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Today's pension plans: how much do they pay.

Under pension plans of medium and large firms, employees retiring on January 1, 1984, at age 65 after 30 years of service would have received monthly pensions averaging from $385 for those earning $15,000 in 1983 to $886 for those earning $40,000. The corresponding range for employees retiring after 20 years of service was $263 to $623. Social Security benefits, however, would significantly raise these levels of retirement income.

these data were calculated from benefit formulas of 832 pension plans in the 1984 Bureau of Labor Statistics survey of employee benefit plans. The annual study covers the United States (excluding Alaska and Hawaii) and private industry establishments employing at least 50, 100, or 250 workers, depending on the industry. The 1984 survey sample consisted of 1,499 establishments, designed to statistically represent 21 million employees in 45,000 establishments.

BLS field representatives obtained from survey respondents the written descriptions of pension plans that, under the Employee Retirement Income Security Act (ERISA), plan administrators are required to provide to covered employees. These descriptions include the formulas used in calculating employee benefits. Using the benefit formula for current service, BLS calculated pensions that would have been paid to employees retiring on January 1, 1984, under each plan by making alternative assumptions regarding the retirees' length of service and earnings history. (See appendix.)

According to the 1984 survey, 82 percent of the active workers in medium and large firms were covered by private retirement pension plans financed wholly or in part by their employers. The plans include defined benefit plans, money purchase plans, and career contribution plans. The money purchase and career contribution plans, each accounting for only 2 percent of the total pension plan participants, were excluded from this analysis. Approximately 16.5 million workers participated in plans used in the calculation of the basic retirement benefits discussed here. Supplemental pension plans, available to a small number of workers in addition to their basic plan, also were excluded.

Finally, capital accumulation plans are not represented in this analysis. The number of these plans--which include profit-sharing, savings and thrift, and various stock plans--has increased in recent years. Except for profit-sharing, these plans are relatively new, and it is difficult to determine their impact on retirement income. Moreover, many allow employees to obtain some portion of the benefits prior to retirement.

Pension levels

Table 1 shows averages of monthly private pension payments calculated from the benefit formulas of plans surveyed in 1984. Because the formulas take account of length of service and, commonly, preretirement earnings as well, annuities under each plan were determined for 42 combinations of service and earnings. In all cases, the data apply to workers retiring on January 1, 1984, at age 65.

Average benefits varied widely among the age-service combinations. The range for all pension plan participants was $137 monthly for retirees with 10 years of service and earning $15,000 in 1983 to $1,075 for retirees with 40 years of service and final earnings of $40,000.

Nevertheless, patterns did appear in the findings. Average payments increased, for examle, with each rise in service and earnings. The amount of increase, however, grew smaller as the length of service increased, particularly for service beyond 30 years. This decreasing return for extra years of service mainly reflects provisions that limit the number of years credited in the payment calculation. One-third of all pension plan participants were covered by such provisions. Also contributing to this result are formulas that provide a lower benefit rate after specified years of service, for example, 1.5 percent of earnings per year of service up to 20 years, and 1 percent thereafter.

At each service period examined, benefits increased with the assumptions of higher final earnings. Moreover, at the all-participant level, for a given increase in earnings, the dollar amount of the pension rise was greater at higher earnings levels. Thus, for employees retiring after 30 years of service, the average pension increased by $71 a month when earnings rose from $15,000 to $20,000 and by $114 when earnings moved from $35,000 to $40,000. In relative terms, when worker earnings increased from $15,000 to $20,000 (33 percent), benefits went up by 18 percent; the considerably smaller percentage growth in earnings from $35,000 to $40,000 (14 percent) was accompanied by a 15-percent increase in pensions.

The relationship between benefit levels and earnings reflects the influence of a number of pension plan features. Benefits as a percent of preretirement earnings (replacement rates) are raised for retirees at the lower end of the earnings distribution when pension plans guarantee minimum benefit levels. Benefit replacement rates are also raised for low-wage earners when plans contain dollar-amount benefit formulas that provide annuities independent of prior earnings. Conversely, provision for maximum benefit levels reduces the return to retirement plan participants with relatively high earnings. High-wage earners do have an advantage when so-called step-rate excess formulas are in effect; these formulas calculate benefits as a percent of prior earnings and specify a higher percentage return on that part of earnings above a specified level than below that level.

Levels of private pension benefits also varied by occupational group. At equal levels of pay and years of service, white-collar groups (professional-administrative and technical-clerical) tended to receive higher benefits than blue-collar or production workers. This held true in all cases except at the lowerst earnings level ($15,000), where production workers had slightly larger benefits. As earnings increased from $15,000 to $40,000, however, the average gain in benefit amounts was much smaller for production workers. Half of the production workers had pension formulas specifying dollar amounts of benefits, usually independent of prior earnings. Conversely, most of the white-collar workers had earnings-based pension formulas, which calculate annuities as percentages of preretirement earnings.

