Pension Lump-Sum Distributions: Do Boomers Take Them or Save Them?

Pension Lump-Sum Distributions: Do Boomers Take Them or Save Them? I. Introduction Boomers are facing a retirement system different from the one their parents knew. A greater proportion of the previous generation s workers were covered by defined benefit (DB) pension plans than is likely to be the case for boomers in retirement. Boomers will probably have to save more on their own to equal the pension benefits that their parents earned. In fact, many boomers have access to and participate in defined contribution (DC) pension plans and tax-deferred savings plans that were not available to the previous generation (Congressional Budget Office 2003). This report examines what boomers, preboomers, and older persons are doing with their pension account funds upon job separation, what socio-demographic and financial attributes affect their decisions to roll over or cash out LSDs, and what implications these decisions have for the retirement income security of these age groups. This analysis is based on 2003 data from the Survey of Income and Program Participation (SIPP) 2001 Panel on Retirement Expectations and Pension Plan Coverage (Wave 7) released by the Census Bureau in February 2005. 1 To preview our findings, the results suggest some cause for concern because more than one-half of all LSD recipients spend their LSDs and do not roll them over into another plan or IRAs. However, patterns differed among boomers where younger boomers are somewhat more likely to roll over LSDs than older boomers. Also, rollovers increased for all persons with higher education and family income. Minorities 1 The reference period of the Retirement Expectations and Pension Plan Coverage Topical Module Wave 7 is February to May 2003. are much less likely to roll over their funds. Race is a significant factor in determining cash-out or rollover behavior, but gender is not. Among all persons who spend their LSDs, and do not roll them over, a majority spend them on paying off some kind of debt. The pattern is similar for boomers. Background. A shift from DB to DC coverage poses several threats to a boomer s retirement income security. This shift can result in less predictable retirement income because participation in most DC plans is voluntary, and contribution levels, in most cases, are solely the decision of the participant. In addition, investment risk is shifted from the employer to the employee, and joint and survivor protections are not required for a 401(k) plan (the most popular DC plan) that is not annuitized. There is a leakage risk a boomer now has easier access to pension funds before retirement. These risks may have detrimental effects on a boomer s accumulation of assets and his or her retirement preparation. Because a DC plan consists of an account balance that accumulates in the participant s name, the worker controls how the money is managed and whether it is borrowed or cashed out. A worker must decide what to do with the account when he or she separates from the employer that is, when one changes employer, remains in the labor force but is unemployed and looking for work, retires but remains the labor force, or retires and leaves the labor force. Easy access to retirement funds is also becoming a growing issue for workers with DB plans. For example, workers with cash balance plans a new and popular type of DB plan with hypothetical individual accounts that are similar, in many ways, to DC accounts always have the option of cashing out their benefits when they leave their employer. There has also been a rise in DD 144

the proportion of traditional DB plans allowing participants to cash out benefits and receive a lump-sum distribution (LSD) especially when balances are smaller than some threshold amount when they leave their employer. Job Separation and LSDs. A worker usually has three options for the disposition of his or her pension account upon job separation: leave the funds with the employer (if the employer permits); roll the funds over to another tax-qualified savings vehicle (i.e., another employer plan if permitted or an individual retirement account [IRA]); or take the LSD in cash (Copeland 2002). 2 The choices workers make regarding LSDs have significant implications for their retirement income security. One key reason is the tax treatment of LSDs. An employee can defer tax on all or part of an LSD by requesting that an employer roll it over into an IRA 3 or another qualified retirement plan. However, mandatory income tax withholding of 20 percent applies to most distributions that are not rolled over. 4 The 2 An LSD from a DC plan, such as a 401(k) plan, is the total amount in the account balance (plan contributions plus returns from investments) that can be rolled over into another plan or given as cash upon job separation. An LSD from a DB plan is the present value of a participant s accrued benefits in the plan at some discount rate. In 2002, the vesting period for 401(k) matching contributions was reduced from five to three years. Some employers may even have a requirement of less than three years. If the employee is vested in the pension plan, the account balance in an LSD includes both the employee s and employer s contributions plus any gains. If a participant is not vested, only his or her own contributions and gains on those contributions are included in an LSD. 3 Note that 401(k) plans have different features for example, 401(k) plans, unlike IRAs, allow loans. Fees and investment options also differ between 401(k)s