savings in american and elsewhere (ron gebhardtsbauer)

8/7/2019 Savings in American and Elsewhere (Ron Gebhardtsbauer)

1/48

1

Savings in America and Elsewhere

RON GEBHARDTSBAUER

SENIOR PENSION FELLOW

AMERICAN ACADEMY OF ACTUARIES

Briefing Sponsored by the:

National Press Foundation1211 Connecticut Avenue NW, Suite 310

Washington, DC 20036

Wednesday, May 18, 2005

9 am 10:15 am

The American Academy of Actuaries is the public policy organization for actuaries of all specialties within

the United States. In addition to setting qualification standards and standards of actuarial practice, a majorpurpose of the Academy is to act as the public information organization for the profession. The Academyis nonpartisan and assists the public policy process through the presentation of clear analysis. The

Academy regularly prepares testimony for Congress, provides information to federal elected officials,regulators and congressional staff, comments on proposed federal regulations, and works closely with state

officials on issues related to insurance.


2/48

2

Topics

Ho Much Is Needed?

Social Security

Company Pension

Home

Individual Savings

Work

Best Ways To Save Ho Are We Doing?

Individually

Nationally


3/48

3

Retirement Income Needed or 100%

Replacement o Spendable Income at Age 65Single Person

0%

20%

40%

60%

80%

100%

120%

140%

$10,000 $20,000 $40,000 $60,000 $80,000 $100,000

Wages just before retirement in 2005

Medigap and LTC

Pension Needed

Social Security


4/48

4

Less Income Needed in Retirement

No longer need to: Pay SS taxes (6.2% o ages up to $90,000)

Pay Medicare taxes (1.45% on all ages)

Contribute to pension plan or savings (0% to 15% o income)

Pay ork-related expenses (do n 0% to ~ 7% o income) Pay as much or meals & home maintenance

Pay as much in income taxes (do n ~ 10% to 17%)

Pay mortgage?

But some expenses may increase Travel Costs

Health Care (Medicare B & D premiums, Medigap & LTC) About $6,000/yr: 60% i income = $10,000

9% i income = $100,000 (extra 3% due to taxes)

Taxes or orkers ho got EITC (earned income tax credit)


5/48

5

35%

25%

15%

11%10% 10%

0%

10%

20%

30%

40%

1959 1969 1979 1989 1999 2004

Year

Poverty Rates For People

Age 65 and Over

Social Security (along with SSI , Pensions, etc.) decreased the percent of elderly below the poverty level to the same % as those for people of

working age! The poverty threshold (for people over 65) is currently about $9,000 per person (~ $12,000 for a couple). The thresholds increasewith CPI-U (which is subject to criticism). Source: US Census Bureau's CPS (Current Population Survey) and ferret.bls.census.gov


6/48

6

Poverty Rates for 2004

18%

13%

11%

9%10%

14%

17%18%

20%

0%

5%

10%

15%

20%

25%

All < 18 18 - 64 65 - 74 65 + 85 + 85 + 85 + 65 +

Women SingleWomen

Non-White

Age, Sex, Marital Status, and Race

6 ! 6 4

6

' ' 6

4


7/48

7

Social Security Replacement Ratiosat Normal Retirement Age (and at Disability)

23%

26%

74%

45%41%

38%34%

31%28%

52%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

$10,000 $30,000 $50,000 $70,000 $90,000

Earnings Just Before Retirement in 2005

PercentofEarnin

gsReplac

V


8/48

8

Social Security Benefitsat Normal Retirement Age (and at Disability)

$7,388

$10,400

$13,414

$16,423

$19,169

$21,587

$20,474

$23,482$23,482$22,632

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $90,000 $100,000

Earnings Just Before Retirement in 2005

EstimatedB

enefit

This and prior graph show the primary goals of Social Security:

(1) Socially Adequate benefits (progressive benefits that are more important to lower wage earners)

(2) Individually Equitable benefits (important to higher wage earners - the more contributed, the more received). Progressive

price indexing eventually creates a flat benefit, and eliminates this principle.


9/48

9

Social Security Normal Retirement AgeYear of Birth Normal Retirement Age

1937 & earlier 65

1938 65 2/12

1939 65 4/12

1940 65 6/12

1941 65 8/12

1942 65 10/121943 1954 66

1955 66 2/12

1956 66 4/12

1957 66 6/12

1958 66 8/12

1959 66 10/12

1960 & later 67

Normal Retirement Age (NRA) = Age for full benefits. 62 is earliest age for benefits

Reductions for retiring earlier than NRA are as follows:

6 2/3% for each year before NRA (up to 3 years), plus

5% for each year more than 3 years

If you work after NRA, your benefit is increased by up to 8% per year.


