Compensation and Working Conditions Winter 2000 31

Participation in Retirement Plans Participation in Retirement Plans

SHARON A. DEVANEY

YI-WEN CHIEN

Participation in Participation in

Retirement Plans: ement Plans: ement Plans: A

Comparison of the Comparison of the Comparison of the

Self-employed and Self-employed and Self-employed and Wage

and Salar and Salar and Salary Workers

Sharon A. DeVaney is an associate professor

and Yi-Wen Chien is a doctoral candidate in

in the Department of Consumer Sciences and

Retailing at Purdue University. The authors’

views are their own and do not necessarily

reflect those of the Bureau of Labor Statistics or the U.S. Department of Labor.

Telephone: DeVaney (765) 494-8300

Chien (765) 449-4858

E-mail: sdevaney@purdue.edu

yc2m@omni.cc.purdue.edu

What factors influence worker participation in retirement

plans? Recent data suggest that this decision is made

differently by the self-employed and wage earners.

The decision to participate in a

retirement plan is likely to be

jointly determined1 when workers select between self-employment

and a wage-earning occupation. Bivariate probit regression with data from the

1995 Survey of Consumer Finances was

used to model two dichotomous decisions: Employment status and retirement plan participation. Some of the

determinants of retirement plan participation were similar for the self-employed and wage earners. Those factors were: Income, a graduate

education, race, and the belief that past

income had increased more than prices

had. In addition, being older, having

some college or a bachelor’s degree,

working full time, and being employed

with a larger firm were determinants of

plan participation for wage earners. The

negative sign of the selection factor for

self-employment means that unobserved factors influencing the decision

to be self-employed are likely to decrease participation in retirement plans

for the self-employed. Hence, more information is needed to understand how

the self-employed plan for retirement.

Recent data show that 79 percent of

full-time employees in medium and

large companies participated in one or

more employment-based retirement

plans in 1997.2 This figure is almost

unchanged since its level of 78 percent

in 1991. One-half (50 percent) of all fulltime employees were enrolled in defined

benefit plans in 1997 (down from 59

percent in 1991) and 57 percent were

enrolled in defined contribution plans

(up from 48 percent in 1991). (Some

employees were enrolled in both types

of plans.) In contrast, retirement plan

participation was lower among employees of small employers. In 1996, data

from the Bureau of Labor Statistics

(BLS) Employee Benefits Survey

showed that only 46 percent of full-time

workers in small private establishments

were covered by a retirement plan. Of

these, 15 percent participated in a defined benefit plan, and 38 percent participated in a defined contribution plan.

Although there is much research on

retirement planning and also on selfemployment, there is a lack of research

linking self-employment and retirement

planning. One expert suggests that the

decision to participate in a retirement

plan is likely to be jointly determined

when workers, aware that they are more

likely to be eligible for benefits when
32 Compensation and Working Conditions Winter 2000

they work for someone else, select between wage-earning occupations and

self-employment.3 Another concern is

that some research on retirement planning excludes the self-employed, either

because there is a lack of information

about self-employment, or because of

the lack of comparability of the information.4

This study examines the link between retirement plan participation and

employment status because, among

other reasons, there are few studies linking these two variables. Workers need

to prepare financially for retirement, and

most make informed decisions about

retirement plan participation when they

choose a wage-earning occupation or

self-employment.

Self-employment

At least 8 percent of the work force is

self-employed, although this statistic

reflects a narrow measure of self-employment.5 Self-employed workers are

defined as those who rely on their businesses for their primary source of income. Secondary job holders, who

work for wages in one job and have

their own unincorporated business, as

well as owners of incorporated businesses, whose primary compensation

is a wage or salary, are not included in

the official count of the self-employed.

Several theories for choosing selfemployment exist. These include the

“engineer of creative destruction,”6 the

“achievement motivation,”7 the “internal versus external locus of control,”8

“risk,”9 and “self-esteem”10 theories.

In a recent study, “the utility derived

from earnings, independence or unemployment”11 was considered the most

likely determinant of self-employment.

