LAURENCE J. KOTLIKOFF, Boston University - Department of Economics
Email: kotlikoff@bu.edu
BEN MARX, Boston University - Department of Economics
Email: benmarx@bu.edu
DAVID RAPSON, Boston University
Email: rapson@bu.edu

Do regular 401(k) and IRA accounts offer greater tax benefits than Roth 401(k)s and Roth IRAs? This is a tough question. Regular 401(k)s and IRAs save taxes in the short term; Roth accounts save taxes in the long term. Regular 401(k)s and IRAs are vulnerable to future income tax hikes, but may benefit from a future switch to consumption taxation if the switch exempts withdrawals from income taxation. Roth accounts are exempt from future income tax hikes, but are exposed to future consumption taxation. For any given assumption about future tax policy, assessing the relative merits of the two types of saving vehicles requires very accurate calculations of taxes in each future year - calculations that incorporate not just standard federal income tax provisions, but also the Savers Credit, the taxation of Social Security benefits, the Alternative Minimum Tax, and state income taxation. This paper uses ESPlanner (Economic Security Planner) - a financial planning software program co-developed by Kotlikoff - to study the relative merits of regular and Roth retirement accounts. In providing its consumption smoothing recommendations, ESPlanner makes the highly detailed tax and Social Security benefit calculations needed to compare retirement account options. In particular, ESPlanner can determine how different retirement account options affect different households' living standards under different assumptions about future tax policy. Our main findings are these: Absent future tax changes, middle-income, single-parent households benefit slightly more from Roth accounts; other single and married households generally fare better with a regular 401(k). Future tax changes, however, can dramatically change this horse race. In the case of low- and middle-income households, Regular 401(k) accounts under-perform Roth accounts in terms of long-run living standards assuming income taxes will rise by 30 percent in retirement. But the Roth falls far short of the regular 401(k) if taxes in retirement are assessed on consumption rather than on income and the transition to consumption taxation exempts 401(k) withdrawals from income taxation.

CRAIG COPELAND, Employee Benefit Research Institute (EBRI)
Email: COPELAND@EBRI.ORG

This paper uses the most recent data (2004) from the Survey of Consumer Finances (SCF), a triennial survey of family finances by the Federal Reserve Board, as well as historical SCF data, to examine the demographic factors associated with the ownership of individual account retirement plan assets. It examines the distribution of total assets held in individual account retirement plans across demographic characteristics of American families. Distribution of the retirement plan assets is then compared against the distribution of all assets owned across these demographic characteristics. The data show that individual account retirement plan assets are concentrated in families with higher net worth, higher family income, higher educational attainment, with older family heads, and with white, non-Hispanic heads. Among families with low levels of assets, the savings in individual account retirement plans account for a greater share of their total financial assets than they do for families with high asset levels.

Total individual account retirement assets -- which include employment-based defined contribution (DC) plan assets (both of active plans and plans held at former employers in the public and private sectors), individual retirement account (IRA) assets, and Keogh account assets -- amounted to $6.767 trillion in 2004, according to the Survey of Consumer Finances. These assets were almost evenly split between employment-based DC plan assets, such as 401(k)s ($3.384 trillion), and IRA/Keogh account assets ($3.383 trillion). The most significant shift in individual account assets from 1992 to 2004 has been the fraction of assets held by families headed by individuals age 55 or older. More than one-half of all individual account retirement plan assets and more than two-thirds of IRA and Keogh plan assets are owned by families headed by these individuals. This fact illustrates the importance of educational efforts and product availability (annuities, fixed withdrawal products, etc.) to individuals as they begin to spend down their assets to pay for retirement expenses.

MATTHEW ALTOMARE, Delaware Journal of Corporate Law
Email: mraltomare@mail.widener.edu

Defined benefit pension plans are losing their place of prominence in this country as a means for workers to secure a level of income upon retirement. Not only is the 401(k) defined contribution plan gaining steam, but the defined benefit plans that are in place are becoming vastly under-funded. Corporations are increasingly dumping their plans onto the Pension Benefit Guaranty Corporation (PBGC), as the government entity charged with administering the nation's pension insurance program has been saddled with a debt approaching $23 billion. Not only has the PBGC racked up a massive debt, but it is also becoming easier for corporations to dump their underfunded plans onto the PBGC in the course of a bankruptcy proceeding. As long as the corporation meets the standards of the reorganization test, it can dump its plans onto the PBGC. Add to this the decision in Kaiser, that courts are to review the plans in the aggregate, not on a plan-by-plan basis, and you have the perfect storm spelling trouble for the PBGC. This comment takes the position that the Third Circuit correctly decided the issue in Kaiser, but at a cost that could spell disaster for the future of the PBGC. The court correctly bases its decision on principles of equity, but in the process makes it easier for corporations to terminate their pension plans, thus increasing the strain on an already debt-riddled agency with little ability to self-correct its situation. If a solution is to come, it must come from Congress, which, up to this point, has done little to show that it will address the problem.