10/48

10

Social Security Bene its

Payable or li e No matter ho long you live

No matter ho bad the markets

Bene its being paid increase by CPI each year Replacement rates maintained

Initial bene its increase by average ages each year

Disability and Survivor bene its (1/3rd o total bene its)

Spousal bene its (at least 50% o orkers bene it) aluable or traditional amily

But SS has inancial problems hich e need to ixsooner rather than later


11/48

11

Other State Systems Old Europe

Large, expensive, mandatory, un unded State systems Raised retirement ages

More years o ork needed or ull bene its

Strengthen link bet een contributions and bene its

United Kingdom Tier I ( lat bene it)

Change to price indexation in early 80s improved solvency

No both parties ind bene its too small

Tier II ( unded pay-related bene it) Worker can contract out to employers scheme or their IRA

Mis-selling controversy

Australia & Canada: some Means Testing


12/48

12

Other State Systems

Southeast Asia

Provident Funds: ully unded, govt. managed DC unds

Chile, other Latin American countries, Kazakhstan

Individually managed accounts (sometimes ith guarantees) Chiles success led to adoption in other countries

Problems: high expenses, less than desired participation, hidden liab.

Sometimes ith a smaller paygo DB plan (or ith a choice)

S eden, Italy, Poland, Latvia Notional DC plan ith speci ied return

Like our Cash Balance pension plans


13/48

13

Company Pension Plans

De ined Bene it Promise a replacement rate based on years orked

Contribution depends on investment returns, etc Risk on company, as eve seen lately, and some employees

PBGC guaranteed bene its or some companies in bankruptcy

De ined Contribution Promises a contribution

Bene it depends on investment returns

Risk on orker

401(k): may only promise a match 30% o orkers contribute nothing and get no match

Partial ixes: automatic participation at hire, automatic investment


14/48

14

Why Have a Plan (particularly DB)? Tax Advantages

Help employers, employees, nation Help employers ith ork orce management

Recruit, retain, retire ith dignity

Most employees participate Only about 70% participate in 401(k)

More likely to get annuity

401(k)s dont require annuities or spousal consent Helps national retirement security

Helped make more e icient markets

Bucking the trend: United Methodist Church, UK

Barclays, Trans-Canada have started up ne DB plans


15/48

15

Tax Advantages o Pension Plans

$29,000

$61,000

$0

$10,000$20,000

$30,000

$40,000

$50,000$60,000

$70,000

After-TaxDistribution

Personal Savings Qualified Pension

In 20 years, $20,000 becomes:

Assumes 8% interest rate, 35% tax bracket ( ed + local), and 7.65% FICA tax rom employer and employee


16/48

16

Pension Coverage Rates o Firms

14%

21%25%

34%

40%50%

59%

65% 69%70%

76% 76%

51%56%

0%

25%

50%

75%

100%

FirmswithPen

sions(%)


17/48

17

Participation Rates in Pension Plans (by type)

45%

48%

19%

35%

16%

12%

0%

10%

20%

30%

40%

50%

1975 1980 1985 1990 1995 2000

%ofLab

orForce

Total

DB

401(k)

Other DC

It's not a battle between DB and DC. It's a battle between 401(k) and the others, and 401(k) is far ahead.

Why? Favorable laws for 401(k), especially pre-tax contributions, match, and improved deductions.

Sources: Workers from BLS statistics: employed (FT & PT) and unemployed wage & salary workers. Coverage from

DOL/PWBA Abstract of 1999 Form 5500 data (Summer 2004) Tables E4, E8, & E20, and NCS for 2000.


18/48

18

Only Hal Covered by a Pension Plan Why?

Complex, Restrictive, & Con licting La s and Regs

Lack o la s/clarity or Cash Balance plans

Tax Re orm is reducing tax advantage 15% capital gains & dividend tax rate

Consumption tax ould eliminate tax advantage

Expensive cost o administration, compliance

Unpredictable sources o unds o small employers Too Expensive

Employees dont value DB bene its?

Small employers dont kno about simple alternatives


19/48

19

De ined Bene it Plans Regulatory Costs

0

100

200

300

400

500

AdministrativeCosts per

Worker

1990$

15 75 500 10,000

Firm Size (# of Workers)

1981

1991

Hay Huggins Company

This sho s hy DBs make more

sense or larger employers.