In a study that permitted open-ended

responses to a question about choosing self-employment or wage work,

“economic opportunity, authority, autonomy, challenge, self-realization, and

participation in the whole process”

were identified by participants as the

most important determinants of selfemployment.12 In other studies, “marital status, family responsibilities, and

flexible working hours” were also related to choosing self-employment.13

Although several theories for choosing self-employment have been advanced, demographic and human capital factors are primarily used as

predictors of self-employment, and the

statistical method employed for prediction of self-employment tends to be either logit or probit regression.14 Based

on previous work, the model for selecting self-employment or wage earning

in this study consists of demographic

and human capital factors. The statistical technique selected was bivariate

probit regression, which will be described in the methods section.

Keogh plans and Individual Retirement Accounts

To meet the needs of self-employed

workers and those who are not covered by employer-sponsored retirement

plans, Keogh plans and Individual Retirement Accounts (IRAs) provide an

alternative.15 Contributions made by

self-employed individuals to Keogh

plans are not currently taxable. The

contributions and any earnings therefrom accumulate tax free until distribution, at which time they are subject to

normal income taxes.

IRAs were originally developed as

a tax-deferred savings plan for workers

without employer pensions. Although

the amount of the annual contribution

per eligible worker has remained at

$2,000 since 1974, IRAs offer advantages to workers, especially those who

are highly mobile. In the early- to mid1980s, growth in IRAs was attributed

to tax deferral on IRA contributions.16

More recently, stock market gains, not

tax deferrals, have been the primary

source of growth in IRAs.17

Employer-sponsored retirement

plans

Employer-sponsored retirement plans

are categorized as two types: Defined

benefit or defined contribution. Defined benefit plans specify a formula

for determining future benefits, while

defined contribution plans specify employer and employee contributions, but

do not guarantee future benefits.18

Defined contribution plans are also

known as 401(k) plans, although the

401(k) is only one of many types of

defined contribution plans.

According to a recent study by a

large investment firm of the retirement

plans it services, the average 401(k) plan

worker participation rate is 75 percent.19

Even though smaller firms are less likely

than larger firms to sponsor a plan,

smaller firms tend to experience higher

participation rates when they offer

401(k) plans. The average participation rate was 84 percent for plans with

less than 50 participants, and 64 percent for plans with 10,000 or more participants. Participation rates tend to

increase with employee age and earnings. Nonparticipants are more likely

to have lower incomes, less education,

to be male, younger, unmarried, and

blue-collar workers.

Method

Empirical model Empirical model. Because the study

investigated two dichotomous decisions that are likely to be jointly determined, bivariate probit regression with

the statistical package LIMDEP was

used.20 The justification for using the

bivariate probit model was to examine

whether there were any unobserved

factors that influenced both the decision about employment status and the

decision about whether to participate

in a retirement plan. If the correlation

of disturbances, or rho, between the

two models was positive and significant, it meant that there was positive

self-selection—that is, the unobserved

factors that influence the decision to

be either self-employed or a wageearner were also likely to increase participation in retirement plans. If the

correlation was negative and significant, it meant that there was negative

self-selection—that is, the unobserved

factors that influence the decision to

be either self-employed or a wageearner were also likely to decrease participation in retirement plans.

The study hypothesized that demographic and human capital factors were

important determinants in selecting

self-employment; but additional factors, such as employment variables,

attitudes about risk in making savings
 Compensation and Working Conditions Winter 2000 33

Participation in Retirement Plans Participation in Retirement Plans

and investment decisions, and expectations about future income, were included in the model of retirement plan

participation.

The equations for the self-employment model were:

Self-employment =

f (Demographics, Human Capital)

Retirement Plan Participation =

f (Demographics, Human Capital,

Employment, Expectations)

The equations for the wage-earner

model were:

Wage-earner =

f (Demographics, Human Capital)

Retirement Plan Participation =

f (Demographics, Human Capital,

Employment, Expectations)

Based on human capital theory and

previous studies, older workers, maleheaded households, professionals, and

those with more education and work

experience were hypothesized to be

more likely than other groups to choose

self-employment.21 It was hypothesized that younger workers with less

education and work experience would

be more likely than other workers to

choose wage-earning occupations.

Participation in retirement plans was

hypothesized to be positively related

to age and income. Also, males, professionals, and white people were believed to be more likely than females,

nonprofessionals and nonwhites to

participate in retirement plans. Those

who work full time and for larger firms

were expected to be more likely to participate in retirement plans than were

part-time workers and those in smaller

firms.

