A M E R I C A N AC A D E M Y of AC T UA R I E S
half of 45-to-54-year-olds put the entire distribution into savings or investments (fig. 23). The tendency of workers under 55 to use amounts saved for retirement for other purposes is especially unfortunate. As shown later, amounts put aside earlier in a worker’s career are generally worth much more at retirement than similar amounts saved late in one’s career. One bright note is that the number of workers preserving their lump sum distributions in IRAs or some other retirement program is on the increase. Only 6 percent of workers receiving their most recent lump sum distribution before 1980 put it in a new retirement account. This jumped to 15 percent for lump sums received from 1980 to the end of 1986, and to 27 percent for lump sums from 1987 to April of 1993.22 The increase after 1986 may have been due in part to the stiffer, 10-percent tax penalty that went into effect then. Trends in pension wealth and plan funding. It is not widely appreciated how important employer pension programs are to the savings of working adults. Along with home ownership, employer-sponsored pensions are the most important way that Americans save, and over the past several decades pensions have been a tremendous source of capital. In 1950, pension assets accounted for about 2 percent of national wealth. By 1993, they accounted for nearly 25 percent (fig. 24).
Another threat to benefit security is lack of asset diversification. In the past, employers often required workers to invest large portions of their defined contribution accounts in the company’s own stock, and some still may encourage such behavior. Some workers, of course, have profited handsomely from this lack of diversification. Others have lost nearly all their retirement savings when the company’s stock declined dramatically in value. Even without prodding from employers, workers may choose not to diversify their investments and, hence, expose themselves to large risks. One of the most serious drawbacks to defined contribution plans as vehicles for retirement saving is that nearly all of them permit lump-sum distributions of account balances to workers who leave the company. Despite having to pay taxes on the income, as well as a 10-percent tax penalty, most workers spend the funds they receive from their defined contribution plans when they change jobs. In 1990, 10.8 million people received lump-sum distributions amounting to $126 billion. Only 56 percent ($71 billion) was rolled over into individual retirement accounts (IRAs). 20 Changing jobs may not even be necessary to withdraw the funds. Workers with 401(k) and other defined contribution plans often have lenient withdrawal provisions available to them. Unlike traditional plans, 401(k) and other individual account plans permit “hardship withdrawals” for medical expenses, education expenses, and first-home purchases. Although withdrawals must be counted as income and taxes must be paid on the money withdrawn, about half the workers in these plans can withdraw funds without changing employers. Half the workers covered are also permitted to borrow against their accounts.21 Studies show that older workers and those with larger amounts in their plans are more likely to return withdrawn money to retirement accounts. For example, in 1993, 60 percent of workers aged 55 to 64 who received distributions put the entire amount into retirement or other savings. Fewer than
Figure 24 Pension Assets as a Percentage of National Wealth, 1950-1993 25
Percent of National Wealth
Figure 23 Workers’ Uses of Their Most Recent Lump Sum Distributions from Pension Plans
Use of Lump Sum
Age at Receipt of Lump Sum 25 to 35 to 45 to 34 44 54
55 to 64
Retirement savings Other financial savings Home, business, debt repayment Spent Multiple and other uses
Source: The Aging of the Baby Boom Generation, Sylvester Schieber and John Shoven, for ACCF Center for Policy Research, January 1997 (rev.), Figure 2, p. 3.
It is not clear how much longer pension plans will continue to be the engine for savings that they have been for the past 15 to 20 years. At some point, they may well change from net buyers of assets to net sellers. This is not a negative development, per se. The pension assets have been accumulated for this purpose. However, given the size of the baby boom generation relative to the cohorts that follow it, there could be impacts on the aggregate economy, just as there appeared to be impacts on housing prices in the 1970s.
Source: Pension and Health Benefits of American Workers, U.S. Department of Labor, May 1994, Table D5, p. D-5.
The Problem and Options for Change PublicPolicyMonograph 1998 No. 1 A MERICAN A CADEMY of A CTUARIES