Sunday, January 4, 2015

Income Security [a Defined-Benefit Pension Plan Is] Key to Retirement (National Institute on Retirement Security)

“National Institute on Retirement Security executive director Diane Oakley testified [on September 17, 2014] before a U.S. House Ways and Means Subcommittee on the critical role of pensions in ensuring retirement income security. Her testimony focused on a key issue -- predictability for both employees and employers. An excerpt from her testimony follows.  

“Forty years ago this month, major consumer protection legislation impacting pension plans, the Employee Retirement Income Security Act of 1974 (ERISA), became law. Congress acted then to protect Americans’ pensions and financial security. As we look to the future, Congress will continue to play a critical role in ensuring pensions remain an important tool for private sector businesses and Americans at a time when retirement readiness is in decline. 

“The first private sector defined-benefit pension plan was created in 1875 by the American Express Company. Over pension’s first century, numerous private sector employers have followed suit by offering DB pensions to their employees because pensions are valued by employees and employers alike. 

“[Governor Rauner needs to understand] Employees value that pensions provide a predictable income that lasts after a lifetime of work. Employers value that pensions provide companies with a powerful human resource tool for recruitment retention, and workforce management while offering cost effective retirement security. 

“As we reflect on ERISA, the title of this 1974 law had the right focus: retirement income security. In fact, one of our nation’s Nobel Prize winning economists wrote in a recent issue of the Harvard Business Review summing up the key issue working American families face in regard to retirement security. 

“Robert C. Merton said that the primary concern of the saver remains the question ‘Will I have sufficient income in retirement to live comfortably?’ He asserts, ‘the relevant risk is retirement income uncertainty.’

“Americans are very worried about their retirement financial security. In Pensions & Retirement Security 2013: A Roadmap for Policymakers, NIRS found that Americans are very uncertain and worried about their retirement outlook despite recovery of the financial markets, declining unemployment and increased consumer confidence. An overwhelming majority of Americans (85 percent) report concern about their retirement prospects, with more than half (55 percent) very concerned. 

“This concern is well founded. Recently, the Federal Reserve Board, in its new ‘Report on the Economic Well-Being of U.S. Households in 2013,’ found that ‘many households reported that they are not ready for retirement,’ with almost half of respondents saying that they had not planned financially for retirement, and 25 percent reporting that they had done no planning at all. Americans want help; 86 percent of Americans believe that that leaders in Washington need to give retirement a higher priority, with 62 percent strongly agreeing. 

“Read the full statement as submitted for the record here.

A Commentary (Redux)

Defined-Contribution Savings Plan (401k) v. Defined-Benefit Pension Plan:

A Defined-Contribution Savings Plan (401k):

  •        With a defined-contribution savings plan (401k, 403b, 457), only the contributions are defined.
  •        A defined-contribution savings plan shifts all the responsibilities and all of the risk from the employer to the employee (unless negotiated otherwise); thus, the benefit is not guaranteed for life.
  •        Nearly 87% of public employees are not eligible for Social Security.
  •        A benefit is based upon individual investment earnings.
  •        The employee assumes all funding, investment, inflationary and longevity risks.
  •        A defined-contribution savings plan does not have the pooled investments, professional asset managers, and shared administrative costs that a defined-benefit pension plan provides.
  •        There are no survivor or disability benefits and guarantees.
  •        Though the employee bears no portability risks, accounts are not always rolled over when an employee changes jobs.
  •        The employer (state) will have to bear the administrative costs of both defined-benefit pension and defined-contribution savings plans when the employee switches over.
  •        Though not the employees problem, “payments to amortize unfunded liabilities for the defined-benefit pension plan may be accelerated” (National Institute on Retirement Security, NIRS, 2012).
  •        The Governmental Accounting Standards Board “requires [an] acceleration of unfunded liability payments when the defined-benefit pension plan is closed to be recognized on financial statements” (NIRS, 2012).
  •        When changing from a defined-benefit pension plan to a defined-contribution savings plan, “new members do not start with any unfunded obligation” (NIRS, 2012).
  •        “Projected defined-benefit savings contributions for new members are worth more than the projected defined-benefit pension costs for those members” (NIRS, 2012).
  •        “No unfunded obligations [liabilities] for existing members are reduced when new members go into a defined-contribution savings plan” (NIRS, 2012).
  •        “The loss of new members make it difficult to finance the unfunded obligations of the defined-benefit pension plan” (NIRS, 2012).
  •        It is nearly impossible for anyone to save enough money in a 401k to last a lifetime of retirement, except for the wealthy elite.

