|Trends and Challenges for Work in the 21st Century|
Pensions and health plans are offered by many employers as part of labor compensation. These benefits are included in compensation packages because they help firms attract and maintain quality workers. These plans impose substantial capital losses on workers who change employers and can affect the workers decision to remain with the company. Government policies can and do restrict company choices concerning plan provisions. Regulations can be used to moderate or eliminate the benefit costs of changing jobs. In this section, potential policy initiatives to enhance the portability of pension and health benefits are examined.
Major policy changes could significantly alter employer decisions to offer pension plans, to offer a particular type of plan, or to offer a more generous and portable pension. These changes would also alter the incentives for workers to participate in pension plans, to delay some of their compensation until retirement, and to remain with the firm until retirement. Policy alternatives for earlier vesting, enhanced portability, and increased coverage are reviewed and evaluated.
Prior to the passage of ERISA, there were no required standards for the vesting of pension benefits. Some plans had very long vesting periods and others essentially required participants to remain with the firm until the specified retirement age in order to receive a benefit. ERISA established a 10 year vesting standard which greatly reduced the loss in pension benefits for many workers who changed jobs. The Tax Reform Act of 1986 reduced the maximum allowable vesting standard to five years of service thus insuring that additional departing workers would be eligible for future retirement benefits. With a five year vesting standard, most workers who have accumulated any significant pension accruals will be eligible to receive a deferred benefit at retirement. Currently, many defined contribution plans have full vesting prior to five years, with many allowing for the immediate vesting of benefits. All employee contributions are immediately 100 percent vested. In contrast, virtually all defined benefit plans impose five year vesting.
Periodically, proposals are made to reduce the vesting period to three years or even one year. To date, these proposals have not received much attention. This is due, in part, to the relatively small impact of a shorter vesting period on the value of pension benefits foregone by workers when changing firms. For example, consider a worker aged 35 with three years of service and annual earnings of $30,000 per year. Assume that the worker is covered by a defined benefit plan with benefit formula that provides 1.5 percent of final salary per year of service beginning at the normal retirement age of 65. The annual retirement benefit available at age 65 based on service to date is $1,350. Using an interest rate of 6 percent to calculate the deferred vested benefit yields a present value of vested benefits of approximately $2,700.
Under the current vesting standard of five years, this worker would forfeit her claim on these funds if she left her employer. If a three year vesting standard was established, she could change jobs and still expect to receive a benefit from this firm in retirement. The loss in pension benefits in this example represents less than 10 percent of one years earnings and is not likely to be a major deterrent to a worker from moving to another job that is more desirable or one that is expected to pay higher wages.
This example shows that lowering the maximum vesting standard from five years to three would modestly reduce the cost of changing jobs for workers with less than five years of tenure and increase the expected retirement benefits for mobile workers. With a vesting standard of one year, the pension loss for workers leaving after only one year on the job would be reduced by less than $1,000. The relatively small size of these effects is one of the primary reasons that proposals for reduced vesting have not been enacted and other aspects of pension regulations continue to receive much more attention than do proposals to lower the vesting period.
The primary loss in pension benefits associated with job changes is the lack of portability of pension credits across defined benefit pension plans. As described earlier in the paper, the loss in life time pension benefits is due to the use of benefit formulas that are based on final average earnings. As a result, workers who remain with a single firm over their career earn one pension benefit based on their earnings just prior to retirement. In contrast, workers who change jobs several times (even if all firms have identical pension plans) will accumulate several pensions but all but the last pension will be based on earnings many years earlier. Therefore, movers will accumulate lower total pension benefits than stayers due to this lack of portability.
The lack of portability could be addressed with several different policies. First, the indexing of deferred vested benefits could be required as a condition for being a qualified pension plan. This would drastically reduce or eliminate the loss in pension wealth associated with job changes. This type of indexing would mean that deferred vested benefits would increase with inflation or some measure of wage growth. While such a policy change would make defined benefit pensions portable, it would also institute a substantial new cost of offering defined benefit plans that would be paid either by the firm the worker was leaving or by the workers new employer.
