficient 401(k) accumulations that, combined with current levels of Social Security retirement benefits, will be able to replace at least 60 percent of their age-64 wages and salary on an inflation-adjusted basis. When the threshold for a financially successful retirement is increased to 70 percent replacement of age-64 income, 73–76 percent of these workers will still meet that threshold, relying only on 401(k) and Social Security combined. At an 80 percent replacement rate, 67 percent of the lowest-income quartile will still meet the threshold; however the percentage of those in the highest-income quartile deemed to be “successful” relying on just these two retirement components slips to 59 percent, reflecting the progressive nature of Social Security.

As positive a result as that seems for many, when the same analysis is conducted for automatic enrollment 401(k) plans (with an annual 1 percent automatic escalation provision and empirically derived opt-outs), the probability of success increases substantially: 88–94 percent at a 60 percent threshold; 81–90 percent at a 70 percent replacement threshold; and 73–85 percent at an 80 percent threshold.

That’s not quite the doomsday crisis scenario portrayed by many of the headlines in vogue today, though EBRI’s projections still show that a large number of Americans—even among those eligible for a 401(k) plan for 30 years—won’t be able to replace that pre-65 salary even at the various levels modeled, based on current savings patterns.

It does, however, illustrate the impact that changes in those current savings behaviors can have—and it underscores the significant role of Social Security as a vital safety net for the nation’s retirement security.

Note

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

Take it or Leave it?

By Nevin Adams, EBRI
Nevin Adams

Nevin Adams

While each situation is different, in my experience leaving a job brings with it nearly as much paperwork as joining a new employer. Granted, you’re not asked to wade through a kit of enrollment materials, and the number of options are generally fewer, but you do have to make certain benefits-related decisions, including the determination of what to do with your retirement plan distribution(s).

Unfortunately, even in the most amicable of partings, workers have traditionally lacked the particulars to facilitate a rollover to either an individual retirement account (IRA) or a subsequent employer’s retirement plan—and thus, the easiest thing to do was simply to request that distribution be paid to him or her in cash.

Over the years, a number of changes have been made to discourage the “leakage” of retirement savings at job change: Legal thresholds for mandatory distributions have been set; a requirement established that distributions between $1,000 and $5,000 on which instructions are not received either be rolled over into an IRA or left in the plan; and even the requirement that a 20 percent tax withholding would be applied to an eligible rollover distribution—unless the recipient elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA. All these have doubtless served to at least give pause to that individual distribution “calculus” at job change.

Indeed, a recent EBRI analysis¹ indicates that workers now taking a retirement plan distribution are doing a better job at holding on to those retirement savings than had those in the past. Among those who reported in 2012 ever having received a distribution, 48.1 percent reported rolling over at least some of their most recent distribution into another tax-qualified savings vehicle, and among those who received their most recent distribution through 2012, the percentage who used any portion of it for consumption was also lower, at 15.7 percent (compared with 25.2 percent of those whose most recent distribution was received through 2003, and 38.3 percent through 1993).

As you might expect with the struggling economy, there was an uptick in the percentage of recipients through 2012 who used their lump sum for debts, business, and home expenses, and a decrease in the percentage saving in nontax-qualified vehicles relative to distributions through 2006. However, the EBRI analysis found that the percentage of lump-sum recipients who used the entire amount of their most recent distribution for tax-qualified savings has increased sharply since 1993: Well over 4 in 10 (45.2 percent) of those who received their most recent distribution through 2012 did so, compared with 19.3 percent of those who received their most recent distribution through 1993.

The EBRI report also notes that an important factor in the change in the relative percentages between the 1993 and 2012 data is the percentage of lump sums that were used for a single purpose. Consider that among those who received their most recent distribution through 2012, nearly all (94.0 percent) of those who rolled over at least some² of their most recent distribution did so for the entire amount.

There is both encouraging and disappointing news in the EBRI report findings: The data show that improvement has been made in the percentage of employment-based retirement plan participants rolling over all of their LSDs on job change, along with less frequent pure-consumption use of any of the distributions. However, the data also show that approximately 55 percent of those who took a lump-sum payment did not roll all of it into tax-qualified savings.

In common parlance, “Take it or leave it” is an ultimatum—an “either/or” proposition that frequently comes at the end, not the beginning, of a decision process. However, as the EBRI analysis indicates, for retirement plan participants it is a decision that can (certainly for younger workers, or those with significant balances) have a dramatic impact on their financial futures.

Notes
¹ The November 2013 EBRI Notes article, “Lump-Sum Distributions at Job Change, Distributions Through 2012,” is online here. 
² Two important factors in whether a lump-sum distribution is used exclusively for tax-qualified savings appear to be the age of the recipient and the size of the distribution. The likelihood of the distribution being rolled over entirely to tax-qualified savings increased with the age of the recipient at the time of receipt until age 64. Similarly, the larger the distribution, the more likely it was kept entirely in tax-qualified savings.

