Retirement Plans and
Personal Accounts

 Proposal  |  Asset Allocation  |  Savings  |  Social Security  |  Pension Plans  |  Annuities  |  Other  |  Resources 

The Pozen Proposal

Draft from Brookings Institution as of January 4, 2005 (PDF file)

According to news and internet sources such as factcheck.org, President Bush announced April 28 that he proposes something similar to Robert C. Pozen's “Progressive Indexing” plan.

“A Social Security Plan for All”  by Robert C. Pozen

“ ... Progressive indexing means the continuation of wage indexing for all workers retiring in 2012 and later years whose career earnings average $25,000 per year or less (indexed to wages over time). All thsee low-wage workers would receive the SS benefits they are presentkly scheduled to receive... .  Most of these low-wage workers do not have sources of retirement income other than SS--e.g., 401(k) plans or IRAs. Progressive indexing would also maintain current schedules for SS benefits for all retirees and all those retiring before 2012.

“The initial benefits of all workers with career earnings above $113,000 per year in 2012 (the maximum wage base subject to FICA taxes in that year) would be increased by price indexing -- the rise in prices during their working careers. These workers are relatively well off; most receive retirement income from 401(k) plans and IRAs in addition to SS benefits.

“The initial benefits of workers above $25,000 per year and lower than $113,000 per year in average career earnings would be increased by a proportional mix of wage and price indexing. For example, a worker with career earnings of $69,000 per year would have his or her SS benefits adjusted upward approximately 50% by wage indexing and 50% by price indexing.

“As a result, the SS benefits of middle and high earners would not grow as quickly as their schedule benefits would have otherwise. But this should not be terms a ‘cut’ for two reasons. First, the SS benefits of these workers in 2012 and later years will be higher, in nominal and real terms, than their SS benefits would have been had they retired in 2004 with the same average earnings during their careers. Second, these workers will have the option (but not the requirement) to earn back most (and perhaps all) of their escheduled benefits thruogh a combination of their slower growing SS benefits and the payments from their balanced accounts,.... .”

[The document goes on to cover "Balanced Accounts" which would be run by the trustees of the Federal Thrift Plan, and a measure to improve solvency.]

“... Starting in 2007, workers under 57 years of age will be permitted to allocate to BAs [Balanced Accounts] 2% of their FICA wages, up to $3,000 per year (increased annual to reflect price inflation). If these workers contribute 2% less a year to the SS system, at retirement they must accept a reduced level of SS benefits than otherwise would be provided by the SS system. Therefore, if these reductions are calculated accurately, the BAs should be revenue neutral to the SS system over the century. However, critics can be expected to point out that the Federal Government would need to borrow monies to finance the transition from the current system to PIBA [Progressive Indexing with Balanced Accounts], since SS needs current FICA taxes to make current payments to retirees.”

Click to read this PDF file now

[L.G. Harper: Question. Pozen proposes that “2% of [the] wages subject to FICA taxes ($90,000 in 2005 and rising annually), up to $3,000 per year” be available to workers to voluntarily allocate to a Balanced Account. It sounds as if the $3,000 itself would be allocated, but we believe Pozen means the tax on the $3,000 would be allocated, instead. Elsewhere he speaks as if 2% of the current SS revenues would be diverted. This needs to be clarified. According to the wording, if it is the wages themselves up to $3,000 if a person's earnings meet or exceed the $90,000 maximum amount of wages subject to Social Security taxes, then a person would have to divert these funds into the Balanced Account much as he or she now has to actually divert monies into an IRA or other retirement account. This is in sharp contrast to President Bush's proposal that 4% tax taken from the 12.4% FICA tax be diverted into a personal account.]

FactCheck.org's summary of Pozen's Proposal

  • Anyone now retired, or retiring before 2012, would get full benefits promised under current formula.
  • Workers averaging $25,000 a year or less (in today's dollars), and retiring after 2012, would continue to get full benefits promised under current formula. This would apply to the lowest 30 percent of earners.
  • Workers averaging $113,000 or more (in today's dollars), and retiring after 2012, would see their benefits rise only enough to compensate for the rising cost of living.
  • Workers in between would have benefits set by a sliding scale, with benefits rising more than the cost of living, but less than under the current formula.

Quote from the White House Fact Sheet, April 28, 2005

“Benefits Should Grow Faster in the Future For Low-Income Workers Than For Those Who Are Better Off.

“Under a reformed system, low-income workers should receive benefits that grow faster than inflation. In order to return the system to solvency, the benefit increases for wealthier seniors should grow no faster than the rate of inflation. This would be accomplished by adopting a sliding-scale benefit formula, similar to the Pozen approach.”

Back to Top

President's Proposal: – Personal Accounts

President's Current Proposal for Social Security:  Personal Accounts

White House web page current as of April 6, 2005

Presidential Action

  • President Bush has discussed the importance of Social Security and the need to fix the Social Security system for future generations of Americans. The President has assured Americans that he will not change the Social Security system in any way for those born before 1950.

* * *

Background on Presidential Action

  • Social Security is sound for today’s seniors and for those nearing retirement, but it needs to be fixed for younger workers – our children and grandchildren. The government has made promises it cannot afford to pay for with the current pay-as-you-go system.
    • In 1950, there were 16 workers to support every one beneficiary of Social Security.
    • Today, there are only 3.3 workers supporting every Social Security beneficiary.
    • In 2008 – just three short years from now – baby boomers will begin to retire. And over the next few decades, people will be living longer and benefits are scheduled to increase dramatically. By the time today’s youngest workers turn 65, there will only be 2 workers supporting each beneficiary.
      • Under the current system, today’s 30-year-old worker will face a 27% benefit cut when he or she reaches normal retirement age.
  • If we do not act to fix Social Security now, the only solutions will be dramatically higher taxes, massive new borrowing or sudden and severe cuts in Social Security benefits or other government programs.
    • Just 13 years from now, in 2018, the government will begin to pay out more in Social Security benefits than it collects in payroll taxes – and shortfalls then will grow larger with each passing year.
      • By the year 2027, the government will somehow have to come up with an extra $200 billion a year to keep the system afloat.
      • By 2033, the annual shortfall will be more than $300 billion a year.
      • By 2042, when workers in their mid-20s begin to retire, the system will be bankrupt – unless we act now to save it.
  • To keep the promise of Social Security alive for our children and grandchildren, we need to fix Social Security now once and for all. We can not pretend the problem doesn’t exist. The fact is Social Security will go broke when our young workers get ready to retire. Every year we wait the problem becomes worse for our children.
  • President Bush has pledged to work with Congress to find the most effective combination of reforms. He will listen to any good idea that does not include raising payroll taxes.
    • Fixing Social Security permanently requires a candid review of the options.
    • Over the years, many people from both parties have offered suggestions such as limiting benefits for wealthy retirees, indexing benefits to prices, instead of wages; increasing the retirement age; or changing the benefit formula to create disincentives for early retirement. All of these options are on the table.
  • As we fix Social Security, we must make it a better deal for our younger workers by allowing them to put part of their payroll taxes in personal retirement accounts.
    • Personal accounts would be entirely voluntary.
    • The money would go into a conservative mix of bond and stock funds that would have the opportunity to earn a higher rate of return than anything the current system could provide.
    • A young person who earns an average of $35,000 a year over his or her career would have nearly a quarter million dollars saved in his or her own account upon retirement.
    • That savings would provide a nest egg to supplement that worker’s traditional Social Security check, or to pass on to his or her children.
    • Best of all, it would replace the empty promises of the current system with real assets of ownership.
  • President Bush understands that reforming Social Security will not be easy. But he believes that if we approach this debate with courage and honesty, we will succeed. Our children’s retirement security is more important than partisan politics.
Back to Top

