Academic journal article Social Security Bulletin

Pension Integration and Social Security Reform

Academic journal article Social Security Bulletin

Pension Integration and Social Security Reform

Article excerpt

by Chuck Slusher*

Many employer-provided pension plans explicitly account for Social Security in their benefit formulas-a practice known as integration. Because integrated pensions are directly linked to Social Security, both the incidence and design of explicitly integrated plans are likely to be affected by changes in the current Social Security program. While integration has been mentioned as an important issue in discussions of Social Security reform, researchers have largely ignored the concept of pension integration. This article provides basic information about pension integration and addresses, in general terms, the relationship between Social Security reform and pension integration.

I. Introduction

When assessing proposals for restructuring Social Security it is necessary to examine the impact of reform on the other two main sources of retirement income: employer-provided pensions and personal savings. While there are myriad avenues through which Social Security, pensions, and savings are interrelated, many employer-- provided pension plans are directly linked to Social Security in that they explicitly account for Social Security benefits when designing their pension benefit formulas, a practice known as pension integration.

Three recent papers discussing Social Security reform have called attention to the importance of pension integration in assessing the effect of Social Security reform on the pension industry. Kelly Olsen, Jack VanDerhei, and Dallas Salisbury ( 1997) of the Employee Benefit Research Institute (EBRI) suggest that, at a minimum, pension providers will adjust integrated benefit formulas to reflect changes in Social Security benefits brought on by reform. Janice Gregory (1997, 1998) of the ERISA Industry Committee (ERIC) takes this idea a step further and argues that because the pension industry and Social Security essentially "grew up" together, all pension plans are implicitly integrated with Social Security.1 This view implies that a major restructuring of Social Security will lead to a redesign of most if not all pension plans.

The common point made by both Olsen et al. and Gregory is that explicitly integrated plans will be affected by Social Security reform. The rationale for this theory is that integrated pension plans are designed to work in combination with Social Security to replace approximately the same fraction of final earnings of high-, middle-, and low-wage employees.2 As a result, any changes in Social Security benefits would require a redesign of integrated formulas to maintain the desired rate of replacement of workers' earnings. Another reason that Social Security reform would affect integrated plans stems from likely changes in the regulatory environment in which integrated plans operate. Restrictions on integrated plans have been adjusted several times in the past, often following adjustments to Social Security.3 It is likely that the rules covering integrated plans will change again in response to forthcoming Social Security reform.

As will be seen in section III, pension integration affects a substantial proportion of pension participants. Consequently, understanding how the prevalence and design of explicitly integrated pension plans will change in response to Social Security reform is an important issue on its own. If, as Gregory suggests, all pension plans are either explicitly or implicitly integrated, examining the effect of Social Security reform on explicitly integrated plans may also illuminate the effect of Social Security reform on the pension industry as a whole. This article provides some basic information about pension integration, gives evidence of the prevalence of integrated pension plans, and discusses the potential impacts of various Social Security reform proposals on pension integration.

If Background and Definitions

Integration of pension plans first came into focus with the Revenue Act of 1942, which was designed, in part, to prevent tax-qualified private sector pension plans from discriminating in favor of supervisors and highly compensated employees. …

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