Transcript Retirement Policy in the 21st Century Jon Forman Alfred P. Murrah Professor of Law University of Oklahoma College of Law OU’s Senior Adult Services “Mornings.

Retirement Policy in the
21st Century
Jon Forman
Alfred P. Murrah Professor of Law
University of Oklahoma College of Law
OU’s Senior Adult Services “Mornings with the
Professor” program
December 9, 2008
available at http://www.law.ou.edu/profs/forman.shtml
Overview
 Retirement Security as a threeLegged Stool
 Social Security
 Private Pensions
 Savings
 Aging of America
 Social Security
 Private Pensions
2
Aging of America
 Americans are living longer but
retiring earlier
 Life expectancy for a male born in
1940 was just 61.4 years
 today it is 73.9 years
 Also, a man reaching age 65 in 1940
could expect to live another 11.9
years
 but a man reaching 65 in the year 2000
could expect to live another 15.9 years
3
Aging of America
 Increasing percentage of Americans
will survive to old age.
 For example, although just 54 percent of
men born in 1875 survived from age 21
to age 65 in 1940
 Almost 83 percent of men born in 1985
are expected to survive from age 21 to
age 65 in 2050
 A graying of America
4
Aging of America
 Trend toward earlier and earlier
retirement
 Average age at which workers begin
receiving their Social Security
retirement benefits fell
 from 68.7 years old in 1940 to 63.6
years old in 2002
 Labor force participation rates for the
elderly have also dropped
5
Labor Force Participation of Men Aged 55 and Older, 1950-2003
100%
90%
80%
Participation Rate
70%
60%
50%
40%
30%
20%
10%
0%
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
Year
Males Age 55-64
Males Age 65 and Older
6
Bureau of Labor Statistics, Labor Force Statistics from the Current Population Survey: Civilian Labor Force Participation Rate (2004),
available at <http://data.bls.gov/labjava/outside.jsp?survey=ln>.
How many people rely on Social
Security for most of their income?
 90% of people 65 and older get
Social Security
 Nearly 2 in 3 (66%) get half or more
of their income from Social Security
 About 1 in 5 (22%) get all their
income from Social Security
7
Most elderly don’t receive pensions
Percent with Employer-Sponsored
Pensions
All age 65+
Couples
Unmarried men
Unmarried women
41%
51%
39%
32%
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Social Security
 How Social Security Works
 Financing Social Security
 How Benefits Are Determined
 Financial Troubles
 How to Fix It
 Raise Taxes
 Cut Benefits
 Increase Investment Returns
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How Many People Get Social
Security?
 49 million people receive Social Security
each month
 1 in 6 Americans get Social Security
benefits
 Nearly 1 in 4 households get income from
Social Security
10
Who Gets Social Security?
30.0 million retired workers
4.8 million widows and widowers
6.2 million disabled workers
0.8 million adults disabled since
childhood
 3.1 million children




11
How Much Does Social Security Pay?
Type of Beneficiary
Average
Monthly
Benefit
All Retired Workers
$1,044
Aged widow(er), non-disabled
$1,008
Disabled worker
$979
Aged couple-both receiving
$1,713
Widowed mother and two children
$2,167
www.ssa.gov/OACT/COLA/colaeffect.html
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Social Security and Poverty
 2007 Poverty Levels
 Single individuals – $10,210 ($851/month)
 Married couples – $13,690 ($1,141/month)
 With Social Security only 9% were poor
 in 2000
 Without it, 48% would have been poor
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Financing Social Security
 Workers and their employers pay with
Social Security taxes
 Workers pay
 6.2% of their earning for Social Security, and
 1.45% of their earnings for Hospital Insurance
under Medicare (Part A)
 Employers pay an equal amount
 The total is 12.4% for Social Security and
2.9% for HI
 Social Security tax base is $97,500 in 2007
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Worker Benefits
 Workers over 62 are eligible
 If they have worked 10 years
 Benefits are based on a workers earnings
history
 Career-average earnings
 Average Indexed Monthly Earnings (AIME)
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Average Indexed Monthly
Earnings (AIME)
 Determine how much the worker earned
every year through age 60
 Determine Benefit Computation Years
 And Earnings in those years
 Index those Earnings for Wage Inflation
 Up to the year the worker turns 60
 Subsequent Work Years Also Count
 Pick the Highest 35 Years
 Drop the rest
16
Average Indexed Monthly
Earnings (AIME), continued
 Add those highest 35 years of
earnings up
 Divide by 35; Divide by 12
 Result is called Average Indexed
Monthly Earnings (AIME)
 AIME is then linked by formula to the
basic retirement benefit
 Result is called Primary Insurance
Amount (PIA)
 Paid at full retirement age
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Full Retirement Age
Year of Birth
1937 or earlier
Full Retirement Age
65
1938 - 1942
plus 2 months per year
1942 – 1954
66
1955 - 1959
plus 2 months per year
1960 and later
http://www.ssa.gov/retire2/retirechart.htm
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18
Primary Insurance Amount
(PIA)
 For a worker turning 62 in 2007,
PIA = 90% of first $680 of AIME
+ 32% of AIME from $680 to $4,110 (if any)
+ 15% of AIME over $4,110 (if any)
 $680 and $4,110 are called bend points
 PIA indexed by cost of living after 62
 Provides higher benefits relative to earnings
for lower paid
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Primary Insurance Amount (PIA) formula
for persons turning age 62 in 2007
$2 ,2 0 0
Primary Insurance Amount
$2 ,0 0 0
Seco nd
Bend Po int
$4 ,110
$1,8 0 0
$1,6 0 0
$1,4 0 0
$1,2 0 0
Firs t
Bend Po int
$6 8 0
PIA
$1,0 0 0
$8 0 0
$6 0 0
$4 0 0
$2 0 0
$0
$0
$1,0 0 0
$2 ,0 0 0
$3 ,0 0 0
$4 ,0 0 0
$5,0 0 0
$6 ,0 0 0
Average Indexed Monthly Earnings
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How do benefits compare to earnings?