If government policy required the old firm to pay for this indexing, the added cost would cause many more employers to terminate their defined benefit plans. These companies might then establish defined contribution plans to replace the terminated defined benefit plans. If new employers had to pay for this indexing of benefits earned on earlier jobs, they would be much less likely to hire such employees. This would further reduce employment opportunities for older workers. Thus, true portability of pension benefits in defined benefit plans could be required through further regulations, however, such a policy would adversely affect pension coverage and exacerbate the trend toward increased use of defined contribution plans.
Another issue related to the value of benefits for departing workers concerns the immediate access to the value of their deferred vested benefit. Upon leaving the company, some worker would prefer to have these funds give to them for immediate use or to be rolled over into a new pension account. McGill, et al. (1998) report that over 40 percent of large sponsors of defined benefit plans provide some lump-sum options and most defined contribution plans allow for the disbursement of plan assets when employment is terminated. Thus, many pension participants who change employers are denied access to their pension funds until retirement.
The lack of access to pension funds is an issue that primarily confronts participants in defined benefit plans. This lack of access my encourage some workers to remain with their current firm rather than seeking new employment. The government could institute a policy requiring that all workers have the option of a lump sum distribution when they leave an employer.
Are lump sum distributions sound retirement policy? Many argue that workers know what is in their best interest and they can decide whether to leave their retirement benefits in the existing plan or whether to withdraw these funds. If the funds are invested and saved for retirement, the worker could accumulate greater retirement savings if the rate of return on the new investments exceeds the interest rate used to calculate the lump sum distribution, obviously, they might also earn lower returns and thus have a lower retirement income. Many retirement specialists fear that individuals will spend these disbursement rather than save them and as a result, retirement income will be lower. In either cases, greater availability of lump sum distributions would tend to reduce the perceived loss in pension wealth with job changes and should increase mobility. Whether a policy promoting lump sum distributions is good retirement policy is debatable.
Government policies to increase pension coverage can be sorted into three groups: policies that would required employers to offer a pension, new incentives to encourage employers to offer pensions, and changes in tax and social security policies that would affect the desirability of pensions for workers and firms.
One problem confronting pension participants who are considering changing employers is that many companies do not provide any pension plan. Thus, the move from one employer to another may result in the loss of pension coverage. The only way to completely eliminate this problem is to require all firms to offer some type of pension. The Presidents Commission on Pension Policy appointed by President Carter in the 1970s recommended such a policy of mandatory pensions.
The Commission proposed that all firms without a pension plan must participate in a universal defined contribution plan based on a minimum 3 percent payroll contribution. All benefits would be immediately vested. Under this plan, workers would have individual accounts that would not be affected by their changing employers the universal pension would have been fully portable (Presidents Commission on Pension Policy, 1981). This plan was widely debated and ultimately rejected. Since the failure of the commissions recommendation, no serious consideration has been given to mandating employer pensions. The main arguments against mandatory pensions are the increase in cost that they impose and the impact on employment in small firms.
overage be expanded? The government could encourage firms to provide pensions through the implementation of new tax incentives or reductions in the regulatory costs associated with pensions. Given the existing preferential tax incentives for pensions, it is unlikely that further incentives will be provided in the tax code. In fact, some analysts (Munnell, 1989) argue that rather than expanding the preferential tax status of pensions, Congress should amend the tax code so that pension contributions and the earnings of pension fund be treated as ordinary income for tax purposes.
Reducing or eliminating the regulatory cost of meeting existing standards would provide a further incentive for companies to offer pensions. In the past, Congress has granted administrative relief to small businesses in an effort to encourage them to provide pensions for their workers through the use of simplified employer pensions (McGill, et al., 1996). Consideration of new policies to eliminate impediments to pension coverage among small employers is on-going. Some analysts worry about the increased prospects for abuse with fewer regulations while others concentrate on the need to expand pension coverage. Without further incentives or simplified regulations, it is doubtful that pension coverage will expand among small employers.
Several changes in national tax policy are now being debated. If enacted these tax reforms would alter the demand for employer pensions. One such policy is to shift from the current income tax to a consumption tax. A consumption tax would tax expenditures rather than income. With a consumption tax, a workers earnings that were saved privately for retirement would have the same tax status as current employer provided pension plans. In such an environment, employer pensions would be less desirable to workers because they would have the alternative of developing their own retirement plans with pre-tax dollars.
