1

A Primer on U.S. Pension Systems

S. Ghon Rhee, K. J. Luke Distinguished Professor S. Ghon Rhee, K. J. Luke Distinguished Professor of International Finance and Bankingof International Finance and Banking

University of Hawai’iUniversity of Hawai’i

The 6The 6thth International Financial Forum International Financial Forum April 27-28, 2005, Seoul, KoreaApril 27-28, 2005, Seoul, Korea

Asia-Pacific Financial Markets Research Center, University of Hawaii

2

US Retirement Pension and Security Systems: Three-Legged Stool

Retirees generally rely on three sources of Retirees generally rely on three sources of income for retirement:income for retirement:

Source: Source: U.S. Social Security Administration, U.S. Social Security Administration, Facts and Figures about Social Facts and Figures about Social Security Security

(August 2004)(August 2004)

Retirement Plans19%

Personal Savings

43%

Social Security38%

Asia-Pacific Financial Markets Research Center, University of Hawaii

3

The U.S. Social Security System:

A “Pay-As-You Go” Basis Social security taxes [or known as FICA (Federal Insurance Contributions Act) taxes] are collected and divided among four Trust Social security taxes [or known as FICA (Federal Insurance Contributions Act) taxes] are collected and divided among four Trust Funds:Funds:

The federal OASI (Old-Age and Survivors Insurance) Trust Fund:The federal OASI (Old-Age and Survivors Insurance) Trust Fund: 5.3% of FICA tax5.3% of FICA tax The federal DI (Disability Insurance) Trust Fund:The federal DI (Disability Insurance) Trust Fund:

0.9% of FICA tax0.9% of FICA tax The federal HI (Hospital Insurance) Trust Fund:The federal HI (Hospital Insurance) Trust Fund:

1.45% of FICA tax 1.45% of FICA tax The federal SMI (Supplementary Medical Insurance) Trust Fund:The federal SMI (Supplementary Medical Insurance) Trust Fund:

funded by general federal tax revenues and funded by general federal tax revenues and monthly premiums paid by enrolleesmonthly premiums paid by enrollees

Asia-Pacific Financial Markets Research Center, University of Hawaii

4

Sources and Uses of Social Security Revenues in 2003

Asia-Pacific Financial Markets Research Center, University of Hawaii

5

Distribution of Social Security Tax Dollar (As of 2004 )

Administrative costs

1 cents

Retirement and survivor

benefits 68 cents

Disability benefits 12 cents

Medicare benefits 19 cents

Asia-Pacific Financial Markets Research Center, University of Hawaii

41.7 million people41.7 million people

7.9 million people7.9 million people

39.7 million people39.7 million people

6

Trust Funds Operations (2004)

  OASI DI HI SMI

Assets (end of 2003) $1,355.30 $175.40 $256.00 $24.00

Income in 2004 566.30 91.40 183.90 133.80

Expenditure in 2004 421.00 80.60 170.60 138.30

 Increase in Assets 145.30 10.80 13.3 -4.50

Assets (end of 2004) 1,500.60 186.20 269.30 19.40

Source: The 2005 Annual Social Security and Medicare Trust Fund Report

Asia-Pacific Financial Markets Research Center, University of Hawaii

Unit: $ Billion Unit: $ Billion

7

Short-Term Outlook for Trust Funds: OASI, DI, and HI Trust Fund Ratios (Assets/Annual Expenditures)%

Source: Source: The 2005 Annual Social Security and Medicare The 2005 Annual Social Security and Medicare Trust Fund ReportTrust Fund Report

Asia-Pacific Financial Markets Research Center, University of Hawaii

8

Long-Term Outlook for Trust Funds (I): Social Security and Medicare Cost as a Percentage of GDP

Source: Source: The 2005 Annual Social Security and Medicare The 2005 Annual Social Security and Medicare Trust Fund ReportTrust Fund Report

9

Long-Term Outlook for Trust Funds (II)

Income and Cost Rates (As Percentage of taxable payroll)

Source: Source: The 2005 Annual Social Security and Medicare The 2005 Annual Social Security and Medicare Trust Fund ReportTrust Fund Report

Asia-Pacific Financial Markets Research Center, University of Hawaii

10

Life Expectancy at Birth Life Expectancy at Birth (1960, 1980, & 2002)(1960, 1980, & 2002)

71.8

74.573.1

78.879.9

66.6

55

60

65

70

75

80

85

1960 1980 2002

Male

Female

Asia-Pacific Financial Markets Research Center, University of Hawaii

11

Life Expectancy at 65 Life Expectancy at 65 (1960, 1980, & 2002)(1960, 1980, & 2002)

14.1

16.615.8

18.319.5

12.8

0

5

10

15

20

25

1960 1980 2002

Male

Female

Asia-Pacific Financial Markets Research Center, University of Hawaii

12

Average Retirement Age(1950-55, 1970-1975, & 1995-2000)

62.962.6

67.9

62.962.6

68.5

59

60

61

62

63

64

65

66

67

68

69

1950-55 1970-75 1995-2000

Men

Women

Asia-Pacific Financial Markets Research Center, University of Hawaii

13

Long-Term Deficits of Four Trust Funds (Percent of GDP)

Asia-Pacific Financial Markets Research Center, University of Hawaii

Source: The 2005 Annual Social Security and Medicare Trust Fund Source: The 2005 Annual Social Security and Medicare Trust Fund ReportReport

14

U.S. Retirement Market Assets (2003)

