1. Retirement Policy in the 21st Century
Jon Forman
Alfred P. Murrah Professor of Law
University of Oklahoma College of Law
December 14, 2005
available at

2. Overview Retirement Security as a three-Legged Stool Aging of America
Social Security
Private Pensions
Savings
Aging of America

3. 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

4. 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

5. 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

6. Bureau of Labor Statistics, Labor Force Statistics from the Current Population Survey: Civilian Labor Force Participation Rate (2004),
available at <

7. 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
Social Security benefits are relatively modest both in dollar amounts and in relation to retirees’ prior earnings. Yet, the benefits are critically important to the families that receive them.
About 90 percent of married couples and unmarried persons age 65 and older receive Social Security. It is the major source of income for most of those beneficiaries.
Nearly two in three of these beneficiaries (66 percent) rely on Social Security for half or more of their total income from all sources.
About one in five elderly Americans (22 percent) get all of their income from Social Security.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

8. Most elderly don’t receive pensions
Percent with Employer-Sponsored Pensions
All age %
Couples 51%
Unmarried men 39%
Unmarried women 32%
One reason that Social Security is such a large portion of income is that most Americans age 65 and older do not receive income from pensions, from either private employment or from jobs in federal, state or local government. Of couples age 65 and older just half (51 percent) do have a pension from the husband’s or wife’s work, or both. The unmarried are less likely to have pensions. About 32 percent of unmarried women and 39 percent of unmarried men receive pensions.
Combining couples and the unmarried together, the pension receipt rate is 41 percent.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

9. Social Security How Social Security Works Financial Troubles
Financing Social Security
How Benefits Are Determined
Financial Troubles
How to Fix It
Raise Taxes
Cut Benefits
Increase Investment Returns

10. How Many People Get Social Security?
47.7 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
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

11. 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
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

12. How Much Does Social Security Pay?
Type of Beneficiary
Average
Monthly Benefit
All Retired Workers
$955
Aged widow(er), non-disabled
$920
Disabled worker
$895
Aged couple-both receiving
$1,574
Widowed mother and two children
$1,979
How much does Social Security pay?
Social Security is designed to serve as a foundation of retirement income that could be supplemented by pensions, savings, and earnings. Benefits alone do not provide a comfortable level of living. The average retired worker benefit in January 2005 was $955 a month, or about $11,500 a year.
The average is somewhat lower for widowed spouses age 60 and older, $920 a month or about $11,000 a year.
The average benefit for disabled workers is $894, or about $10,700 a year.
When both a retired husband and wife receive benefits, the average is $1,574 or about $18,900 a year.
Each year the benefits are adjusted to keep up with the cost of living. The cost of living adjustment comes in the January checks.

13. Social Security and Poverty
2005 Poverty Levels
Single individuals – $9,570 ($798/month)
Married couples – $12,830 ($1,070/month)
With Social Security only 9% were poor
in 2000
Without it, 48% would have been poor

14. 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 $94,200 in 2006

15. 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)

16. 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

17. 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

18. Full Retirement Age Year of Birth Full Retirement Age 1937 or earlier65
plus 2 months per year
1942 – 1954 66
1960 and later 67
How much does Social Security pay?
Social Security is designed to serve as a foundation of retirement income that could be supplemented by pensions, savings, and earnings. Benefits alone do not provide a comfortable level of living. The average retired worker benefit in January 2005 was $955 a month, or about $11,500 a year.
The average is somewhat lower for widowed spouses age 60 and older, $920 a month or about $11,000 a year.
The average benefit for disabled workers is $894, or about $10,700 a year.
When both a retired husband and wife receive benefits, the average is $1,574 or about $18,900 a year.
Each year the benefits are adjusted to keep up with the cost of living. The cost of living adjustment comes in the January checks.

19. Primary Insurance Amount (PIA)
For a worker turning 62 in 2006,
PIA = 90% of first $656 of AIME
+ 32% of AIME from $656 to $3,955 (if any)
+ 15% of AIME over $3,955 (if any)
$656 and $3,955 are called bend points
PIA indexed by cost of living after 62
Provides higher benefits relative to earnings for lower paid

21. How do benefits compare to earnings?
Retired worker age 65, 2005
This chart shows how Social Security benefits compare to a retiree’s past earnings for a “low;” “medium;” “high;” and “maximum” earner. The short bars are the benefits that a retiree would get at age 65. The tall bars represent the retiree’s typical (or average indexed) lifetime earnings while working.
Social Security benefits replace a larger share of past earnings for lower earners. While higher earners receive larger benefit checks, those checks represent a smaller fractions of what they had been making.
For example, a 65-year-old who retired in 2005 with a lifetime of “medium” earnings (about $35,300 in 2004) would receive about $14,800 a year, which would replace about 42 percent of past earnings.
A “low” earner, who made about $15,800 in 2004 would receive about $9,000, which would replace about 57 percent of prior earnings.
A worker who always earned the maximum amount that is taxed and counted toward Social Security ($90,000 in 2004) would get benefits that replace about 25 percent of prior earnings.
These benefits are for workers who claim Social Security at age 65. Workers who take benefits at 62 (the earliest eligibility age) would receive 20 percent less because they claimed benefits early.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