Retired worker age 65, 2005
$90,000
$80,000
Past Wages
Benefits
$60,000
$55,400
$40,000
$35,300
35%
$20,000
42%
25%
$22,500
$19,600
$15,800
57%
$14,800
$9,000
$0
"low"
"medium"
Earnings Amount
"high"
"maximum"
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Worker Benefits:
Increases and Decreases
 Indexed for inflation
 Actuarial decrease for early retirement
 Example: average-wage worker, 62 in 2006
 Will get $1,332.80 per month at her full
retirement age of 66
 or $999 per month at 62
 Actuarial increase for later retirement
 8 percent per year
 Retirement Earnings Test
 In 2007, early retirees lose $1 of benefits for
each $2 of earnings over $12,960
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Family Benefits
 Spouses, dependents, and survivors
 Husband or wife gets 50% of worker’s
PIA
 Together, couple gets 150%
 Widow or widower gets 100% of
worker’s PIA
 A joint and two-thirds annuity
 Dual entitlement rule limits benefits
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Estimates for 2006 Finances
Trust Fund income = $745 billion (taxes)
Trust Fund outgo = $555 billion (benefits)
Surplus =
$190 billion
By law, surpluses are invested in U.S.
government securities and earn interest
that goes to the trust funds.
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How do actuaries estimate the
future?
 Review the past: birth rates, death rates,
immigration, employment, wages,
inflation, productivity, interest rates
 Assumptions for the next 75 years
 Three scenarios: Low cost; High cost;
Intermediate (best estimate)
25
Social Security Administration, 2007 Trustees’ Report
26
27
American Academy of Actuaries (2005), available at <http://www.actuary.org/pdf/socialsecurity/medicare_socsec_briefing_april05.pdf>.
The Long-Range Forecast
(Best estimate)
 In 2017, tax revenues into the trust funds
forecasted to be less than benefits due
that year. Interest on the reserves and
the assets themselves will help pay for
benefits until 2041.
 In 2041, reserves are projected to be
depleted. Income is forecast to cover
75% of benefits due then.
 By 2081, assuming no change in taxes,
benefits or forecasts, revenue would cover
70% of benefits due then.
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Social Security’s Financing Problem
 2007 Trustees Report shows
 Expenses will exceed payroll tax income in 2017
 Trust funds will be out of money in 2041
 75-year deficit equals 1.95% of taxable payroll
 Immediate payroll tax increase of 1.95% needed to
restore actuarial balance
 Alternatively, immediate ~12.8% across-the-board
benefit cut
 $4.7 trillion unfunded liability
 About 0.7% as a share of the entire economy (GDP)
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Only 3 Ways to Fix Social Security
 Raise Taxes
 Cut Benefits
 Increase Investment Returns
 Private investment
 Either government or individual
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Options: Raise Taxes
OPTION
 Increase tax rate by
2% total
 Tax all earnings
 Tax 90% of earnings
 Include new state &
local govt. workers
 Tax SS benefits like
pensions
% of Deficit Eliminated
104%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2004).
93%
40%
10%
20%
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Options: Cut Benefits
OPTION
 Raise retirement age
(to 67 faster & index)
 Reduce COLA by ½%
each year
 Cut benefits by 5% for
those starting to get
benefits in 2005
 Increase # years in
wage avg. to 40
% of Deficit Eliminated
28%
41%
32%
21%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).
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Options: Increase Investment
Returns
OPTION
% of Deficit Eliminated
 Investments in equities
36% - 50%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).
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Social Security Game
 American Academy of Actuaries Social
Security reform game,
http://www.actuary.org/socialsecurity
/game.html
 Play the game to explore options for
Social Security reform and their
impact on the program's solvency.
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Two Basic Types of Pensions
 Defined benefit plans
 Defined contribution plans
 Also, hybrid plans
35
What is a Defined Benefit Plan?