Use It or “Lose” It

By Nevin Adams, EBRI

nevinadams

At the time that EBRI was founded 35 years ago, I was about six months into a job doing pension accountings for a large Midwestern bank. At the time, I didn’t realize I’d still be working with those kinds of issues in 2013—in fairness, like most recent college graduates, I wasn’t really thinking about anything that was 35 years in the future. I had a job, a car that ran, and a reasonably nice stereo in an apartment in the Chicago suburbs that didn’t have much else.

My employer had a nice defined benefit (DB) pension, and an extraordinarily generous thrift-savings plan, but those weren’t big considerations at the time. I had to wait a year to participate in the latter (pretty much standard at the time), and as for the former—well, you know how exciting pension accruals are to 22-year-olds (even those who get paid to do pension accountings). Turns out, I worked there for nearly a decade, and walked away with a pretty nice nest egg in that thrift savings plan (that by then had become a 401(k)), and a pension accrual of…$0.00.

At the time, I didn’t think much about that.  Like many private-sector workers, I hadn’t contributed anything to that pension, and thus getting “nothing” in return didn’t feel like a loss.

By the time I left my second employer (this time after 13 years), the mandated vesting schedules had been shortened by legislation—but even then, the benefit I hope to collect one day won’t amount to much on an annual basis, and won’t be anything like the benefit that plan might have provided if only I had remained employed there – for the past 20 years. Instead, like my service with that prior employer, that DB benefit is frozen in time. That result stands in sharp contrast with the 401(k) balances I have accumulated and that continue to grow, despite having changed employers twice since then.

Of course, national tenure data suggest that my job experience was something of an anomaly.  When you consider that median job tenure in the United States  has hovered in the five-to-seven-year range going back to the early 1950s[i], there have doubtless been many private-sector workers who were, for a time, like me, participants in a traditional defined benefit pension plan, only to see little or nothing come of that participation[ii].

I often hear people say that 401(k)s were “never designed to replace pensions,” a reference to the notion that the benefit defined by most traditional pension plans stood to replace a significant amount of pre-retirement income at retirement.  Now, there’s no question that the voluntary nature of the 401(k) programs, as well as their traditional reliance on the investment direction and maintenance by participants, can undermine the relative contribution of the employer-sponsored plan “leg” to a goal of retirement income adequacy.

However, what often gets overlooked in the comparison with 401(k)s is that when you consider the realities of how most Americans work, traditional defined benefit realities frequently fell short of that standard as well. Indeed, in many cases, based on the kinds of job changes that occur all the time, and have for a generation and more, they could provide far less[iii].

In both cases, it’s not the design that’s at fault—it’s how they are used, both by those who sponsor these programs, as well as those who are covered by them.

Notes 


[i] See “Employee Tenure Trends, 1983–2012” available here.  

[ii] And a great number of private-sector workers never participated in a defined benefit plan.  See “Pension Plan Participation” available here.  

[iii] A recent EBRI Issue Brief provides a direct comparison of the likely benefits under specific types of defined contribution (DC) and DB retirement plans. See “Reality Checks: A Comparative Analysis of Future Benefits from Private-Sector, Voluntary-Enrollment 401(k) Plans vs. Stylized, Final-Average-Pay Defined Benefit and Cash Balance Plans”.

“After” Images

By Nevin Adams, EBRI

Adams

Adams

“Replacement rates”—roughly defined as the percentage of one’s pre-retirement income available in retirement—arguably constitute a poor proxy for retirement readiness.

Embracing that calculation as a retirement readiness measure requires accepting any number of imbedded assumptions, not infrequently that individuals will spend less in retirement. While there is certainly a likelihood that less may be spent on such things as taxes, housing, and various work-related expenses (including saving for retirement), there are also the often-overlooked costs of post-retirement medical expenses and long-term care that are not part of the pre-retirement balance sheet.

That said, replacement rates are relatively easy to understand and communicate, and, as a result, they are widely used by financial planners to facilitate the retirement planning process. They are also frequently employed by policy makers as a gauge in assessing the efficacy of various components of the retirement system in terms of providing income in retirement that is, at some level, comparable to that available to individuals prior to retirement.

A recent EBRI analysis looked at a different type of measure, one focused on the years prior to the traditional retirement age of 65, specifically a post-65 to pre-65 income ratio. The analysis was intended to provide a perspective on household income five and 10 years prior to age 65 compared with that of household income five and 10 years after age 65, specifically for households that didn’t change marital status during those periods. Note that in some households at least one member continues to work after age 65 (part-time in many cases) and may not fully retire until sometime after the traditional retirement age of 65.

Based on that pre- and post-65 income comparison, the EBRI analysis finds that those in the bottom half of income distribution did not experience any drop in income after they reached 65, although the sources of income shifted, with drops in labor income offset by increases in pension/annuity income and Social Security.