Assuming equal levels of earnings and service, technical-clerical workers commonly were eligible for greater benefits than professional-Administrative workers. The latter employees, however, actually average higher salaries and thus tend to receive larger pension benefits at retirement.

Pension benefits varied widely within, as well as among, service-earnings groupings. Table 2 shows the distribution of participants by amount of benefits at selected service and earnings levels. As can be seen, retirees with 30 years of service and $30,000 in final earnings could receive annuities ranging from less than $100 monthly to $1,200 or more. This spread in benefits reflects the wide variety of benefit formulas in private pension plans. The dispersion widens as earnings increase, because the benefits of workers with earnings-based formulas rise, while benefits remain constant when formulas provide flat dollar annuities per year of service independent of earnings. Dispersion also widens as service increases, but to a lesser extent. This is because nearly all pension plans incorporate length of service in the benefit formula.

Replacement rates

Pension benefits are frequently evaluated through the use of replacement rates, that is, expressing the annuities as percentages of preretirment earnings. This facilitates examination of the degree to which pensions permit maintenance of preretirement standards of living. Because consumption patterns, tax liabilities, and rates of personal savings change upon retirement, living standards are typically maintained at less than a 100-percent replacement rate. The final report of the President's Commission on Pension Policy includes an estimate that, for single persons retiring in 1980, 79 percent of gross preretirement income was needed to maintain living standards at $6,500 level of preretirement income; a 51-percent rate was needed at a $50,000 income level. The corresponding ratios for married couples were 86 and 55 percent.

Estimates of replacement rates required to maintain living standards vary, depending in part on the precise definition given to the replacement rate concept. Are the annuities and preretirement earnings measured before or after taxes? Is the preretirement earnings base the final year's earnings? Is it some average of earnings in years immediately preceding retirement (such as the 3 years of highest earnings in the last 10)? Or is it an average of earnings over the entire working career? In this analysis, pension benefits are measured before taxes and preretirement earnings are defined as gross earnings in the final full year of employment. Consequently, replacement rates reported here are lower than if other definitions of earnings were employed, because earnings typically peak in the final year of work.

Table 3 presents the monthly pension payments shown in table 1 (annualized) as percentages of earnings in the final year of work. These replacement rates rise substantially as service increases from 10 to 40 years. At the $30,000 level of earnings, for example, the average replacement rate for all pension plan participants increases from 18.5 percent at 20 years of service to 26.5 percent at 30 years and 32.6 percent at 40 years.

Replacement rates for the overall group, however tend to decrease as earnings levels increase within each service category. This results primarily from plus for production workers. While white-collar workers experience slight increases in average replacement rates as earnings rise above $20,000, production workers experience a marked decline. As indicated earlier, the explanation for this difference lies in the relatively greater incidence of earnings-based benefit formulas among white-collar workers.

As shown in table 4, earnings-based formulas tend to yield higher replacement rates as final earnings rise. Dollar-amount formulas (commonly providing benefits independent of earnings produce the opposite result. In fact, dollar-amount formulas produced the highest replacement rates for final earnings of $15,000--the lowest level used in this analysis.

Earnings-based private pensions commonly are integrated with Social Security benefits. This explains the tendency for greater replacement rates at higher earnings levels under these private formulas. The Social Security benefit formula yields pensions that, as a percent of preretirement earnings, are greater for retirees with relatively low earnings histories, and it takes account only of earnings up to the Social Security taxable wage base--$37,800 in 1984. Integrated private pension plans counter this by providing higher replacement rates as earning rise. Dollar-amount pension formulas, however, are rarely integrated with Social Security benefits.

Social Security as a component

Private pension plans do not operate independently. They supply retirement income as part of a "three-legged stool," which also inlcudes Social Security and individual savings. Replacement rates, consequently, become more meaningful when Social Secuirty benefits are added to the computation.

The Office of the Actuary, Social Security Administration, determined the benefit amounts that would be applicable for workers with the earnings histories used in this study. These Social Security benefits were added to the private pension benefits presented in table 1, and new replacement rates were determined using the combination of these two sources of retirement income.

Table 5 shows average replacement rates of combined private pension and Social Security retirement income for a single worker (one who is not receiving spousal benefits under Social Security). The inclusion of Social Security retirement benefits raises the rates significantly from those in table 3. Except at the higher earnings and service levels. Social Security benefits provide the major share of total retirement income.