and IRAs. 4 This requirement was established by The Unemployment Compensation Amendments of 1992. Tax Reform Act of 1986 imposed an additional 10 percent excise tax on distributions that are not rolled over into taxqualified plans if the worker is under age 59½. 5 Literature Review. Most prior research has studied the LSD behavior of all workers but little has focused on boomers (Hurd 2003; Engelhardt 2001; Moore and Muller 2002; and Purcell 2005). Earlier research has uncovered important patterns about LSD eligibility and use (i.e., spending versus saving). There is evidence that eligibility for LSDs has increased significantly over the past two decades (Moore and Muller 2002). Analysis of the Census Bureau s April Supplement of Current Population Survey (CPS) data has identified a 12 percentagepoint increase (from 56 to 68 percent) between 1988 and 1993 in the proportion of workers with pensions who said they would be eligible for LSDs if they left their current jobs (Burman, Coe, and Gale 1999). 6 Another analysis using 2003 SIPP data found that more than 85 percent of all workers age 21 and older were covered by 5 There is an exception to the 59½ distribution rule that allows an employee to withdraw 401(k) funds if he or she retires, quits, or is fired after age 55. The employee also needs to begin taking out funds from an IRA by age 70½. The Economic Growth and Tax Relief Reconciliation Act of 2001 included several changes that significantly liberalized rollover rules, generally effective beginning in 2002. Rollovers may now be made freely among private and public plans and IRAs without regard to the type of plan. Prior law generally required that the amount be rolled over to the same type of plan from which it was distributed. However, there is no requirement that an employer plan accept rollovers. In addition, unless a participant makes an affirmative election to the contrary, a plan cashing out benefits between $1,000 and $5,000 must automatically transfer the amount to a participant s IRA. 6 This estimate is restricted to workers participating in pension plans on their current job and excludes the 15.6 percent of respondents who reported not knowing whether they would qualify for LSDs. 2

retirement plans that offered LSDs as payment options (Purcell 2005). A worker separating from a job is not likely to roll over an entire LSD into another plan. In an earlier study based on the April 1993 CPS, Korczyk (1996) found that only 1 in 5 of all LSD recipients and far smaller proportions of those who could be considered at risk reported having rolled over their LSD into an IRA or other retirement savings vehicle. Workers with the poorest long-term earnings prospects were most likely to spend their LSDs on current consumption. According to another analysis (Purcell 2005) based on the 1998 SIPP data, only 36 percent rolled over the entire amount of their most recent LSD into an IRA or another plan, which accounted for 59 percent of the LSD dollars. By 2003, the comparable figures were 44 percent and 67 percent, respectively. 7 Older workers were more likely than the overall workforce to save pre-retirement LSDs. Using the 1992-2000 Health and Retirement Study (HRS) data to analyze the pensions of workers ages 51 to 61 in 1992, Hurd, Lillard and Panis (1998) and Hurd and Panis (2003) found that only 31 percent of workers DB and DC pension plans (16 percent of all workers pension plan dollars) involved an LSD. Less than half of these LSDs, involving just 13 percent of worker pension plans (only 5.3 percent of all worker pension plan dollars) were cashed out. And only 6 percent of worker pension plans (just 7 In 1998, 42.4 percent of respondents who had received an LSD within the last 5 years reported that they had rolled over the full amount of the LSD into another plan. In the 2003 survey, the comparable figure was 45.8 percent, an increase of just 3.4 percentage points. The higher overall percentage of recipients who reported having rolled over their most recent LSD in the 2003 survey 44 percent, as compared to 36 percent in the 1998 survey results mainly from the fact that a much higher proportion of LSDs represented in the 2003 survey occurred after 1992. A significant increase in the proportion of LSD rollovers followed the tax withholding requirement established in 1992. 2 percent of all worker pension plan dollars) involved spending on current consumption or use to pay off debt. Engelhardt (2001), using the HRS data to analyze LSDs for workers ages 51 to 61, concluded that onequarter of households could have increased their pension wealth by 25 percent or more had they rolled over their LSDs to some taxqualified plans. Data. The 2003 SIPP data set used in this report is the most recent and detailed information available on types of pension and retirement plan coverage for a large representative sample of U.S. workers. In the SIPP survey, a question on pension coverage in current employment is asked of all workers age 16 and older, while a question on pension coverage from previous employment is asked only of those who are age 25 and older (who may or may not currently be in the labor force). Questions about lump-sum payments, which include survivor benefits and some LSD cash outs or direct rollovers, are asked of those age 21 and older. (We do not have information about previous pension plan coverage for those who are age 16-24.) The 2003 SIPP survey collected information on all LSD recipients (age 21 and over) from their employers. Even though the question about previous pension plan coverage (which generates most LSDs) was only asked of persons age 25 and older, some rollovers and survivor s benefits could begin at age 21. 8 Our analysis therefore included all persons age 21 and older who received LSDs, rollovers, or survivor s benefits. The survey permits the analysis of rollover decisions of LSD recipients (i.e., the entire or partial amount) but not the exact amount in dollars rolled over. 9 Our study therefore 8 These LSD recipients also included a small group of those who received survivor benefits (Chart 2). 9 SIPP collected data on amounts rolled over into retirement accounts in Wave 1, but we did not find it useful to match this with the LSD data in Wave 7 because the rollover data were presented 3