20/48

20

More Problems

Tax Re orm could kill company pension plans Reduce 15% tax rate on Cap gains and Dividends to 0%

Enact Li etime Savings Accounts

Change to National Sales Tax, AT, Flat tax In all cases, they eliminate pensions tax advantage

Why lock up money until retirement i no advantage?

Consumption tax ont increase national savings, iemployers drop pension plans

Lo & middle income orkers ont save as much on their o n

olatile pension unding rules

Lack o clarity on Cash Balance rules

Non-level playing ield or DB plans


21/48

21

Pe s ec e s e s r -

%L

%

%

Source: CPS - Retirement Bene its o American Workers, p.13

In 1989, only 40% got lump sums.


22/48

22

Uses o u p Su str butions

rom etirement ans - 1996

5046

27

3

0

20

40

60

Spent It Rolled ver

some ofit

Invested ther

ercent

Source: EBRI, ASEC, 1996 Retirement Con idence Survey


23/48

23

Participation Rates

17

9

65

40

93

83

0

25

50

75

100

IRAs 401(k)s DB plans

All mployees

Low Income nes

Source: April 1993 CPS. DB numbers are estimates. IRA numbers are rom 1983 hen everyone as eligible


24/48

24

Individual Savings

Many people dont kno ho much to save

Dont save enough

Dont understand risks

Dont understand investments

Dont kno ho to pay themselves in retirement

Boomers may have more saved dollar ise, but

less as a percentage o ages (CBO) So replacement ages ill decrease


25/48

25

Ho much is needed?Female ants to retire at age 62 ith in lation-indexed annuity

Percent o ages1. Annual income needed in retirement (incl LTC/Medigap) 85%

2. Your annual mortgage (i gone by retirement) 0%

3. Your annual Social Security bene it 35%

4. Your pensions rom all employers 0%

5. Annual Income Needed (1 2 3 4) 50%

6. Assets needed at Retirement1 10times ages With risk

7. Your net assets by retirement (incl. amt o reverse mortgage?) 1 times ages 2

8. Additional cash needed by retirement (6 7) 9 times ages 8

9. Number o years until retirement 30 40

10. Annual savings needed as a % o pay (8 / 9) 30% 20%

1 In lation indexed annuity price (very rough estimate): multiply line 5 by 82 minus age at

retirement (minus 4 i level pension ok). Multiply by 50 i TIPS (22 i level pension ok)

2 Items in red re lect an investment rate o return greater than the gro th in ages


26/48

26

Ho much is needed?Male ants to retire at age 66 ith level annuity

Percent o ages1. Annual income needed in retirement (incl LTC/Medigap) 85%

2. Your annual mortgage (i gone by retirement) 0%

3. Your annual Social Security bene it 35%

4. Your pensions rom all employers 10%

5. Annual Income Needed (1 2 3 4) 40%

6. Assets needed at Retirement1 5 times ages With risk

7. Your net assets by retirement (incl. amt o reverse mortgage?) 2 times ages 4

8. Additional cash needed by retirement (6 7) 3 times ages 1

9. Number o years until retirement 30 40

10. Annual savings needed as a % o pay (8 / 9) 10% 2.5%

1 In lation indexed annuity price (very rough estimate): multiply line 5 by 82 minus age at

retirement (minus 4 i level pension ok). Multiply by 50 i TIPS (22 i level pension ok)

2 Items in red re lect an investment rate o return greater than the gro th in ages


27/48

27

Best Ways to Save (it varies) DB/DC plan generally employer pays 100%

I reduces ages, compare ith other irms

I mobile, go or shorter vesting and cash balance plan

401(k) i has employer match Tax credit or lo income savers

Unless high ees or doesnt have unds you ant IRA vs. Roth IRA

Regular IRA better i tax rate ill be lo er in retirement

Tax rate can increase in retirement due to the ay SS is taxed

Roth can permit slightly larger deductions

De erred annuities & tax exempt bonds i high tax rate Lo er tax rates on stocks and taxable bonds can make them better

NQ Diversi ied mutual unds vs. individual securities Stocks, Li e Cycle, Bonds, Stable alue, Money Market

Bonds inside Quali ied Plan and stocks outside Quali ied Plan


28/48

28

John Hancock Survey - 2004

40% dont kno hat to expect or investment returns Remainder are too optimistic

Ma orities think: Employer stock in less risky than stock und

Bonds less risky than money market unds 60% dont kno they can lose money in bonds

4

5% think money market unds hold stocks Under 10% kno they only hold short-term investments

Under 25% kno best to buy bonds be ore rates drop


29/48

29


Average expected retirement age up 5 years since1995 survey

18% dont expect to retire until a ter age 70 Triple the 1995 ans er

Almost 70% a raid they ont live com ortably inretirement

But disengaged Dont take an active role in investing EG, no changes to allocation

More than hal say no time to manage investments

Only hal have estimated money needed or retirement


30/48

30


Financial planning needed

Plans need to re lect human behavior

Not economic theory Education needed?