The expectation factors included in

the study were the relationship between prices and past and future income; having an idea about next year’s

income; and risk tolerance. At least

one study has shown that self-employed workers were risk-seeking,22

while another study showed low reliability for the risk tolerance variable.23

Hence, self-employed workers might

prefer to invest in their business instead of putting money into retirement

plans, a decision suggesting that they

were risk tolerant, while those who were

risk averse might be more likely to participate in retirement plans.

Holding the belief that past income

had increased more than prices had

could mean that workers would be more

willing to participate in retirement plans,

because they now have more income

than expected. Also, they may be more

willing to participate in retirement plans

if future income was expected to go up

more than prices would, because this

would create a surplus. However, wage

earners must decide the amount of their

contribution to defined contribution

plans before the contributions are withdrawn, and they would not have information in advance about future prices.

Those who have a good idea about

next year’s income may be more likely

to plan for retirement. However, selfemployed workers may choose to invest more in their business if they expect income to go up.

Data and sample. Data were drawn

from the 1995 Survey of Consumer Finances (SCF), which is sponsored by

the Federal Reserve Board, with the

cooperation of the Department of the

Treasury.24 The purpose of the survey is to provide comprehensive information on the financial characteristics

of U.S. households. A multiple imputation technique was used to handle

missing data. The 1995 SCF contains

five implicates, meaning that five values were known or imputed for each

variable. To simplify the analysis, only

the first implicate was used in this

study. Descriptive statistics were

weighted to represent the full population of the United States. Among the

4,299 households in the 1995 SCF, 1,046

household heads identified themselves

as being self-employed, and 2,317

household heads said that they worked

for someone else—that is, they were

wage earners.

Dependent variables. The first probit

regression modeled the choice of employment status. The dependent variable was dichotomous, with 1 equal to

self-employment and 0 equal to “other,”

or, for the wage-earner equation, 1

equal to wage earner and 0 to “other.”

For the second probit regression, the

dependent variable was assigned a 1

for those who had at least one retirement plan (such as an IRA or Keogh

plan, defined benefit plan or defined

contribution plan, or both defined benefit and defined contribution plans)

and 0 for those who had no retirement

plan. This definition of participation

was based on the descriptive statistics

that showed both that a few self-employed workers had employer plans in

addition to IRAs and Keoghs, and that

some wage earners had IRA accounts

and Keogh plans in addition to employer plans.

Independent variables. The independent variables included: Age, gender

of the household head, professional or

managerial status, education, work experience, race, income, size of firm, fulltime status, hours worked per week, risk

tolerance, and expectation factors. The

last variables, in turn, included belief

about past income in relationship to

prices; expectation about future income

in relationship to prices; and having a

good idea about what next year’s income would be. Because bivariate

probit regression is sensitive to variables of highly different magnitudes,

the natural log of income was used.

Coding of the independent variables

and the characteristics of wage earners and the self-employed are shown

in table 1.

Results

Characteristics of workers. The characteristics of self-employed workers

and wage earners were examined using

t-tests and chi-square analysis. For the

chi-square analysis, all of the p-values

were less than 0.001. For the t-tests, all

of the p-values were less than 0.001

except for household size, which was

0.7494, indicating no statistical difference between the size of households.

The following differences were revealed: The self-employed were more
34 Compensation and Working Conditions Winter 2000

likely than wage earners to be white,

older, and have higher incomes; households of self-employed workers were

more likely than wage-earner households to be headed by a man, a person

with a graduate degree, or a person who

has a professional or managerial occupation. The self-employed spent more

years in full-time work since age 18,

worked more hours per week, and were

more likely both to expect future income

to go up more than prices would, and

to say that they would take a substantial amount of risk when making saving

and investing decisions. Wage earners were more likely than self-employed

workers to work in a larger firm, to work

full time, and to have a good idea about

next year’s income. (See table 1.)

Determinants of occupational status Determinants of occupational status.

The parameter estimates of the probit

models for predicting either self-employment or wage-earner status are presented in table 2. Older workers, workers in male-headed households, those

with a college education (compared with

those with 12 years or less of education), and those with more work experience were more likely to select selfemployment. Workers who selected

wage-earner status were younger and

more likely to be female and, the more

years worked, the more likely they were

to be a wage earner.

Determinants of participation in re- Determinants of participation in retirement plans. Table 3 presents the

results of the second probit model to

predict participation in plans. Five factors were significant in the self-employment model, while nine factors were significant in the wage-earner model. The

significance of rho was considered to

evaluate the presence of self-selection.