A Defined-Benefit Pension Plan:·       

  •   A defined-benefit pension plan is more cost efficient than the defined-contribution savings plan.
  •        A defined-benefit pension plan offers predictable, guaranteed monthly benefits for life.
  •        Funds are invested by professional asset managers in a diversified portfolio that follows long-term investment strategies.
  •        The large-pooled assets reduce asset management and miscellaneous fees.
  •        A defined-benefit pension plan provides spousal (survivor) financial benefits.
  •        A defined-benefit pension plan provides disability benefits.
  •        The state is responsible for funding, investment, inflationary and longevity risks.
  •        A defined-benefit pension plan is a more effective protection than the defined-contribution savings plan.
  •        A defined-benefit pension plan provides an employee with self-sufficiency in retirement.
  •        A defined-benefit pension plan is associated with far fewer households that experience food privation, shelter adversity and health care hardship.
  •        A defined-benefit pension plan is less expensive for taxpayers than Social Security – a reason why legislators had negotiated for Illinois teachers to not pay into Social Security.
  •        The Teachers Retirement System of Illinois is the 39th largest in the U.S. with over 390,000 members (TRS, 2014).
  •        The average rate-of-return for TRS: 10% (over last 30 years) (FY 2014, TRS).
  •        TRS assets: $45.3 billion (as of June 30, 2014, TRS).
  •        A defined-benefit pension plan has an economic impact of over $4 billion on Illinois; the effect on Gross Domestic Product is $2.38 billion; jobs that are created: 30,448 (TRS, 2012).
  •        Defined-benefit pension plans contribute over $100 billion to annual local, state, and federal revenue in the U.S. and provide capital to financial markets (NIRS, 2012).
  • Pension plans enjoy higher investment returns and lower fees than individual accounts, generating a 27 percent cost savings (NIRS, 2014). 
  • Unlike individual investors who generally enjoy high-risk, high-reward investment strategies when they're young but switch to lower-risk portfolios that yield far lower returns as they age, pension plans can maintain a balanced portfolio that yields consistently high returns, generating an 11 percent cost savings (NIRS, 2014). 
  • Pension plans pool longevity risk, meaning that they only have to save for the average life expectancy of a group of individuals. Workers in a 401(k) plan need an investment strategy that provides for the event that they live a longer than average life. Longevity risk pooling generates a 10 percent cost savings (NIRS, 2014).

Sources: the National Institute on Retirement Security (NIRS), the Teachers Retirement System of Illinois 


  1. The Impact of Defined-Benefit Pension Plans

    Pension Spending Supports 6.2 Million Jobs, $943 Billion in Economic Output Nationwide (The National Institute on Retirement Security)

    Pensionomics 2014: Measuring the Economic Impact of Defined Benefit Pension Expenditures reports the national economic impacts of public and private pension plans, as well as the impact of state and local plans on a state-by-state basis. The study measures the economic ripple effect of retiree spending of pension benefit income, which typically is a stable source of income that lasts through retirement…

    This biennial study by the National Institute on Retirement Security finds that jobs supported by pension expenditures in 2012 paid nearly $307 billion in labor income. The analysis indicates that pension spending by retirees supported some $135 billion in tax revenue at the local, state and federal levels.

    Pensionomics 2014 includes a business and a retiree profile to demonstrate the importance of pensions to retirees, businesses in the economy and government coffers. The study also calculates that for 2012:

    Nearly $477 billion in pension benefits were paid to 24 million retired Americans, including:

    • $228.5 billion paid to some 9.0 million retired employees of state and local government and their beneficiaries (typically surviving spouses);
    • $70.7 billion paid to some 2.5 million federal government retirees and beneficiaries; and
    • $175.6 billion paid to some 12.7 million private sector retirees and beneficiaries.

    Expenditures made out of those payments collectively supported:
    • 6.2 million American jobs that paid nearly $307 billion in labor income;
    • $943 billion in total economic output nationwide;
    • $555 billion in value added (GDP); and
    • $135 billion in federal, state, and local tax revenue.

    Pension expenditures have large multiplier effects:
    • Each dollar paid out in pension benefits supported $1.98 in total economic output nationally; and
    • Each taxpayer dollar contributed to state and local pensions supported $8.06 in total output nationally. This represents the leverage afforded by robust long-term investment returns and shared funding responsibility by employers and employees.
    The largest employment impacts occurred in the food services, real estate, health care, and retail trade sectors.

    The study is authored by Nari Rhee, Ph.D.., NIRS manager of research. It was conducted using the most current data available from the U.S. Census Bureau and IMPLAN, an input-output modeling software widely used by industry and governments analysts.

    The National Institute on Retirement Security is a non-profit organization established to contribute to informed policymaking by fostering a deep understanding of the value of retirement security to employees, employers, and the economy through national research and education programs.

  2. from TRS:

    Fiscal Year 2015 Investment Returns
    Updated: November 1, 2015

    Issue: Teachers’ Retirement System investments generated a positive 4.57 percent rate of return, gross of fees, (3.95 percent net of fees) during fiscal year 2015. The investment return in FY 2014 gross net of fees was 18.1 percent and 17.4 percent net of fees.

    TRS ended FY 2015 on June 30 with $46 billion in assets, which places the System among the top 40 largest pension funds in the United States.

    Discussion: The rate of return for FY 2015 validates the investment strategy of the TRS Board of Trustees to maintain a widely diversified portfolio, which combats volatility in the world financial markets. By diversifying the System’s assets across a wide range of investment opportunities, any losses in one particular investment class are balanced by gains in other sectors. The goal is to achieve steady growth over the long-term.

    TRS maintains approximately 40.9 percent of its investments in publicly-held companies around the world, approximately 17.5 percent in bonds and other fixed-income securities, approximately 13.5 percent in real estate worldwide, approximately 11.6 percent in private equity opportunities and the remainder in various alternative investments, including hedge funds and commodities.

    The TRS investment strategy does not focus on a single year’s worth of investment returns and will always take a long-term view of investment returns because the System is a perpetual entity that must be in place for retired members and active members for decades to come. During the 30-year period that ended in 2015, TRS investments earned 9.4 percent net of fees against a long-term target of 7.5 percent.

    The 4.57 percent rate of return gross of fees for FY 2015 matched the System’s 4.57 percent custom benchmark for the fiscal year. Since 2000, TRS has recorded positive investment returns in 12 fiscal years.