A new system of Universal Voluntary Accounts (UVAs) would make low cost, portable 401(k) type pensions available to all workers. Participation would be at the option of the worker, and the employer could contribute as much as she likes, subject to 401(k) restrictions and laws on non-discrimination. Participants would have a limited choice of investment options that give varying mixes of risk and return.
The program is designed to minimize administrative costs for both employers and the government, and it could be offered at the national or state levels. The system's finances would be strictly separated from any government accounts. Furthermore, the administration of the accounts could be handled by government agencies other than the Social Security Administration, including state agencies such as a state unemployment insurance office.
Pensions for the 21st Century
The Social Security system provides a core income to tens of millions of retired workers and their spouses. It does this at a very low administrative cost, and with a minimal amount of fraud. It is projected to be solvent for at least the next three decades. The nation's system of private pensions is not anywhere near as healthy. Unfortunately, public debate has been almost completely focused on the public Social Security system, which is working, as opposed to the private pension system, which is not.
This paper identifies four major problems with the current pension system:
1) Access --
At present, just over half the work force even has access to a pension at their work place. Many employers do not offer pensions at all, or only to workers that have been at a job for two to three years. Since workers shift jobs frequently in today's economy, many find themselves without pension coverage for much of their working life. For most workers, private pensions are the primary form of savings, other than a home. If workers do not even have access to a pension, they will likely have little retirement income other than Social Security.
2) Cost --
The annual administrative costs of defined contribution pension plans average approximately 1.3 percent of assets. This can easily reduce the lifetime accumulations of a middle income worker by more than $40,000. In addition, the financial industry typically charges a premium of 15 percent to issue an annuity, effectively reducing a worker's retirement income by this amount.
3) Small businesses --
There are substantial fixed costs associated with setting up a pension plan which are independent of the size of the firm. This discourages many small businesses from offering pensions, which places them at a competitive disadvantage in trying to retain workers.
4) Savings for low income workers --
Many low and moderate income workers find it extremely difficult to place any money into a pension and still manage to pay current expenses. In a pension system that is increasingly dominated by defined contribution pensions, lower paid workers will often manage only minimal accumulations, unless there is a substantial employer side contribution or government subsidy.
The paper then analyzes three recent proposals for pension reform:
1) President Clinton USA Accounts plan --
This plan will provide a substantial subsidy to low and moderate income workers' pensions. However, the ceilings on contributions are sufficiently low that it will not be able to serve as the primary pension vehicle for most middle income workers. For this reason, it will do little to contain administrative costs.
2) The Pension ProSave plan (introduced by Senators Bingamin and Jeffords) --
This plan establishes a national pension portability clearinghouse. This will allow businesses to establish pensions with a minimal degree of paperwork. The costs of these pensions should be low and they will be portable between jobs. This system should significantly reduce costs and extend coverage, although it will not make pension coverage universal, since participation will still be at the discretion of the employer.
3) The Eisner Plan --
This proposal calls for allowing every worker to have a 401(k) type account that would be an add-on to their Social Security account. While the money would be professionally managed and deposited in standard investment vehicles (e.g. stock and bond index funds), the money would be integrated with the accounts for Social Security and the federal budget. This plan would provide universal low cost pensions, but the link to the finances of Social Security and the federal budget raises significant political issues.
The paper then lays out a proposal for a system of Universal Voluntary Accounts (UVA). Like the Eisner plan, this system would make low cost 401(k) type pensions available to all workers. Unlike the Eisner plan, the finances of a system of UVAs would be strictly separated from any government accounts. Furthermore, the administration of the accounts could be handled by government agencies other than the Social Security Administration, including state agencies such as a state unemployment insurance office. This would allow UVAs to be offered at the state level, if the program is blocked at the national level. In its structure, UVAs build on a proposal for individual accounts designed by the State Street Bank. While this proposal was intended to be used for accounts that are carved out of Social Security, it is at least as well suited for low cost pensions that will supplement workers' Social Security benefits.
The paper finds that under reasonable cost assumptions, UVAs can:
1) increase the lifetime accumulations of low income workers (contributing $400 annually) by close to $8,000, compared with a worker who placed the same amount of money in an existing 401(k) type account. For middle income workers (contributing $2000 annually), the savings on administrative costs could increase lifetime accumulations by close to $40,000. For somewhat higher income workers ($5,000 annual contribution), the gains would be close to $100,000.
>2) These gains would translate into substantial increases in retirement income. The difference in the size of annuity payments as a result of placing money in UVAs compared with current 401(k) type accounts would be more than $400 for a low income worker, over $2100 for a middle income worker, and over $5000 for a higher income worker. Using reasonable assumptions about reduced annuity premiums with UVAs, the gains would be even larger: over $500 annually for a low income worker, more than $2600 for a middle income worker, and more than $6500 for a high income worker.
3) UVAs could have important macroeconomic effects. With plausible assumptions they could increase national savings by close to 0.5 percentage points of GDP. They also could effectively increase real wages by close to 0.2 percent. These effects are larger than those of many other policies that have attracted significant public attention.
In short, by extending a new choice to the nation's workers, UVAs can allow them to substantially
increase their savings for retirement. This can have substantial beneficial effects for individual workers and also for the economy as a whole.