Rehearsal for Retirement

Via the TaxProf, we have the CRS Report Pension Sponsorship and Participation: Summary of Recent Trends. The report makes for fairly easy reading even for those not well-acquainted with retirement plans. Several points are worth noting:

• There are essentially two types of retirement plans, defined benefit plans and defined contribution plans. "In a defined benefit plan, it is the employer who bears the investment risk of the plan, while in a defined contribution plan it is the employee who bears the investment risk." Although the report does not point this out, Social Security is, in essence, a defined benefit plan, while Bush's plan to gut reform Social Security was (is?), to a large extent, a defined contribution plan.


• The number of defined benefit plans is declining. "Between 1985 and 2004, the number of defined benefit pension plans with fewer than 100 participants fell from 90,911 to 18,835, a decline of 79.3%. The number of large DB plans fell from 23,485 to 12,403, a decline of 47.2%."


• Overall, participation in an employer sponsored plan has been declining. "In 2004, 52.9% of men who were employed year-round, full-time participated in a company-sponsored retirement plan, compared to 54.1% of women. Both of these participation rates were lower than the peak participation rates of 1998-1999. The participation rate for men was 6.3 percentage points lower in 2004 than in 1999. The participation rate for women was 2.1 percentage points lower in 2004 than in 1999."


• A lower percentage of Black and Hispanic workers than White, Non-Hispanic workers participated in employer sponsored plans, but the gap between Black and White, Non-Hispanic participation has narrowed somewhat.


• There is a dramatic gap in participation between low wage (lower quartile) and high wage (upper quartile) employees, with low wage employees having a participation rate of less than one-half of upper wage employees. Although not mentioned in the study, this accentuates the tax burden on these two groups, since contributions to retirement plans are tax deferred. As a practical matter, this means that the tax burden on income earned by lower income workers is higher than that borne by upper income workers.

Also last week, the CBO published a paper on The Risk Exposure of the Pension Benefit Guaranty Corporation. The PBGC is the insurer of last resort in the event that a defined benefit plan sponsor becomes insolvent and the plan has insufficient assets to cover the liabilities.

The PBGC does not pledge the full faith and credit of the Federal government. Theoretically, that means that in the event its assets are insufficient to meet its obligations, the tough nuggies rule kicks in and participants in failed plans would just have to face up to losing their pensions. Because this would cause a political furor, the CBO assumed that the Federal government would, in fact, shoulder any shortfall notwithstanding the fact that it currently has no legal obligation to do so.

The CBO report is unsettling. "Over 10 years, the prospective market-value cost of the program is $63.4 billion. Adding PBGC's accumulated deficit of $23.3 billion results in a total cost of $86.7 billion. Extending the horizon increases total net costs to $119 billion for the next 15 years and $141.9 billion for 20 years." These amounts, however, are smaller than estimates from other quarters. For instance, the report notes that "CBO's estimate is only two-thirds of the $96 billion in reasonably possible losses reported by PBGC." And, comparing CBO's "estimates with numbers reported in PBGC's financial statements, the 10-year forwardlooking market value of the insurance is only about 15 percent of the more than $450 billion in reported aggregate pension underfunding." In other words, while things are bad, they might end up being a whole lot worse.

Traditional economic theory tells us that employees effectively bargain for the services they render to their employers. To the extent that, for instance, they have bargained for a defined benefit retirement plan, they are at risk of losing the benefit of their bargain. In any event, there is a decided downward trend in the ability of employees to fund their retirement. Current trends in retirement plans are increasing the risk that employees will have sufficient assets to fund their retirement. Fewer employees are covered by retirement plans, the retirement plans increasingly tend to place the downside investment risk on the employees, and the insurer of last resort for existing defined benefit plans faces a dramatically increasing loss profile.