Chart 1: Career Pension (Current and Previous) Coverage of All Persons, 2003 All persons (who may or may not be in labor force, age 25 and older) All workers in labor force (age 16 and older) = 185.0 million = 138.6 million Current pension coverage only (age 16 and older) = 63.4 million workers Both previous plans and current coverage = 13.3 million workers Previous plan coverage only = 27.6 million (11.1 million workers in labor force; 16.5 million out of the labor force) Any previous pension plan coverage during career (age 25 and older) = 40.9 million persons analyzes the factors influencing the proportion of recipients who rolled over all or part of their LSDs, instead of how much money was actually rolled over Using the SIPP definition, LSD recipients include: (a) all persons age 21 to 24 who received a non-retirement lump sum 10 regardless of whether they rolled it over into another type of retirement plan; (b) all persons age 25 and older who were covered by a previous pension plan and expect to receive retirement benefits in the future from a DB plan 11 ; (c) all persons age 25 and older who were covered by a previous pension plan and who received a lump sum, regardless of whether they rolled it over into another type of retirement plan; and (d) all persons age 25 and older who were covered by a previous plan and who either rolled over money into another retirement plan or who expected to receive benefits in the future from a DC plan. in wide intervals rather than in actual amounts rolled over. 10 These LSDs are coded as non-retirement lump sums. In SIPP, pension/retirement lump sum distributions and non-retirement lump sums are classified separately. A non-retirement lump sum also includes survivor benefits. 11 For DB plans, retirement benefits can be received only after attaining a certain age i.e., the early or normal retirement age. II. Pension Plan Coverage from Previous Jobs and Lump-Sum Distributions As shown in Chart 1, career pension coverage includes those workers age 16 and older who had a pension plan from a current job only (63.4 million), and persons age 25 and older who had coverage from a previous pension plan during their careers (40.9 million). Among those individuals who had coverage from previous employment, 13.3 million had pension plans from both current and previous employment, and 27.6 million had a pension plan from previous employment only (11.1 million of whom did not have a pension plan from their current employment, and 16.5 million of whom were no longer in the labor force). We have divided the population into five age groups in 2003 as shown in Table 1. Table 1: Age Groups in 2003 Birth Year Younger persons (age 21-37) 1966-82 Boomers (age 38 to 57) 1946-65 Younger boomers (age 38-47) 1956-65 Older boomers (age 48-57) 1946-55 Pre-boomers (age 58 to 64) 1939-45 Older persons (age 65 and Older) 1938 or before 4

Table 2: Pension Coverage of All Persons from Previous Employment During Career (Excluding Current Employment and Coverage) by Age, Gender, and Race, 2003 Number of Previous Pension Percent Covered by Gender and Race Persons by Age Persons Coverage By Gender By Race Millions Millions Percent Men Women White Nonwhite All (age 25 and Older) 185.048 40.870 22.1 24.3 20.1 23.5 14.9 By Age Younger persons: age 25-37* 51.357 7.763 15.1 14.2 16.0 16.1 11.1 Boomers: age 38-57 82.225 17.212 20.9 21.3 20.6 22.4 13.8 Younger boomers: age 38-47 45.003 8.946 19.9 19.6 20.1 21.4 13.0 Older boomers: age 48-57 37.222 8.266 22.2 23.3 21.2 23.6 14.8 Pre-boomers: age 58-64 17.371 4.998 28.8 34.0 24.0 30.0 21.1 Older persons: age 65 and older 34.094 10.896 32.0 44.7 22.6 33.0 24.1 * Question on pension coverage from previous employment in the SIPP questionnaire is asked of only those who are age 25 and older, regardless of whether or not they are in the workforce. Among almost all of the 185 million persons age 25 and older (both those currently in the labor force and those out of the labor force), pension coverage from previous employment at any time during a career increased with age (Table 2). Although only about 15 percent of younger persons (age 25-37) had a plan from previous employment, almost one-third of persons age 65 and over had such coverage. While gender differences in pension coverage from previous employment were not significant among younger persons and boomers, coverage for male pre-boomers was 10 percentage points higher, and that of male older persons was 22 percentage points higher, than that of their female counterparts (Table 2). Women are more likely to work part time and have fewer years in the workforce than men, which reduces their likelihood of pension coverage. Whites with pension coverage from previous employment also outnumbered nonwhites by a significant margin, ranging from 5 to 9 percentage points among all age