Data and Research September 25, 2019

Retirement System Problems Contribute to Financial Inequality

Researchers contend that financial asset inequality is exacerbated by regressive tax incentives for retirement savings and unequal access to employer-provided retirement plans, and they offer suggesting for addressing this.

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Financial asset inequality among Americans continues to increase, and combined with dangerously low retirement savings among most households, poses a significant threat to retirement for working Americans, researchers say in an Issue Brief released by the National Institute on Retirement Security (NIRS).

The researchers contend that financial asset inequality is exacerbated by regressive tax incentives for retirement savings and unequal access to employer-provided retirement plans.

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They found that the share of Baby Boomer financial assets owned by the wealthiest 5% of households in this generation grew from 52% in 2004 to 60% in 2016. Over the same time period, the share of financial assets owned by the top 10% of Baby Boomer households grew from 68% to 75%, and the share owned by the top 25% grew from 86% to 91%. The share of assets owned by the bottom 50% of Baby Boomer households shrank from 3% in 2004 to less than 2% in 2016.

The data shows Generation X and Millennials appear to have reached comparable degrees of financial asset concentration among the wealthiest households as Baby Boomers, at younger ages.

A 2018 NIRS report analyzing U.S. Census Bureau data found deeply inadequate retirement savings levels among working age Americans. More specifically, the median retirement account balance among all working individuals is $0.00, and 57% of working age individuals do not own any retirement account assets in an employer-sponsored defined contribution (DC) plan, individual retirement account (IRA) or pension.

The researchers say in the current report that the lack of retirement plan access is largely to blame.

The current Issue Brief also points out that Social Security provides critical retirement income for a large majority of Americans. The program has a progressive benefit structure that helps lower-income Americans retire above the poverty line and helps retirees keep up with generational improvements in the standard of living. However, the Social Security tax structure has become increasingly regressive over time. The cap on earnings subject to Social Security payroll taxes, known as the tax max, has failed to keep up with increasing earnings inequality. Even though the share of workers with earnings above the tax max has remained relatively stable for decades at about 6%, the system captures a smaller and smaller share of U.S. earnings every year.

The researchers offer suggestions for improving the financial asset inequality that is caused by retirement system issues. First, the President and Congress could strengthen Social Security. Eliminating the earnings cap would increase revenues for the program, which would help to improve the Social Security trust fund’s funding shortfall. These increased revenues could also finance improvements to the program, such as more generous benefits for lifetime lower-income earners and earnings credits for those who take time out of the workforce to provide caregiving.

Second, the researchers say, states can play an important role by creating state-facilitated retirement savings plans for those who are not offered a plan through their employer. This will provide a meaningful wealth-building opportunity for workers who lack access to employer-sponsored plans. Ten states so far have established retirement savings plans for workers without a plan. After just two years of operation, Oregon workers are accumulating $2.5 million per month through the state’s auto-IRA program.

Of note, however, U.S. Attorneys have filed a Statement of the Interest of the United States in a lawsuit, offering evidence that California’s state-run auto-IRA program is preempted by the Employee Retirement Income Security Act (ERISA).

Finally, the researchers suggest the federal government could act to improve and promote the federal Saver’s Credit. They say the rapid phase-out at low income levels and lack of refundability restrict the credit’s effectiveness. The average credit in 2014 was only $174, and the cost to the federal government was miniscule compared to the tax expenditures that subsidize the savings of higher-income earners through 401(k) tax provisions.
Investing September 25, 2019

Several Strategies Help DB Plan Sponsors Manage Financial Risks

MassMutual discusses four main strategies for limiting or eliminating defined benefit plan risks over time: hibernating risks, establishing glide paths, hedging risks by re-allocating investment assets and shifting pension obligations to a life insurer by purchasing annuities.

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As employers wrestle with how to best mitigate the financial risks associated with sponsoring defined benefit (DB) pension plans, they should weigh the relative benefits of limiting versus eliminating those risks over time, according to a new white paper from MassMutual, “Key Decisions for De-Risking Your Pension Plan.”

