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SOCIAL SCIENCE RESEARCH NETWORK
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 7, No. 19: July 20, 2006
Editors: PAMELA J. PERUN
Urban Institute
PAMELA@PLANETNOW.COM
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Topic of This Issue:
Investing for Retirement
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T A B L E O F C O N T E N T S
"Lifecycle Asset Allocation Strategies and the Distribution of
401(k) Retirement Wealth"
JAMES M. POTERBA
Massachusetts Institute of Technology (MIT) - Department
of Economics, National Bureau of Economic Research (NBER)
DAVID A. WISE
National Bureau of Economic Research (NBER), Harvard
University - John F. Kennedy School of Government
JOSHUA D. RAUH
University of Chicago - Graduate School of Business,
National Bureau of Economic Research (NBER)
STEVEN F. VENTI
Dartmouth College - Department of Economics, National
Bureau of Economic Research (NBER)
"Making Investment Choices as Simple as Possible but Not Simpler"
ZVI BODIE
Boston University - Department of Finance & Economics
JONATHAN TREUSSARD
Boston University - Department of Economics
"Why are Healthy Employers Freezing Their Pensions?"
MAURICIO SOTO
Boston College - Department of Finance and Department of
Economics
ALICIA H. MUNNELL
Boston College - Center For Retirement Research
FRANCESCA GOLUB-SASS
Boston College - CRR
FRANCIS VITAGLIANO
Boston College - Center For Retirement Research
"The State of Private Pensions: Current 5500 Data"
MAURICIO SOTO
Boston College
MARRIC BUESSING
Boston College - Center For Retirement Research
"401(k) Plans are Still Coming up Short"
ALICIA H. MUNNELL
Boston College - Center For Retirement Research
ANNIKA E. SUNDÉN
Stockholm University - Swedish Institute for Social
Research (SOFI)
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"Lifecycle Asset Allocation Strategies and the Distribution of
401(k) Retirement Wealth"
NBER Working Paper No. W11974
Contact: JAMES M. POTERBA
Massachusetts Institute of Technology (MIT) -
Department of Economics, National Bureau of
Economic Research (NBER)
Email: poterba@mit.edu
Auth-Page: http://ssrn.com/author=21561
Co-Author: DAVID A. WISE
National Bureau of Economic Research (NBER), Harvard
University - John F. Kennedy School of Government
Email: dwise@nber.org
Auth-Page: http://ssrn.com/author=56391
Co-Author: JOSHUA D. RAUH
University of Chicago - Graduate School of Business,
National Bureau of Economic Research (NBER)
Email: jrauh@gsb.uchicago.edu
Auth-Page: http://ssrn.com/author=392051
Co-Author: STEVEN F. VENTI
Dartmouth College - Department of Economics,
National Bureau of Economic Research (NBER)
Email: Steven.F.Venti@dartmouth.edu
Auth-Page: http://ssrn.com/author=71610
Full Text: http://ssrn.com/abstract=878061
ABSTRACT: This paper examines how different asset allocation
strategies over the course of a worker's career affect the
distribution of retirement wealth and the expected utility of
wealth at retirement. It considers both rules that allocate a
constant portfolio fraction to various assets at all ages, as
well as lifecycle rules that vary the mix of portfolio assets as
the worker ages. The analysis simulates retirement wealth using
asset returns that are drawn from the historical return
distribution. The results suggest that the distribution of
retirement wealth associated with typical lifecycle investment
strategies is similar to that from age-invariant asset allocation
strategies that set the equity share of the portfolio equal to
the average equity share in the lifecycle strategies. There is
substantial variation across workers with different
characteristics in the expected utility from following different
asset allocation strategies. The expected utility associated with
different 401(k) asset allocation strategies, and the ranking of
these strategies, is very sensitive to three parameters: the
expected return on corporate stock, the worker's relative risk
aversion, and the amount of non-401(k) wealth that the worker
will have available at retirement. At modest levels of risk
aversion, or in the presence of substantial non-401(k) wealth at
retirement, the historical pattern of stock and bond returns
implies that the expected utility of an all-stock investment
allocation rule is greater than that from any of the more
conservative strategies. Higher risk aversion or lower expected
returns on stocks raise the expected utility of following
lifecycle strategies or other strategies that reduce equity
exposure throughout the lifetime.