In the self-employment model, rho was

significant and negative, meaning that

unobserved factors influencing the

decision to be self-employed were likely

to decrease participation in retirement

plans. In the wage-earner model, rho

was negative, but not significant. This

suggests that the factors that predict

being a wage earner were not related to

participation in retirement plans.

For the self-employed, those who

were white, received higher incomes,

and had a graduate degree were more

TABLE 1. Coding of independent variables and characteristics of wage earners and the self-employed in the 1995 Survey of

Consumer Finances

Age of household head ........................................................ Continuous 48 – 41 –

Gender of household head is male ..................................... 1 = yes, 0 = no – 87.07 – 76.57

Head is professional or managerial ..................................... 1 = yes, 0 = no – 42.44 – 26.51

Head has 12 years of education or less ............................. 1 = yes, 0 = no – 37.82 – 43.95

13 to 16 years of education ................................................. 1 = yes, 0 = no – 41.66 – 44.32

17 or more years of education... ......................................... 1 = yes, 0 = no – 20.52 – 11.73

Years worked full time since age 18 .................................... Continuous 18.17 – 17.26 –

Household income ............................................................... Continuous $79,720 – $47,138 –

Race of household head is white......................................... 1=yes, 0 = no – 85.36 – 76.82

Household size (number of persons) ................................. Continuous 2.79 – 2.82 –

Size of firm (employment size) ............................................ Continuous 1.40 – 3.89 –

Full-time worker ................................................................... 1 = yes, 0 = no – 78.81 – 89.95

Hours worked per week...... ............................................... Continuous 45.68 – 43.25 –

Belief that past income increased more

 than prices did .................................................................... 1 = yes, 0 = no – 20.39 – 20.21

Expect future income to increase more

 than prices will .................................................................... 1 = yes, 0 = no – 26.63 – 22.60

Have a good idea what next year’s income will be ............. 1 = yes, 0 = no – 53.46 – 67.32

Willing to take substantial or above-average risk ............... 1 = yes, 0 = no – 25.68 – 19.91

Self-employed

(n = 1,046)

Mean

Wage earners

(n = 2,317)

Percentage Mean Percentage

Variable Coding

TABLE 2. Results of bivariate probit regression for determinants of self-employed or wage-earner status

Age of household head ....................................... 0.0080 (1) -0.0518 (1)

Gender of household head is male .................... .6787 (1) -.2344 (1)

Professional or managerial ................................. .6134 (1) .0003 0.9959

13 to 16 years of education ................................ .2096 (1) -.0240 .6466

17 or more years of education ........................... .3418 (1) -.1252 .0642

Years worked full time since 18 .......................... .0238 (1) .0291 (1)

 1 P-value is less than or equal to 0.001.

Self-employed (n = 4,256) Wage earner (n = 4,256)

Variable Parameter

estimate P-value Parameter

estimate

P-value
 Compensation and Working Conditions Winter 2000 35

Participation in Retirement Plans Participation in Retirement Plans

likely to participate in retirement plans

than were nonwhites or those who had

a high school education or less. Those

who thought that past income had

gone up more than prices had were more

likely to be plan participants. Compared

with those who expected that future

income would increase less than prices

would, those who expected income increases to be greater than price increases were less likely to participate

in a retirement plan. This suggests that

the self-employed are not willing to

commit to retirement plan participation

until income is known.

For wage earners, whites and those

with higher incomes were more likely

to be plan participants. Compared with

those with less education, those with

some college or a degree were more

likely to be plan participants. Full-time

workers and those who were employed

by larger firms were more likely to be

retirement plan participants. When

wage earners believed that past income

had gone up more than prices had, plan

participation for them was more likely

to occur. Contributions to IRAs can

be made until April 15 of the year following the year in which income was

earned. This may be the retirement savings method that both types of workers were using to take advantage of an

increase in past income in relationship

to prices. Wage earners who had a

good idea about next year’s income

were more likely to be plan participants.

Conclusions

This study attempted to link retirement

plan participation and employment status. Some of the determinants of plan

participation were comparable for wage

earners and the self-employed. Those

determinants were higher income, a

graduate education, being white, and

the belief that past income had increased more than prices had. The only

additional factor predicting plan participation for the self-employed was

their expectation that future income

would increase more than prices would.

