Annuity Choice Driven by Pension Plan Rules

EBRI_IB_01-13.No381.Pg1_Page_01Why do some retiring workers with a pension choose to take a stream of lifetime income, while others cash out their entire benefit in a lump-sum distribution?

Amidst growing concerns about workers outliving their retirement savings, this has emerged as a key issue—and it depends to a large extent on whether the individual pension plan allows or restricts lump-sum distributions (LSDs), according to new research by EBRI. A better understanding of these decisions stands to shed light not only on the outcomes for traditional pensions, but also for defined contribution plans, where LSDs are the rule rather than the exception.

EBRI’s research, the first time this level of analysis has been done on this scale, reveals that differences in defined benefit (DB) plan rules or features result in very different annuitization rates. In fact, the results show that the rate of annuitization—the rate at which workers choose to take their benefit as an annuity—varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution. In choosing an LSD, the individual takes on the investment risk and responsibility for managing the distribution, and, ultimately, arranging his or her own income flow in retirement from those funds.

Analyzing data from more than 80 different pension plans, EBRI compares the “annuitization rate” among individuals at various age, tenure, and account balances, along with the rules and distribution choices within individual pension plans. EBRI found that between 2005 and 2010, pension plans with no LSD distribution options had annuitization rates very close to 100 percent. In contrast, the annuitization rate for defined benefit and cash balance plans with no restrictions on LSDs was only 27.3 percent.

“Whether people annuitize depends to a large extent on whether or not they are allowed to choose some other option,” said Sudipto Banerjee, EBRI research associate and author of the study. “Any study of annuitization that fails to take into account the impact of plan design on participant choice will likely lead to misinterpretations.”

The report notes that through the 1960s DB pension plans offered mainly one distribution choice: a fixed-payment annuity. That changed beginning in the 1970s, as some DB plans began to offer the option of full or partial single-sum distributions, and as “hybrid” pension plans expanded in the 1980s, so did distribution options. Today, most DB pension plans offer some type of single/lump-sum option, in addition to the traditional annuity choice.

The full report is published in the January 2013 EBRI Issue Brief no. 381, “Annuity and Lump-Sum Decisions in Defined Benefit Plans: The Role of Plan Rules,” online at www.ebri.org

Covered “Call”

By Nevin Adams, EBRI

Adams

Adams

Sooner or later, at just about every retirement plan conference, you’ll hear someone—and generally more than just one someone—cite the statistic that “only about half of working Americans are covered by a workplace retirement plan.”

It’s a data point that is widely and openly presented as fact—not only by those inclined to dismiss the current system as inadequate (or worse), but even by some of its most ardent champions, who see it as a call to action for expanded access to these programs. It’s drawn from the U.S. Census Bureau’s March 2012 Current Population Survey (CPS).(1) But does it tell the full story?

A recent EBRI Issue Brief notes that in 2011, 78.5 million workers worked for an employer/union that did not sponsor a retirement plan. Looking specifically at those who did not work for an employer that sponsored a plan, the report notes that:

  • 8.9 million were self-employed (and were thus barred from having a plan by their own inaction).
  • 6.2 million were under the age of 21 (below ERISA’s mandated coverage level).
  • 3.9 million were age 65 or older (beyond “normal” retirement age).
  • Just over 31 million were not full-time, full-year workers.
  • 16.8 million had annual earnings of less than $10,000.

Taking those factors(2) into account, it’s not hard to see why a large percentage of the 78.5 million people who worked for an employer that did not sponsor a plan—roughly 66.8 million in 2011, based on the CPS estimates above—might not be covered by a workplace plan for reasons that have little to do with the efficiency or efficacy of the current retirement plan structure.

When you filter out the overlap between those categories—situations where workers fall into several of those categories simultaneously (for example, workers who are under age 21, have less than $10,000 in annual earnings, and who are not a full-time, full-year worker)—there are about 42.4 million workers whose lack of coverage might be attributed to being in one or more of those categories. And yes, that’s more than half of the “uncovered” workers in the CPS analysis.

Indeed, while claiming that “fewer than half of working Americans have access to a workplace retirement plan” might be technically accurate, doing so exaggerates the size of the coverage “gap”—and obscures factors that might actually help explain it.

Notes
(1) A similar result can be gleaned from the National Compensation Survey from the Bureau of Labor Statistics.
(2) There are other factors linked to rates of participation. For example, the EBRI Issue Brief also notes a correlation between firm size and participation. See Figure 30 in “Employment-Based Retirement Plan Participation; Geographic Differences and Trends, 2010.”