No, more simpli ication and automatic options Automatic enrollment at hire

Automatic Li e Cycle und

Automatic Rebalancing

Automatic increases at pay increase dates

Back to DBs?


31/48

31

Fidelity - 2004

10,000 plans; 8 million participants Participants are staying course

Continued their contributions Could be inertia on part o orkers already in plan

Participation rates actually decreased rom 70% to 66% I heard ne employees are less likely to enroll

Account balances back up to 2000 levels I drop out ne employees, balances are lo er than 2000

And this is 4 years later ith 4 years o more contributions

Needs to be higher (due to in lation and being closer to retirement) Median = $20,000; Mean = $55,000

Participants in 60s: Median = $40,000; Mean = $119,000

More valuable i as a percentage o ages

Cumulative net exchanges chart sho s e buy high;sell lo


32/48

32

SOA Misperceptions paper

Save too little Didnt calculate ho much needed OR calculations are lo

Retirement may occur be ore expected

Hal ill live longer than expected

Not acing acts about LTC needs

Di icult to sel -insure against long li e We like li etime income but dont buy annuities

Dont understand investments

Rely on poor advice; dont seek out pro essionals

Misunderstand retirement income sources

Fail to prepare or in lation

Dont provide or spouse


33/48

33

Parents

A raid to spend rom their ealth

Retirement Security = li etime income + Health Ins. Not cash

Their ranking o pre erred sources o income1. Social Security

Because it goes up ith in lation

Even though its smaller than pension

2. Level pension

3. ariable pension

4. Home (particularly valuable i housing costs skyrocket)

5. Investments (a raid to to touch it, even though they no have LTCI)

6. Work (because they are too old to ork no )


34/48

34

Merrill Lynch Survey 1/02

Inconsistencies ith economic realities in survey We expect unrealistically high returns, even in retirement

25% said they earn ( ill earn) at least 15% annually

Some said they earn ( ill earn) at least 50% annually

Stock decline had no impact on inancial position Took several years to sink in

Was it denial?

2/3rds think others ill have problems, but not them

But 3/4

ths o participants expect to retire at age 70 no ; as 65 in 2000 49% think401(k)s have guarantees by la (up to a certain amount)

Want control, but lack kno ledge and ability Over hal think SS should be privatized; that changed

Under 1/4th think la s should restrict employer stock

Want investment advice provided by employer


35/48

35

Reasons e dont buy Annuities Fear they ill die early

Liquidity and Extra ordinary expenses

They have enough income They ant to pass on more to heirs

Financial Advisor bias

They think they can do better

Li e Insurance agents dont push

Lack o in lation protection

They didnt save enough and dont mind el are


36/48

36

Minimum Require Distributions

vs

Annuities

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

70 75 80 85 90 95 100 105

Age

Single Life Annuity with 3% COLA

Single Life Annuity - No COLA

Single Lifef - Recalc

This one has no

inflation protection.

Single Life with Recalc: Payable

for more years than withoutRecalculation. It gives fund

balance to heirs when retiree

dies. It is lousy for those who live

longer.

This one insures against

inflation and longevity the best.

The indexed life annuity

generally exceeds the MRD

even with returns of 9%

(Standard Deviation =20%).


37/48

37

Minimum Require Distributions

vs

Annuities

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

70 75 80 85 90 95 100 105

Age

Single Life Annuity with 3% COLA

Single Life Annuity - No COLA

Single Lifef - Recalc

This one has no

inflation protection.

Single Life with Recalc: Payable

for more years than withoutRecalculation. It gives fund

balance to heirs when retiree

dies. It is lousy for those who live

longer.

This one insures against

inflation and longevity the best.

The indexed life annuity

generally exceeds the MRD

even with returns of 9%

(Standard Deviation =20%).


38/48

38

Work in Retirement? Some may have to ork in retirement

Part Time, Temporary, Phased Retirement

When baby boomers retire, employers may pay

extra to retain some orkers


39/48

39

Average Increases in Labor Force and Population

How do demographics affect economy?