That was not, however, the case for those in the top-income quartile, who experienced a drop in income as they crossed 65, with their post-65 income levels only about 60 percent of that in the pre-65 periods.

This is not to suggest that the lower-income households were “well-off” after age 65. Changes in marital status, not considered in this particular analysis, particularly in the years leading up to (and following) retirement age, can have a dramatic impact on household income.

The current analysis does, however, show that Social Security’s progressivity is serving to maintain a level of parity for lower-income households with household income levels in the decade before reaching age 65, and in some cases to improve upon that result—and it helps underline the significance of the program in providing a secure retirement income foundation.

The EBRI report, published in the September EBRI Notes, “How Does Household Income Change in the Ten Years Around Age 65?” is available online here.

“Better” Business?

By Nevin Adams, EBRI

Adams

Adams

It has become something of a truism in our industry that defined benefit plans are “better” than defined contribution plans. We’re told that returns are higher(1) and fees lower in the former, that employees are better served by having the investment decisions made by professionals, and that many individuals don’t save enough on their own to provide the level of retirement income that they could expect from a defined benefit pension plan. Even the recent (arguably positive) changes in defined contribution design—automatic enrollment, qualified default investment alternatives, and the expanding availability of retirement income options(2)—are often said to represent the “DB-ification” of DC plans.

However, a recent analysis by EBRI reveals that DB is not always “better,” at least not defined as providing financial resources in retirement. In fact, if historical rates of return are assumed, as well as annuity purchase prices reflecting average bond rates over the last 27 years, the median comparisons show a strong outcome advantage for voluntary-enrollment (VE) 401(k) plans over both stylized, final-average DB plan and cash balance plan designs.(3)

Admittedly, those findings are based on a number of assumptions, not the least of which include the specific benefit formulae of the DB plans, and the performance of the markets. Indeed, the analysis in the June EBRI Issue Brief takes pains not only to outline and explain those assumptions,(4) but, using EBRI’s unique Retirement Security Projection Model® (RSPM) to produce a wide range of simulations, provides a direct comparison of the likely benefits in a number of possible scenarios, some of which produce different comparative outcomes. While the results do reflect the projected cumulative effects of job changes and things like loans, as well as the real-life 401(k) plan design parameters in several hundred different plans, they do not yet incorporate the potentially positive impact that automatic enrollment might have, particularly for lower-income individuals.

Significantly, the EBRI report does take into account another real-world factor that is frequently overlooked in the DB-to-DC comparisons: the actual job tenure experience of those in the private sector. In fact, as a recent EBRI Notes article(5) points out, the data on employee tenure (the amount of time an individual has been with his or her current employer) show that so-called “career jobs” NEVER existed for most workers. Indeed, over the past nearly 30 years, the median tenure of all wage and salary workers age 20 or older has held steady, at approximately five years. Even with today’s accelerated vesting schedules, that kind of turnover represents a kind of tenure “leakage” that can have a significant impact on pension benefits—even when they work for an employer that offers that benefit, they simply don’t work for one employer long enough to qualify for a meaningful benefit.

So, which type of retirement plan is “better”? As the EBRI analysis illustrates, there is no single right answer—but the data suggests that ignoring how often people actually change employers can be as misleading as ignoring how much they actually save.

Notes

(1) In the days following publication of the EBRI Issue Brief, (“Reality Checks: A Comparative Analysis of Future Benefits from Private-Sector, Voluntary-Enrollment 401(k) Plans vs. Stylized, Final-Average-Pay Defined Benefit and Cash Balance Plans,” online here),  a number of individuals commented specifically on the chronicled difference in return in DB and DC plans; outside of some exceptions in the public sector, DB investment performance generally has no effect on the benefits paid.

(2) A recent EBRI analysis indicates that, even in DB plans, the rate of annuitization varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution. See “Annuity and Lump-Sum Decisions in Defined Benefit Plans: The Role of Plan Rules,” online here.

(3) While the DC plans modeled in this analysis draw from the actual design experience of several hundred VE 401(k) plans, in the interest of clarity it was decided to limit the comparisons for DB plans to only two stylized representative plan designs: a high-three-year, final-average DB plan and a cash balance plan. Median generosity parameters are used for baseline purposes but comparisons are also re-run with more generous provisions (the 75th percentile) as part of the sensitivity analysis.

(4) The report notes that a multitude of factors affect the ultimate outcome: interest rates and investment returns; the level and length of participation; an individual’s age, job tenure, and remaining length of time in the work force; and the purchase price of an annuity, among other things.

(5) The EBRI report highlights several implications of these tenure trends: the effect on DB accruals (even for workers still covered by those programs), the impact of the lump-sum distributions that often accompany job change, and the implications for social programs and workplace stability. “See Employee Tenure Trends, 1983–2012,” online here.