Academic journal article Monthly Labor Review

Pension Integration and Retirement Benefits

Academic journal article Monthly Labor Review

Pension Integration and Retirement Benefits

Article excerpt

Pension integration ,generally increases benefits modestly for workers with less tenure and decreases benefits substantially for workers with more tenure; offset integrated plans have significantly higher replacement rates than excess-rate integrated plans

The issue of retiree income is important in a time of proposed Social Security reform. In 1996, for example, the shares of aggregate income for those aged 65 or older were, on average, 40.3 percent from Social Security, 18.5 percent from employer pensions, 20 percent from employment, and 21.1 percent from assets and other forms of income.(1) Integration of pension income with Social Security income likely reduces benefits for many retirees, making research on income from integrated pensions critical.

Previous research creates hypothetical earnings histories to simulate the effect of integration on actual plans. In one such simulation, Avy Graham finds that integration decreases replacement rates for low earners and increases them for middle and high earners, compared with those with nonintegrated pensions.(2) By contrast, Keith Bender reports that recent survey data show only a slight correlation between higher replacement rates and higher income for integrated plans.(3) The current article presents new evidence, using a combination of survey data on workers and on their actual pension plans.

Background

Some basics on pension integration. An employer pension plan is integrated when it explicitly takes into account Social Security benefits in determining the pension benefit.(4) Because both defined-benefit and defined--contribution plans can be integrated, integration affects a significant number of workers. Data on the rate of integration in private-sector defined-benefit plans are found in the Employee Benefits Survey conducted by the Bureau of Labor Statistics. In 1995, 51 percent of full-time private-sector workers in medium-sized and large establishments who participated in a defined-benefit pension plan were in an integrated plan. However, because roughly half of the workforce was covered by a defined-benefit plan that year, the rate of defined-benefit pension integration among all full-time private-sector workers in medium-sized and large establishments was 26.5 percent. No data have been published on integrated defined-contribution plans, but Bender, using data from the Health and Retirement Study (HRS), shows that approximately 8 percent of workers participating in such plans have an integrated pension.(5) Overall, integration rates in the study are approximately 32 percent for the subsample covered by a pension and 14 percent for the working subsample. Finally, pension integration is rare among government employees. The Federal retirement system is not integrated with Social Security, and, as Ann C. Foster reports, less than 10 percent of all State and local government employees have plans that are integrated with Social Security.(6)

Integration in defined-benefit plans can take place in two ways. Before the Tax Reform Act of 1986, the offset method reduced the employer pension by a portion (usually 50 percent) of the retiree's Social Security retirement benefit. For example, suppose that, in the absence of the offset, a new retiree would receive an annual pension benefit of $10,000 and an annual Social Security benefit of $8,000. If the pension was integrated by the offset method, then the annual benefit would be reduced by half of the Social Security benefit, to $6,000. Therefore, the pension income of the retiree is $4,000 lower under an integrated plan than it would be in the absence of the plan.

However, the new provisions under the 1986 act modified the offset to be at most 50 percent of the employer pension benefit. This was done to ensure that the employer pension could not be reduced to zero, as was possible under the previous integration provisions when the Social Security benefit was more than twice the pension benefit. …

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