 Employer promises employees a
specific benefit at retirement
 To provide that benefit, the employer
makes payments into a trust fund
and makes withdrawals from the trust
fund
 Employer contributions are based on
actuarial valuations
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Defined Benefit Plan
 Employer bears all of the investment
risks and responsibilities
 Typical plan provides each worker
with a specific annual retirement
benefit that is tied to the worker’s
final average pay and number of
years of service
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Defined Benefit Plan
 For example, a plan might provide
that a worker’s annual retirement
benefit is equal to 2% times years of
service, times final average pay
 B = 2% × yos × fap
 Final-average-pay formula
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Defined Benefit Plan
 Worker with 30 years of service
would receive 60 percent of her preretirement earnings
 Worker earning $50,000 would get
$30,000-a-year pension




B = $30,000
= 60% × $50,000
= 60% × fap
= 2 percent × 30 yos × $50,000 fap
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Defined Benefit Plan
Effect of inflation on real value of retirement income
Years in
No
retirement inflation
0
5
10
15
20
25
100
100
100
100
100
100
3% Annual 10%
Inflation
Annual
inflation
100
86
74
64
55
48
100
62
39
24
15
9
40
Only 3 ways to fix an underfunded
Defined Benefit Plan
 Raise Contributions
 Cut Benefits
 Increase Investment Returns
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What is a Defined Contribution
Plan?
 Individual account plan
 Employer typically contributes a
specified percentage of the worker’s
pay to an individual investment
account for the worker
 Owned by employee
 Benefits based on contributions and
investment earnings
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Defined Contribution Plan
 For example, employer might
contribute 10% of annual pay
 Under such a plan, a worker who
earned $30,000 in a given year would
have $3,000 contributed to her
account
 $3,000 = 10% × $30,000
 Benefit at retirement based on
contributions, plus earnings
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Defined Contribution Plan
 Money purchase pension plans
 401(k) and 403(b) plans
 allow workers to choose between
receiving cash currently or deferring
taxation by placing the money in a
retirement account
 Profit-sharing plans & stock bonus
plans
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What is a Hybrid Plan?
 “Hybrid” plans mix features of defined
benefit and defined contribution plans
 For example, a cash balance plan is a
defined benefit plan that looks like a
defined contribution plan
 Another common approach is to offer a
combination of defined benefit and
defined contribution plans
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Goals for a Pension Plan
 First, ensure that every employee
earns a meaningful retirement benefit
 and that long-time employees are
guaranteed an adequate income
throughout their retirement years
 Second, have a minimum of work
disincentives for employees coming in
and out of service
 Third, be affordable and well-financed
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Long-term Reform
 Retirement system should ensure
that every elderly American has an
adequate retirement income
 Redesign the current system
 Two-tier system
 First tier: poverty-level benefit
 Second tier: earnings-related benefit
 Earnings sharing
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First Tier: Basic Benefit
 Government guarantee of poverty-level
income
 2007 Poverty Levels
 Single individuals – $10,210 ($851/month)
 Married couples – $13,690 ($1,141/month)
 Would replace SSI and redistribution
within the current SS system
 Pay for with general revenues
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Second Tier: Earnings-related
Benefit
 Individual accounts
 Hypothetical (“cash balance”) accounts
 Invested by professionals
 Pay for with reduced payroll taxes
 Pay out lifetime annuities
 Inflation-adjusted annuities
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Earnings Sharing
 Credit each spouse with one-half of
couple’s combined earnings during
marriage
 At retirement, each spouse’s benefit
would be based on her half of the
couple’s earnings, plus her prior
earnings
 Would replace spousal benefits
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Conclusions
 Social Security has a $4.7 Trillion
Unfunded Liability
 Oldest baby-boomers are 60
 Only half of the elderly have pensions
 Reforms are needed
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Select Sources
 American Academy of Actuaries, Social Security Reform:
Solutions Inside the Box: Proposals Not Including Individual
Accounts (2004), available at
http://www.actuary.org/pdf/socialsecurity/briefing_041604.p
df.
 Jon Forman, Making America Work (Washington, DC: Urban
Institute Press, 2006). See
http://www.urban.org/books/makingamericawork/index.cfm.
 National Academy of Social Insurance, Options to Balance
Social Security Over the Next 25 Years (Social Security Brief
No. 18, February 2005), available at
http://www.nasi.org/usr_doc/SS_Brief_18.pdf.
 Social Security and Medicare Boards of Trustees, 2007 Annual
Report of the Board of Trustees of the Federal Old-Age and
Survivors Insurance and Disability Insurance Trust Funds
(2007), available at http://ssa.gov/OACT/TR/TR07/tr07.pdf.
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About the Author
 Jonathan Barry Forman (“Jon”) is the Alfred P.
Murrah Professor of Law at the University of Oklahoma
College of Law, where he teaches courses on tax,
pension, and elder law.
 Professor Forman is also Vice Chair of the Board of
Trustees of the Oklahoma Public Employees Retirement
System (OPERS) and the author of Making America Work
(Washington, DC: Urban Institute Press, 2006).
 Prior to entering academia, Professor Forman served in
all three branches of the federal government. He has a
law degree from the University of Michigan, and he also
has master’s degrees in economics and psychology.
 Jon can be reached at [email protected] or (405) 3254779. His web page is
www.law.ou.edu/faculty/forman.shtml.
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