There are four main strategies, according to MassMutual: hibernating risks, establishing glide paths, hedging risks by re-allocating investment assets and shifting pension obligations to a life insurer by purchasing annuities.

“There are several different risk strategies for employers to contemplate when managing pension risks over both the short and long term,” says Neil Drzewiecki, head of pension risk transfer for MassMutual. “More employers are concluding that transferring those risks to a life insurer is in the best interest of the company and its employees.

Drzewiecki says that annuities might be the most preferable approach because they help employers shift pension risks off their balance sheets, reduce their long-term financial liabilities and costs, and enables them to maintain long-term financial security and service to plan participants.

“The growing popularity of PRT [pension risk transfer] is good news for both plan sponsors and participants,” Drzewiecki says. “When a plan participant receives a notice in the mail that his or her pension benefit will be paid by a financially secure, experienced life insurer with great service, it’s great news.”

In fact, annuities are the only way to eliminate pension obligations under current law, MassMutual notes. In 2018, pension buy-out transactions totaled $26.4 billion, up demonstrably from $3.84 billion in 2013, according to the LIMRA Secure Retirement Institute.

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Another approach to de-risking a DB plan is to “hibernate risks,” i.e. close the plan to any new entrants and to stop accruals for participants who are still accruing benefits. This is also known as freezing a plan. The goal of the hibernation strategy is to limit the financial risks of the plan while the sponsor continues to manage the plan.

A plan with a hibernation strategy will typically establish a glide path in which investments are increasingly allocated to fixed income as its funded status improves. This is done for two reasons. First, assets can’t revert to the plan sponsor, so as a plan approaches being 100% funded, the risk/reward associated with equities starts to diminish.

Second, fixed income assets offer a hedging effect on pension liabilities because interest rates affect fixed income assets and pension liabilities in a similar manner. MassMutual says that on the positive side of the equation, this approach protects against the risk of unanticipated benefits increases. It also saves money for the employer and reduces their risks before eventually executing a pension buyout.

However, plans are still exposed to many other risks, especially interest rate risk. Even though in hibernation, the plan must still be managed to some degree, and, therefore, continues to incur costs, including investment management expenses, actuarial consulting costs, recordkeeping fees and reporting fees.

Another approach DB plans can take is to hedge risks by investing fixed income assets to match the plan’s liability sensitivity to interest rate movements, known as “duration,” to offset changes in the plan’s liabilities. When interest rates decrease, the asset portfolio will increase in value in an amount to close to the increase in liabilities.

On the plus side, this can reduce the plan’s investment risks—but it does not eliminate the risk. While the hedging lowers market risk and makes it less volatile, market risk still exists, MassMutual says. And the assets and liabilities of the DB plan still remain on the sponsor’s balance sheet.

Finally, MassMutual explores annuitizing the plan. Besides the benefits noted above, MassMutual notes that annuities provide income for life, and are guaranteed and fixed. In some cases, income from an annuity can increase over time, providing much-needed inflation protection. However, inflation protection is not provided by all annuities.

Finally, the annuitant can decide when to begin taking payments and they are often offered a death benefit. Typical death benefits pay 100%, 75% or 50% of the initial annuity payment. The higher the death benefit percentage, the lower the initial income payment at the start of the annuitant’s retirement.

MassMutual also underscores the importance of the employer performing due diligence on the insurer before the process begins. They need to look at its ratings provided by insurance rating agencies. They need to look at the quality and diversification of their investment portfolio, and the size of the insurer relative to the annuity purchase.

They need to explore the level of capital and surplus held by the insurer, and the insurer’s other lines of business and liabilities that they are exposed to. Finally, employers need to thoroughly examine the structure and terms of the annuity contract. MassMutual recommends that employers turn to experts to conduct this analysis, as well as to assess quotes for annuity purchases.

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