22. Worker Benefits: Increases and Decreases
Indexed for inflation
Actuarial decrease for early retirement
Example: average-wage worker, 62 in 2006
Will get $1, 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 2006, early retirees lose $1 of benefits for each $2 of earnings over $12,480

23. 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

24. Estimates for 2005 Finances
Trust Fund income = $690 billion (taxes)
Trust Fund outgo = $527 billion (benefits)
Surplus = $163 billion
By law, surpluses are invested in U.S. government securities and earn interest that goes to the trust funds.
First, in the near term Social Security is taking more in than it is paying out in benefits.
In 2004, projected income to the trust funds (mainly Social Security taxes) was $690 billion, while projected outgo (mainly benefit payments) was $527 billion, leaving an annual surplus of $163 billion.
These surpluses, by law, are invested in U.S. treasury securities and earn interest that goes to the trust funds.
The “outgo” from the Social Security trust funds covers administrative expenses of the Social Security program, as well as benefit payments. Administrative costs are about 1 percent of total outgo.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

25. Social Security’s Financing Problem
2005 Trustees Report shows
Expenses will exceed payroll tax income in 2017
Trust funds will be out of money in 2041
75-year deficit equals 1.92% of taxable payroll
Immediate payroll tax increase of 1.92% needed to restore actuarial balance
Alternatively, immediate 12.8% across-the-board benefit cut
$4 trillion unfunded liability
0.6% as a share of the entire economy (GDP)

26. Social Security Administration, 2005 Trustees’ Report

27. 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)
How do actuaries project the future?
The Social Security actuaries forecast the future of the Social Security system 75 years into the future. They update their forecast every year. The purpose is to help policy makers anticipate whether Social Security is likely to face financing problems in the future. The actuaries make three forecasts: Low cost; High cost; and Intermediate (or best estimate).
For each, they use assumptions that have been reviewed and agreed to by the Trustees. The assumptions are about future trends in aspects of the population and the economy that would affect the income and outgo of the trust funds.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

28. 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 74% of benefits due then.
By 2079, assuming no change in taxes, benefits or forecasts, revenue would cover about 68% of benefits due then.
What does the 2005 long range forecast show?
Under the intermediate (or best estimate) set of assumptions, the 2005 report finds:
The system will continue to run annual surpluses until In that year, for the first time, tax revenue is projected to be less than benefits due. But interest income on the reserves will help cover the costs.
Interest on the trust fund reserves and the assets themselves will help pay for benefits until 2041.
In 2041, reserves are projected to be depleted (assuming no change in benefits or taxes). Income is projected to cover 74 percent of benefits due then.
The system will not be “broke” in that Social Security taxes will keep coming in. But, if this projection holds, policymakers will need to make some changes before 2041, to ensure that all legislated benefits can be paid.
National Academy of Social Insurance,
Social Security Finances: A Primer (2005)

29. American Academy of Actuaries (2005), available at <http://www

30. Only 3 Ways to Fix Social Security
Raise Taxes
Cut Benefits
Increase Investment Returns
Private investment
Either government or individual

31. 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%
93%
40%
10%
20%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).

32. 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).

33. Options: Increase Investment Returns
Investments in equities
% of Deficit Eliminated
36% - 50%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).

34. Two Basic Types of Pension Plans
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

36. 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

37. 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

38. 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

39. Defined Benefit Plan Effect of inflation on real value of retirement income
Years in retirement
No inflation
3% Annual Inflation
10% Annual inflation
100 5 86 62 10 74 39 15 64 24 20 55 25 48 9

40. Only 3 ways to fix an underfunded Defined Benefit Plan
Raise Contributions
Cut Benefits
Increase Investment Returns

41. 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

42. 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

43. 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

44. 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

45. Conclusions Social Security has a $4 Trillion Unfunded Liability
Oldest baby-boomers are 59½
Only half of the elderly have pensions
Reforms are needed

46. Sources
American Academy of Actuaries, Social Security Reform: Solutions Inside the Box: Proposals Not Including Individual Accounts (2004), available at
Jon Forman, Reforming Social Security, 76 (9) Oklahoma Bar Journal (March 12, 2005), available at
Jonathan Barry Forman, Public Pensions: Choosing Between Defined Benefit and Defined Contribution Plans, 1999 (1) Law Review of Michigan State University Detroit College of Law (2000).

47. Sources, cont.
Jonathan Barry Forman, Making Pensions Work, in New York University Review of Employee Benefits and Compensation, Chapter 5, pp. 5-1 to 5-60 (Alvin D. Lurie ed., 2004).
National Academy of Social Insurance, Social Security Finances: A Primer (April 2005), available at
National Academy of Social Insurance, Options to Balance Social Security Over the Next 25 Years (Social Security Brief No. 18, February 2005), available at
Social Security and Medicare Boards of Trustees, 2005 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (2005), available at