About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline
LOG IN
LOG IN

How Pension Financing Affects Returns to Different Generations 1 (September 2004)

handle is hein.congrec/cbo10173 and id is 1 raw text is: A series ofissue summaries from the Congressional Budget Office No. 12, SEPTEMBER 22, 2004 How Pension Financing Affects Returns to Different Generations A pension system designed to be self-sustaining can be financed in two basic ways: on a funded or on a pay- as-you-go basis. In a funded system, contributions are used to purchase assets, which are saved to pay for future benefits. (In the United States, private pension plans are required by law to be funded.) By contrast, in a pay-as- you-go system, such as Social Security,1 contributions by workers go directly to pay benefits to retirees. A pay-as- you-go pension system can provide higher returns than a funded system to particular generations who retire rela- tively soon after the system is implemented or benefits are increased, but a funded system provides higher returns in the long run. However, moving a pension system from a pay-as-you-go to a funded basis would impose a burden on some generations. In either type of pension system, over time the total amount of contributions must equal the total amount of benefits in present value.2 If, on average, some genera- tions receive more than they contributed, then some other generations must get less in benefits than they paid into the system. This brief examines how funded and pay-as-you-go systems have different effects on the rela- tive financial returns that different generations receive. The analysis in this brief focuses on broad, general attri- butes of pension systems. It examines the average benefits received and taxes paid by different generations, rather than the benefits and taxes of particular members of those 1. In a pure pay-as-you-go system, revenues exactly equal outlays in each year. Social Security is not a pure pay-as-you-go system; its revenues (excluding interest on the balances in the two Social Security trust funds) currently exceed outlays by about 14 percent. That excess of revenues over outlays is temporary; beyond 2018, revenues are projected to fall short of outlays by increasing amounts. See Congressional Budget Office, The Outlook for Social Security (June 2004). 2. Present value adjusts for the fact that money is more valuable the earlier it is received because it can be invested and earn interest. generations. The brief does not address issues of imple- mentation.3 Returns in Funded and Pay-As-You-Go Systems In a funded system, contributions are used to purchase assets that finance benefits upon retirement. The average rate of return that participants receive on their contribu- tions in a funded system is the average rate of return on those assets. That is equivalent to the rate people could earn if they saved the money themselves rather than con- tributing it to the system. Therefore, in general, a funded system does not affect the average financial resources available to any generation.4 By contrast, in a pay-as-you-go system, the average rate of return-and therefore the effect of the system on genera- tions' financial resources-can differ widely for different generations depending on whether they face stable or changing tax and benefit rates.5 First, consider the people who participate in a system with constant tax and benefit rates over their whole lives. For them, the sustainable av- erage implicit return is limited to the growth rate of the 3. See, for example, Congressional Budget Office, Acquiring Finan- cial Assets to Fund Future Entitlements, Long-Range Fiscal Policy Brief No. 8 (June 16, 2003). 4. Differences in the tax treatment of individual savings versus pen- sion contributions can create an apparent financial advantage for participants in a funded system. However, some generation must finance the tax advantage; to the extent it is financed by the same generation that receives it, there is no net gain. Differences in the cost of managing group as opposed to individual savings could lead to modest differences in returns. 5. In a pay-as-you-go system, the rate of return is not explicit. An implicit rate of return on contributions can be calculated for each generation on average. That implicit rate is the rate of return a generation's contributions would need to earn to exactly finance its pension benefits.

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Short-term subscription options include 24 hours, 48 hours, or 1 week to HeinOnline.

Purchase Access

Contact us for annual subscription options:

Contact Us

Already a HeinOnline Subscriber?

Log In

profiles profiles most