groups. Table 3 shows LSD recipients and LSD rollovers among only those who had pension coverage from previous employment. Of the 40.9 million persons with previous pension coverage, 16 million (39.2 percent) received LSDs (not shown, 14.8 million from a pension or retirement lump sum and a small number, 1.2 million, from a survivor s benefit). LSD recipients decreased directly with age. Younger persons were most likely to have received an LSD (52.5 percent) and older persons were the least likely (20.0 percent). Rollovers also differed significantly by age groups. Pre-boomers were the most likely to have rolled over their LSDs (54.6 percent), whereas younger persons were the least likely (37.9 percent). significantly by age groups. Pre-boomers were the most likely to have rolled over their LSDs (54.6 percent), whereas younger persons were the least likely (37.9 percent). The fact that younger boomers were slightly more likely than older boomers (48.9 percent versus 46.7 percent) to have rolled over their LSD might be due to higher DC coverage among younger boomers than older boomers. Older boomers were more likely than younger boomers to have DB pension coverage, which tends not to provide an LSD option (data not shown here). Except for pre-boomers, less than one-half of all LSD recipients rolled over their LSDs. When examined by gender, more women (39.6 percent) received LSDs than men (33.4 percent). This gender difference could result from women s discontinuity in jobs due to family responsibilities. Female recipients of survivor s benefits (data not shown here) also outnumbered male recipients in all age groups. As regards race, whites (36.9 percent) were more likely to be LSD recipients than nonwhites (31.4 percent. For example, white pre-boomers and white older 5

Table 3: Recipients of LSDs or Rollovers Among Those Who Had Pension Coverage From Previous Employment by Age, Gender, and Race, 2003 Percent of LSD Recipients by Gender and Previous Rollovers from All LSD Recipients Race LSD Receipients By Age Coverage Current LSDs By Gender By Race Millions Millions Percent Men Women White Nonwhite Millions Percent All Recipients 40.870 16.007 39.2 33.4 39.6 36.9 31.4 7.361 46.0 By Age Younger: age 21-37* 7.763 4.072 52.5 47.3 48.2 48.9 40.8 1.543 37.9 Boomers: age 38-57 17.212 8.044 46.7 41.4 47.4 44.9 40.6 3.851 47.9 Younger boomers: age 38-47 8.946 4.310 48.2 42.7 49.3 46.8 41.1 2.106 48.9 Older boomers: age 48-57 8.266 3.734 45.2 40.2 45.4 43.1 40.0 1.745 46.7 Pre-boomers: age 58-64 4.998 1.716 34.3 29.4 37.1 34.3 19.0 0.937 54.6 Older persons: age 65 and older 10.896 2.176 20.0 16.5 17.5 17.7 9.2 1.03 47.3 * The question on previous pension coverage is asked only of those age 25 and older, but the question on LSDs and rollovers is asked of those age 21 and older because some workers may receive survivor benefits or direct rollovers or cashouts at age 21. From age 21 to 25, most LSDs/rollovers are either in the form of survivor benefits or disability benefits. persons were more likely to have received LSDs than their nonwhite counterparts, by 15.3 and 8.5 percentage points, respectively (Table 3). III. LSDs and Rollovers In 2003, LSD withdrawal was mandatory for 38 percent of the 16.0 million recipients and voluntary for the rest (Box A, Chart 2). Among these LSD recipients, 81 percent were in private employment; 17 percent were in federal, state, and local government; and the remaining (2 percent) received LSDs from other sources (Box B). Of all LSD recipients, 54 percent (8.6 million) cashed out and spent it all (Box C), and 46 percent (7.4 million) either rolled the LSD over directly, or first cashed it out and then rolled it over partly or fully into some tax-qualified plan (Box D). 12 Of those who rolled the LSD over, 70 percent rolled it into an IRA, 13 percent into another employer plan, 7 percent bought an annuity, and the remaining 10 percent invested in some other retirement plan (Box E). 12 Of the 16 million LSD recipients, 6.4 million (40 percent) rolled it over directly into some plan, while about 1 million first cashed it out and then rolled over. Thus, a total of 7.4 million (46 percent) rolled their LSDs into some plan while 8.6 million (54 percent) spent it all. Of the 11.7 million who did not receive LSDs by the end of the reference period of SIPP Wave 7 (February-May 2003) and who expected to receive benefits in the future, 5.4 million had DB plans and 6.3 million had DC plans (Box F). Among DC plan holders, about two-thirds had less than $25,000 in their account balances (Box G). About 60 percent of these account holders could withdraw money immediately, and 40 percent would have to wait to draw money until the required age of withdrawal without penalty. The likelihood of receiving an LSD also depended on the amount of the lump sum. As expected, the pattern was significantly different for younger persons than for preboomers and older persons. Almost twothirds of younger persons and a little less than one-third of pre-boomers and older persons received LSDs of $5,000 or less. At the upper end, only 3 percent of younger recipients compared with almost 27 percent of pre-boomers and older persons received LSDs of $50,000 or more (Figure 1). There were significant gender differences among 2003 LSD recipients (Figure 2). More women (66.3 percent) than men (52.1 percent) received LSDs of less than $10,000, whereas more men (29.3 percent) than women (15.6 percent) received LSDs of $25,000 and more. The modal amount received by both men and women was 6