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"Making Investment Choices as Simple as Possible but Not Simpler"
Contact: ZVI BODIE
Boston University - Department of Finance &
Economics
Email: zbodie@bu.edu
Auth-Page: http://ssrn.com/author=16745
Co-Author: JONATHAN TREUSSARD
Boston University - Department of Economics
Email: jtreussa@bu.edu
Auth-Page: http://ssrn.com/author=504640
Full Text: http://ssrn.com/abstract=900005
ABSTRACT: Target-date retirement funds (TDRFs) are advocated as
the universal solution to the complex task of determining the
appropriate asset allocation among funds in 401(k) plans, IRAs,
and other personal investment accounts. In our
partial-equilibrium model of rational life-cycle choice, a TDRF
is nearly optimal for certain individuals. These individuals are
natural TDRF holders. However, individuals who adopt the same TDRF
but whose human capital risk and tolerance for market risk differ
from those of natural TDRF holders will necessarily incur welfare
losses. A prudent design is to offer at least a second fund to
each age cohort of life-cycle investors: a risk-free investment
portfolio with a matching investment horizon. Relatively high and
uniform welfare levels can then be obtained by directing
individuals of any particular age to either the TDRF or the
risk-free fund depending on their personal characteristics.
______________________________
"Why are Healthy Employers Freezing Their Pensions?"
Contact: MAURICIO SOTO
Boston College - Department of Finance and
Department of Economics
Email: rhoder@bc.edu
Auth-Page: http://ssrn.com/author=639540
Co-Author: ALICIA H. MUNNELL
Boston College - Center For Retirement Research
Email: MUNNELL@BC.EDU
Auth-Page: http://ssrn.com/author=256440
Co-Author: FRANCESCA GOLUB-SASS
Boston College - CRR
Email: golubsas@bc.edu
Auth-Page: http://ssrn.com/author=639541
Co-Author: FRANCIS VITAGLIANO
Boston College - Center For Retirement Research
Email: vitaglif@bc.edu
Auth-Page: http://ssrn.com/author=639589
Full Text: http://ssrn.com/abstract=893214
ABSTRACT: The shift in pension coverage from defined benefit plans
to 401(k)s has been underway since 1981. This shift is the result
of three developments: 1) the addition of 401(k) provisions to
existing thrift and profit sharing plans; 2) a surge of new
401(k) plan formation in the 1980s; and 3) the virtual halt in
the formation of new defined benefit plans. A conversion from a
defined benefit plan to a 401(k) plan was an extremely rare
event, particularly among large plans. Historically, the only
companies closing their defined benefit pension plans were facing
bankruptcy or struggling to stay alive. Now the pension landscape
has changed. Today, large healthy companies are either closing
their defined benefit plan to new entrants or ending pension
accruals for current as well as future employees. Why are healthy
employers taking this action? And why now?
This brief reviews the major pension freezes during the last two
years and explores the impact on employees at different stages in
their careers. It then offers four possible explanations why
employers are shutting down their plans. The first is that some
U.S. companies are cutting pensions to reduce workers' total
compensation in the face of intense global competition. The
second explanation is that employers have been forced to cut back
on pensions in the face of growing health benefits to maintain
existing compensation levels. The third explanation, by contrast,
points to the finances of the plans themselves - specifically,
their market risk, longevity risk, and regulatory risk that make
defined benefit pensions unattractive to employers. The final
explanation is that with the enormous growth in CEO compensation,
traditional qualified pensions have become irrelevant to upper
management who now receive virtually all their retirement
benefits through non-qualified plans. Each of these explanations
contains a kernel of truth, and they all help explain the current
trends.