Counter Proposals

Comparison of Counterproposals

Washington Post, February 24, 2005

View a graphical comparison [as of 2/24/2005] of the proposals of:

  • President Bush
  • Robert Pzen, an investment executive who served on Bush's Social Secuiry tCommission
  • Robert M. Ball, former Social Security commissioner
  • Edward M. Gramlich, Federal Reserve Board governor
  • Peter J. Ferrara, an economis who wrote the first book for the Cato Institute about personal accounts
  • Peter A. Diamond and Peter R. Orszag, Democratic economists

Federal Reserve Governor Edward Gramlich's Proposal

A First Step in Dealing with Growing Retirement Costs, April 21, 2005

Remarks at the Spring 2005 Banking and Finance Lecture, Widener University, Chester, Pennsylvania

Proposals include one that "raises the retirement age three months every two years, or 1.25 years every decade, and taxes all wages for both Social Security and Medicare."

Mr. Gramlich cites the experience of countries such as Italy and Japan where the ratio of workers versus retirees is expected to drop "to less than 1"

Back to Top

Proposals On The Table

Social Security Long Range Solvency Proposals, April 25, 2005

The Office of the Chief Actuary (OACT) at Social Security has prepared a complete actuarial analyses, showing the estimated effects on the long-range financial status of the OASDI program, which would likely result from various proposals currently "on the table" that address the long-range solvency problem of OASDI. Differing assumptions are used, and the OACT groups its analyses according to the assumptions used.

Using Intermediate Assumptions of the 2004 Trustees Report:

See also these links:

Using the Intermediate Assumptions of the 2003 Trustees Report:

Using the Intermediate Assumptions of the 2002 Trustees Report:

Using the Intermediate Assumptions of the 2001 Trustees Report:

Back to Top

Proposals for Social Security Made in March 1981

The Trust Fund Was Depleted and Unfunded Debt was $5 Trillion

Click to read. The National Commission on Social Security made 88 recommendations to Congress to strengthen Social Security and avert a crisis.

White House Fact Sheet cites Thrift Savings Plan

Strengthening Social Security for the 21st Century, dated February 10, 2005

“... The system of personal retirement accounts would be similar to the Federal employee retirement program, known as the Thrift Savings Plan (TSP). Contributions would be collected and records maintained by a central administrator.

“Personal retirement accounts would be invested in a mix of conservative bond and stock funds. Workers would be permitted to allocate their personal retirement account contributions among a small number of very broadly diversified index funds patterned after the current TSP funds.

“Personal retirement accounts would be protected from sudden market swings on the eve of retirement. To protect workers as they near retirement, personal retirement accounts would be automatically invested in the "life cycle portfolio" when a worker reaches age 47, unless the worker and his or her spouse specifically opted out by signing a waiver form stating they are aware of the risks involved. The life cycle portfolio would gradually shift the allocation of investments as the individual neared retirement so that it was weighted more heavily toward low-risk bonds.

“Personal retirement accounts would not be eaten up by hidden Wall Street fees. Personal retirement accounts would be low-cost. Most of the administrative fees, estimated at 30 basis points, would be for recordkeeping, which would be done by the government, not investment management done by Wall Street.

“Personal retirement accounts would not be accessible prior to retirement. Account holders would not be allowed to make withdrawals from, take loans from, or borrow against their accounts prior to retirement.

“Personal retirement accounts could not be emptied out all at once, but rather would be paid out over time, as an addition to traditional Social Security benefits. Security procedures would be established to govern how account balances would be withdrawn at retirement.

“Personal retirement accounts would be phased in. To ease the transition to a personal retirement account system, participation would be phased in over three years according to the age of the worker. ...”

Back to Top

President establishes Commission for Strengthening Social Security (CSSS)

(emphasis added as underlined text)

On May 2, 2001 President Bush announced establishment of a bipartisan, 16-member Commission "to study and report specific recommendations to preserve Social Security for seniors while building wealth for younger Americans."

Guiding Principles

The Commission was asked to make recommendations to modernize and restore fiscal soundness to Social Security, using six guiding principles:

  • Modernization must not change Social Security benefits for retirees or near-retirees.
  • The entire Social Security surplus must be dedicated only to Social Security.
  • Social Security payroll taxes must not be increased.
  • The government must not invest Social Security funds in the stock market.
  • Modernization must preserve Social Security`s disability and survivors insurance programs.
  • Modernization must include individually controlled, voluntary personal retirement accounts, which will augment Social Security.
Back to Top

Testimony re Final Report of CSSS

Statement of Dr. Olivia S. Mitchell, International Foundation of Employee Benefit Plans Professor of Insurance & Risk Management, The Wharton School of the Univ. of Pennsylvania [and a CSSS member]

(emphasis added)

Testimony before the Senate Finance Committee, Hearing on the Final Report of the President's Commission to Strengthen Social Security, October 3, 2002

“... [T]he Commission worked with the 2001 Trustees' Report estimates, which showed that Social Security's benefit obligations will start to exceed annual cash income in 2016.(This date has shifted to 2017 in the most recent [that is, 2002] Trustees' Report.)  At this point, the federal government will have to allocate additional cash to the Social Security program to cover promised or scheduled benefits. Specifically, Congress will have to allocate not only all projected payroll tax dollars, but also more additional [sic] revenues to redeem debt held by the Social Security Trust Fund. The figure [see PDF file, p.2] shows that, under current law, these costs will escalate very rapidly, and the revenue and cost lines will forever pull further apart. ...”

Back to Top

Back to Top

A Self-Styled "Guide to the Debate"

NOT DIRECTLY FROM GOVERNMENT - links (underlined) to government sources provided by L.G. Harper

Pros vs. Cons: A Guide to the Debate

New York Times April 12, 2005, by Edmund L. Andrews

“... below the surface, the battles are becoming ever more specific: 'add-on' accounts versus 'carve-out' accounts; 'wage-indexing' versus 'price indexing'; higher payroll taxes versus delayed retirement ages.

The choices are often expressed in the jargon of benefit formulas and actuarial analysis. But they would lead to profoundly different results for retirees in the future.

Here is a guide to the debate.

How Big a Problem?

President Bush often warns about an $11 trillion deficit, and others refer to a $4 trillion deficit.  Both estimates come from the Social Security program's trustees, but neither sheds much light on its own.

The lower estimate is the projected gap between payroll tax revenues and benefit costs over the next 75 years. The $11 trillion estimate is the gap projected to infinity.

But the long-term problem is less daunting when it is compared with the amount of money people would be earning in the future. The trustees estimate that the 75-year shortfall is equal to about 1.92 percent of projected payrolls. In other words, the shortfall could be eliminated by immediately raising payroll taxes to 14.32 percent from 12.4 percent.

That would be a painful jump in payroll taxes - about $960 for a person who earns $50,000 a year - or a comparable drop in benefits. But the projected gap is smaller than the cost of making President Bush's tax cuts permanent, and it is about one-sixth the long-term gap projected for Medicare.

Looking at the Cash

Another way to look at the problem is in terms of cash flow. The trustees project that Social Security will start running deficits in 2017, and reserves in the trust fund will be used up by 2041. Without any changes in the law, the government would have to slash benefits by about 27 percent to match up with incoming payroll taxes.

