A recent analysis by the National Conference on Public Employee Retirement Systems (NCPERS) links pension reforms to income inequality, claiming that middle-class participants could be paying more as the retirement industry shifts from defined benefit (DB)-style plans to defined contribution (DC) strategies.
One main point in the analysis, “The Hidden Costs of Pension Reforms: Rising Income Inequality, Lagging Economic Growth,” underlines findings from the Census Bureau and the Bureau of Labor Statistics (BLS). The NCPERS found that the share of the U.S. workforce enrolled in DB plans, including both private and public sector employees, decreased 13% from nearly 50% in 1977 to 37% in 2021. At the same time, the NCPERS, using the Census Bureau and BLS data, reports that income inequality—measured as the ratio of the top income quintile to the bottom income quintile—increased from 7.4 to 13.8. This means that while the top income quartile previously earned over seven times more than the bottom quintile, that figure has now almost doubled.
While the NCPERS analysis points to pension reforms for the disparity—consisting of changes to DB plans, increases in employee contributions, reductions in benefits, and restricting pension access to new hires or altogether—it also lists other factors that could have further accelerated income inequality like regressive taxation, a lack of investment in public education, and an overall decline in union membership.
In fact, the analysis shows other correlations that could have contributed to income inequality during the same time frame. According to the analysis, the marginal tax rate declined from 70% in 1977 to 37% in 2021, while income inequality nearly doubled during that period. Similarly, a lack of public education spending in the state and local level, along with a downward slide in union memberships over the decades, may have added to the income imbalance.
Such rising inequities could ultimately contribute to slower national economic growth and consumer spending, the analysis states. During economic downturns, middle- and lower-class workers are still likelier to spend their income on day-to-day costs and necessities, while wealthier cohorts tend to save and invest. Such imbalances could ultimately lead to a recession, the NCPERS notes.
“The study examines whether such changes have social and economic consequences, do such changes have increases in income inequality, and whether rising income inequality slows down the economy,” said Michael Kahn, lead researcher of the NCPERS, in an interview with 401(k) Specialist.
Another point in the analysis highlights the impact of pension spending on state and local economies, as well as its stability during points of economic downturn and market volatility. A 2023 report by the National Institute on Retirement Security (NIRS) found that retiree spending of public and private sector pension benefits in 2020 generated $1.3 trillion in total economic output, which in turn, supported close to 6.8 million jobs throughout the U.S.
“Retirees spend their pension checks in the communities, which grows the economy,” states Kahn. “The economy really grows through consumer spending—almost 70% of economic growth comes through this spending.”
DB to DC shifts
Even as it names added factors that could have contributed to this inequity, the NCPERS analysis specifically calls out conversions from DB pension plans to the DC market as a large driver of the inequality and of poverty among retirees.
The analysis cites a 2023 Congressional Budget Office study that examined how the move to DC plans have touched wealth inequalities, finding that “between 1989 and 2019, the shift accounted for nearly a fifth of the increase in the Gini coefficient,” a measure representing wealth inequality, and “a fifth of the increase in the share of wealth held by families in the top 10 percent of the wealth distribution.”
It also points to a 2019 article by economists and the Federal Reserve Board’s John Sabelhaus and Alice Henriques Volz, which when using data from the Federal Reserve Board’s Survey of Consumer Finances, observed that trends in employer-sponsored retirement plans negatively impacted families outside the top wealth quartile, and primarily among families in the third quartile of the wealth distribution. From 1989 through 2016, this quartile saw their share of total retirement plan wealth fall from 25% to 17%, while the bottom half of the wealth distribution fell from 7% in 1989 to 4% in 2016.
Other sources, however, expressed skepticism that such a shift towards 401(k)s and 403(b)s directly correlates to wealth and income inequalities. “There has certainly been a shift—income inequality and wealth inequality has gone up, but there really is not much evidence that the shift from DB to DC has had much to do with it at all,” said Peter Brady, senior economic advisor of Retirement and Investor Research at the Investment Company Institute (ICI).
An analysis from the ICI states that retirement plans can generate wealth and income for retirees. Using data from the Federal Reserve Board’s Survey of Consumer Finances, the ICI found that while near-retirement households hold 38% of their income from DB plans, 69% of retirement assets are in 401(k) accounts or individual retirement accounts (IRAs). Overall, 77% of near-retiree households have saved for retirement using DB plans, DC plans, and IRAs, according to the ICI.
A separate analysis from the organization looked at tax data for those transitioning into retirement from ages 55 to 72, finding that over 70% had income from employer plans and IRAs at the latter age.
Social Security’s impacts
Outside of retirement plan and pension assets, Social Security is another major driver of retirement income and wealth for certain cohorts, added Brady. Bottom wealth quartiles tend to rely heavily on Social Security to fund their retirement, whereas wealthier groups depend less on Social Security and more on investments and assets gained from wealth management strategies.
“You look at total income in what you get from retirement plans and Social Security, and what you find is that most retirees are able to replace the large percentage of the income that they had prior to retirement,” he added. “Even though they’re most dependent on Social Security, the highest replacement rates tend to be at the lower income, not at the higher.”
Yet, while previous generations could once benefit from the three-legged stool of retirement, comprising of pension and retirement plan assets, Social Security, and personal savings, the model has wobbled over years, as pension assets decline and Social Security risks turning insolvent in future years. The state of the federal program has led American workers to question whether they’ll be able to sustain a livable income throughout retirement and therefore urge Congress to address the gap before it’s too late.
“Social Security’s finances are a concern, and we hope that Social Security will get put on sound financial footing because it is so important to everybody, and that’s something that our policymakers will have to grapple with at some point,” said Sarah Holden, senior director of Retirement and Investor Research at the ICI.
Potential in collective defined contribution plans
Ultimately, NCPERS Lead Researcher Kahn touches on the potential of collective DC (CDC) plans in sustaining retirement income for workers, although notes in separate research that the plans are not an end-all, be-all remedy for income disparities.
Like 401(k)s and DB plans, employees and employers contribute to a CDC plan and receive lifetime retirement income. However, these benefits are not guaranteed.
“These collective DC plans are really like 401(k) plans, but they are modified, assets are pooled, and investments and benefits are managed like those of a defined benefit plan,” stated Kahn. “Unlike DC plans in which individual participants deal with the investment and longevity risk, the collective DC plans allow assets to be pooled, risks to be managed and shared, and the benefits and contribution rates are adjusted based on aggregates, limits, and auto-triggers.”
While mainly used in the UK, Netherlands, and Canada, the hybrid retirement plans have gained traction in Wisconsin’s public retirement system, and Maine has used some of its features in its retirement structure.
Despite its advantages, the plan requires serious and clear communication and implementation from both lawmakers and employers due to its nuances and untraditional approach to retirement savings, the NCPERS states in its research.
Eventually, similar to pension and Social Security reforms, changes will only be absolute once policymakers are involved.
SEE ALSO:
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- NIRS Urges Pension Coverage for Private Sector to Senate HELP Committee
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.
