Today's pension plans: how much do they pay

Monthly Labor Review, Dec, 1985 by Donald G. Schmitt

Table 3 presents the monthly pension payments shown in table 1 (annualized) as percentages of earnings in the final year of work. These replacement rates rise substantially as service increases from 10 to 40 years. At the $30,000 level of earnings, for example, the average replacement rate for all pension plan participants increases from 18.5 percent at 20 years of service to 26.5 percent at 30 years and 32.6 percent at 40 years.

Replacement rates for the overall group, however tend to decrease as earnings levels increase within each service category. This results primarily from plus for production workers. While white-collar workers experience slight increases in average replacement rates as earnings rise above $20,000, production workers experience a marked decline. As indicated earlier, the explanation for this difference lies in the relatively greater incidence of earnings-based benefit formulas among white-collar workers.

As shown in table 4, earnings-based formulas tend to yield higher replacement rates as final earnings rise. Dollar-amount formulas (commonly providing benefits independent of earnings produce the opposite result. In fact, dollar-amount formulas produced the highest replacement rates for final earnings of $15,000--the lowest level used in this analysis.

Earnings-based private pensions commonly are integrated with Social Security benefits. This explains the tendency for greater replacement rates at higher earnings levels under these private formulas. The Social Security benefit formula yields pensions that, as a percent of preretirement earnings, are greater for retirees with relatively low earnings histories, and it takes account only of earnings up to the Social Security taxable wage base--$37,800 in 1984. Integrated private pension plans counter this by providing higher replacement rates as earning rise. Dollar-amount pension formulas, however, are rarely integrated with Social Security benefits.

Social Security as a component

Private pension plans do not operate independently. They supply retirement income as part of a "three-legged stool," which also inlcudes Social Security and individual savings. Replacement rates, consequently, become more meaningful when Social Secuirty benefits are added to the computation.

The Office of the Actuary, Social Security Administration, determined the benefit amounts that would be applicable for workers with the earnings histories used in this study. These Social Security benefits were added to the private pension benefits presented in table 1, and new replacement rates were determined using the combination of these two sources of retirement income.

Table 5 shows average replacement rates of combined private pension and Social Security retirement income for a single worker (one who is not receiving spousal benefits under Social Security). The inclusion of Social Security retirement benefits raises the rates significantly from those in table 3. Except at the higher earnings and service levels. Social Security benefits provide the major share of total retirement income.