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Characteristics and Performance of Target Date Funds in the United States

Constantijin W.A. Panis and Michael J. Brien, 2017 | Full Report

Target date funds (TDFs) are generally mutual funds that hold a diversified mix of stocks, bonds, and other investments. They are designed for individuals with a particular retirement date in mind—the “target date” or target year. Over time, TDF holdings automatically shift toward relatively safe assets. TDFs are rapidly gaining popularity, especially in defined contribution plans, and managed almost a trillion dollars at the end of 2016. This study characterizes the TDF landscape and analyzes the expenses, asset allocation, and (risk-adjusted) performance of TDFs.

We find that, in the aggregate, TDFs live up to their objectives of diversification and gradual reduction of exposure to risk. As expected, their rates of return move largely in tandem with those of domestic and international stocks, and fluctuations in valuations are more muted for TDFs that are close to or have passed their target year. Indeed, funds with more remote target years fared worse during the Great Recession. They also took longer to recover funds with a 2035 or later target year on average took 4.9 years to climb back to their pre-Recession highs, compared with 3.0 years for pre-2020 funds.

There are large differences among TDFs, even among TDFs with the same target year. Adjusted for risk, we find large differences in rates of return, which are only partially explained by funds’ expense ratios. Also, a fund’s target year is not necessarily indicative of the extent to which it tolerates risk. For example, the returns of some 2030 funds were more volatile than those of some 2020 funds. We suggest an easy-to-calculate relative volatility metric that may better capture a fund’s risk tolerance than target year alone.

How Might Legal Recognition of Same-Sex Marriage Affect Retirement Incomes and Federal Programs?

Karen E. Smith, Stephen Rose, and Damir Cosic 2016 | Full Report

This paper uses the Urban Institute’s Dynamic Simulation of Income Model (DYNASIM) to estimate the impact of legal same-sex marriage on retirement incomes of lesbians and gays from 2015 to 2065. It also estimates the impact of legal same-sex marriage on government budgets. Legal same-sex marriage reduces government budgets (increases the deficit) but also increases retirement incomes for seniors in the bottom three-fifths of the income distribution. 

We find that legal same-sex marriage increases some components of net income while reducing others. Net per capita retirement income increases on average for lesbians and gays in the bottom three lifetime earnings quintiles, but falls for those in the top quintile and the change gets bigger over time. Marriage provides an important financial cushion for partners during periods of unemployment, ill health, and in retirement. Poverty rates among gays and lesbians ages 62 and older are projected to fall from 18 percent in 2015 to 5 percent in 2065 after same-sex marriage becomes legal. Legal same-sex marriage is one factor contributing to this reduction. 

Legal same-sex marriage on net lowers aggregate government budgets (increases the deficit) in the long run, but because lesbians and gays are a small share of the US population, the aggregate effect of legal same-sex marriage is small (about $3.5 billion (less than 1 percent) lower in 2065). The number of Social Security beneficiaries and benefit outlays increase with expanded access to spouse and survivor benefits. More Social Security beneficiaries will pay taxes on Social Security benefits, contributing to an increase in federal income taxes. The number of Medicare Part B and D participants falls slightly as some same-sex partners gain employer sponsored health insurance through a working spouse. On net, the savings from Medicare and higher revenue from taxes do not offset the increase in Social Security spending.

Drawing Down Retirement Wealth: Interactions between Social Security Wealth and Private Retirement Savings

Philip Armour and Angela A. Hung, 2016 | Full Report

Individual financial planning for retirement in the US is increasingly important, given the trend away from employer-provided defined benefit (DB) plans, the rising Social Security (SS) Full Retirement Age (FRA), and retiring baby boomers. A key financial decision that Americans make is how to draw on their retirement wealth across various sources, including both privately saved retirement funds and SS benefits. For SS retirement benefits, the main decision is at what age to claim, with claiming before the FRA resulting in lower monthly benefits, and claiming later leading to higher benefits. The terms of this tradeoff have changed in recent years: since 2003, the FRA has risen from 65 and will gradually increase to 67 by 2027, representing a drop in the present value of SS benefits. Meanwhile, defined contribution (DC) plans have gained in popularity, presenting retirees with more control over their private retirement wealth. The changing dynamics of both SS wealth and the private retirement decision space underscore the need for examining how individuals make decisions across their entire portfolio of retirement wealth. We use HRS survey data matched to SS administrative data to study how households integrate SS benefits into their general retirement income plans. We find starkly different non-SS retirement asset decumulation patterns across individuals who claim at different ages, with those claiming before the FRA drawing down pension and IRA wealth faster than those who claim at or after the FRA. However, the earliest claimants, those who claim SS retirement benefits exactly at age 62, are a highly heterogeneous group, consisting of both low-income, high expected mortality individuals as well as individuals with high pension holdings. We further find that this earliest claimant group is more likely to have retired and begun decumulating non-SS retirement assets even before age 62; however, this group’s median and average assets are not substantially lower than later claimants. An analysis of claiming behavior by non-SS retirement wealth holdings shows that individuals with more retirement savings were overwhelmingly likely to claim between the ages of 62 and the FRA. On the other hand, those with the least retirement savings are more likely to either claim SS benefits as early as possible, either in the form of disability benefits or retirement benefits, or they would delay claiming SS retirement benefits until after the FRA. Moreover, birth cohorts facing higher FRAs tend to delay claiming SS retirement benefits on average; however, those most affected by this reduction in SS wealth – those with few other retirement assets – are the least reactive. Finally, households that do delay claiming as the FRA rises also tend to delay retirement and drawing down their non-SS retirement assets, indicating complementarity between SS and non-SS decumulation decisions and strong spillovers from changes in both SS and private retirement policy.

