Coordinating Private Pension Benefits with Social Security

By Graham, Avy D. | Monthly Labor Review, March 1994 | Go to article overview

Coordinating Private Pension Benefits with Social Security


Graham, Avy D., Monthly Labor Review


Many American workers can expect retirement income from an employer pension plan and Social Security. These two benefits often work in tandem; for example, both provide retirement income for older Americans, both frequently provide disability income, and both include survivor provisions to continue payments after a beneficiary dies. In addition, employer pension plans frequently contain provisions for coordinating plan benefits with Social Security.

The coordination of employer pension benefits and Social Security, often called "Social Security integration," is designed to reduce employer costs for providing pensions to account for the cost of Social Security. This integration began shortly after Social Security was enacted in the 1930's, and was intended to help reduce pension costs for employers, who were required to pay Social Security payroll taxes. [1] Because most employers are required to pay Social Security taxes on the wages they pay their employees, integration allows employers to lower their overall retirement plan costs by reducing the benefits--and the cost---of the employer pension plan.

Social Security integration provisions are widespread among pension plans covering private-sector workers, particularly white-collar employees. In 1991, about three-fifths of the full-time employees in private establishments employing 100 workers or more were covered by a traditional pension plan, known as a defined benefit plan, and a little more than half of those workers had benefits computed using an integrated formula. Over the last decade, defined benefit pension plans have become less prevalent, while integrated formulas have become more prominent. In 1980, a little more than two-fifths of plan participants were covered by integrated formulas. [2]

This increased prevalence of integrated benefit formulas has coincided with the enactment over the past decade of laws and regulations affecting pensions. Among these numerous laws was the Tax Reform Act of 1986, which imposed new rules for pension plans that integrate benefits with Social Security. As will be described in more detail later, the 1986 tax law has had an impact on two forms of integration--the offset method, which is becoming less prevalent, and the step-rate method, which has become more widely used.

While integration provisions are widespread, the original intent of reducing employer pension costs has taken on a new purpose--to provide proportionally greater benefits as income increases. Bureau of Labor Statistics data indicate that for employees earning $35,000 or more, pensions available from integrated plans are greater than those from nonintegrated plans. The formulas for computing benefits differ widely, but the resulting pension benefits differ only slightly.

This summary examines the details of pension integration--how integrated formulas affect plan benefits and the changes brought about by the new law. It also includes projections of plan benefits, and compares integrated and nonintegrated formulas. Data are from the annual BLS Employee Benefits Survey, which provides information about the incidence and characteristics of employee benefits, including pension plans. The survey covers approximately 90 million workers in private industry and State and local government; data in this article are based primarily on the 1991 survey's approximately 32 million full-time workers in private establishments with 100 employees or more. Survey data on retirement benefits include the availability of pension plans; detailed data on plan provisions, such as benefit formulas and Social Security coordination features; and projected benefit payments based on assumed salary levels and years of service. [3]

Employer pension plans

An employer pension plan is designed to provide retirement income to employees, generally based on the employees' years of service and wages. There are two basic types of pension plans: Defined benefit and defined contribution.

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