Chart 2: LSD Rollover Decisions of Persons with Pension Coverage from Previous Employment, 2003 All persons (age 25 and older) = 185.0 million All workers (age 16 and older) = 138.6 million All persons with pensions from previous employment (age 25 and older) = 40.9 million (22% of 185 million persons) Box A Persons received or rolled over LSDs = 16.0 million (39% of those who had previous pensions) (1) From previous plans = 14.8 million (2) Survivors benefits = 1.2 million LSD Withdrawal: 62% voluntary; 38% mandatory Box F Persons who have yet not received retirement benefits from previous plans = 11.7 million (1) From DB plans = 5.4 million (2) From DC plans = 6.3 million (Persons received benefits already =13.2 million) Box B Employment Sources of LSD Payments: Private = 12.9 million (81% ) Federal/Military = 0.5 million (3%) State & Local = 2.2 million (14%) Other =0.4 million (2%) Total = 16.0 million (100%) Box C Cashed out and spent it all = 8.6 million persons (54% of LSD recipients) Box D Rolled over directly or cashed and then rolled into another tax-qualified plan = 7.4 million persons (46% of LSD recipients) Box G: Total Balance in DC Plans Total Balance Expected Number of Recipients Millions Percent Less than $10,000 2.442 38.5 $10,000 to $24,999 1.704 26.8 $25,000 to $49,999 0.761 12.0 $50,000 to $99,999 0.843 13.3 $100,000 to $199,999 0.368 5.8 $200,000 or more 0.230 3.6 Total 6.348 100.0 60% can withdraw now; 40% will have to wait until the required age... Box E Rollovers into: IRA = 70% Total 100% Plan on new job = 13% (7.4 million persons; Annuity = 7% 46% of all LSD Recipients) Other plan = 10% All percentages in italics are rounded and add up to 100% 7

45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0-22.3 Figure 1: Percent Distribution of LSD Recipents by Amounts Received and Age, 2003 (Age 21 and Older, n = 16 million) Percent by Age 10.4 8.6 42.3 30.8 18.7 17.0 15.8 13.8 13.0 20.7 19.1 13.4 10.3 10.9 3.7 3.0 Less than $1,000 $1,000 to $4,999 $5,000 to $9,999 $10,000 to $24,999 $25,000 to $49,999 $50,000 and more LSD Amount Received Younger persons (4.1 million) Boomers (8 million) Pre-boomers and older persons (3.9 million) (Total n =16 million) (n = 2.1 mil, 13%) (n = 5 mil, 31%) (n = 2.5 mil, 16%) (n = 2.9 mil, 18%) (n = 1.5 mil, 9%) (n = 2 mil, 13%) 26.5 Note: Figure 1 shows LSD amounts received by three age groups. Each age group (gender in Figure 2) sums to 100%. The percentages in each LSD range represent the percent of persons by age group receiving an LSD amount in that range. All recipients by each LSD range are shown in parentheses. All parentheses sum to 16 million. 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 - Percent by Gender Figure 2: Percent Distribution of LSD Recipients by Amounts Received and Gender, 2003 (Age 21 and Older, n = 16 million) 10.0 15.6 26.9 34.2 15.2 16.5 18.6 18.1 10.8 Men (7.6 million) Women (8.4 million) 18.5 8.1 7.5 Less than $1,000 $1,000 to $4,999 $5,000 to $9,999 $10,000 to $24,999 $25,000 to $49,999 $50,000 and more LSD Amount Received between $1,000 and $4,999. The distribution was even more skewed at the higher end of LSD amounts. For example, 18.5 percent of men received lump-sum payments of $50,000 and more compared with 7.5 percent of women. The difference in LSD amounts could be due to several factors: (a) gender differences in earnings and hence in accumulated pension balances; (b) gender differences in pension mobility more men than women had jobs that provided pension portability; and (c) the fact that in 2003, more women than men were likely to have DC accounts with balances of less than $1,000 that could be cashed out as a direct payment to employees by their employers without the employees approval. If LSD recipients were grouped by marital status (data not shown in these tables), 64 percent would be married, 23 percent widowed/divorced/separated, and 13 percent would be never married. These data provide some reason for concern because more than one-half (54 percent) of the recipients did not roll over any of their LSDs into another retirement plan, annuity, or IRA at their current job. They cashed out and spent it all. Only 40.1 percent of recipients rolled over all of their LSDs, and 8

about 6 percent rolled over amounts (entirely or partly) from their cash outs. The proportion of recipients who spent all of their cash outs declined with the amount received. The proportion of recipients who rolled over directly increased with the LSD amount received (Table 4). Table 4: Percent Distribution of LSD Recipients by Amounts Received and Types of Disposition (n = 16.0 million) Cashed All Rollovers (46%) LSD Amount Out and From Cash-outs Received Spent All Direct Rollovers (54%) Entirely Partially Less than $1,000 76.7 18.1 4.8 0.4 $1,000 to $4,999 65.6 29.7 3.5 1.1 $5,000 to $9,999 56.8 39.3 2.3 1.6 $10,000 to $24,999 47.6 44.7 4.3 3.5 $25,000 to $49,999 35.8 58.1 4.0 2.1 $50,000 to $99,999 24.6 65.8 8.7 0.8 $100,00 or more 19.5 71.3 7.0 2.3 Total 54.0 40.1 4.2 1.7 All rows add to 100% As seen in Table 5, among those who did not roll over part or all of their LSDs, a majority (55.6 percent) paid off mortgage, loans, other debt, taxes, medical and dental bills, and moving or relocating expenses. About 30 percent spent it on vacations, consumer items, every day expenses, and miscellaneous items; and 14.8 percent saved it in the form of time deposits, savings accounts, stocks, bonds, IRAs, a family business, or some other form of retirement savings. Table 5: Multiple Uses of Cash-Outs by LSD Recipients [Who Did Not Roll Over] by Their Most