However, for wage earners, being older,

having some college education or a

baccalaureate degree, working full time

and for a larger firm, and having a good

idea of next year’s income predicted

participation in a retirement plan.

Although these results were consistent with the hypotheses, the study

raised a question. Because rho was

negative for the self-employed, this

was an indication that unobserved factors that influence the decision to be

self-employed are likely to decrease

participation in plans. It is possible

that the study did not include all of

the factors that explain the future plans

of the self-employed. For example, selfemployed workers may be planning for

retirement through investments in their

business. Another possibility is that

retirement is viewed differently by the

self-employed. They may intend to

work indefinitely and consequently

may have delayed participation in retirement plans. These ideas could be

explored in future studies. Also, the

definition used for retirement plan participation was designed to be as inclusive as possible, but it could be more

appropriate to ask, “If you are preparing financially for retirement, what

methods are you using?”

Small employers who do not offer

retirement plans explain that they have

lower revenues and/or employees who

are younger, earning lower salaries,

with less formal education, and who

have the tendency to work short-term.25

Perhaps small employers would benefit from learning more about ways to

reduce turnover, increase profitability,

and reduce taxes.

The results of the study support the

TABLE 3. Results of bivariate probit regression for determinants of participation in retirement plans by wage

earners and the self-employed

Age of household head .......................................................... -0.0057 0.1369 0.0164 (1)

Gender of household head is male ....................................... -.2037 .2322 -.1002 0.2649

Professional or managerial .................................................... -.1795 .0623 .1407 .0880

13 to 16 years of education ................................................... .0072 .9397 .2875 (1)

17 or more years of education .............................................. .3432 (2) .3257 (2)

LN household income ............................................................ .1226 (1) .3007 (1)

Race of household head is white........................................... .2652 (3) .1849 (3)

Household size ...................................................................... -.0164 .5520 .0184 .4598

Size of firm .............................................................................. .1063E04 .9997 .2565 (1)

Full-time worker ..................................................................... -.1226 .3764 .6664 (1)

Hours per week ..................................................................... .0009 .6617 .0035 .2844

Belief that past income increased more than prices did ....... .1749 (3) .1793 (3)

Expect future income to increase more than prices will ....... -.1743 (3) -.1408 .0990

Have a good idea what next year’s income will be ............... .1358 .0661 .1934 (2)

High risk tolerance ................................................................. .0987 .2116 .1271 .1266

Rho ......................................................................................... -.8157 (1) -.1882 .3651

Log likelihood .......................................................................... -2404.35 – -3225.02 –

 1 P-value is less than or equal to 0.001. 2 P-value is less than or equal to 0.01. 3 P-value is less than or equal to 0.05.

Self-employed (n = 1,026) Wage earner (n = 2,128)

Parameter

estimate P-value Parameter

estimate

Variable

P-value
36 Compensation and Working Conditions Winter 2000

hypotheses about which wage earners

are not participating in retirement plans.

They include younger workers, nonwhites, those with lower incomes and

less education, part-time workers, and

those who work in smaller firms. These

ACKNOWLEDGMENT: This research

was supported by a grant from the AARP

Andrus Foundation. 1

 “Jointly determined” means that when

a person chooses to be self-employed, that

person is making an implicit decision about

the importance of employee benefits. 2 Employee Benefits in Medium and

Large Private Establishments, 1997, Bulletin 2517 (Bureau of Labor Statistics, September 1999). 3

 John Turner, “An Economic Analysis

of Pensions in the Workplace,” presentation

at the Bureau of Labor Statistics in Washington, Oct. 14, 1999. At the time of the presentation, Turner was an economist with the

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 Marjorie Honig, “Retirement Expectations: Differences by Race, Ethnicity, and

Gender,” The Gerontologist, June 1996, pp.

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 G. T. Silvestri, “Considering self-employment: What to think about before starting a business,” Occupational Outlook Quarterly, Summer 1999, pp. 15-23.

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George Eddy, “Entrepreneurship: Research

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retirement plans because they haven’t

worked long enough, or they may be

eligible but not participating. They may

be employed at a firm that does not provide a retirement plan of any type. Perhaps, if the nonparticipating workers

were able to increase their education

and skills, they could acquire a job that

included pension coverage. Also, employers may need to increase their efforts to improve participation rates.

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