Innovations and Trends in Annuities: Qualifying Longevity Annuity Contracts (QLACs)

Constantijn W.A. Panis and Michael J. Brien, 2016 | Full Report

The recent shift from defined benefit (DB) to defined contribution (DC) pensions reduced lifelong guaranteed income for many American workers. Qualifying Longevity Annuity Contracts (QLACs) offer a potential way to secure income for older ages while limiting retirees’ exposure to investment risks. QLACs are deferred longevity annuities, i.e., contracts between individuals and insurance companies in which the insurance company promises lifelong monthly benefits starting at a future date in exchange for a lump sum premium payment. The Internal Revenue Service (IRS) defined QLACs and made them eligible for certain fiscal benefits in 2014. The market for QLACs is therefore still in its infancy.

This document first explains QLACs and similar financial products. To qualify as a QLAC, the interest rate must be fixed for the entire accumulation period, benefit payments must start at or before age 85, the premium must be paid from an Individual Retirement Account (IRA) or defined contribution (DC) plan, and the premium must not exceed the lesser of $125,000 or 25% of the source balance. An advantage of QLACs over other longevity annuities is that the premium is disregarded for the purpose of required minimum distribution (RMD) rules, which stipulate that individuals must start withdrawing at least certain minimum amounts starting at age 70½.

We document sales of various types of annuities since 2001 as a baseline to gauge future adoption of QLACs and similar products. We also present QLAC prices for a number of scenarios. Separately, we point out that household surveys collect only limited information on annuity holdings and suggest survey questions to learn about the adoption of QLACs.

Hispanics Retirement Security: Past Trends and Future Prospects

Richard W. Johnson, Stipica Mudrazija, and Claire Xiaozhi Wang, 2016 | Full Report

The number of older Hispanics in the United States is growing rapidly, but many face significant financial challenges because of employment histories marked by low-earning jobs that do not generally offer retirement benefits. Older Hispanics receive much less income, hold much less wealth, and are much more likely to be impoverished than older non-Hispanic whites. Financial outcomes are significantly worse for older foreign-born Hispanics than for those born in the United States. Among working age adults, US-born Hispanic men are somewhat less likely to participate in the labor force than non-Hispanic white men, while foreign-born Hispanics are more likely to participate. Hispanic women, especially those born outside the United States, are less likely work. Hispanics employed full time earn significantly less than their non-Hispanic white counterparts and are less likely to be covered by an employer-sponsored retirement plan.

Household Retirement Saving: The Location of Savings Between Spouses

Katherine G. Carman and Angela A. Hung, 2016 | Full Report

Retirement planning is often a joint household decision-making process, and therefore the household is often the more appropriate unit of analysis. However, retirement savings in tax advantaged accounts are held in the name of one individual. While spouses have rights to these assets in the case of divorce and in most cases of death, the separation of accounts in name may cause couples to treat their accounts as separate, with each spouse making decisions separately.

In order to optimize retirement planning, couples should consider the entire household portfolio together, accounting for the characteristics of the retirement accounts, the age of the spouses, and income differences between spouses. With separate accounts, one spouse may not be aware of the contributions or assets accumulated in the other spouse's accounts. This may lead to sub-optimal decision-making, as individuals in a couple may not fully optimize across all available retirement accounts.

Little is known about how households divide retirement contributions and assets between spouses. In this project, we investigate how households locate contributions across tax deferred savings accounts that are nominally held in one spouse's name and how these decisions may impact accumulated assets. In particular we first document who within a couple nominally holds retirement assets. Using data from the Health and Retirement Study and Survey of Consumer Finances, we find that household retirement assets and contributions are more likely to be located in accounts held in the husband's name or the primary earner's name. In our regression analysis, we find that the location of contributions is largely driven by the distribution of earnings within couples.

Opting out of Retirement Plan Default Settings

Jeremy Burke, Angela A. Hung, and Jill E. Luoto, 2016 | Full Report

The introduction of automatic enrollment (AE) features into employer sponsored defined contribution plans has greatly increased retirement plan participation by automatically enrolling employees into their employers' plans. We analyze administrative data provided by Vanguard on approximately 100,000 newly hired employees who are eligible for 206 unique plans featuring automatic enrollment. We find that most participants will at some point take an "active" stance towards their retirement savings by choosing either a different contribution rate or investment portfolio than that specified by their plan's default settings. Among our sample of over 95,000 newly hired employees participating in their employer's AE plan, we find that 59 percent elect a different contribution rate, investment portfolio, or both within the first few years of participation. Selecting a different contribution rate is considerably more common than selecting different investments: 57 percent of participants choose a contribution rate different than the default, while only 17 percent elect a different investment portfolio. Moreover, among those that select a different contribution rate, roughly two thirds increase their contribution rate above that specified by their plan while another third decreases their contribution rate below the plan default.

When examining what characteristics are predictive of becoming an active participant, we find that women are slightly more likely than men to choose a contribution rate different than the default, and do so by reducing their contribution levels on average. Conversely, participants with higher incomes are more likely to select contribution rates above the default than their lower-income peers. Plan-level characteristics are also important predictors of choosing a contribution rate different than the default. In particular, participants are more likely to actively increase their contribution rates if they are in plans that offer immediate vesting of employer contributions, or if they face a default contribution rate this is too low to receive the maximum possible employer match. Conversely, participants are more likely to reduce their contributions below the default rate if they participate in plans that feature default enrollment in automatic escalation (a plan feature under which a participant's contribution rate automatically increases over time), or plans that initially have a default deferral percentage above 3 percent (the median default contribution rate in our data).