Important Category,* 2003 (n = 8.6 million) Millions Percent Invested in IRAs, time deposits, stocks, bonds, land, family businesses, or saved for education 1.747 14.8 or retirement in other forms of retirement savings. Paid off mortgage, bills, loans, taxes, and other debt; moving or 6.581 55.6 relocating expenses; medical and dental bills Spent on vacations, consumer items, everyday expenses, other items, or given to family members 3.502 29.6 * Category totals do not equal the number of LSD recipients because some recipients may have spent in more than one category. IV. Logistic Model of Rollovers We have estimated a logistic model to predict the expected probabilities of rollovers by individual socio-demographic characteristics, holding all other characteristics constant. The proportion of all LSD recipients who rolled their money over into some kind of tax-qualified plan (employer plan, annuity, or IRA) in our weighted sample is 46 percent (Table 4) (45 percent in the unweighted sample, Table 6 for all ages, and 46.8 percent for all boomers). This initial proportion is the probability of rollovers we would expect (i.e., prior to estimating the logistic model) if we had no knowledge of the individual characteristics of LSD recipients. Descriptive tabulations are not able to measure the effect of a specific sociodemographic, financial, or retirement plan characteristic on rollover behavior while holding all other characteristics constant. To isolate the effect of each characteristic on rollover decisions, we estimated a binary (meaning two outcomes) logistic model. The two outcomes were whether recipients rolled over any of their LSDs (Rollover = 1) or rolled over none of their LSDs (Rollover = 0). The independent variables were the key socio-demographic, financial, and retirement plan characteristics of workers. We estimated the model for two sets of observations: total population of all ages, and boomers alone. The purpose of estimating this model was to analyze how the initial probability of rollovers would change with a specific characteristic, holding all other characteristics constant. These probabilities are shown in Table 6. General Characteristics. Although a smaller proportion of women than men rolled over their LSDs, after estimating the model we found that the coefficients of gender and marital status were insignificant in predicting the rollover decisions for recipients of all ages and for boomers. However, race was significant. The expected probability of rollovers decreased to 35.4 9

percent for nonwhite recipients among all age groups and 38.9 percent among boomers as compared with initial proportions of 45 percent and 46.8 percent respectively. Table 6: Expected Probabilities of Rollovers a by Recipient Characteristics, 2003 All Ages Boomers (age 38-57) General Characteristics Female (Male = 0) 46.1% 44.1% Nonwhite (White = 0) 35.4% ** 38.9% ** Married (Single = 0) 46.3% 53.0% High School (<HS = 0) 63.5% ** 76.3% * Some College 60.8% ** 74.4% * College 69.6% ** 82.7% ** Age Received LSD (Age < 35 = 0) Age 35-44 52.2% ** 60.0% ** Age 45-54 51.8% ** 54.8% Age 55-64 54.4% ** Age 65 and older 41.8% Amount of Lump Sums (<$1,000 = 0) $1,000 - $4,999 52.3% ** 46.9% $5,000 - $9,999 60.9% ** 62.3% ** $10,000 - $24,999 68.7% ** 65.6% ** $25,000 - $49,999 77.6% ** 80.0% ** $50,000 - $99,999 87.9% ** 96.9% ** $100,000 and more 88.4% ** 92.3% ** Household Income (<$30,000 = 0 ) $30,000 - $59,999 50.9% ** 63.5% ** $60,000 - $99,999 58.5% ** 67.7% ** $100,000 and more 56.2% ** 64.0% ** Current Retirement Plans and Other Assets DB Plan Only 46.2% 55.7% DC Plan Only 54.1% ** 61.6% ** Cash Balance Plans 60.8% ** 61.1% Both DB and DC Plans 49.5% 58.7% Owns IRAs 82.9% ** 90.4% ** Owns Thrift/401(k)s 46.4% 46.1% Owns Stocks 47.2% 56.4% ** Owns Mutual Funds 58.7% ** 64.6% ** LSDs Received After 1986 69.7% ** 77.4% ** Rollovers: Initial Proportion 45.0% 46.80% Unweighted sample size 3,751 1,900 * Significant at 10%; ** Significant at 5% or less a Rollovers either fully or partially. Education. With less than a high school education as the base category in our model, the expected probability of rollovers increased to 69.6 percent (82.7 percent among boomers) for those who had a college education, and to 63.5 percent (76.3 percent among boomers) for those who had a high school diploma. Age When LSD Was Received. Decisions on rollovers also depended on how old recipients were when they received their LSDs. With age less than 35 as the base category, the probability of rollovers increased to 54.4 percent if the recipient s age was 55 to 64, but declined to 41.8 percent for persons age 65 and older, as expected. Among boomers the expected probability of rollovers increased to 60 percent if they received lump sums before age 44, and 54.8 percent if they received lump sums between ages 45 to 54. Amount of LSDs. With all other variables held constant, the probability of rollovers increased with the amount received, confirming the findings of other studies (Moore and Muller 2002). For boomers, these probabilities were even higher for amounts received of $25,000 or more. For example, the expected probability of rollovers increased to 96.9 percent for lump sums between $50,000 and $99,999, and 92.3 percent for lump sums of $100,000 or more. Income. Because the decision to roll over LSDs is usually a family decision, we chose to examine household income (instead of personal income) as an independent variable. Expected probabilities increased with income under $100,000. In addition, the expected probabilities of rollovers were much higher for boomers than the total population in all household income ranges. 13 13 In some studies based on the HRS, the rollovers have been higher than in our study, but that could be due to differences in the two datasets. The HRS universe pertains to ages 51 to 61, while SIPP includes all workers age 16 and older for pension coverage; 25 and older for pension coverage from previous job(s); and 21 and older for all pre-retirement LSDs, rollovers, and survivor benefits. Cash outs are likely to be lower, or rollovers are likely to be higher, for those age 51 to 61 than for younger workers. In our model, the expected probabilities also increased with age until 64 and then declined. 10

