The Problem With Pension Portability

• Publication year: 2021

77 Nebraska L. Rev. 344. The Problem with Pension Portability

344

Steven L. Willborn*

The Problem with Pension Portability

TABLE OF CONTENTS

I. Introduction ........................................... 344
II. Pension Portability: The Landscape ..................... 346
III. Evaluating the Costs and Benefits of Enhanced
Portability ............................................ 349
A. Financial Effects ................................... 350
1. Sources of Increased Benefits and Costs .......... 350
a. Table 1: The Wage-Indexing Effect of
Portability ................................... 351
2. Magnitude and Distribution of Increased Costs
and Benefits ..................................... 352
b. Table 2: Effects of Enhanced Portability in a
Dynamic World ................................. 357
B. Labor Market Effects ................................ 359
C. Administrative and Technical Issues ................. 361
IV. The Problem With Portability ............................ 363

I. INTRODUCTION

Pensions are a very important type of employee benefit, but some of the problems with them arise precisely because they are employee benefits. This Article discusses one of those problems: portability. When employees change jobs, they often lose pension benefits. Sometimes employees may not be fully "vested" in their pensions, and so they lose all or a part of their benefits when they change jobs. Other employees may be in plans that implicitly impose penalties for changing jobs, even if the employees are vested. Portability refers to the ability of employees to carry their pension benefits with them as they change jobs.

Concern about limited portability is a current (fn1) and recurrent (fn2) topic of public policy debate. This article will not resolve much in that de-

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bate. Indeed, its message is quite the opposite: the portability debate will be very difficult to resolve for two interrelated reasons. First, the debate involves very difficult questions about the costs and distributional effects of changes in the rules relating to portability. Pension portability sounds good in general, as a soundbite or one-line campaign theme. After all, who could be against workers carrying their pension benefits with them as they change jobs? But pension portability will have costs that will be distributed across workers and employers in a particular way. Those costs and distributional effects pose an empirical challenge: it is difficult to determine what they are with an acceptable degree of precision. And they pose a normative challenge: with its costs and distributional effects, does portability provide a net benefit? The status quo, which is quite powerful in any event, becomes an even more formidable opponent when the consequences of every alternative are clouded with uncertainty.

Second, the portability debate is difficult because any changes affect, not only the ability of employees to transfer benefits, but also the calculus employers make when they decide whether to offer pensions as an employee benefit. Employers offer pensions, not out of the goodness of their hearts, but because pensions serve certain functions, such as retaining good employees, motivating them, and regulating retirement flows. Portability would interfere with the ability of pensions to perform these functions both directly (by making it more difficult to use pensions to serve those functions) and indirectly (by making it more expensive to use pensions for those purposes). Employers have an option when portability interferes with their ability to use pensions to pursue their employment objectives: offer fewer and less generous pensions.

This Article is about pension portability, but the problems addressed are important and general ones affecting all types of employee benefits. All employee benefits are part of the compensation package and, as such, all are designed to pursue certain employment-related goals. Portability of health care benefits, for example, poses issues similar to those posed by pension portability.(fn3) Regulation on that is-

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sue, and indeed regulation of all employee benefits, occurs in the context
of uncertainty about the costs of regulation and its distributional effects and about its effect on the continued willingness of employers to offer the benefit. This Article is intended both as an exploration of the issue of pension portability and as a case study of the challenges posed to lawmakers as they consider regulation of employee benefits generally.

II. PENSION PORTABILITY: THE LANDSCAPE

In general terms, portability refers to the ability of participants to transfer pension rights from one employer to another following a change in employment. For convenience, I am going to refer to the employer that the participant is leaving as the "old employer" and the employer that the participant is joining as the "new employer."(fn4)

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Participants may be interested in transferring two distinct types of pension rights.(fn5) First, participants may want to transfer service credit. In general terms, service credit means credit for the number of years participants have worked with the old employer.(fn6) Second, participants may be interested in transferring assets held on their behalf in the old employer's fund.

The ability to transfer service credit may be important for participants in both defined-benefit (fn7) and defined-contribution plans.(fn8) Both types of plans may have "vesting" requirements that provide for all or

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some portion of an employee's pension benefits to be forfeited if she changes jobs too soon. Generally, employees become fully vested only after working five to seven years.(fn9) The ability to transfer service credit would permit more employees to vest and, hence, to receive amounts that would otherwise remain unvested and thus be forfeited. For example, an employee who changed jobs every three years would never vest if all her employers had five-year cliff vesting rules. But if a portability scheme permitted service credit to be transferred, she could vest after two years with her second employer and with every later employer.

The ability to transfer service credit is important in defined-benefit plans even for participants who are vested with the old employer. One of the elements of the formula that defines an employee's pension in a defined-benefit plan is "final salary."(fn10) As long as an employee continues to work for the same employer, this element serves to index the employee's pension to wage inflation. That is, as the employee's wages go up, so does the pension promised to the employee. But, in the absence of portability, when an employee leaves an employer, the final salary element of the pension formula is frozen at the amount of her final salary with that employer. If ten years elapse before she begins to receive the pension, it is quite likely that its value will be considerably diminished because of inflation. On the other hand, if the employee could transfer her years of service to her new employer and insert those years into the new employer's pension formula, the wage-indexing property of the final salary component of the pension formula would continue to work its magic. As will be detailed in a later section, (fn11) this effect of portability-permitting employees to retain wage-indexed pensions-can be quite significant.

Participants may also be interested in the portability of assets held on their behalf by the old employer's fund. Participants may want as-

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sets transferred from the old to the new employer for a number of reasons. For example, the participant may think that the new employer's fund is more stable financially or has better investment advisors; the transfer may permit the participant to buy years of service credit in the new employer's plan; or the transfer may simply make it easier for the participant to keep track of her money by minimizing the number of accounts. As a general matter, in contrast to the portability of service credit, enhanced portability of assets would not be likely to have a significant financial effect. Employees would have greater control over who holds their money, but the amount of money held would be about the same.(fn12)

III. EVALUATING THE COSTS AND BENEFITS OF

ENHANCED PORTABILITY

The portability debate is difficult, in part, because evaluating the costs and benefits of enhanced portability is quite difficult. A number of factors are relevant to the evaluation and not all of them cut in the same direction. Moreover, a number of the factors are quite difficult to assess because their impact depends on unknown information, for example, about how the labor market operates. This section will discuss these difficulties by surveying and assessing the relevant factors and by pointing out where roadblocks to full assessment exist. The section is divided into three major parts: the financial effects of enhanced portability, the labor market effects, and administrative and technical issues.

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A. Financial Effects

1. Sources of Increased Benefits and Costs

As indicated in Section I, enhanced portability of service credit would tend to increase costs and benefits in two primary ways. First, enhanced portability would ease vesting requirements indirectly. Without portability, workers lose their unvested benefits when they change employers. If workers could transfer their service credit to new employers, they could maintain their claim on unvested benefits and eventually work long enough for them to vest. To the extent workers eventually vest in benefits that would otherwise be forfeited, worker benefits have increased. To the same extent, employer costs have increased.(fn13) Without portability, employers never incur the expense of making payments for forfeited unvested benefits...