When it comes to choosing a different investment portfolio than the default, we find that men, those with higher incomes, and participants in plans that feature immediate vesting of employer contributions are more likely to choose their own investment portfolio.

Financial Risks due to Long-Term Care

Constantijn W.A. Panis and Michael J. Brien, 2016 | Full Report

This report characterizes the current landscape and outlook of long-term care utilization, its costs, and its financing. We draw on academic and trade literature and present new statistics based on primary research. Approximately one-half of Baby Boomers are projected to require paid, formal long-term care, creating a troublesome outlook for the elderly's personal finances and the Medicaid program. While recognizing fundamental challenges to simultaneously preserving a safety net for low-income Americans and ensuring fiscal sustainability of the Medicaid program, we discuss potential policy implications.

Brokerage Accounts in the United States

Constantijn W.A. Panis and Michael J. Brien, 2015 | Full Report

This document outlines the extent to which American households have brokerage accounts, use advice from brokers, and related issues. The analysis is based on the 2001-2013 Survey of Consumer Finances, a triennial household survey.

We find that 17 million American households owned a brokerage account in 2013, down from 19 million in 2001. Most households with a brokerage account also owned an Individual Retirement Account (IRA). While some households actively traded through their brokerage account, 65% traded at most three times in the year before the survey interview.

In 2013, 27% of households with brokerage accounts reported using the advice of a broker for saving and investment decisions, down from 35% in 2001. Excluding assets in IRAs and defined contribution (DC) plans, on average, households with a brokerage account owned $248,000 in stocks, $221,000 in mutual funds, and $51,000 in bonds. However, most of those holdings were concentrated among relatively few investors; at the median, stock holdings were $6,200, and most households with a brokerage account did not hold any mutual funds or bonds outside of IRAs and DC plans. In addition, most households with a brokerage account owned an IRA or a DC plan with average balances of about $237,000 and $140,000, respectively.

Savers With and Without a Pension

Constantijn W.A. Panis and Michael J. Brien, 2015 | Full Report

This document studies the savings and investments of households without pensions based on data from the 2013 Survey of Consumer Finances. The analysis broadly characterizes such households in terms of financial resources and life cycle stage. It documents specific asset holdings, the sources upon which households rely when making saving or investment decisions, risk aversion, planning horizons, and reasons for saving. Throughout, households without a pension are compared to those with a pension. We find that households without a pension generally are younger, have lower incomes, and less wealth. They are also less likely to own an Individual Retirement Account (IRA), but that appears to be driven by their leaner financial resources. Holding income and net worth constant, the data support the hypothesis that households without a pension compensate for lack of pension coverage through savings in an IRA.

While their average financial asset holdings are lower than the holdings of households with a pension, households without a pension hold sizable shares of their financial assets in stocks, mutual funds, savings and money market accounts, and trusts. Households without a pension are less likely to state retirement as a reason for saving, less likely to take financials risks when investing, and less likely to plan for the long term than those with a pension. While other explanations are possible, these patterns suggest that individuals who want to save for retirement and have a long-term planning horizon self-select into jobs that offer pension benefits.

Target Populations of State-Level Automatic IRA Initiatives

Constantijn W.A. Panis and Michael J. Brien, 2015 | Full Report

Recent initiatives by state governments aim to increase the retirement savings of U.S. workers. The purpose of this report is to provide background analysis related to those initiatives. Specifically, this report provides a high-level overview of employer-sponsored pension coverage in the 50 states and the District of Columbia, and a more detailed characterization of workers who are targeted by the California and Illinois initiatives to expand retirement saving.

Among American private sector workers, we find that 72 million workers (53%) did not have access to an employer-sponsored pension plan in 2013. In both California and Illinois, workers targeted by state initiatives had lower incomes, were more likely to work part-time or part-year, were younger, were more likely to have never married, belonged more likely to a minority race or ethnicity, and were less likely to be U.S. citizens than other private sector workers. Despite these patterns, targeted workers are a diverse group. For example, in 2013 about 6%-7% of them lived in households with an income of $200,000 or more.

While targeted workers may benefit from state initiatives to boost retirement savings, they also face weaker incentives to save for retirement because they are farther from retirement and can expect relatively more from Social Security than workers with access to an employer-sponsored pension plan. Given these weaker incentives, some may opt out of enrollment into their state plan. Opt-out rates are, however, outside the scope of this study.

Asset Allocation of Defined Benefit Pension Plans

Constantijn W.A. Panis and Michael J. Brien, 2015 | Full Report

This document analyzes the asset portfolio composition of large defined benefit (DB) pension plans. DB pension plans face conflicting objectives to seek returns in risky assets and to avoid volatility by investing in safer assets. Recent studies found inconclusive evidence on the relationship between asset allocation and the financial health of plans, but those studies were constrained by incomplete data. This study builds on the existing literature by analyzing a more current and complete dataset of pension asset allocation based on the Form 5500 Annual Return/Report of Employee Benefit Plan and the asset allocation fields of its Schedule R Retirement Plan Information. We find that large pension plans "de-risk" into less volatile investments as plans' funding ratios improve. This finding holds for both single-employer and multiemployer large DB plans. We also find evidence that plans de-risk asset allocations as their share of active participants declines or after plans freeze benefit accruals, i.e., when their liability horizon shortens.