Retirement Plans. We also analyzed the impact of workers current participation in retirement plans and IRAs on the decision to roll over their LSDs. Boomers who had a DB plan only had a 55.7 percent likelihood of rolling over their LSDs (although the coefficient of the DB plan only variable was statistically insignificant 14 ). However, the expected probability of rollovers increased to 61.6 percent for boomers who had a DC plan only. This was statistically significant. Having a Cash Balance (CB) plan had a significant effect on rollovers for recipients of all ages but was insignificant for boomers. This was probably because most of the recipients in CB plans were younger workers. About 61 percent of those who had CB plans were expected to roll over their LSDs. Because most of the LSDs were rolled over into IRAs, the expected probability of rollovers increased to almost 90 percent if LSD recipients already owned IRAs, but participation in thrift or 401(k) plans did not influence rollovers. Other Assets. In the absence of a precise value of wealth in the SIPP dataset, we included a dummy variable if recipients of LSDs owned mutual funds and stocks (1 if yes; 0 otherwise). For the total population model, those who owned mutual funds among all ages had a 58.7 percent probability of rolling over their LSDs. For boomers, the presence of mutual funds increased the expected probability of rollovers by almost 18 percentage points to 64.6 percent relative to the initial probability, and the presence of stocks increased the expected probability by 10 percentage points relative to the initial probability. Tax Reform. We also hypothesized that rollovers should increase as a result of the Tax Reform Act of 1986, which introduced a tax penalty of 10 percent on LSD payouts not rolled over by those under age 59½. We 14 The coefficient on DB plans was insignificant because among all LSD recipients, 4.5 percent had a DB plan only. introduced a dummy variable for the year LSDs were received (1 if the year of LSD was 1986 or later; 0 otherwise). The dummy variable was highly significant and confirmed the hypothesis that the probability of rollovers would have increased to almost 70 percent if LSDs were received after 1986 for all workers (77.4 percent for boomers). From a policy perspective, tax laws have been successful in encouraging rollovers (Burman, Coe, and Gale 1999). V. Comparison of Lump Sums and Rollovers in 1998 and 2003 Using data from both the 1998 and 2003 SIPP (Wave 7), we examined recent changes in the incidence of rollovers from previous pension plans at any time during a career for boomers and all for persons. This period overlapped with the cyclical downturn in the economy. The number of persons with previous pension coverage increased from 34.7 million in 1998 to 40.9 million in 2003 an increase of almost 18 percent. This increase was probably due to high labor turnover during the economic downturn (Table 7). The number of workers with both current and previous pension plans increased more than 30 percent between 1998 and 2003, from 9.9 million to 12.9 million (Table 7). Workers who received LSDs upon separation from a previous job increased from 14.3 million in 1998 to 16 million in 2003 an increase of almost 12 percent during the 5-year period (Table 8). We have made two types of comparisons: first by age group, and second by birth cohort. An examination by age group shows that the number of those who rolled over all or part of their LSDs dramatically increased during this period from 38 percent to 46 percent. An increase occurred across all age groups; however, the largest increases occurred in age groups 43 to 52 in 1998 and 53 to 64 in 2003. 11

Table 7: Previous Plan Coverage in 1998 and 2003 1998 2003 Those with pension plan(s) from previous job(s) (millions) 34.7 40.9 Percent of age 25 and older 20% 22% Those with pension plan(s) from current job and previous job(s) (millions) 9.9 12.9 Percent of labor force 7% 9% Table 8: Comparison of LSD Recipients and Rollovers 1998 2003 LSD recipients (millions) 14.3 16.0 Those who rolled over all or part of their LSDs (%) 38% 46% Boomers in 1998: Younger (age 33-42) 36% 44% Older (age 43-52) 39% 49% Pre-boomers and older persons in 1998: Age 53-64 42% 52% Age 65 and older 45% 47% After 5 Years Boomers in 2003: Younger (age 38-47) 49% Older (age 48-57) 47% Pre-boomers and older persons in 2003: Age 58-64 55% Age 65 and older 47% An examination of the LSD behavior by birth cohort over this five-year period shows that younger boomers increased their rollovers from a previous job more than older boomers did. In 1998, 36 percent of younger boomers (age 33 to 42) rolled over an LSD from a previous pension 5 years later the percentage of rollovers for this birth cohort (now 38 to 47) increased to 49 percent. This compares to an increase from 39 percent