But the cash-flow problems start much earlier, because drawing on the trust fund is different from Paris Hilton drawing on her inheritance. The government already spends the annual Social Security surpluses - $156 billion in 2004 - on regular government operations. If the surpluses disappear on schedule in 2017, the government will have to come up with cash equal to nearly two years of war costs in Iraq - and more each year after that.

According to the Social Security trustees, the annual shortfall will exceed $1 trillion in current dollars in 2040.

How Private Accounts Work

One crucial battle is over carve-out accounts and add-on accounts.

Mr. Bush favors a carve-out approach, so named because the money for private accounts would be carved out of existing payroll taxes. Mr. Bush's plan would allow people to divert up to 4 percentage points of their payroll taxes - about two-thirds of a worker's Social Security contribution - to private accounts.

This approach would require huge borrowing over the next two decades, possibly more than $4 trillion, because the government would lose revenue while still having to pay full benefits to retirees who had already earned benefits under today's system.

Mr. Bush and his supporters say the government would eventually get all the money back, because benefit costs would decline as retirees in the future relied more heavily on their private accounts.

Democratic lawmakers say that would be fiscally reckless. But many Democrats support add-on accounts, like today's 401(k) plans, that would come on top of today's system.

In themselves, neither type of account addresses the shortfall for Social Security.

Mr. Bush's plan would cut benefits, but would also cut tax revenues. Add-on accounts would increase savings - some would call it a new tax - but would not reduce government obligations.

At least for the moment, neither approach has enough support to pass Congress.

What's a Clawback?

If Mr. Bush's plan ever gets any traction in Congress, this could be a huge sleeper issue.

For every dollar that a person diverts from taxes to a private account under Mr. Bush's plan, the government would reduce that person's retirement benefit by a dollar, compounded at an annual interest rate of 3 percent above inflation.

In other words, a person would have to earn 3 percent a year on his or her private account - 6 percent, at today's inflation rate - to break even.

The administration based this offset - sometimes called a clawback - on the supposedly risk-free average return on Treasury bonds.

But administration officials worry privately that the break-even point is too high. The actual yield on inflation-protected Treasury bonds, known as TIPS, is only 2 percent.

A 2 percent offset would make personal accounts much less risky, and could mean thousands of dollars more for a person at retirement. But it could also greatly increase the cost of Mr. Bush's plan.

What's an Increase?

The last big changes in Social Security, based on recommendations to Congress from a bipartisan commission in 1983, sought to extend the program's solvency through a combination of tax increases and benefit cuts, and many experts say something similar is needed for the shortfalls ahead.

Mr. Bush staunchly opposes any increase in the payroll tax rate, but he has not ruled out an increase in the payroll tax ceiling, a step that could raise just as much money.

Under current law, payroll taxes are applied on wages and salaries only up to $90,000 a year. About 6 percent of workers earn more than that, accounting for about 15 percent of aggregate pay.

According to the National Academy of Social Insurance, imposing the payroll tax on all pay would raise 116 percent of the expected shortfall.

If the earnings ceiling were lifted, but people also earned extra benefits for their extra taxes, the academy estimated that the shortfall would still decline by 93 percent. That is because high-income people get a much smaller benefit for each dollar of payroll tax than low-income people do.

Several polls show that raising the ceiling on payroll taxes is more popular than any proposal for cutting benefits. But that does not mean it can pass Congress; any such proposal would invite bitter opposition from millions of rich, educated and politically engaged voters.

What's a Cut?

If Social Security benefits simply rose in line with inflation, experts say the program might not even have a shortfall. But under a law passed in 1977, benefits rise with wages, and wages rise about one percentage point a year on average faster than prices.

Earlier this year, White House officials floated the idea of price indexing. A person's initial benefit would have the same buying power in the future as today, but it would be about half what is now promised to a worker starting off now.

Actuarial experts say price indexing would save enough to close the projected $4 trillion shortfall. But experts say benefits would not keep up with rises in the standard of living. If benefits had remained constant ever since 1940, for example, retirees might have enough money for black-and-white television sets but not for cable television. More concretely, people would feel much poorer upon retirement because Social Security would replace a much lower share of a person's pre-retirement income.

Under current law, Social Security benefits would replace about 40 percent of a middle-income worker's pay in 2065, according to the Congressional Budget Office. With price indexing, it would replace only 21.7 percent.

A newer variant is progressive price indexing, which would apply the new formula only to people above a particular income level. Benefits for people in the bottom third of earnings would rise in line with the general standard of living.

Proposed by Robert Pozen, a former executive at Fidelity Investments, the idea has many supporters in the White House.

Government actuaries estimate the proposal could close about three-quarters of the projected shortfall over 75 years. But it could also deepen political divisions: high-income people already get a much smaller return on their payroll taxes than low-income workers, and that gap would widen every year.

Should People Work Longer?

Life expectancies have risen, and they are expected to keep rising in the future. Under changes imposed in 1983, the "normal retirement age" is gradually climbing to 67 from 65 for those reaching retirement in 2022.

If the normal retirement age was set at 67 immediately and raised to 68 over the next 12 years, the National Academy of Social Insurance estimated the shortfall would shrink by 28 percent. If the retirement age kept climbing gradually to 70, the shortfall would decline by 36 percent.

Many experts contend that delayed retirement would simply reflect improving health care. Critics counter that it would be unfair to people with physically demanding jobs or lower-income people, who on average die younger than the well-off.

Polls show none of the alternatives are popular with voters, which is why President Bush has yet to get specific and why even Republican lawmakers are pessimistic about passing a law this year.

Copyright 2005 The New York Times Company

Glossary for Retirement Planning

(Sources as Indicated)