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"The State of Private Pensions: Current 5500 Data"
Contact: MAURICIO SOTO
Boston College
Email: mauricio.soto.1@bc.edu
Auth-Page: http://ssrn.com/author=374701
Co-Author: MARRIC BUESSING
Boston College - Center For Retirement Research
Email: marric.buessing@bc.edu
Auth-Page: http://ssrn.com/author=639574
Full Text: http://ssrn.com/abstract=908272
ABSTRACT: Every year, pension plan sponsors are required to file a
return with the U.S. Department of Labor. These returns, known as
the Form 5500 series, contain detailed information about the
plans' finances, participants, and administrators that allows
government agencies to monitor compliance with the Employee
Retirement Income Security Act (ERISA) and the Internal Revenue
Code. The comprehensive nature of the Form 5500 series makes them
a primary source for examining the state of the private pension
world: from participation rates to financial health to 401(k)
investment in company stock to the size of employer contributions
- it is all there.
Unfortunately, these rich data are not available in a timely
manner. The data from the Private Pension Plan Bulletins Abstract
of Form 5500 Annual Reports - the official tabulations put out by
the Department of Labor commonly used by practitioners and
researchers - have a five-year lag. Sponsors have up to ten
months to file the forms, and it can take up to two years to
convert the raw forms, which generally are filed in paper, into a
manageable and complete dataset. Then, these data must be
cleaned, analyzed, and tabulated. The resulting lag meant that as
of early 2006, official tabulations were available only up to
2000.
This brief uses raw 5500 Form data from the Department of Labor to
extend the tabulations to 2003 - the latest year in which the
datasets are available. The estimations are done for the
1990-2003 period, and are presented as a data appendix to this
brief. The 1990-2000 numbers match closely those from official
reports; the 2001-2003 calculations bring the tabulations as
up-to-date as currently possible.
Using these recent data, this brief highlights trends that are
impossible to observe in the current official releases: a notable
increase in pension contributions for defined benefit plans; the
decline and recovery of pension assets in the 2001-2003 period;
the continued use of cash balance plans; and the sustained move
in coverage towards defined contribution plans.
______________________________
"401(k) Plans are Still Coming up Short"
Contact: ALICIA H. MUNNELL
Boston College - Center For Retirement Research
Email: MUNNELL@BC.EDU
Auth-Page: http://ssrn.com/author=256440
Co-Author: ANNIKA E. SUNDÉN
Stockholm University - Swedish Institute for Social
Research (SOFI)
Email: annika.sunden.1@bc.edu
Auth-Page: http://ssrn.com/author=44117
Full Text: http://ssrn.com/abstract=908264
ABSTRACT: The release of the Federal Reserve's 2004 Survey of
Consumer Finances (SCF) is a wonderful opportunity to re-assess
the role that 401(k) plans are playing in the provision of
retirement income. The SCF is a triennial survey of a nationally
representative sample of U.S. households, which collects detailed
information on households' assets, liabilities, and demographic
characteristics. Because the SCF over-samples wealthy
individuals, it provides the most comprehensive measure of wealth
of any household survey. The 2001 survey showed that 401(k)
accumulations were coming up short. The 2004 survey shows some
progress but most of the problems persist.
401(k) plans require the employee to decide whether or not to join
the plan, how much to contribute, how to invest the contributions
and when to re-balance, what to do about company stock, whether
to roll over accumulations when changing jobs, and how to use the
money in retirement. Recent data continue to indicate that at
every step along the way a significant fraction of participants
makes serious mistakes. A fifth of those eligible to participate
in a plan choose not to do so. Only about 10 percent of those who
do participate contribute the maximum. Over half fail to diversify
their investments, many over-invest in company stock, and almost
none re-balance their portfolios in response to age or market
returns. Most importantly, many cash out when they change jobs.