Implications of Expanded Annuitization for Old-Age Well-Being

Constantijn W.A. Panis and Michael J. Brien, 2015 | Full Report

This document presents a framework for evaluating the effects of more widespread annuitization of wealth in retirement. We attempt to quantify the implications for oldage consumption of the annuitization of defined contribution (DC) plan balances and individual retirement account (IRA) assets. Following a model developed and estimated by Michael Hurd in his 1989 Econometrica article on "Mortality Risk and Bequests," we solve for optimal consumption paths of unmarried retirees. Next, we counterfactually assume that DC/IRA balances are annuitized. We then re-optimize consumption paths and compare the resulting patterns to the baseline. Data for this exercise come from the 1992-2010 Health and Retirement Study (HRS).

Annuitization removes liquid wealth and replaces it with lifelong-guaranteed income. We therefore hypothesize that annuitization can raise consumption in old age and can reduce old-age poverty. Our results are consistent with that hypothesis and are generally plausible and intuitive. We consider both nominal and real annuities and found larger reductions in old-age poverty from real annuities. Annuitization is predicted to also enhance general satisfaction with retirement and boost lifetime utility. While these results hold for the vast majority of sample members, a small number of individuals who wish to leave a bequest became worse off under full annuitization. Even they, though, could benefit from partial annuitization.

The analysis is based on a theoretical model with fairly restrictive assumptions and that is applicable to unmarried people only. Given this narrow focus, we do not intend for our results to be extrapolated to the U.S. population of retirees. That said, the analysis plausibly demonstrates that certain retirees can benefit from increased annuitization. The current trend away from defined benefit (DB) to DC pensions implies a de-annuitization of retirement resources, which risks additional old-age poverty in the future. Increased annuitization of DC and IRA balances appears to have the potential to mitigate those risks.

Pension Plan Structures Before and After the Pension Protection Act of 2006

Barbara A. Butrica, Keenan Dworak-Fisher, and Pamela Perun, 2015 | Full Report

The Pension Protection Act of 2006 (PPA) included provisions designed to enhance defined contribution plans—such as new protections for automatic enrollment and less stringent nondiscrimination safe harbor rules. This study analyzes the extent to which pension plan structures changed after the PPA. Our results show that autoenrollment rates, employer maximum contribution rates, default contribution rates, and the likelihood of meeting the safe harbor requirements all increased after the PPA. Difference-in-difference regressions suggest that the PPA did not directly affect autoenrollment, but did reduce default contribution rates and the chances of employers meeting the new safe harbor requirements.

Trends in Pension Cash-Out at Job Separation and the Effects on Long-Term Outcomes

Philip Armour, Michael D. Hurd, and Susann Rohwedder, 2015 | Full Report

Might the financial security of working Americans during retirement be jeopardized by their ability to cash out their pension plans when they leave a job? Federal tax rules discourage such actions, but the limited evidence available suggests the practice is common. This paper takes advantage of long-term longitudinal data in the Health and Retirement Study to update prior findings, investigate cohort differences and study the long-term consequences of pension cash-out at job separation. We find that pension cash-out is more concentrated among workers who experience economic or health shocks around the time of job separation. The most recent cohort of older workers more often cashed out pension balances and more frequently used the balances for spending or to pay off debt. This is likely due to most of the job separations for this cohort occurring during or in the aftermath of the Great Recession, which brought about economic shocks at higher frequency. Long-term outcomes for those who cashed out pension balances are worse than for those who did not cash out, but so were their baseline characteristics. Taking this together with the fact that outcomes are largely similar across populations of workers with or without access to pension cash-out, we conclude that the worse outcomes among workers who cashed out are due to the experience of shocks leading to cash-out behavior rather than due to access to the cash-out option.

Defaulting In and Cashing Out? The Impact of Retirement Plan Design on the Savings Accumulation of Separating Employees

Angela A. Hung, Jill Luoto, and Jeremy Burke, 2015 | Full Report

The shift to defined contribution (DC) retirement savings plans among employers has given both more freedom and more responsibility to employees who must decide whether and how much to save for retirement. Importantly, DC plans allow employees to decide what to do with their accumulated savings at points of job separation. While the advent of automatic enrollment (AE) policies has helped increase overall participation rates in DC plans, little consideration has been given to the interplay between the rise of AE policies and what happens to accumulated retirement savings at points of job separation.

We use administrative data from Vanguard covering the accounts of over a half million participants from 385 plans to explore the participation and distribution decisions of those who separate from their employers. We find that job separation is a significant source of leakages from retirement accounts among our sample. Over 50 percent of separating employees take a cash distribution. Notably, even after controlling for income and account balance size, those separating from AE plans are significantly more likely to take a cash distribution than are those separating from plans in which they enrolled voluntarily. Though AE policies may help encourage retirement savings among those who otherwise would not save, such policies may fail to realize their full potential if savings accumulated during periods of employment effectively dissipate at points of job separation, and with taxes and penalties paid out in some cases.

Automatic Enrollment in Retirement Savings Vehicles: Evidence from the Health and Retirement Study

Jeremy Burke, Angela A. Hung, Jill Luoto, 2015 | Full Report

While there has been considerable research investigating the impact of automatic enrollment on participation and savings outcomes, less research has focused on characterizing individuals who actively choose to opt out of a DC plan in which they were automatically enrolled. In this study, we use data from the 2008 and 2010 waves of the HRS to examine how employers' automatic enrollment policies influence longer-run participation and contribution status among older Americans, with a focus on examining demographic, financial, and health differences between those who choose not to participate under automatic enrollment, those who choose not to participate under voluntary enrollment policies, and those who are actively participating.

