SummaryThis analysis uses variants of the EBRI-ERF Retirement Income Projection Model (RIPM) and Retirement Security Projection Model® (RSPM®) to provide quantitative assessments of the future financial security implications of a move away from defined benefit promises and from annuity payments ("traditional" employer-provided pensions).
The analysis provides preliminary results on the impact of benefit accrual freezes for pension plans, modifications to cash balance plans, lump-sum distributions of retirement benefits, and payment of retirement accumulations as life annuities. Major findings include:
- Freezing benefit accruals for all private defined benefit plans beginning in 2005 would have a larger impact (as measured in terms of average real dollar decrease in first year surplus) on younger cohorts. The average annual decrease for those in the youngest cohort modeled (born between 1961 and 1965, inclusive, or those currently between ages 39 and 43) would be $4,886 for families, $2,752 for single males, and $1,686 for single females (Figure 3).
- Terminating all cash balance plans without a replacement plan in 2005 has a smaller impact than the benefit accruals freeze, since a much smaller percentage of participants would be affected (Figure 6).
- The last two sensitivity analyses tested the value of annuitization and therefore needed to simulate a significant number of future life-paths to capture the longevity risk experienced by retirees. The output metric used was the median percentage of additional compensation that must be saved annually until retirement for a 75 percent chance of covering simulated expenses.
- If one assumes that all defined benefit participants take lump-sum distributions at retirement, the average annual increase in needed savings is 14.9 percent (Figure 7), whereas assuming that all individual accounts are annuitized at retirement has an impact twice as large—but in the opposite direction (a 30.0 percent decrease in additional annual savings, Figure 8).
Policymakers should take action sooner rather than later in order to create greater regulatory certainty for plan sponsors. Decisions are needed on the status of cash balance pension plans, permanent funding rules, and interest rates to be used in plan calculations, accounting treatment related to using smoothing versus mark-to-market for investment returns and interest rates, and rules and premiums under Title IV of ERISA and the Pension Benefit Guaranty Corporation. Until these kinds of policy decisions are made, further erosion of the defined benefit system can be expected to continue. While the decisions made could either slow or speed that erosion, they would at least create an environment in which individuals could better assess what they are likely to have as retirement assets and income, and plan to continue working, or to exit the work force, accordingly. A demographic time bomb is ticking, and the time to act is now.