0%

1%

2%

3%

4%

1962 1967 1978 1990 2000 2010 2020 2030 2040 2050 2060 2070

Labor Force (Supply)

Total Population (Demand)

Source: 2005 SSA Trustees Report, Tables V.A2 and V.B2 Due to smaller increases in labor force,

employers may encourage employees to retire later, and workers may become more productive.

Increase in Labor Supply > Increase in Demand for labor

Higher unemployment

Lower w ages

More early retirements

Lots of (cheap) labor means less captial to increase productivity

Many y oung people means expensive homes

Increase in Labor supply < Incresae indemand for labor

Low er unemployment

Higher w ages to retain employees

Delay retirements

Increased Immigration of w orkers (w ho have higher fertility rates)

More capital to increase productivity

Will greater productivity of fset f ew er w orkers?

Or w ill productivity not increase enough, so inflation will increase?Many retirees increase costs of retirement homes, health care, etc

Increased emigration of retirees (in search of cheaper costs)

Market Prices and Inflation?

Accumulation caused high stock prices.

Will deaccumulation cause stock market meltdow n?See paper by Geanakoplos, Magill, Quinzii

Will low labor supply imply higher costs, or w ill increased produc tivity keep costs dow n?


40/48

40

US Labor Force Participation Rates - Male

706562 63

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

55 60 65 70 75 80

1940

1970

19852004

Note the dramatic decreases in labor orce participation pre-1985. Much as due to Social Security and Medicare. Since 1985

participation rates have gone up a little post-age-62, possibly due to pro- ork policies, e er ne orkers, and economy. Labor

Force = Employed + Unemployed (those actively seeking and available) Source: 1940 data rom US Census; 1965 and later rom

Consumer Population Survey data (BLS).


41/48

41

US Labor Force Participation Rates - Femal

0%

20%

40%

60%

80%

100%

55 60 65 70 75

1970

1985

2004

Note the INCREASE in laborfor e participation forwomen at youngerages ( ue to baby boomers working more)

aborForce = Employed + Unemployed (those actively seeking and available)

Source: Un ublished data from BLS ConsumerPo ulation Surve


42/48


43/48

43

Personal Savings Rates are Do n

0%

2%

4%

6%

8%

10%

12%

1950 1960 1970 1980 1990 2000%

ofDisposalPe

rsonalIncome

Personal Savings

Excluding Pensions

While we dont save as muchthru pensions as we did in the 1980s, withoutthem

saving is negative. We save thru homes too, butthey are heavily leveraged. Note:

net of dis-saving by retireds. CG excluded.


44/48

44

Personal Savings vs. Change in Net Worth(as a % of disposable personal income)

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Personal Savings

Change in Net Worth in excess of CPI (3 yr avg)

Savings rates use to go down when Net Worth went up (& vice versa). Source: 3/2005 Federal Reserve Flow of Funds R.100

2002 savings rates (2005 Stat Abstract of US, Table 1338): Italy & France:16%, Germany:10%, Japan:6%, UK:5%, US & Canada:4%

but we spend much more on education, research, and developement, which helps our economy grow faster.


45/48

45

Savings as a % o Disposable Income

0

5

10

15

20

25

30

US France Germany Italy UK Japan Canada

1980

1990

2002


46/48

46

Net National Savings

-5%

0%

5%

10%

15%

20%

1950 1960 1970 1980 1990 2000

P

nto

f

DP

P on S n (in P n ion

ov nm nt S vin (in St t & Lo )Co po t Undist ibut dP ofits

Tot N t N tion S vin s

Net Savings is net o consumption o ixed capital. Sources: 3/05 NIPA

rom Survey o Current Business by BEA, Tables 1.1 and 5.1 Higher i

education and research included.


47/48

47

Ho Increase National Savings? Increase Productivity and/or Reduce Consumption

Reduce US de icit

Increase taxes (FIT and SS payroll taxes) Cut government programs

Social Security: Not easy to cut bene its today

Would Individual Accounts increase national savings?

Carve out contributions ont help

Due to additional US borro ing

Add On contributions ould help

O set by less saving in our401(k)s and IRAs (Substitution E ect)


48/48

48

Comparisons

Social Security US system less generous than many European countries

Most ill have inancial problems

UK is even less generous than US

Gradual bene it reductions helped inancial stability But no orry they ent too ar

Pension plans/schemes Larger, more prevalent in US & UK due to smaller state scheme

But some irms getting out o DBs, due to rules & risks, esp UK

Individual Savings Many in US are not saving as much as in other countries

But e spend more on Education and Research

Have greater productivity and stock gro th

savings in american and elsewhere (ron gebhardtsbauer)

Documents