We find large socioeconomic and health differences between individuals who are participating in their employer's DC plan and those who are not. Plan participants are significantly more likely to be white, married, college educated, enjoy higher incomes, be longer tenured at their current employers, in good health, and have higher wealth both within and outside of retirement accounts than individuals not participating in their plan. While there are large differences between individuals who are participating in their employer-sponsored DC plan and those who are not, we find relatively little differences in characteristics across enrollment regimes when we condition on participation decisions. In particular, those who have chosen to opt out of participating in a plan in which they were automatically enrolled appear fairly similar to those who have elected not to participate under voluntary enrollment and both groups appear to be largely financially unprepared for retirement.

Similar to previous analyses, we find that automatic enrollment is associated with a large increase in plan participation and is particularly effective at getting lower income, less educated, and minority individuals to participate. However, automatic enrollment is not positively associated with longer-run contribution status in our sample – those who opt-in are more likely to continue making contributions over time.

Plan Sponsor Data Technical Working Group Meeting: Meeting Notes

Summit Consulting, 2014 | Full Text

This document summarizes the major points of the discussion that took place on January 10, 2014 during a Plan Sponsor Data Technical Working Group meeting between EBSA, Summit Consulting, and external Subject Matter Experts that have worked with the Form 5500 data and external plan sponsor data sets. Specifically, this document outlines the discussion as it pertained to: 1) the Subject Matter Experts' research performed using Form 5500 data and outside data sources and the related data issues; 2) Other external data sources of interest; 3) Suggested indicators of financial and operational performance of sponsors and plans; and 4) The experts' Form 5500 wish list.

The Impact of Informal Caregiving on Older Adults' Labor Supply and Economic Resources

Barbara Butrica and Nadia Karamcheva, 2014 | Full Text

This study analyzes the effect of informal caregiving on older adults' labor supply and economic resources. Although we find no evidence that caregiving affects the wages or hours of workers, we do find that it reduces the likelihood of working. Men who provide personal care to parents or intensive care to spouses are less likely to work, as are women who provide intensive care to parents. As a result, over time, caregivers have a significantly higher probability of falling into poverty and also experience a smaller percentage growth in assets—particularly those who care for their spouses.

Implications of Projecting Recent Trends in DB Pension Plan Freezes into the Future

Martin Holmer, 2013 | Full Text

This report documents how the recent trend in defined benefit pension plan freezing — as revealed in unpublished tabulations of National Compensation Survey data — has been used to project future freezes in PENSIM. The report describes the nature of the freeze assumptions that, beginning in 2013, are included in the baseline PENSIM assumptions regarding employer pension offerings. The report also describes the consequences of this trend for pension participation, employer pension cost, and future employee pension benefits. The sensitivity of the pension benefits consequences are tested by projecting future freezes at half the recent rate and at twice the recent rate.

Revenue and Benefit Effects of Reducing DC Pension Salary-Reduction Caps

Martin Holmer, 2013 | Full Text

This report contains estimates of the impact of lowering maximum allowable pretax contributions to salary-reduction defined-contribution pension plans beginning in 2012. Several reforms are considered, including lowering the base contribution cap, eliminating the catchup cap, combining those two reforms, and replacing the current caps with a 20/20 cap. For each reform, estimates of the aggregate dollar decline in DC plan contributions by employees and employers are presented. In addition, an estimate of the rise in federal individual income tax revenue during the first year of the reform is provided. And finally, the retirement income effects of each reform are estimated using a cohort sample of individuals who experience the reform over their whole work career.

Designing Better Pension Benefits Statements - Current Status, Best Practices and Insights from the Field of Judgment and Decisionmaking

Lauren A. Fleishman-Mayer, Angela Hung, Joanne Yoong, Jack Clift and Caroline Tassot, 2013 | Full Text

Decisionmaking on saving for retirement requires individuals to have knowledge on fundamental issues, such as the functioning of pension systems, portfolio allocation, future expected benefits, contribution histories and risks. Currently, the information provided in pension benefits statements vary widely by plan provider as well as by the nature of benefits offered. The inconsistency could occur partly because recommended best practices for, and empirical studies that test, the design and content of statements vary widely in the literature. Furthermore, little is known on how people think about saving for retirement. Insights from the fields of behavioral economics, and judgment and decisionmaking can fill some of these literature gaps by applying psychological theories to help better inform consumers about their financial decisions and retirement status using benefits statements. In this paper, we provide a normative and positive review of pension benefit statement design. We begin by reviewing best practices and recommendations provided from the trade literature. Next, we describe the content and design of a cross section of statements that are currently being used by plan providers. Finally, we review the academic literature on individuals' understanding of, and information needs related to, pension benefits statements. The latter includes a description of the few studies explicitly researching pension statement design related questions, general behavioral and decisionmaking literature that can be applied to the content and presentation of information, and general literature on whether and to what extent uncertainty should be presented.