    401(k) plan
    Employees contribute part of their salary and, in many instances, direct their own investments.Fees and expenses may be paid by your 401(k) plan.Most investments offered under 401(k) plans today pool the money of a large number of individual investors. Pooling money makes it possible for individual participants to diversify investments, to benefit from economies of scale and to lower their transaction costs.  For more information click here.(Department of Labor)
    Acknowledgment of risk
    An acknowledgment that any investment carries risk of loss.
    With respect to the government Thrift Savings Plan, acknowledgment of risk is described as:  an acknowledgment that any investment in the F Fund, C Fund, S Fund, or I Fund is made at the participant's risk, that the participant is not protected by the United States Government or the Board against any loss on the investment, and that neither the United States Government nor the Board guarantees any return on the investment."(CFR Title 5, Volume 3, Sec. 1601.1 Definitions
    Baby Boomers
    Individuals born from 1943 to 1960.Cf. Millennial Generation (1982 to present day), Generation X (1961-1981), and the Silent Generation (1925-1942).(Secretary of Labor's report on 2002 National Summit on Retirement Savings)
    Cash balance pension plan
    A defined benefit plan defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance.The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).  For more information click here.(Department of Labor)
    C Index Fund (under TSP)
    C Fund means the Common Stock Index Investment Fund established under 5 U.S.C. 8438(b)(1)(C).(Under a government Thrift Savings Plan)Code of Federal Regulations, Title 5, Volume 3).See Index fund
    Defined Benefit Plans
    A defined benefit plan is set up to pay a fixed annual amount to eligible employees during their retirement years. Your quarterly or annual contribution is based upon an actuarial determination of what your retirement benefits should be, not on profits.
    To figure out how much you should contribute, the plan administrators look at how much money must be contributed now in order for there to be enough money to pay you a fixed amount of benefit(s) in the future. (These projections assume a reasonable expected rate of return on the money you contribute to the plan).
    The maximum annual retirement benefit for any participant is the smaller of:
    • $165,000
    • Your average compensation from your three highest consecutive calendar years. (For example, if the income from your three highest income years added up to $150,000, the maximum amount you could contribute would be $50,000.)
    If you want benefits to start before you reach age 62, you face lower limits on your contributions. If you want benefits to start after age 65, the dollar limit is increased.
    If you're considering establishing a defined benefit plan, contact a professional pension plan consultant for advice.
    Defined benefit plans are usually best for those within 20 years of retirement, because they allow larger annual contributions than defined contribution plans. (TurboTax, ©1997-2005 Intuit Inc.)
    Defined Contribution Plans
    A defined contribution plan requires that an individual account be set up for each participant in the plan, even if the only participant in the plan is you. You can only contribute a fixed maximum amount to the plan each year. The contributions aren't based on your expected retirement benefit, but rather on a percentage of your income, a percentage that's specified in the plan.
    These plans are frequently set up by self-employed people as single-participant plans (a money purchase Keogh plan for yourself, for example), but the rules require that you also must make provisions for any employees you might have now or at any time in the future. (TurboTax, ©1997-2005 Intuit Inc.)
    EBSA
    Educational Materials from EBSA - the Employee Benefits Security Administration, of the U.S. Department of Labor, which provides a wealth of resources on employee benefits and pension plans.
    EGTRRA
    Economic Growth and Tax Relief Reconciliation Act of 2001.  (Internal Revenue Service Announcement 2001-106)
    ERISA - Employee Retirement Income Security Act of 1974
    F Fund (under TSP)
    F Fund means the Fixed Income Investment Fund established under 5 U.S.C. 8438(b)(1)(B). (Under a government Thrift Savings Plan)Code of Federal Regulations, Title 5, Volume 3).See Index fund
    G Fund (under TSP)
    G Fund means the Government Securities Investment Fund established under 5 U.S.C. 8438(b)(1)(A).
    G Fund interest rate means the interest rate computed under 5 U.S.C. 8438(e)(2). (Under a government Thrift Savings Plan)Code of Federal Regulations, Title 5, Volume 3).See Index fund
    Generation X
    Individuals born from 1961 to 1981.Cf. Millennial Generation (1982 to present day), the Baby Boom Generation (1943-1960) and the Silent Generation (1925-1942).(Secretary of Labor's report on 2002 National Summit on Retirement Savings)
    I Fund (under TSP)
    I Fund means the International Stock Index Investment Fund established under 5 U.S.C. 8438(b)(1)(E). (Under a government Thrift Savings Plan)Code of Federal Regulations, Title 5, Volume 3).See Index fund
    Index Fund
    A portfolio of investments that are weighted the same as a stock-exchange index in order to mirror its performance. This process is also referred to as indexing.
    Investing in an index fund is known as passive investing. The primary advantages to such a strategy is the lower management expense ratios on index funds. Also, a majority of mutual funds fail to beat broad indexes such as the S&P 500. (Investopedia.com) (See also C Index Fund, F Fund, G Fund, I Fund), and S Fund
    Life-cycle fund
    • ... A fund of funds invests in other mutual funds.Also known as life-cycle funds and multifunds, funds of funds allow investors to build a broadly diversified portfolio by making a single investment choice rather than several. ... (Fund of Funds:Simplifying 401(k) Investments by Randy Myers from: Nation's Business, November 1998)
    • As people age, they should move their portfolios from riskier investments like stocks to more conservative options like bonds and cash. ... [L]ife-cycle funds--also called target-date or target-maturity funds--jumped more than 65% last year, to $44 billion, with people buying them mostly in retirement plans like 401(k)s and IRAs. The Federal Government is a fan too, adding them to its employee-retirement plan this summer. President Bush has even suggested offering them for proposed privatized Social Security accounts.
      • However appealing, though, these funds do have their pitfalls. Typically, a life-cycle portfolio invests in a mix of other funds, delivering risk-reducing diversification--but also a chance for an added layer of fees. ...
      Another warning: each fund has its own one-size-fits-all mentality--and that size might not be yours. ...
      Finally, life-cycle funds are meant to be all-in-one portfolios. ... (The Life Cycle, by Barbara Kiviat, Time Archive
    • Click here to read CNN article on simplifying investment with life-cycle funds.
    Millenial Generation
    Individuals born from 1982 to present day.Cf. Millennial Generation (1982 to present day), the Baby Boom Generation (1943-1960) and the Silent Generation (1925-1942).(Secretary of Labor's report on 2002 National Summit on Retirement Savings)
    QDRO - qualified domestic relations order
    While division of marital property is generally governed by state domestic relations law, assignments of pension interests must comply with ERISA and the Internal Revenue Code requiring pension interests be assigned only if the judgment, decree, or order that creates or recognizes the interest of a spouse, former spouse, child, or other dependent in an individual's pension benefits constitutes a "qualified domestic relations order. It provides an exception to "anti-assignment and alienation" rules are intended to ensure that a participant's pension benefits are actually available to provide financial support during the participant's retirement years. A QDRO creates or recognizes the existence of an "alternate payee's" right to receive, or assigns to an alternate payee the right to receive, all or a portion of a participant's benefits.  For more information click here.(Department of Labor)
    S Fund (under TSP)
    S Fund means the Small Capitalization Stock Index Investment Fund established under 5 U.S.C. 8438(b)(1)(D).(Under a government Thrift Savings Plan)Code of Federal Regulations, Title 5, Volume 3).See Index fund
    Saver's Credit
    Enacted as part of EGTRRA in 2001, the Saver's Credit is an income tax credit that is available to eligible taxpayers who contribute to a retirement plan or IRA ... taxpayers with adjusted gross income that does not exceed $50,000.  (Internal Revenue Service Announcement 2001-106)
    SEP - Simplified Employee Pension
    SEPs are retirement programs established by you, as an employer, which allow you to provide retirement benefits for yourself and your employees without paying the start-up and operating costs of conventional plans. They are also an easy, low-cost retirement plan option for employers, instead of a separate retirement plan, where the employer makes contributions to his or her own Individual Retirement Account (IRA) and the IRAs of his or her employees, subject to certain percentages of pay and dollar limits.
    You can set up a SEP by using the Internal Revenue Service's "Model SEP" agreement Form 5305-SEP.  For more information click here.(Department of Labor)
    SEP-IRA
    The two critical differences between SEP-IRAs and other IRAs are that: (1) SEP contributions are generally made by employers, not employees. The amounts contributed to SEPs can be much larger than the amounts contributed to IRAs, and (2) As a general rule, up to 15 % of each employee's pay, including your own, can be put into a SEP-IRA each year.  For more information click here.(Department of Labor)
    Silent Generation
    Individuals born from 1925 to 1942.Cf. Millennial Generation (1982 to present day), Generation X (1961-1981), and the Baby Boom Generation (1943-1960).(Secretary of Labor's report on 2002 National Summit on Retirement Savings)
    SIMPLE - Savings Incentive Match Plan for Employees of Small Employers
    Helps employees of businesses with up to 100 employees to save for retirement through employee salary reductions and employer matching contributions ( similar to those found in a 401(k) plan). Some advantages are:
    • Eligible employees can contribute up to $6,000 each year through convenient payroll deductions.
    • Employers offer matching contributions equal to employee contributions (up to 3 percent of employee wages) or fixed contributions equal to 2 percent of employee wages.
    • SIMPLE plans eliminate many of the administrative costs associated with larger retirement plans.
    • Model plan documents, employee notices and salary reduction agreements are available from the IRS.
    (Department of Labor)
    Supplemental Security Income (SSI)
    [From SSA Q&A, not from Glossary] The SSI program provides monthly income to people who are age 65 or older, or are blind or disabled, and have limited income and financial resources. Effective January 2005 the SSI payment for an eligible individual is $579 per month and $869 per month for an eligible couple. If you are married, and only one person is eligible, a portion of your spouse's income may be counted. In addition, your financial resources (savings and assets you own) cannot exceed $2,000 ($3,000 if married). You can be eligible for SSI even if you have never worked in employment covered under Social Security.
    Generally, to be eligible for SSI, an individual also must be a resident of the United States and must be a citizen or a noncitizen lawfully admitted for permanent residence. Also, some noncitizens granted a special status by the Department of Homeland Security (DHS) may be eligible. (SSA Answers to Your Questions)
    Thrift Savings Plan or TSP
    COMMENT:President Bush has stated his proposed personal accounts proposal might be similar to the Thrift Savings Plan.
    The TSP is a retirement savings plan for civilians who are employed by the United States Government and members of the uniformed services.The Federal Retirement Thrift Investment Board, administers the Thrift Savings Plan (TSP). The Web site http://www.frtib.gov, provides information about the FRTIB electronic reading room [on TSP topics].
    Thrift Savings Plan accounts can be borrowed against subject to restrictions of (see 5 U.S.C. 8433(g) and (h)), unlike the proposal in the White House 2/10/05 Fact Sheet. They can be passed on to heirs.
    Click here for the latest (May 2004) Federal Register changes regarding TSP withdrawals.
    "A participant may make or change the manner in which future deposits to his or her account are allocated among the TSP's investment funds only in accordance with 5 CFR part 1601."(CFR Title 5, Volume 3, Sec.1600.11Types of elections
    "All participants may elect to invest all or any portion of their deposits in any of the TSP's five investment funds."(CFR Title 5, Volume 3, Sec. 1601.12Investing future deposits in the TSP investment funds
    "Acknowledgment of risk means an acknowledgment that any investment in the F Fund, C Fund, S Fund, or I Fund is made at the participant's risk, that the participant is not protected by the United States Government or the Board against any loss on the investment, and that neither the United States Government nor the Board guarantees any return on the investment."(CFR Title 5, Volume 3, Sec. 1601.1Definitions
    For more TSP details click here.