PAULA LOPES, Financial Markets Group, LSE
Email: p.lopes@lse.ac.uk
ALEXANDER MICHAELIDES, London School of Economics, Centre for Economic Policy Research (CEPR)
Email: A.Michaelides@lse.ac.uk
JOACHIM INKMANN, Tilburg University
Email: j.inkmann@uvt.nl

Using U.K. microeconomic data, we analyze the empirical determinants of voluntary annuity market demand. We find that annuity market participation increases with financial wealth, life expectancy and education and decreases with other pension income and a possible bequest motive for surviving spouses. We then show that these empirically-motivated determinants of annuity market participation have the same, quantitatively important, effects in a life-cycle model of annuity demand, saving and portfolio choice. Moreover, reasonable preference parameters predict annuity demand levels comparable to the data, thereby questioning the conventional wisdom that limited annuity market participation is a puzzle to be explained.

SANTIAGO CABALLERO, Watson Wyatt Worldwide
Email: santiago.caballero@watsonwyatt.com

Many pensions' markets are experiencing a transition from Defined Benefit (DB) to Defined Contribution (DC) schemes, with most of the former being closed, frozen or wound up. Against this backdrop this paper aims to calculate the DB market's future growth, but approaching the problem from the liabilities' side. We develop a general model whereby we can project DB liabilities based on the expected future trends in longevity, membership dynamics and salary growth. We then can deduce the expected future evolution of DB liabilities, which if tied to assets, may be seen as an approach to predict the pension asset management market in the future. We apply this model to the UK pensions market. The main result is that even if all UK DB schemes are considered closed, DB liabilities still show a growing trend until the year 2017, reaching a maximum of 39% above their current level and only returning to their current level around 2035.

ERIK HURST, University of Chicago - Graduate School of Business, National Bureau of Economic Research (NBER)
Email: erik.hurst@gsb.uchicago.edu

This paper summarizes five facts that have emerged from the recent literature on consumption behavior during retirement. Collectively, the recent literature has shown that there is no puzzle with respect to the spending patterns of most households as they transition into retirement. In particular, the literature has shown that there is substantial heterogeneity in spending changes at retirement across consumption categories. The declines in spending during retirement for the average household are limited to the categories of food and work related expenses. Spending in nearly all other categories of non-durable expenditure remains constant or increases. Moreover, even though food spending declines during retirement, actual food intake remains constant. The literature also shows that there is substantial heterogeneity across households in the change in expenditure associated with retirement. Much of this heterogeneity, however, can be explained by households involuntarily retiring due to deteriorating health. Overall, the literature shows that the standard model of lifecycle consumption augmented with home production and uncertain health shocks does well in explaining the consumption patterns of most households as they transition into retirement.

RICHARD M. ENNIS, Ennis, Knupp & Associates
Email: r.ennis@ennisknupp.com

Actuarial convention has the effect of driving equity allocations of public pension plans upward. It also pushes the risk of pension funding onto future generations of taxpayers, which has fostered taxpayer discontent. Yet, pension plans in the public sector have much to offer in terms of design features, benefit security, cost effectiveness, and investment performance. Ideally, they will evolve into quasi-autonomous financial institutions. For this to happen, they will have to (1) mark assets and liabilities to market, (2) implement funding and benefit-improvement disciplines, and (3) cease to pursue social, political, and economic development ends.

JULIA LYNN CORONADO, Barclays Capital
Email: julia.coronado@barcap.com
OLIVIA S. MITCHELL, University of Pennsylvania - Insurance & Risk Management Department, National Bureau of Economic Research (NBER)
Email: mitchelo@wharton.upenn.edu
STEVEN A. SHARPE, Federal Reserve Board - Research & Statistics
Email: SSHARPE@FRB.GOV
S. BLAKE NESBITT, University of Pennsylvania - The Wharton School
Email: blake.nesbitt@gmail.com

Some research has suggested that companies with defined benefit (DB) pensions are sometimes significantly misvalued by the market. This is because the measures of pension cost and pension net liabilities embedded in financial statements, taken at face value, can provide very misleading picture of pension finances. The more pertinent information on pension finances is relegated to footnotes, but might not receive much attention from portfolio managers. But dramatic swings in the financial conditions of large DB plans around the turn of the decade focused widespread attention on pension accounting practices, and dissatisfaction with current accounting standards has recently prompted the Financial Accounting Standards Board (FASB) to take up a project revamp DB pension accounting. Arguably, the increased attention should have made investors wise to the informational problems, thereby eliminating systematic mispricing in recent years. We test this proposition and conclude that investors continued to misvalue DB pensions, inducing sizable valuation errors in the stock of many companies. Our findings suggest that FASB's current reform efforts could substantially aid the market's ability to value firms with DB pensions.