Inclusion of Social Security benefits also changes the relationship between the size of the replacement rate and the preretirement earnings level. Private pension plans, on average, yield slightly higher replacement rates for white-collar workers, when earnings rise above $20,000 (table 3). After adding Social Security benefits to the replacement rate calculation, however, the highest replacement rates are at the lower earnings levels. As already noted, the Social Security benefit formula provides higher replacement rates to lower wage earners.

If the retired worker has a husband or wife age 65 or over who is not eligible for a Social Security benefit on his or her own account, an additional benefit from Social Security equal to 50 percent of the worker's benefit is payable to the spouse. Adding this benefit to the worker's private pension and Social Security payments results in the average replacement rates presented in table 6. Here, except in the high income and short service examples, the data typically show replacement rates of 60 percent or more. Indeed, workers with relatively low earnings and long service may have all or nearly all of their preretirement income replaced by combined private pension and Social Security benefits when the latter includes an additional amount for the spounse.

APPENDIX: Analyzing pension plans

This study of pension benefit levels follows one of a number of alternative approaches to examining private pension plan provisions. A common approach is to review individual plan provisions, such as vesting requirements, early and normal retirement ages, benefit formulas, and pre- and post-retirement survivor options. This approach provides a wealth of detail about plan provisions but does not permit summarization on an overall plan basis.

Such summarization is possible through examination of amounts employers spend on funding their pension liabilities, either in terms of dollars per employee per year, cents per hour worked, or percent of total compensation outlays. Employer cost levels, however, are commonly influenced not only by plan provisions, but also by such characteristics of the covered work force as age, length of service, and earnings history and the actuarial assumptions used in financing individual plans.

The approach used here looks at the level of benefits available under plans in effect in 1984. It focuses on the pensions payable to workers retiring on January 1, 1984, under the latest (current service) benefit formulas of their pension plans at that time.

Aside from the pension formula itself, retirement benefits may be affected by possible coordination of private benefits with Social Security payments, limits on years of credited service, and minimums and maximums on benefits. These were takne into account in calculating retirees' pensions for this analysis. Also, many plans had more than one pension formula, and specified use of the formula providing the highest benefit for each worker's circumstances. When multiple formulas were found, each alternative within a plan was examined and, for each combination of years of service and earnings considered for study, the formula selected was the one yielding the highest pension.

Nevertheless, the study did not take account of all factors affecting a retiree's pension. For example, it did not consider benefit reductions to finance continuation of payments to a surviving spouse (joint-and-survivor annuity). Similarly, the possibility of post-retirement pension increases--either on an ad hoc basis or through an automatic cost of living adjustment formula--was ignored.

After determination of the pension benefits under individual plans, overall averages were computed. In computing these averages, individual plans were weighted by the number of active workers pacticipating in each plan.

Benefits under a given pension plan are influenced by retirement age, lenght of service with the firm, and earnings history. It is, therefore, necessary to specify values for these variables to determine retirement benefits. One approach is to assume average conditions prevailing throughout the economy--average retirement age, average seniority, average earnings. This approach, however, ignores the fact that benefit formulas in individual pension plans are influenced by the characteristics of the workers that they cover.

Consequently, in the approach followed here, age 65 was chosen as to their fully accured benefit at that age under the Employee Retirement Income Security Act. (Sixty-three percent of the participants in the pension plans studied, however, were under plans which allowed for full retirement with an unreduced pension before age 65.)

Instead of using a single assumption regarding the employee's length of service and earnings history, the multiple assumptions shown on the tables were used. The earnings levels specified represent the employee's gross earnings in the final year of work (1983). Earnings levels in each year from 1944 to 1983 were then developed from these final earnings using year-to-year changes in Social Security data on national average wage levels.

The same final earnings levels and earnings histories were used for all three occupational groups studied--professional-administrative, technical-clerical, and production workers. Nevertheless, some of the final earnings levels presented would not have wide applicability in each occupational group. For example, it is unlikely that many technical-clerical workers in medium and large firms had final earnings as high as $40,000, nor is it likely that many professional-administrative workers had final earnings as low as $15,000 in 1983. Because pension benefit formulas are often designed for a specific group of workers with a known range of earnings, some distortion in benefits at unlikely earnings levels is possible. Thus, when examining the results of this analysis, the focus should be on the benefits provided at earnings levels applicable to a particular occupational group.

Social Security benefits are important not only as a source of retirement income but also as a factor affecting benefits under many private pension plans. For example, a common approach to integrating private and public annuities is to reduce private pensions by a percentage of Social Security benefits. To estimate benefits under the Social Security system, it was assumed that an employee worked in covered employment for a total of 40 years.
COPYRIGHT 1985 U.S. Bureau of Labor Statistics
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1985 Gale, Cengage Learning. All rights reserved.

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Author:Schmitt, Donald G.
Publication:Monthly Labor Review
Date:Dec 1, 1985
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