Back to Top

Savings

Statement of Benjamin J. Stein

Honorary Chairperson, The National Retirement Planning Coalition

before the Committee on Education and the Workforce, U.S. House of Representatives, February 25, 2004

MR: STEIN:  ... In the United States today we are facing a crisis in “retirement readiness.” More than 77 million “baby boomers” are rapidly approaching retirement. The majority are seriously under-prepared to meet the huge financial needs they will face. Other millions are in the "war baby" cohort already at retirement age and likewise have seriously under funded pension provisions on a personal level.

There are a number of factors fueling this crisis. Comprehensive pension plans, so called defined benefit plans, are rapidly becoming an endangered species. Instead, the responsibility for funding and managing retirement is now in the hands of the future retirees themselves through vehicles including 401(k)s, IRAs and other retirement vehicles.

While Social Security, which we assume you in government will maintain in a vital, strong form, was never intended to be the primary source of an individuals’ retirement income, it may play a diminishing role in the future for a variety of reasons.

At the same time, Americans are living longer, healthier lives. This means that retirement incomes will need to last longer than ever. In addition, healthcare costs are rising dramatically, putting a further demand on individuals’ retirement income needs.

And, on top of all of this, the stock market drop between 2000 and 2003 dramatically reduced a significant portion of many Americans’ accumulated assets earmarked for retirement.

In other words, there is a very large gap between what Americans have in the way of income for retirement and what they are going to need to retire. In the aggregate, the amount is in the trillions. On a per family basis, it is in the hundreds of thousands.

As a result, millions of Americans will fall short of accumulating the assets necessary to maintain the standard of living they have grown accustomed to when they retire. For many, this will require that they retire later than planned, try to find some form of employment in retirement to generate additional income or dramatically scale back their retirement lifestyles. None of these is desirable.

... There are a number of alarming statistics underscoring the seriousness of the retirement readiness crisis.

Many Americans assume that their retirement income will come primarily from Social Security. The reality is that Social Security was never intended to be the sole means of an individual’s retirement income. According to the Social Security Administration, in 2001, Social Security supplied only 39 percent of total retirement income for persons 65 and older. This percentage is likely to fall in the future.

Thus, the ability of Social Security to fully support the desired lifestyles of large numbers of baby boomers approaching retirement is clearly inadequate.

In the past, many Americans could depend on employer-sponsored pension programs to fund their retirement, but these programs are becoming less and less common. In 2001, only 30 percent of participants in private sector retirement plans were in defined benefit plans. And, according to Wilshire Associates, a global investment advisory firm, a significant majority of corporate pension plans are under funded.

Individually, many Americans have failed to plan for two key retirement income risk factors that may cause their retirement resources to run out well before their retirement objectives are fulfilled.

The first is “Longevity Risk,” the risk of outliving retirement assets. According to the Society of Actuaries, for those individuals that reach 65, more than 50 percent of single women and more than 40 percent of single men will still be alive at age 85. For married couples, in over 70 percent of the cases at least one spouse will still be alive at age 85. Consequently, if these survivors had planned to have their retirement income last just until their life expectancy of 85, they would have depleted their retirement savings considerably before they die, again, a highly undesirable situation.

The second, “Financial Market Risk,” is the risk that capital market fluctuation may result in the reduction and/or depletion of the value of one’s retirement assets. Unfortunately, there are market events, such as the recent three-year sustained market downturn, where a constant withdrawal strategy combined with prolonged negative market forces can result in a complete depletion of assets far sooner than planned.

The dramatically rising costs of healthcare have added to the problem. AARP estimates that 46 percent of people over 65 will live in nursing homes for some time during the next 20 years, costing as much as $100,000 per year. This is a devastating drain on resources for many retirees. The reality is that all healthcare costs are increasing year-to-year at a staggering pace. And it is clear that many pre-retirees have not planned for these costs.

For women, these challenges are even more dramatic. Since women live, on average, considerably longer than men, their money will need to last longer in retirement. Yet there is no sign that they have saved accordingly.

Probably the biggest factor fueling the retirement readiness crisis is that Americans simply are not saving enough. Charles Schwab estimates that individuals need to save $230,000 for every $1,000 they will need in monthly retirement income. However, only 31 percent of working Americans have saved $100,000 or more for retirement in total. Obviously, a major disconnect between needs and resources is in the making.

In addition, only about 15 percent of working-age Americans have an IRA, and only 22 percent contribute to a 401(k) plan, according to the Employee Benefit Research Institute and the U.S. Census Bureau.

... To address the retirement readiness crisis, it is imperative that all Americans develop a personal retirement plan. Americans need to understand that they must take personal responsibility for their financial futures.

Our group, The National Retirement Planning Coalition, is traveling around the country teaching that the solution to this problem will come from individual action by tens of millions of American families: making a retirement savings plan; finding a competent, respectable financial advisor to help with the plan; substantially adding to savings to make the plan a reality; and sticking to the plan during and after retirement.

