The Cost of “Choice” in a Voluntary Pension System

1. The Cost of “Choice” in a Voluntary Pension System Prof. Jon Forman & Sandy Mackenzie for the Tax Economist Forum Washington, DC Third Way, 1025 Connecticut Ave., NW May 15, 2013

2. Figure 1. How Benefits Compare to Earnings(2012 dollars & percentage of final wages)

3. Figure 2. Initial Social Security Replacement Rates for Retired Workers(1970s birth cohort, percent)

4. Table 1. Share of Workers Participating in the Pension Plans, 2011 (percent)

5. Table 2. Social Security: Administrative Outlays as a Percent of Trust Fund Income and Benefit Payments, FY 2013

6. COSTS OF PRIVATE PENSIONS • The Cost of Choice • Administrative and Compliance Costs • median participant’s all-in fee (ICI) was 0.78% of assets ($248 per year) • Opportunity Costs • Lost investment returns • Lost savings opportunities • Lost opportunity to buy longevity insurance • Leakage

7. Table 3. Form 5500 Income Statement of Pension Plans by type of plan, 2010 (amounts in millions)

8. Yields Administrative Expenses: • For defined benefit plans • 7.5% of contributions • 2.4% of total income • 5.8% of total benefit payments • 0.4% of assets • For defined contribution plans • 1.3% of contributions • 0.6% of total income • 1.4% of total benefit payments • 0.1% of assets

9. Regulatory Costs Are Not Substantial • IRS $110 million • EBSA $183 million • PBGC $6.5 billion • The total of $6.8 billion is a very small fraction of the value of retirement assets, $18.9 trillion.

10. Figure 3. Pension funds’ operating expenses as a share of total investment in selected OECD countries, 2009 (percent)

12. Table 4. 2008 Replacement Ratios (married couple, ages 65/62, one working)

13. Table 5. Lump Sum Amounts Needed at Retirement from Private and Employer Sources as a Multiple of Final Pay

14. Reducing Costs • A Universal, Second-Tier Pension System • Expand Social Security; or • Strengthen the Private Pension System with a Simple System of Add-on Accounts • More Modest Approaches • Encourage Default Investments • Employer Retirement Savings Accounts • Multiple Employer Plans • State Funds

15. Two approaches to reform: 1. The blank slate • Assume a blank slate, or tabula rasa • Ask what the second tier would look like if policy had a free hand • A case can be made for heavy government involvement • Social Security is a natural platform for a second tier; it can funnel savings at little cost to providers of retirement savings vehicles

16. The blank slate, cont’d • Employers above a certain size not offering their own plan could be required to as a conduit for a government plan, or private sector savings vehicles. • Social Security can also act as a low-cost intermediary for the purchase of annuities and other lifetime income products.

17. The blank slate, cont’d • Because the SSA is already providing annuities (which are indexed), it could conceivably provide an additional annuity piggy-backed on the first tier. • In one version of this reform, the government simply acts as a conduit, although its role is mandated. In the more radical version, it becomes the provider of retirement savings vehicles and longevity insurance.

18. 2. Incremental reform • Woodrow Wilson—work with the system as it is, do not assume a tabula rasa. • Increase the second tier’s coverage by requiring the use of defaults: employees participate automatically unless they explicitly opt out, • Require more appropriate default investments (e.g. TDFs).

19. 2. Incremental reform, suite et fin • Reduce liability concerns of providers over provision of annuities and other lifetime income products by enacting appropriate safe harbors. • Make a concerned effort to improve financial education. • Replicate California’s experiment with a state fund.