Pension funds,

Insurance companies, banks and Brokerage

Mutual funds

Total 12.0 trillionTotal 12.0 trillion

The $2.7 trillion in mutual fund retirement assets accounted for 1/3 of all mutual fund assets

Source: Investment Company Institute, 2004 Fact Book Source: Investment Company Institute, 2004 Fact Book

Asia-Pacific Financial Markets Research Center, University of Hawaii

$9.3 Trillion$9.3 Trillion

$2.7 Trillion$2.7 Trillion

IRA IRA 1.29 Trillion1.29 TrillionEmployer sponsored Employer sponsored accounts accounts

1.4 1.4 TrillionTrillion

15

U.S. Retirement Assets by Types of Accounts

The $12 trillion in U.S. retirement market assets The $12 trillion in U.S. retirement market assets are divided between IRA ($2.98 trillion) and are divided between IRA ($2.98 trillion) and Employer Sponsored Accounts ($9.0 trillion)Employer Sponsored Accounts ($9.0 trillion)

IRA

Employer Sponsored Accounts

Total 12.0 trillionTotal 12.0 trillion

Source:Source: Investment Company Institute, 2004 Fact Investment Company Institute, 2004 Fact Book Book

Asia-Pacific Financial Markets Research Center, University of Hawaii

$9.0 Trillion$9.0 Trillion

$2.98 Trillion$2.98 Trillion

16

Who Manages IRA Assets?

Source: Investment Company Institute, 2004 Fact Book Source: Investment Company Institute, 2004 Fact Book

255 268

69

315 346

1,292

386

1,104 1,056

2,979

0

500

1000

1500

2000

2500

3000

1 2 3 4 Total

19942003

1.Bank and thrift Institutions1.Bank and thrift Institutions

2. Life Insurers2. Life Insurers

3. Mutual funds3. Mutual funds

4. Securities Companies4. Securities Companies

Asia-Pacific Financial Markets Research Center, University of Hawaii

Unit: $ BillionUnit: $ Billion

17

Mutual Fund-Managed Retirement Assets (2003)

IRAs

401(k) plans

403(b) plans

Other Retirement

Plans

Total $2,687 BillionTotal $2,687 Billion

Source: Investment Company Institute, 2004 Fact Book Source: Investment Company Institute, 2004 Fact Book

Asia-Pacific Financial Markets Research Center, University of Hawaii

$1,292 Billion$1,292 Billion$898 Billion$898 Billion

$260 Billion$260 Billion$237 Billion$237 Billion

18

Mutual Fund Retirement Assets by Types of Funds (2003)

Asia-Pacific Financial Markets Research Center, University of Hawaii

Source: ICI, 2004 Fact BookSource: ICI, 2004 Fact Book

Unit: $ BillionUnit: $ Billion

19

Employer-Sponsored Retirement Assets (2003)

Private Defined

Contribution Pension Plans

Private Defined Benefit

Pension Plans

Federal Government

Defined Benefit Plans

State & Local Government Employee Retirement

Plans

Annuity Reserves

Total $9.00 trillion

Asia-Pacific Financial Markets Research Center, University of Hawaii

$2.3 Trillion$2.3 Trillion$2.5 Trillion$2.5 Trillion

$1.9 Trillion$1.9 Trillion

$1.3 Trillion$1.3 Trillion

$1Trillion$1Trillion

Source: ICI, 2004 Fact BookSource: ICI, 2004 Fact Book

20

401(k) Plan 401(k) plans: Named after the section number of of

the Internal Revenue Code; Most important component of profit sharing program

Similar salary-deferral retirement plans are authorized in the tax code for:

457 plans: Public-sector employees 403(b) plans: Nonprofit-sector employees

401(K) plan assets: $1.9 trillion (2003) Number of Participants:

44 million workers EBRI/ICI Joint Database

15.0 million 401(k) plan participants 45,152 employer-sponsored 401(k) plans $776.0 billion in assets.

Asia-Pacific Financial Markets Research Center, University of Hawaii

21

Asset Allocation by 401(k) Plan (2003)

Asia-Pacific Financial Markets Research Center, University of Hawaii

44

8

19

75

16

51

8

19

5 4

11

45

9

16

10

5

13

0

10

20

30

40

50

60

Equity Funds Balancedfunds

Companystock

Bond Funds Money Funds GICs andother stablevalue Funds

1996

2000

2003

Source: EBRI/ICI (2004)Source: EBRI/ICI (2004)

22

Employee Stock Ownership Plans

An ESOP is a defined contribution plan An ESOP is a defined contribution plan that allows employees to become owners that allows employees to become owners of stock in the company they work for.of stock in the company they work for.

Equity based deferred compensation plan. Equity based deferred compensation plan. Only ESOP is required by law to invest Only ESOP is required by law to invest

primarily in the securities of the primarily in the securities of the sponsoring employer. sponsoring employer.

401(k) plan may be used for employee 401(k) plan may be used for employee ownership; a company can match ownership; a company can match employee contributions with its own employee contributions with its own stock. stock.

Asia-Pacific Financial Markets Research Center, University of Hawaii

23

Growth of ESOP Assets (Estimates)

YearYear AssetsAssets19901990 $133 billion$133 billion19941994 $184 billion$184 billion19951995 $226 billion$226 billion19981998 $350 billion$350 billion20012001 $400 billion$400 billion20052005 $500 billion$500 billion As of 2005: 10 Million People Participating As of 2005: 10 Million People Participating

in 11,500 plansin 11,500 plans

Asia-Pacific Financial Markets Research Center, University of Hawaii

Source: National Center for Employee OwnershipSource: National Center for Employee Ownership

24

Mahalo for You Attention!