Retirement Income Effects of Changing the Income Tax Treatment of DC Pension Plans

Martin Holmer, 2012 | Full Text

This paper presents estimates of the after-tax retirement income effects of switching, over a whole lifetime, the federal income tax treatment of defined contribution (DC) pension plan contributions and withdrawals from the traditional tax-exempt and taxable to an alternative treatment in which all DC contributions would be taxable and all DC withdrawals would be tax-exempt. The estimates are produced using a microsimulation model of lifetime pension accumulation that contains a federal income tax calculator and a social security benefit calculator. Two sets of estimates are presented: one in which income tax thresholds are assumed to be indexed to wages and another in which thresholds are indexed to prices as under current law. The estimates suggest that the average effect on after-tax retirement income of this switch in the federal income tax treatment of DC contributions and withdrawals would be less than a one percent decrease when tax thresholds are indexed to wages and slightly more than a two percent increase under current-law price indexing. The magnitude of the changes rise with lifetime earnings and there is considerable variation around the average effect especially when tax thresholds are indexed to prices.

Annuities in the Context of Defined Contribution Plans

Michael J. Brien and Constantijn W.A. Panis, 2011 | Full Text

This report sheds light on the market for annuities and the demand for annuities by defined contribution ("DC") plan participants. An annuity is a financial product that promises a periodic payment, typically over the course of the annuitant's life, in exchange for a up-front premium. The individual market for annuities has become increasingly important as employers shift from defined benefit pension plans to 401(k) or other defined contribution plans. The report first provides an overview of the market for annuities in the United States. Annuity prices have generally risen over the past 25 years (or, equivalently, the monthly benefit per $1,000 premium has fallen), while the spread in prices across insurance companies has narrowed since 2003. The report then turns to the extent to which annuities are available to DC plan participants. Roughly 1% of DC plans offer a deferred annuity among their investment options. Separately, about 6% of plan participants annuitized some or all of their plan balances upon retirement; the option to do so appears to have become less widespread over the past decade. Finally, plan participants may roll over the balance into an IRA and purchase an annuity with IRA assets.

Target Date Funds and Retirement Savings

Michael J. Brien, Philip J. Cross, Thomas A. Dunn, Constantijn W.A. Panis, and Joice A. Pharris, 2010 | Full Text

Deloitte Financial Advisory Services LLP ("Deloitte FAS") and Advanced Analytic Consulting Group Inc. ("AACG") explore how Target Date Funds (TDFs) can affect the accumulation of retirement wealth by using the micro-simulation model PENSIM to examine the distribution of Defined Contribution (DC) benefits accumulated by investors under various asset allocation strategies. The PENSIM model, together with the companion SSASIM model, consist of numerous equations that predict individual outcomes, such as job changes, pension plan availability, and DC contributions under random macroeconomic scenarios. Deloitte FAS and AACG study the differences in the distributions of pension wealth accumulation across many macroeconomic scenarios for a random selection of approximately 30,000 individuals in the 1995 birth cohort.

The authors find that the TDFs specified in the study outperformed debt-only investment styles in about 70 percent of the macro scenarios. The all-equity investor styles in the study outperformed the TDFs 60 to 80 percent of the time. It is important to note that these conclusions are based on projected differences in DC pension benefit accumulations generated under a specific set of macro scenarios; a different set could produce different results. Additionally, these results could be sensitive to the premium on equity returns over debt built into the model, which is assumed to be 2.0%.

The authors also investigate the insurance properties of TDFs by selecting scenarios with poor equity returns just prior to retirement. For these scenarios, the conservative TDF outperforms most equity investment styles and fares better than the aggressive TDF. The authors suggest that the value of TDFs may be heightened when poor equity returns occur just prior to retirement.

Volatility Metrics for Mutual Funds

Michael J. Brien, Constantijn W.A. Panis, and Karthik Padmanabhan, 2010 | Full Text

It is possible that inexperienced 401(k) participants may be over-influenced by recent historical returns, and do not properly factor return volatility into their allocation decisions. This report from Deloitte Financial Advisory Services LLP ("Deloitte FAS") and Advanced Analytic Consulting Group Inc. ("AACG") explores the extent to which a number of commonly used volatility metrics convey consistent information by comparing the metrics across a set of funds. The authors distinguish between absolute and relative volatility metrics and conclude that relative metrics can be misleading to investors who lack sufficient understanding of the comparison that is implicit in relative metrics.

The study examines six commonly-used absolute volatility metrics, some of which may be more intuitive and easier to understand than others. The value of each of the six absolute volatility metrics is calculated for a selection of funds and individual company stocks. Deloitte FAS and AACG conclude that the volatility rank order of funds is similar for most, but not all, absolute risk metrics, so that 401(k) participants may benefit as much from an intuitive, easy-to-understand metric as from more complex metrics.

In particular, the report shows that a casual investor is likely to draw similar conclusions about the volatility rank order of funds in his investment menu whether he uses the best/worst historical return, the standard deviation of daily returns, the standard deviation of monthly returns, the number of trading days with price changes in excess of 1 percent, or the Financial Engines Fund Risk metric. Given the absence of clear superiority of any single metric, relatively minor advantages and disadvantages may draw distinctions among them. For example, the number of trading days with price changes in excess of 1 percent might be preferred because it is intuitive and easy to understand. Of the six absolute volatility metrics studied, the five metrics mentioned above appear to hold merit for educating 401(k) participants about the volatility rank order of their fund options.

