How Will the Rise in 401(k) Plans Affect Bequests?

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This project explores how the shift from defined benefit to defined contribution pension plans might affect bequests and thereby consumption and saving. Bequests can occur under two different types of circumstances: (1)individuals plan to leave an inheritance for their heirs (an intended bequest); or (2) individuals have no specific inheritance plans, but die before consuming all of their assets (an unintended bequest). This brief concludes that both types of bequests will increase as retirees receive more of their pension benefits as lump–sum amounts rather than as annuity payments, which provide a lifetime stream of income.

A key reason underlying the likely increase in bequests is that many people are reluctant to spend accumulated wealth. This reluctance is evident in four different ways: (1) the small size of the U.S. annuity market; (2) the aversion of older homeowners to reverse mortgages; (3) the holdings of life insurance by retirees; and (4) the limited dissaving in retirement. In the past, any reluctance to turn assets into income streams was mitigated by the fact that most retirement wealth – Social Security and private pensions – came in the form of annuity payments. Today, the story is different because more and more private sector pension plans provide lump–sum benefits.

The effect of pensions on bequests is potentially large and significant. First, in 1998, bequeathable wealth in the hands of decedents was $15 billion (3.2 percent) higher as a result of the increase in defined contribution plans as a share of pension wealth between 1992 and 1998. Thus, the shift in pension form has already significantly increased the potential for unintended bequests, and the transition to defined contribution plans was far from complete in 1998. Second, interest in leaving a bequest is greater among individuals who receive a larger proportion of their pension wealth as lump sums rather than annuities. The likely rationale is that individuals find it easier to accumulate wealth for a bequest from a pile of assets rather than from saving out of current income. Thus, it appears that lump–sum payments affect intended as well as unintended bequests. Third, workers react very differently to their defined contribution accumulations than they do to the present value of annuity pensions. They do not reduce their other saving in anticipation of payments from defined contribution plans as they do in response to promised Social Security and defined benefit pension payments. Finally, the most significant increase in lump–sum pension accumulations occurs in the middle and lower portions of the wealth distribution, so that the increase in bequests should help to reduce wealth inequality.