A second less comprehensive proposal is to retain the current income tax structure but make pension contributions and pension fund earnings taxable. Implementation of this policy would also equalize the tax status of private saving and employer-provided pension plans. Either of these changes would reduce the desirability of employer provided pensions relative to private savings. Such a change in tax policy probably would result in fewer retirees having pension benefits in the future; however, the decline in pension benefits might be somewhat offset by greater private savings. This private response would be greater with the adoption of a compensation tax which would raise the net return to private savings. Eliminating the preferential tax status of pensions within the income tax code would leave the net return to private savings unchanged while raising the cost of saving for retirement through employer pensions.
Changes in Social Security policy also impact the preferences for pensions of both workers and firms. Significant reductions in Social Security benefits might encourage firms and workers to expand employer pensions so that total retirement benefits remain relatively constant and from the firms perspective, older workers would continue to have appropriate retirement incentives. Employers develop human resource policies in order to achieve various strategic objectives within the context of required programs such as Social Security, Medicare, and Unemployment Insurance. Changes in these programs alter total compensation from working and incentives that may influence worker behavior. Managers may attempt to offset the new incentives associated with the changes in governmental policies. For example, if modifications to the Social Security benefit formula or the normal age of retirement provide incentives for older persons to remain on the job, employers may seek to undo this incentive by altering their pension and retirement policies. The size and significance of this response remains to be seen.
Further government regulation of pensions that raise their administrative costs would result in lower coverage in the twenty-first century. Since the passage of ERISA, periodic changes in pension regulations have added to the administrative cost of pension plans making them less desirable to firms (and workers if administrative costs are passed on to employees in the form of lower benefits or lower wages). Policy makers must recognize that pensions are voluntary benefits and that the introduction of new regulations on defined benefit plans, no matter how well intended, may reduce the likelihood that companies will provide these plans in the future.
If future regulations fall most heavily on defined benefit plans, as they have in the past, the movement toward greater utilization of defined contribution plans will be accelerated. Such regulations typically result in greater increases in the administrative costs for smaller firms and would, therefore, likely accelerate the disappearance of defined benefit plans among small employers. The introduction of and frequent changes in government regulations of pensions contributed to the ending of the expansion of pensions coverage during the last 25 years and the shift toward greater reliance on defined contribution plans.
This section has reviewed a variety of proposals that might reduce or eliminate the loss of pension benefits associated with job changes. It is important to remember that this is not the sole (or perhaps, even the primary) focus of pension policy. Workers desire employer pensions in order to more efficiently save for retirement. Congress has encouraged the adoption of employer-based pensions as a central part of our national retirement policy. Thus, in considering policies to increase the portability of pension benefits, we should not lose sight of the goal of providing an adequate retirement income.
Policies that enhance portability of benefits for those covered by a pension but result in fewer firms offering pensions are not necessarily good public policies. Similarly policies that further regulate defined benefit plans, such as those that require indexing of deferred vested benefits or immediate vesting, may result in a greater reliance on defined contribution plans. Whether this tradeoff is desirable is also debatable. It is ironic that many of those proposing new regulations are strong proponents of defined benefit plans and prefer these plans to defined contribution plans. In assessing the impact of new pension mandates it is important to remember that pensions are not required by law but are voluntary benefits. In the face of higher administrative costs and reduced flexibility, existing plan providers may simply decide to eliminate their plans, new firms may opt not to establish plans at all, and other firms will continue to shift to the use of defined contribution plans, stock options, and other forms of incentives.
In the United States, company-provided health insurance is the primary method that nonelderly Americans acquire health insurance. However, not all companies offer health insurance and the quality and value of employer plans is quite different. Workers currently covered by employer-provided health insurance must consider the impact changing employers will have on their access to health insurance. The portability of health insurance has been addressed by the passage of COBRA and HIPAA. COBRA allows job changes to retain coverage under their former employers health plan for up to 18 months but with the individual paying the full cost of this insurance. HIPAA reduces the problems associated with moving across health plans associated with pre-existing health conditions.
The main problem currently facing those considering a job change is whether potential new employers will offer health insurance and whether this health insurance will be of the same quality as that in the current job. The only real solution to this problem is the adoption of a national health insurance program where all employers were required to provide a minimum health insurance plan. Proposals by the Clinton administration for this type of national health insurance ended in failure and reconsideration of such plans in the near future seems doubtful.