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Retirement Policy in the 21st Century
Jon FormanAlfred P. Murrah Professor of LawUniversity 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
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Overview
Retirement Security as a three-Legged Stool Social Security Private Pensions Savings
Aging of America Social Security Private Pensions
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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
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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
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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
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6Bureau 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>.
Labor Force Participation of Men Aged 55 and Older, 1950-2003
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002
Year
Pa
rti
cip
ati
on
Ra
te
Males Age 55-64 Males Age 65 and Older
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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
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Most elderly don’t receive pensions
Percent with Employer-Sponsored Pensions
All age 65+ 41%Couples 51%Unmarried men 39%Unmarried women 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
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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
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How Much Does Social Security Pay?
www.ssa.gov/OACT/COLA/colaeffect.html
Type of Beneficiary AverageMonthly 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
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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
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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
http://www.ssa.gov/retire2/retirechart.htm
Year of Birth Full Retirement Age
1937 or earlier 65
1938 - 1942 plus 2 months per year
1942 – 1954 66
1955 - 1959 plus 2 months per year
1960 and later 67
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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) formulafor persons turning age 62 in 2007
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
$2,000
$2,200
$0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000
Average Indexed Monthly Earnings
Pri
mar
y I
nsu
ran
ce A
mo
un
t
PIA
Second Bend Point$4,110
FirstBend Point$680
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How do benefits compare to earnings?
$19,600$22,500
$15,800
$35,300
$55,400
$90,000
$14,800
$9,000
57%
42%
35%25%
$0
$20,000
$40,000
$60,000
$80,000
"low" "medium" "high" "maximum"
Earnings Amount
Past Wages Benefits
Retired worker age 65, 2005
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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)
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26Social Security Administration, 2007 Trustees’ Report
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27American Academy of Actuaries (2005), available at <http://www.actuary.org/pdf/socialsecurity/medicare_socsec_briefing_april05.pdf>.
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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 Eliminated104%
93%40%10%
20%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).
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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 Eliminated28%
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 Investments in equities
% of Deficit Eliminated36% - 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
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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 pre-retirement 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 PlanEffect of inflation on real value of retirement income
Years in retirement
No inflation
3% Annual Inflation
10% Annual inflation
0 100 100 100
5 100 86 62
10 100 74 39
15 100 64 24
20 100 55 15
25 100 48 9
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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.pdf.
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) 325-4779. His web page is www.law.ou.edu/faculty/forman.shtml.