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Private Pensions and Employee Mobility.

Private Pensions and Employee Mobility In Private Pensions and Employee Mobility, Izzet Sahin present a mathematical study of the effect of changing jobs on pension benefits. A worker who changes job during a career will usually receive a smaller pension than a worker who remains at one firm during a career, all other things being equal. Inflation can erode pension benefits for workers who terminate their jobs before retirement. In addition, workers may lose some or all of their benefits if they are not vested in a plan. Sahin creates a model to measure lost pension benefits for various types of pensions and levels of mobility.

Because studying the effects of mobility requires measurement over time, the model makes assumptions about economic conditions. Inflation is assumed to stay constant at 5 percent, real growth in wages (above inflation) at 2 percent, and real rate of return on investment at 2 1/2 percent. Sahin arrives at these figures by taking long-term averages of economic data.

Using his model, Sahin demostrates how changing jobs can reduce pension benefits even if a worker is fully vested in a pension upon termination of employment. Because pension benefits are commonly based on earnings, inflation will lower the value of the pension. A worker who leaves a firm in 1965 and retires in 1990 will receive pension benefits based on a salary that does not reflect current living standards.

Sahin uses his economic assumptions to compare different types of pension benefit formulas, that plans that base benefits on the earnings of the final years of a career provide a greater incentive for workers to stay at a firm that plans that base the pension on average career earnings. Consider a simplified example to demonstrate Sahin's point: Two workers join a firm, and each earns $1,000 during the first year, $2,000 the second year, $3,000 during the third, and so on. One worker leaves the firm after 10 years, and another stays 40 years; both receive a pension that is equal to the average salry in the last 3 years worked. The worker who left after 10 years will receive $9,000 a year. The worker who stayed will receive $39,000 a year, or $30,000 more. If the pensions were equal to the average earnings for the career, the first worker would earn $5,500, and the second, $20,500, or only $15,000 more. The difference is less in the career average plan because the salaries for the first years are reflected in the pension benefits of both workers. If wages are rising over time, as Sahin assumes, the plans based on final average earnings provide relatively greater benefits to workers with low mobility.

By gathering data from several large industries, Sahin calculates the average mobility of workers. These data are used to make explicit calculations of the effects of mobility on pensions. The book provides a variety of tables on various scenarios. For example, an employee enters a firm at age 30, works for 10 years, and must make a decision about taking a new job with the same salary and pension plan as her current job. Her chances of changing jobs in the future are equal to tha average mobility rate, as calculated by Sahin. She currently receives a pension that provides 1 percent of the average salary of the final 3 years worked times the number of years of employment. The model shows that she will need a salary increase of 11.58 percent to be indifferent about the change in employment. If she invests this salary increase at the assumed rate of return, she will make up the loss in pension benefits.

Sahin uses the model to show how the three vesting options of the Employee Retirement Income Security Act (ERISA) affect the mobility of workers. Vesting is the nonforfeitable right to future pension benefits. The first option, cliff, vesting, requires no vesting until 10 years, and full vesting thereafter. The second option, graded vesting, requires 25-percent vesting after 5 years, with an increase of 5 percentage points a year until 10 years, and then an increase of 10 percentage points a year until full vesting at 15 years. The third option, the rule of 45, requires 50 percent vesting when service plus age equal 45, then increases by 10 percentage points in each of the next 5 years. (The Tax Reform Act of 1986 reduced the years of service requirements for vesting that may be imposed.)

Sahin considers the benefits of these three options for workers with average mobility. Under his model, graded vesting is themost advantageous for a worker starting employment at age 20. At this age, graded vesting provides for partial vesting in the least amount of time. The rule of 45 is the least advantageous at this age because many workers will leave before any vested percentage is earned. For workers starting careers at age 29.58 or older, the rule of 45 is the most advantageous. Cliff vesting is never the most advantageous for an employee because of the likelihood of termination of employment in the first 10 years, with no vested benefit.

Sahin's model shows that most forms of private pension tend to discourage mobility. By assuming the economic conditions and levels of mibility, Sahin is able to provide calculations to support his argument. His model allows him to explore a wide variety of issues in the field of pensions, from plan types to vesting rules. Private Pensions and Employee Mobility provides a framework for analyzing decisions on policy affecting this timely issue.
COPYRIGHT 1990 U.S. Bureau of Labor Statistics
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Author:Ford, Jason L.
Publication:Monthly Labor Review
Article Type:Book Review
Date:Oct 1, 1990
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Next Article:Pension plans.

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