A personal retirement plan enables each American to set specific retirement goals, put specific mechanisms in place to help them reach those goals and ensure a steady stream of income to support their retirement lifestyles. While each person’s retirement plan will be unique, most retirement plans will include a mix of savings and investment strategies.

We believe these plans should call for diversification of savings: mutual funds, bonds, real estate, stocks, and annuities. I especially like variable annuities because I saw them work so well in my parents' lives and because they shift the risk of outliving one's savings from the retiree to the insurer – and outliving your savings is a highly undesirable situation to be in.

The first place Americans should start is to evaluate their personal finances. Uncontrolled debt, particularly from credit cards, can significantly hinder retirement savings efforts. Reducing or eliminating such debt – which may first require evaluating personal spending patterns – will help ensure more money is available each month to put aside for retirement. This should be a top priority for prospective retirees.

Americans should also be sure to take advantage of available tax-deferred investment opportunities. Many companies offer 401(k), profit sharing or defined benefit retirement plans. These offer tax advantages and often incorporate matching contributions made by the employer. This option also makes it easy for Americans to save since the money is taken directly from their paychecks.

Other tax-deferred vehicles, such as IRAs, Roth IRAs and Keogh plans, should also be considered. And, by diversifying investment vehicles to include lifetime income-producing financial instruments, retirees can significantly minimize the impact of longevity and financial market risks to their accumulated assets. It is hard to overestimate the value of transferring risk from oneself to a large insurer where issues of lifetime financial security are concerned.

With the complexity of financial options available today for retirees, many people will need help and guidance. For many Americans, this will mean consulting with a certified financial advisor or retirement planner. Keeping current with tax law changes, private letter rulings and complicated tax planning can be a difficult task. In addition, portfolio risk exposure may need to be reduced as retirement nears. There are thousands of qualified financial professionals who can help Americans get started developing a plan, or direct them to the appropriate person. These people include bankers, life insurance agents, investment brokers, accountants, and estate-planning attorneys. They are there to help, and should be called upon.

The main requirement is to address the problem in one's head, then take action, and to start now. Any amount of planning and preparation is better than none, and none is what far too many Americans are doing. People always ask me if it's not too late to start when you're in your late forties or fifties. I always say, "It is never too late to do better than not starting at all." And for younger workers, the earlier they start, the easier the entire process will be.

But it will take some sacrifice and self-discipline. It is impossible to both spend as much as you want and save as much as you want for most people. We are a nation that is unmatched in spending. Now we have to learn about savings – and for the baby boomers, we have to learn fast. The prospect of being old and without adequate funds should be more than sufficient inducement to all but the very most resistant boomers.

The National Retirement Planning Coalition stands ready to help, especially with our website, www.retireonyourterms.org. There is a wealth of information there, including an extremely ingenious retirement calculator that tells users how much they need to save to reach their goals. We hope people will use it and take heed of its numbers.

In America, the greatest of free countries, we create our own reality in large measure. The National Retirement Planning Coalition’s goal is to educate Americans to create the reality of a comfortable, secure retirement by planning and action to increase and diversity their retirement savings.

Americans need to begin planning for their retirements immediately to make sure they will have the income necessary to achieve their desired retirement lifestyles, and also to have the peace of mind knowing that their financial futures are secure. My message to Americans is that it is not too late to ensure that you can Retire On Your Terms.

Thank you very much. ...”

Back to Top

2002 National Summit on Retirement Savings

convened by the Department of Labor under the SAVER Act of 1997 and co-hosted by White House and Congress

from President Bush's remarks, February 28, 2002

PRESIDENT BUSH:“... Saving is never easy; it's hard for some to do. But it's always worthwhile. Particularly when you think about the power of compounding interest. The power of compound interest is one of the great advantages of American citizens. And they must learn to use it. If a worker starts saving just $20 a week at age 22, and earns a 5.5 percent real interest rate on the investment, that adds up to a nest egg of nearly $180,000 by age 65.

“This summit was created by Congress to educate workers and citizens about the power and rewards of saving, and I want to thank you for participating. You've accomplished a great deal, but there's much more to do.

“Americans are saving too little -- often, dangerously too little. The average 50-year-old in America has less than $40,000 in personal financial wealth. The average American retires with only enough savings to provide 60 percent of his former annual income.This problem is especially acute for women and minorities.

“We must encourage for all our people the security and independence provided by savings. I want America to be an ownership society, a society where a life of work becomes a retirement of independence. ...”

2002 National Summit on Retirement Savings

convened by the Department of Labor under the SAVER Act of 1997 and co-hosted by White House and Congress

from Federal Reserve Chairman Greenspan's remarks, February 28, 2002

CHAIRMAN GREENSPAN:“One of the most complex economic calculations that most workers will ever undertake is, without doubt, deciding how much to save for retirement. At every stage of life, individuals ought to make judgments about their likely earnings before retirement and their desired lifestyle in retirement. Also implicit in such decisions are assumptions about prospective rates of return, life expectancy, and the possible accumulation of a nest egg for one's children. The difficulty that individuals face in making these projections and choices is compounded by the need to forecast personal and economic events many years into the future.

“Insurance companies make some of the same judgments in calculating premiums for annuity contracts or life insurance. Defined-benefit pension plans make similar calculations for large groups of employees. The social security and medicare trustees replicate some of the same calculations in their annual assessments of the actuarial viability of those programs. Aside from these institutionalized forms of retirement saving, of course, is the discretionary saving that each of us does consciously by periodically setting aside portions of our income. ...”

Back to Top

Secretary of Labor

at 2002 National Summit on Retirement Savings

A. from the Secretary of Labor Elaine L. Chao's report to President Bush, the Speaker and Minority Leader of the U.S. House of Representatives, the Majority and Minority Leaders of the Senate, and Chief Executive Officers of the States on the second convening (2002) of the National Summit on Retirement Savings

“... The theme of the Summit was “Saving for a Lifetime:  Advancing Generational Prosperity.” The Summit delegates participated in breakout sessions focusing on four specific generational groups: the Millennial Generation (individuals born from 1982 to present day), Generation X (1961-1981), the Baby Boom Generation (1943-1960) and the Silent Generation (1925-1942). ...”

B. from Remarks by Labor Secretary Elaine L. Chao, February 28, 2002

(emphasis added)

SECRETARY CHAO:  “... every year of our longer lives is bringing new change.Our workplaces and homes have been transformed by technology, from computers to cell phones to the Internet.The 20th century saw 19 business cycles, an explosion in global markets, and the creation of whole new industries and services.Where once people worked a lifetime for one employer, today’s 32-year-olds have already worked for an average of nine different companies.Innovation in the financial world has brought new investment vehicles, from mutual funds to defined contribution plans. ...

“... [I]f Americans are to enjoy a secure retirement tomorrow, they must plan and save today.For most people, this means learning new saving and investment strategies, and having lifelong awareness about their retirement needs.In this changing world, we need to re-learn how to save, in the same way that the changing workplace has required ongoing retraining in new job skills. ...

“... Our first challenge is to get the message out. ... create retirement-saving campaigns for four key generations  ... [A]t different life-stages, different life-demands affect how people save.Young people are starting careers and families.At mid-life, people find themselves working every hour of the day to manage busy lives and responsibilities.Older Americans are marshalling their resources for retirement. ...