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Retirement Plan Participation Stabilizing

As the economy slowly recovered from the recent recession, American workers’ participation in employment-based retirement plans stabilized, according to a new report by EBRI.

In 2011, the percentage of workers participating in an employment-based retirement plan was essentially unchanged from a year earlier. Specifically, the percentage of all workers (including part-year, part-time, and self-employed) participating in an employment-based retirement plan moved from 39.6 percent in 2009, to 39.8 percent in 2010, to 39.7 percent in 2011.

“The increase in the number of workers participating in 2011 halted the three year decline from 2008–2010,” said Craig Copeland, senior research associated at EBRI and author of the report. “The downturns in the economy and stock market in 2008 and into 2009 showed a two-year decline in both the number and percentage of workers participating in an employment-based retirement plan. The 2010 and 2011 participation levels stabilized as the economy recovered.”

As the EBRI report explains, the type of employment has a major impact on participation rates. Among full-time, full-year wage and salary workers ages 21–64 (those with the strongest connection to the work force), 53.7 percent participated. However, this rate varies significantly across various worker characteristics and the characteristics of their employers.

For instance, being nonwhite, younger, female, never married; having lower educational attainment, lower earnings, poorer health status, no health insurance through own employer; not working full time, full year, and working in service occupations or farming, fisheries, and forestry occupations were all associated with a lower level of participation in a retirement plan. Workers in the South and West were less likely to participate in a plan than those in other regions of the country.

The overall percentage of females participating in a plan was lower than that of males, but when controlling for work status or earnings, the female participation level actually surpasses that of males. The retirement plan participation gender gap significantly closed from 1987–2009 before slightly widening in 2010 and 2011.

Full results are published in the November 2012 EBRI Issue Brief, “Employment-Based Retirement Plan Participation: Geographic Differences and Trends, 2011,” online at www.ebri.org

401(k) Ownership Continues to Grow, While IRA Ownership Falls

Although fewer American families are participating in a retirement plan at work, more of those with a plan are in a 401(k). At the same time, ownership of individual retirement accounts (IRAs) is falling, according to a new report by EBRI.

Analyzing the four-year period from 2007‒2010, EBRI finds that the share of American families with a member in any employment-based retirement plan from a current employer increased steadily from 38.8 percent in 1992 to 40.6 percent in 2007, before declining in 2010 to 37.9 percent.

Ownership of 401(k)-type plans among families participating in a retirement plan more than doubled from 31.6 percent in 1992 to 79.5 percent in 2007, and increased again in 2010 to 82.1 percent. But the percentage of families owning an IRA or Keogh retirement plan (for the self-employed) declined from 30.6 percent in 2007 to 28.0 percent in 2010. In addition, the percentage of families with a retirement plan from a current employer, a previous employer’s defined contribution plan, or an IRA/Keogh declined from 66.2 percent in 2007 to 63.8 percent in 2010.

As in the past, EBRI found that retirement plan assets account for a growing majority of most Americans’ financial wealth, outside the value of their home. The median (mid-point) percentage of families’ total financial assets comprised by defined contribution plan assets and/or IRA/Keogh assets (assuming the family had any) increased from 2007 to 2010, and accounted for a clear majority of these assets:

  • Defined contribution plan balances accounted for 58.1 percent of families’ total financial assets in 2007, and that share grew to 61.4 percent in 2010.
  • Defined contribution and/or IRA/Keogh balances increased their share as well, from 64.1 percent of total family financial assets in 2007 to 65.7 percent in 2010. Across all demographic groups, these assets account for a very large share of total financial assets for those who own these accounts.

However, the EBRI report notes that the most recent data, along with other EBRI research, indicate that many people are unlikely to afford a comfortable retirement. “Americans lost a tremendous amount of wealth between 2007 and 2010, and the percentage of families that participated in an employment-based retirement plan and/or owned an IRA decreased as well,” said Craig Copeland, EBRI senior research associated and author of the report.

However, he added, the percentage of family heads who were eligible to participate in a defined contribution plan and actually did so remained virtually unchanged during this time. Therefore, despite all the bad news that resulted from this period, one positive factor should be noted: “Those eligible to participate in a retirement plan continued to participate—which may help change the likelihood of a lower retirement standard for many Americans,” Copeland said.

The full report is published in the September 2012 EBRI Issue Brief, available at EBRI’s Web site at www.ebri.org   The press release is online here.