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The Cost of 'Choice' in a Voluntary Pension System

2013 New York University Review of Employee Benefits and Executive Compensation 6-1 to 6-55

56 Pages Posted: 21 Nov 2013  

Jonathan Barry Forman

University of Oklahoma College of Law

George A. (Sandy) Mackenzie


Date Written: November 7, 2013


The United States and most other industrialized nations have multi-pillar retirement systems that fit within the World Bank’s multi-pillar model for retirement savings consisting of a first-tier public system, a second-tier employment-based pension system, and a third-tier of supplemental voluntary savings. While in many countries, the second-tier occupational pension is mandatory or quasi-mandatory, in the United States, both the second and third-tier retirement savings systems are voluntary. That is, employers are not required to offer pensions, and when they do, they have considerable choice over the type of pension plan to have and over many of that plan’s features. Moreover, when employers do offer a pension plan, it is probably a 401(k)-type plan that offers employees considerable choice about whether to participate, about how much to contribute, about how to invest those contributions (and prior accumulations), and about the timing and nature of distributions. In short, unlike our first-tier, mandatory Social Security system, America’s second-tier, private pension system is replete with choice: choices about the type of pension plan, choices about the amount and timing of contributions, choices about investments, and choices about the timing and nature of distributions.

To be sure, the availability of pension choices may be of value to employers and individuals, but, on the whole, the costs of choice almost certainly exceed the benefits. Pertinent here, one of the major problems with the current pension system is its incredible complexity. That complexity imposes significant costs on individuals, employers, and government, especially when compared to the relatively rigid, but straightforward, Social Security system. As more fully discussed below, the administrative costs for Social Security’s retirement system are well under 1% of benefits paid. Meanwhile, other than the cost for a payroll withholding service, employers incur almost no costs because of Social Security; and almost the only choice that workers face is the choice about when to take their benefits, at which point in time, a costless and simple application leads to a lifetime of inflation-adjusted retirement income.

On the other hand, employers, individuals, and government all incur significant costs in connection with the current pension system. Employers incur significant costs in choosing, designing, administering, or even outsourcing their pensions; individuals incur significant costs in connection with the management, investment, and distribution of their contributions and benefits; and the government incurs significant costs in regulating thousands of disparate pension plans and millions of Individual Retirement Accounts (IRAs). Also, because of the voluntary nature of our second-tier, private pension system, coverage and participation rates are low, and retirement savings may be inadequate for many retirees.

All in all, this Article focuses on the costs of choice in America’s voluntary private pension system. At the outset, Part II of this Article provides an overview of the current U.S. retirement system — both Social Security and private pensions. Next, Part III of this Article looks at the costs associated with the current Social Security and private pension systems. Finally, Part IV of this Article outlines some ways to reduce the costs associated with the private pension system. In particular, Part IV discusses how to reduce costs by moving to a universal, second-tier pension system; and Part IV also discusses some more modest approaches for reducing the costs associated with the current private pension system.

Keywords: pensions, Social Security, retirement, pension investments, choice

JEL Classification: G23, H55, J11, J26

Suggested Citation

Forman, Jonathan Barry and Mackenzie, George A. (Sandy), The Cost of 'Choice' in a Voluntary Pension System (November 7, 2013). 2013 New York University Review of Employee Benefits and Executive Compensation 6-1 to 6-55. Available at SSRN:

Jonathan Barry Forman (Contact Author)

University of Oklahoma College of Law ( email )

300 Timberdell Road
Norman, OK 73019
United States
405-325-4779 (Phone)
405-325-0389 (Fax)


George A. (Sandy) Mackenzie

Independent ( email )

No Address Available

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