Dr. Laura Dawson Ullrich April 1, 2014

 Definition: ◦ a regular payment made during a person's retirement from an investment fund to which that person or their employer has contributed during their working life.  Two types: ◦ Defined benefit plans (annuity plan) ◦ Defined contribution plans (payout depends on amount invested and return on investment)

 Defined Benefit ◦ Employees and employer make regular contributions during the employees’ working years ◦ After retirement, employee receives monthly payments that are calculated based on tenure at work and salary  Defined Contribution ◦ Employees make contributions during their working years (employers may as well) ◦ Employee can choose how fund is invested ◦ After retirement, employee can make withdrawals from account

 Defined Benefit Example ◦ Employee makes $100,000 a year during the last four years of employment ◦ Employee has 30 years of service at Company X ◦ Company X contributes 9% of employee’s salary per year into pension fund; employee does the same ◦ The multiplier used by Company X is 2.07% per year of service. ◦ After retirement, pension is calculated as follows: (30 * ) * $100,000 = * $100,000 = $62,100 This means that the employee will receive $5,175 per month (before taxes) until death

 Defined Benefit Programs ◦ Under a defined benefit program, the employee does not bear the investment risk. ◦ The pension payment is the same regardless of the success of the pension program investment. ◦ Defined benefit programs have become less common over time.  1985 – 89 of Fortune 100 companies  1998 – 67 of Fortune 100 companies  2004 – 38 of Fortune 100 companies  2010 – 17 of Fortune 100 companies  2013 – 7 of Fortune 100 companies

 Defined Benefit Programs ◦ Why have they become less common in the private sector?  Still common in government jobs  Private companies are hesitant to bear risk  Employees no longer expect/demand them  Companies and employees are less loyal than in previous generations

 Nearly all countries have some sort of social insurance (pension) program for the elderly.  Social insurance: ◦ government provision for unemployed, injured, or aged people; financed by contributions from employers and employees as well as by government revenue  These insurance programs for the elderly generally come in the form of a pension and healthcare

 Many citizens do not work in jobs that provide a pension after retirement.  Altruism: we are generally uncomfortable with the thought of the elderly living in extreme poverty.  To reward years of hard work.  To guarantee some source of income in case of poor investment outcomes in other accounts.

 The level of income replacement from the public pension varies greatly from country to country.  Pension replacement for median income earners: ◦ United States:41.0 percent ◦ Netherlands: 91.4 percent ◦ Denmark:83.7 percent ◦ South Africa:11.8 percent ◦ Saudi Arabia: percent

 The amount replaced by governments may is heavily dependent on other social services offered for the elderly.  OECD average: 57.9 percent

 The public pension in the United States is known as Social Security  The Social Security Act of 1935 was a part of Franklin Delano Roosevelt’s “New Deal” during the Great Depression  Provided workers aged 65 and older monthly pension checks based on years worked and salary earned.

 Because of the financial situation in the US in 1935, the Social Security program was designed as “pay as you go”. ◦ Current working-age citizens pay for current retirees’ benefits.  Employees and employers contribute 6.2% of wages (each) up to $117,000 in wages (wages above that are not taxed) – PAYROLL TAX  Employees must work at least 40 quarters to qualify for full Social Security benefits  Those who never work can qualify for spousal benefits after their spouse’s death.

 The first person to receive a check was Ida May Fuller in  By the time Ida May died at 100 years old she had collected $22, in Social Security benefits (she only paid $24.75 into the system).

 Retirement age: ◦ Early benefits can be received at age 62 (with penalty for early withdrawal) ◦ Full benefits are received at age 67 (for most Americans, for some it is still 66)  Maximum monthly benefit: ◦ $2,642 per month  Social Security tax is only placed on the first $117,000 of wages ◦ Self-employed must pay payroll taxes themselves

 Pay-as-you-go has become a big issue. ◦ The number of workers per retiree has fallen dramatically. ◦ This will get worse during the Baby Boomers’ retirement.  From 1940 until now, payroll tax revenues have always exceeded Social Security payouts. That will no longer be the case after 2015 or 2016.

 Too many retirees are relying on Social Security as the sole source of income.  In 1935, life expectancy for a man was 59.9 years and for a woman was 63.9 years. Since Social Security benefits started at age 65, most people would never receive them.  Today, life expectancy for men is 76.2 years and 81.2 years for women. Since early retirement is at age 62, the average retiree would receive payments for greater than 15 years!

 Raise the retirement age ◦ Raising it to 70 would fix the problem for the foreseeable future.  Increase the payroll tax rate  Raise the payroll tax cap (or eliminate it entirely)  Reduce benefits  Reduce or eliminate the cost of living adjustment (COLA) Surprise: None of these is politically popular.