Target Date Funds: Historical Volatility/Return Profiles

Michael J. Brien, Philip J. Cross, and Constantijn W.A. Panis, 2009 | Full Text

This study by Deloitte Financial Advisory Services LLP ("Deloitte FAS") and Advanced Analytic Consulting Group Inc. ("AACG") explores the returns and volatility of families of target date funds (TDFs), especially the performance of target-2010 funds during the recent economic crisis. The study makes use of data on 1,645 funds ranging in size from less than $1 million to $16.8 billion in assets. Over the period 2005-2009, TDF returns generally increase with equity exposure, except in 2008, when these funds performed particularly poorly. The findings suggest that rates of return and volatility on target-2010 funds varied substantially in 2008. The spread in returns can be traced to substantial variation in equity exposure. In fact, some fund families maintain equity exposure of more than 60 percent, even for their 2010 fund. Small 2010 funds as a whole exhibited more heterogeneous volatility than large 2010 funds.

The authors select seven families of target date funds for an in-depth look at their returns, volatility, and equity exposure. From these seven families, the best performing 2010 funds in 2008 were not "typical" TDFs. One invests only in Treasury securities, while another does not have 2020, 2030, 2040, 2050 sibling funds. Deloitte FAS and AACG further find that the overall objective of funds, as stated in fund prospectuses, is generally not informative of whether a fund is aggressive or conservative.

Generally Accepted Investment Theories

Constantijn Panis and Joshua B. Schaeffer, 2007 | Full Text

This document summarizes influential investment theories in modern finance literature. The authors start with a description of the foundations laid by Markowitz (1952) and a widely cited application, the Capital Asset Pricing Model (CAPM). The report next turns to several extensions of Markowitz (1952) and CAPM which by now have become widely used among finance scholars and practitioners. In particular, recognizing that the objectives of investors and their exposure to various risks may change over time, the authors discuss extensions which form the basis of dynamic portfolio allocation and reallocation over the life cycle.

Participation in Defined Contribution Plans

William E. Even and David Macpherson, 2005 | Full Text

During the 1990s, many pension plans shifted the responsibility for directing the investment of pension plan assets to the employee. This study examines the rapid growth of the participant directed pension plans using data from the Survey of Consumer Finances, the Survey of Income and Program Participation, and IRS Form 5500. Several relevant questions are addressed. First, what types of workers are most likely to be in a participant directed plan and what types of employers are most likely to offer such plans? Second, how does participant direction affect the allocation of assets and the risk/return performance of the pension? The study has two important findings. First, participant direction has a significant effect on asset allocation in pension plans, shifting pensions away from employer stock and towards other types of stock. Second, based on risk-adjusted rates of return, participant directed plans actually outperform employer directed plans.

Defined Contribution Pension Plans and Retirement Wealth Adequacy

Gary V. Engelhardt, 2005 | Full Text

This project uses a newly developed defined contribution (DC) pension wealth calculator to generate new estimates of DC pension wealth for individuals in the Health and Retirement Study (HRS) with employer-provided pension Summary Plan Descriptions (SPD). There are four primary findings. First, pension wealth from voluntary saving (and accrued earnings thereon) comprises half of DC pension wealth calculated from the sample of matched SPDs in the HRS. Second, the DC/401(k) Calculator yields dramatically lower mean estimates of DC pension wealth for HRS participants than the Pension Estimation Program. In particular, DC pension wealth is calculated to be as much as 20-25 percent less when using an increase in the number of modeling assumptions offered to the user and arguably better input data, and wealth in 401(k)-type pension plans is implied to be as much as 40-50 percent less. Third, most of the reduction in estimated DC wealth occurs in the upper portion of the pension-wealth distribution. Fourth, the Pension Estimation Program actually understates DC wealth in the middle of the pension-wealth distribution. These results suggest that previous analyses that have used HRS pension wealth created from the matched SPD data have overstated retirement wealth adequacy among HRS participants.

Valuing Assets in Retirement Savings Accounts

James M. Poterba, 2004 | Full Text

Assets in retirement saving plans have become an important component of net worth for many households. While many studies compare household balances in tax-deferred retirement accounts such as 401(k) plans with the financial assets held outside these accounts, these different asset components are not directly comparable. Taxes and in some cases penalties are due when assets are withdrawn from some retirement saving plans. These factors can make a dollar held inside a retirement account less valuable than a dollar held in a similar asset outside these accounts, particularly for those who are considering withdrawing assets from the tax-deferred accounts in the near future. For younger households who do not plan to withdraw tax deferred assets for many years, the opportunity for tax-free compound returns in retirement accounts can make a dollar inside such an account more valuable than a dollar outside such accounts from the standpoint of providing retirement resources, even though the principal from the retirement account will be taxed at the time of distribution, while the principal outside such accounts is untaxed. This paper illustrates the potential differences in the value of a dollar of invested in a bond, or in corporate stock, inside and outside tax-deferred accounts. It draws on a range of data sources to calibrate the value of the tax burden, and the benefit of compound growth, for assets held in retirement accounts, and describes the differences in relative valuation for households of different ages.

The Causes and Consequences of Pension Fund Holding of Employer Stock

William Even and David Macpherson, 2004 | Full Text

This report examines the causes and consequences of investing pension funds in employer stock using a merger of data from Form 5500 pension filings and stock return data from the Center for Research on Security Prices (CRSP). Section II reviews the existing hypotheses and related empirical evidence on factors that lead pension funds to invest in employer stock. Results from the Capital Asset Pricing Model are employed in section III to derive a measure of the non-diversification costs of holding employer stock. Section IV provides a description of the data used in our study and an empirical analysis of factors influencing pension fund holdings is provided in section V. The effect of employer stock holdings on the risk and return of pension portfolios is examined in section VI along with projections of how legislated limits on employer stock holdings would affect the distribution of returns.