“... It’s easy, for example, for young people to assume that retirement is tomorrow’s worry.But the magic of compounding means that the earlier we save, the larger our nest egg will be when we retire.Take a 20-year-old who’s got $100 in hand.Maybe she thinks that’s too little to save to make a difference.She needs to know that her $100, invested now, can grow to more than $1900 by the time she’s 65. That’s in real, inflation-adjusted dollars, by the way, and it assumes historical rates of growth.In contrast, if she waits until she’s 40 to save that $100, she’ll end up with less than half as much at age 65. ...

“... [O]ur second challenge [is] to channel our national energies, public and private, to give people the help they need to save.

“Let me start with employers.It is at the workplace that Americans can find some of the most important vehicles for personal retirement savings.Yet, today [2002], almost half of all working Americans do not have access to a company retirement plan.

“In businesses with 100 or fewer employees, only one worker in four participates in a company retirement plan. And even where employees have access to a plan, all too many fail to participate, or do not contribute as much as they can – especially, minority workers and youths.

“The private sector has a huge stake in turning this around. ... The financial community also has a stake in improving retirement saving. Currently, there are $2 trillion in 401(k) assets.This represents the hopes and aspirations of 42 million Americans for a secure, decent retirement.It also helps fuel America’s capital markets.But whether and how much people save depends on their confidence that their hard-earned money will be honestly and wisely invested.

“The fact is, most people simply don’t have the time or inclination to become experts in managing financial portfolios, even their own.They have jobs to do, children to take care of, and bills to pay.Especially in less certain economic times, people need help to chart their retirement strategies; strategies that will fit their lives and goals; strategies that respond quickly to new and changing investment options and realities. ...”

Back to Top

Congressional Attendee Comments

2002 National Summit on Retirement Savings

from Plenary Sessions of the 2002 National Summit on Retirement Savings (at the NSRS link, scroll down to find the Secretary's report on the Congressional Breakfast.See also remarks by President Bush and Federal Reserve Chairman Greenspan).

(emphasis added)

Congressional Breakfast - At the Congressional breakfast on the second day of the Summit, Senators Arlen Specter and Tim Johnson joined Representatives Earl Pomeroy and Sam Johnson to offer a variety of perspectives on retirement savings.

Senator Arlen Specter said he supported legislation to increase the limit on IRAs from $2,000 to $5,000. “To defer those funds for retirement is really very, very vital,” he said.

On the idea of personal retirement accounts for Social Security, Specter commented, “I’ve always been reluctant to see individuals manage their own portfolios because it is so complicated. But if a portion of it were to be set aside so that there was still security in the balance, and [the investing] was done with professional management, then I think it has a lot of merit.”

Representative Earl Pomeroy—an original co-sponsor of the SAVER legislation—began by noting that today’s retirement system arose haphazardly, yet the elements “all work together by fortuitous accident in kind of a complementary fashion,” providing universal coverage, basic income guarantees, strong incentives for personal responsibility and a significant role for employers.”

One problem, however, is the need to match an individual’s nest egg to their longevity, he said. “We’ve been looking at asset buildup. What about asset drawdown relative to years in retirement?” Annuity vehicles will become a popular tool for addressing this risk, he suggested. Congress can help with tax incentives to encourage the purchase of annuities. “I’m convinced that we’d save money in the long run doing the tax incentive for annuity purchase, instead of being prepared to pay full services for people who have outlived their assets by not having the protection,” he said.

Pomeroy argued against private retirement accounts, charging they would add unacceptable risk to a retirement system that already has “loads of risk.” Yet the two sides can find common ground, he urged. One way would to be to stop spending Social Security payroll taxes on unrelated government functions. “Budget projections show we’re on track to spend $1.5 trillion of cash coming in for Social Security on other government expenses over the next ten years. This is unacceptable.” He stated that Social Security funds should be reserved for Social Security.

Representative Sam Johnson, co-sponsor with Chairman Boehner of the Pension Security Act and Chairman of the House Subcommittee on Employer/Employee Relations, said his committee plans to address the fact that many companies simply cannot afford to offer retirement plans. The problem, Johnson said, is “well-intentioned government regulation” that imposes high costs on employers, preventing many from setting up plans.

Senator Tim Johnson, the final breakfast speaker, chairs the Senate’s Financial Institutions Subcommittee. Along with colleagues on the Banking Committee, Johnson has co-sponsored the Safe and Fair Deposit Insurance Act of 2002 (the Safety Act), which proposes that FDIC coverage be extended from its current limit of $100,000 to $250,000 in the case of retirement accounts. “We ought to allow people to put it into hometown banks and keep that money turning over in their local community, while at the same time giving themselves an insured safe haven for their money,” he argued.

Back to Top

Saver's Credit, made law in 2001

Scheduled to expire in 2006, this credit under EGTRRA (the Economic Growth and Tax Relief Reconciliation Act of 2001) balances, to some extent, the strong tendency of those tax credits aimed at encouraging savings to weigh favorably with taxpayers in the higher income brackets and to be meaningless to those who pay little or no tax, with or without the credits.

Internal Revenue Service Announcement 2001-106 on the Saver's Credit

The Saver's Credit is an income tax credit that is available to eligible taxpayers who contribute to a retirement plan or IRA ... taxpayers with adjusted gross income that does not exceed $50,000.  Click to download 5 page PDF publication.

Non-governmental, potentially partisan sources:

Principal Financial Group (commercial enterprise)

In a PDF formatted booklet, Principal Financial Group describes the Saver's Credit along with a sample explanatory notice employers can give to employees.

Retirement Security Project, supported by non-governmental groups the Pew Foundation, Georgetown University's Public Policy Institute and the Brookings Institution

Scheduled to expire in 2006, this credit under EGTRRA (the Economic Growth and Tax Relief Reconciliation Act of 2001) balances to some extent the tendency of tax credits to encourage savings to appeal more strongly to those in higher income brackets.

For a detailed explanation of the Saver's Credit by the Retirement Security Project,  click here.

Back to Top
Compound Interest

Speech by the President on "Strengthening Social Security" in Washington, D.C., April 21, 2005

PRESIDENT BUSH:“... what's called a personal retirement account. Essentially, that would be a conservative mix of bonds and stocks that grows over time. Today, the real rate of return on the Social Security for your money is about 1.8 percent. At that rate, it will take you nearly 40 years to double your money. If you put the money in the market and get a 4-percent return, your money will double in about 18 years. If you get the historical market average of 7 percent, your money will double in just over 10 years. ...”

Back to Top

IRA Savings

"Look Outside the Box"

From "Retirement 101:  5 Tips: Getting started on your retirement fund."

“... Look outside the box.

“If you're late ..., you might consider investing beyond the 401(k) and Roth IRA, which come with limits on contributions.

“If you are younger than 50-years-old, you can only contribute up to $14,000 of your pre-tax earnings to your 401(k) this year. If you are 50 or older, you can contribute up to $18,000. As far as Roth IRAs go, you can contribute up to $4,000 this year, or $4,500 if you are 50 or older.

“Think outside those traditional retirement investments and consider investing in real estate, mutual funds (bonds & equities), certificates of deposit, or money market accounts. With any type of investment, however, you'll want to do your research. ...”

Back to Top

Asset Allocation

American Association of Individual Investors - discussion

Asset Allocation and Retirement: Do You Need to Make a Change? by Iris Mack Dayoub

(excerpt from full article)

Picking an Allocation

Every portfolio has an asset allocation that can be described by the percentage of assets in each asset class or subcategory. Diversifying among a broad range of asset classes is an important part of the asset allocation process.