to 47 percent for older boomers during this 5-year period. Some of this difference is probably due to the fact that younger boomers are more likely to have only DC plans than are older boomers. VI. Conclusions Boomers now have easier access to pension funds before retirement than their parents did. They often receive pre-retirement and retirement LSDs from their previous employers. Whether they roll over their LSDs into some tax-qualified plan or spend them has significant implications for their retirement income security. This study differs from other analyses of LSDs in two important respects: (1) it analyzes different age groups: boomers (including younger and older boomers), preboomers, and older persons; and (2) it examines whether current retirement plan coverage (DB-only, DC-only, cash balance plans, or both DB and DC plans) and other assets such as IRAs, mutual funds, and stocks affect the decision to roll over or consume retirement assets accumulated on prior jobs. The results of this analysis of the 2003 SIPP (Wave 7) data suggest some cause for concern because more than one-half of all LSD recipients do not roll over all or even part of the amount received. Our results confirm several findings from previous studies based on different datasets that rollovers increased with age until 64 and then declined. However, we found a different pattern among boomers that younger boomers are somewhat more likely to roll over LSDs than are older boomers (48.9 percent versus 46.7 percent, respectively). The difference is small but significant. We also found that rollovers increased for all persons with higher education and family income. The expected probability of rollovers from LSDs is highly dependent on the amount received the higher the amount received, the higher the probability of rollovers. 12

Our analysis also focused on the rollover behavior of vulnerable groups women and minorities. Both groups are less likely to have pension plan coverage than their male and white counterparts (Verma and Lichtenstein 2003). Women are more likely than men to have received an LSD, but their rollover decisions are not statistically different from those of men. Minorities, on the other hand, are much less likely than whites to have received an LSD and are even less likely to have rolled over their funds. Thus, all else being equal, race is a significant factor in determining cash-out or rollover behavior, but gender is not. There is some evidence that the leakage from retirement accounts is not entirely consumed in ways that weaken the financial strength of households. This study shows that among all persons who did not roll over all or part of their LSDs, a majority spent them paying off some kind of debt. The pattern was similar for boomers. In sum, reducing leakage from retirement accounts might improve the retirement income security of boomers. Automatic rollover of smaller amounts of LSDs into IRAs is one approach to stem leakage, which would make it more likely that these modest amounts would be preserved for retirement. Another policy might be to permit plan sponsors to purchase life annuities for terminated employees. In addition, tax subsidies supporting DC plans could be more restrictive and could be withheld from plans without a rollover distribution option for participants. Our results suggest that additional policies may be needed to discourage cash outs by boomers and workers in general. References Burman, Leonard E., Norma B. Coe, and William G. Gale (1999). Lump Sum Distributions from Pensions Plans: Recent Evidence and Issues for Policy and Research, National Tax Journal, Vol. LII, No.3. Burman, Leonard E., Norma B. Coe, and William G. Gale (2001). What Happens When You Show Them the Money?: Lump Sum Distributions, Retirement Income Security, and Public Policy, Second Annual Conference for the Retirement Research Consortium, The Outlook for Retirement Income, Washington, D.C., May 17 20. Congressional Budget Office (2003). Baby Boomers Retirement Aspects: An Overview, Washington, D.C.: U.S. Government Printing Office. Copeland, Craig (2002). Lump-Sum Distributions: An Update, EBRI Notes, Vol. 28, Number 7, July. Engelhardt, Gary V. (2001). Pre- Retirement Lump-Sum Pension Distortions and Retirement Income Security: Evidence from the Health and Retirement Study, National Tax Journal, December. Hurd, Michael, Lee Lillard, and Constantinjn Panis (1998). An Analysis of the Choice to Cash Out Pension Rights at Job Change or Retirement, RAND Corporation, DRU-1997-DOL. October. Hurd, Michael, and Constantijn Panis (2003). The Choice of Cash Out Pension Rights at Job Change or Retirement, Draft, RAND Corporation, May. Korczyk, Sophie (1996). Pre-Retirement Pension Distributions in a Lifetime Perspective, AARP Public Policy Institute Issue Paper, Number 9608, April. Moore, James H., and Leslie Muller (2002). An Analysis of Lump-Sum Pension Distribution Recipients, Monthly Labor Review, May. Purcell, Patrick J. (2005). Pension Issues: Distributions and Retirement Income Security, CRS Report for Congress, Congressional Research Service, Order Code RL 30496, August. 13

Verma, Satyendra K., and Jules Lichtenstein (2003). Retirement Plan Coverage of Baby Boomers and Retired Workers: An Analysis of 1998 SIPP Data, Issue Paper, AARP Public Policy Institute, No. 2003-10, July. Written by Satyendra Verma and Jules Lichtenstein AARP Public Policy Institute 601 E Street NW, Washington, DC 20049 202-434-3871; E-mail ppi@aarp.org August 2006 2006, AARP http://www.aarp.org/ppi Reprinting with permission only. 14