How Much and In What Manner Should Americans Save?

Jagadeesh Gokhale and Laurence J. Kotlikoff, 2004 | Full Text

This study uses ESPlannerTM -- a life-cycle, financial planning model -- to investigate how much American households should save and to understand the best form in which to do so. ESPlanner's saving and life insurance recommendations generate the smoothest possible survival-state contingent lifetime consumption path for the household without putting it into debt. Such consumption smoothing is predicted by economic theory and appears, in general, to accord with actual behavior. By running households through ESPlanner based on current policy as well as on alternative fiscal policies, one can easily compare the program's recommended consumption and saving response to hypothetical tax and transfer policy changes and assess the degree to which borrowing constraints (the inability to borrow significant amounts beyond one's mortgage) may be playing a role in determining the size of those responses. The program can also indicate what method of saving, be it in 401(k) and other tax-deferred accounts, Roth IRAs, or in non-retirement accounts is most efficacious with respect to minimizing lifetime taxes and maximizing lifetime consumption.

The 964 households used in our analysis are drawn from the Federal Reserve's 1995 Survey of Consumer Finances. This data set provides detailed information on household earnings, assets, housing, demographics, and retirement plans -- all of which is used by ESPlanner in formulating its recommendations. The policies we consider are tax hikes, tax cuts, social security benefit cuts, and the elimination of tax-deferred saving. Our analysis distinguishes between immediate and future policy changes as well as between permanent and temporary ones.

Our results are strongly influenced by the fact that a majority—58 percent—of our sample of households, many of which are young, is borrowing-constrained and, thus, more responsive to current than future policy changes no matter how long their duration. Borrowing constraints refer to the inability to smooth one's consumption without incurring additional non-mortgage debt. In running ESPlanner, we assume that households cannot borrow simply to smooth their living standards, as apart from buying a home. This ignores the ability of households to borrow relatively small sums on their credit cards. But including a relatively small credit card borrowing limit would make very little difference to our results. While we assume a zero-non mortgage debt limit in running our sample households through the program, the fact that 58 percent of the households can't perfectly smooth their living standards without going into debt represents a finding, rather than an assumption, of our analysis.

Because so many of our sample households are borrowing constrained, their consumption and saving responses to policy changes are very sensitive to the particular policy being enacted. Income tax changes, for example, have little effect on the consumption/saving of low-income households for the simple reason their income tax liabilities are relatively small. And social security benefit cuts will have minor effects on the young because they lie so far in the future and the young are generally borrowing constrained. On the other hand, eliminating tax-deferred saving will have no effect on current retirees, but greatly influence the spending of the young, since such a policy would relax their borrowing constraints. We also show that a small segment of households would end up raising their lifetime taxes and reducing their lifetime consumption by contributing to tax-deferred retirement accounts. For these households switching to Roth IRAs appears to be advantageous.

Cross-Trading by ERISA Plan Managers

Thomas H. McInish, Ph.D., C.F.A., 2002 | Full Text

ERISA prohibits cross trades, the exchange of assets between two accounts without going through a public market. There have been numerous exemption requests motivated by a desire to reduce transaction costs (typically one to four percent). Mutual fund cross trades under Rule 17a-7 achieve economically significant savings. Transaction costs comprise commissions, market impact, and opportunity costs of missed trades. Further, round trip trades incur a bid-ask spread, which covers order processing costs (the normal expenses of providing liquidity) and asymmetric information costs (dealer losses to informed traders). Dealer quotes reflect asymmetric information costs and trade size. Trade prices exhibit regularities, including U-shaped patterns in returns and volume. Without a market trade, it is impossible to know what price each counterparty would have paid/received. If both parties are equally motivated and seek to trade at the same time, it makes sense to cross at the spread midpoint. But if one party typically uses patient trading strategies or is accommodating the counterparty, determination of a fair crossing price is difficult. If the goal is to minimize risk, cross trading should be prohibited. In a cost-benefit context, steps such as having written implementation plans and strong monitoring can reduce risk of abuse.

New Trends in Pension Benefits and Retirement Provisions

Olivia S. Mitchell, 2000 | Full Text

Private sector pension plans have undergone substantial change in form and structure in the United States over the last two decades. This paper explores and evaluates these changes using information on pension plan characteristics gathered by the U.S. Department of Labor (DOL) since 1980 in their periodic Employee Benefits Survey (EBS) of medium and large establishments. We also discuss how future data collection efforts could be improved to better measure key changes in the form and design of employer-sponsored pensions.

Key findings are as follows: Many aspects of defined benefit plans changed over time. For example, vesting rules were loosened; plans eased access to normal retirement; and pension benefit formulas moved toward final rather than career earnings, with increased weight on straight-time pay. In addition, these plans became more integrated with social security; at the same time, the form of social security integration changed substantially. The evidence also indicates that defined benefit plan replacement rates fell over time and benefit caps limit years of service counted in the retirement formula. In addition, disability benefit provisions grew more stringent; and participants were increasingly permitted to take a lump sum from their defined benefit plan.

Defined contribution plans also have evolved over time. Here, plan participants were granted greater access to diversified stock and bond funds, and fewer were permitted to invest in own-employer stock, common stock funds, and guaranteed insurance contracts. Participation and vesting rules appear most lenient for workers in 401(k) plans; generally employees must contribute a fraction of their pay to their plans rather than relying only on employer contributions; and employee access to pension fund assets prior to retirement is growing.