The theory behind this is that by diversifying among different asset classes, an investment portfolio can be constructed that has less risk than the weighted average of its component parts. In other words, different asset classes move up and down at different times. The up and down movements are a risk for each asset class, but when combined with other asset classes the ups and downs of the total portfolio tend to be smoothed, with less subsequent risk.

Effective diversification depends not only on the number of assets in a portfolio but also on the ways and degrees in which their responses to economic events tend to reinforce, cancel, or neutralize one another.

One of the most common asset allocation techniques considers only three asset categories: stocks, bonds, and cash (or cash equivalents such as money markets and CDs). More sophisticated models use subcategories such as: large-capitalization stocks, foreign stocks, Treasury bills, corporate bonds, etc. Other categories might include various styles such as growth and value.

There are many ways to choose an asset allocation for your portfolio. Let’s look at some of the advice currently proposed to the investing public:

  • Investor questionnaires on risk tolerance are readily available from brokerage firms, mutual fund and insurance companies, and various Web sites. Asset allocations are then recommended based on the answers.
  • Life cycle investing is an increasingly popular method—using the investor’s stage of life to determine the portfolio allocation. Many of the life cycle concepts assume that age is the paramount criterion.
  • Rule-of-thumb formulas are also sometimes suggested. One of the most popular formulas designed to provide a stage of life allocation—the Age Method—is to subtract your age from 100 to determine your stock percentage, put 10% in cash, and the remainder in bonds.

However, there is a way to determine an appropriate asset allocation for a portfolio that has nothing to do with age or multiple-choice questions, neither of which will provide you with the answers you need. I call this the Resource/Goal method for determining an appropriate asset allocation, and it is a three-step process:

  • The first decision is to establish a time horizon. The longer the time horizon, the more you can afford to allocate to equities. Money that is needed in the next few years should not be invested in stocks.
  • The second decision is to choose the asset classes that you want to include. Your attitude toward risk will help you choose the assets for your portfolio. Ask, “How much money am I willing to lose in a given year?” Then compare the losses that have occurred in a specific class during various market conditions. Consider also the size of your portfolio. High transaction costs may deter you from some classes, such as foreign bonds. Another consideration is your knowledge or experience—do not invest in an asset class that you do not understand.
  • The last decision is to determine how much of the portfolio to invest in each asset class so that the targeted return can be achieved. Your target return, taking into consideration your risk tolerance, will help determine the percentage in stocks, bonds, and cash; then, within each specific asset class, different strategies or styles can be used. The main objective here is to choose an allocation whose expected returns and risk accomplish the goals you have set for your portfolio.
Back to Top

Click here to read page and view tables.

Back to Top

Allocation Percentages

Percentage game:  What's the best asset-allocation scheme in retirement?

(emphasis added)

“Time was when pundits would use a simple formula to determine what percent of your nest egg should go in stocks, what percent in bonds and what percent in money-market funds. Retirees would simply subtract their age from 100 to determine what percent should go in stocks. Someone 80 years old would be told to put 20% in stocks and the balance, 80%, in bonds. Someone 60 would be advised to put 40% in stocks and the balance, 60%, in bonds.

“But that was then and this is now. Experts today suggest retirees approach the asset-allocation question the same way they did when they were saving for retirement: That they assess their sources of income during retirement, their time horizon and their tolerance for risk and select the asset allocation that matches those factors.

“But as with things investing, that's easier said than done. ...”

Read entire article free, including a chart of representative mutual funds and their asset allocations, at CBS MarketWatch.

Back to Top

Using a Range of Investment and Savings Opportunities Wisely, including:

  • Choosing the Level of Risk and Return that's Best for You

    •     Selecting investments with the appropriate risk levels

    • Higher and less predictable anticipated returns at greater levels of risk
    • Moderate and more probable anticipated returns at moderate levels of risk
    • Lower but more stable anticipated returns at low levels of risk

        from among

    • Savings Institutions: banks, savings & loans, credit unions, bank certificates of deposit (CDs)
    • U.S. Treasury securities: US savings bonds, T-bills, etc.
    • Mutual funds designed for differing investment goals
    • Insurance plans such as full life and annuities
    • The bond market other than US Treasuries, at various risk levels
    • The equity markets
    • "Tangible" investments including real estate, commodities, art, collectibles
Back to Top

Social Security

Informational pages on your retirement; provisions that may affect you:

No matter what your full retirement age is, you may start receiving benefits as early as age 62.

GOOD NEWS:  SSA is developing online access to your own earnings history. They are considering also providing online an estimate of your retirement benefits BASED ON your personal earnings record. [Source: SSA online feedback query.]

Back to Top

Other Aspects of Retirement

Look Before You Leap– or –

“Do I HAVE to watch for pitfalls as I retire?”

“Can't I retire Simply?”

A Message from Leslie Grey Harper

Several "pitfall" areas exist in connection with retirement and Social Security; and we have undoubtedly noticed only a few so far in gathering information for this web site.

You may not run across them, either, until it is too late ... UNLESS YOU ARE WARY and take the time NOW to investigate how your retirement income sources will be affected by the laws and regulations for your locality and your particular circumstances.

Things to consider (NOT an exhaustive list):

  • Exactly when can you collect your retirement money – or MUST you collect it? With a regular IRA you MAY collect it after age 59 1/2 and MUST begin to collect it at age 70 1/2. With Social Security there is early retirement at 62 with a permanent cut in benefits, or you may wait to begin collecting. Does your pension plan have specific requirements? What are the pros and cons of retiring earlier or later?
  • Tax treatment of capital gains: Will you sell your home? – if so, will you buy another?  Will you be selling securities where the "basis" is way below the selling price?
  • Tax treatment of retirement income: Do you have an IRA with taxable funds in it? Will you be working after you begin collecting Social Security? if so, your earnings can result in significant taxable income that obeys its own set of tax laws – investigate BEFORE you choose early retirement and BEFORE you earn the money, and avoid the pain. Read up on taxes, state by state, at Retirement Living Information Center.
  • How will your marital status affect the pension or Social Security money you expect to collect? Your spouse? There are wrinkles in the law when it comes to retirement and Social Security benefits for persons who have been divorced or widowed.
  • Governmental retirement plans instead of or alongside Social Security benefits can result in unexpected taxes or even loss of benefits – look into how this might apply to you, if you have paid into more than one such system.
  • Do you need to work MORE before you retire, to receive the level of benefits you deserve? Read the benefit projections you receive from Social Security prior to retirement; ask questions if necessary.
  • Take time to imagine what your tax forms will look like after retirement, and familiarize yourself with the calculations as they would apply to you if you were already retired and filling out your Form 1040.
  • Familiarize yourself with how your retirement programs will work, including any pension plans, insurance programs, veterans benefits, and governmental retirement plans you may be eligible for. Familiarize yourself with the rules for any IRA or 401(k) accounts you may have. Look at your assets in terms of their value if liquidated and what capital gains may be realized.
  • Don't forget your spouse! Do a thorough analysis of your spouse's retirement picture as well as your own, and analyze how each of you would make out if suddenly left alone.
  • If you are unable to care for yourself, then what? What people and what funds are available to help you? Are you eligible for any programs to help? Veterans benefits and Medicaid are just two possibilities.
  • Read some books, magazines and websites devoted to planning for your retirement. Don't just expect to quit work one day, and everything will take care of itself.

– Leslie Grey Harper

Location, Location, Location

Choose a Tax-Friendly State for Retirement

CBS MarketWatch:  The State of Tax Affairs:  Income only one consideration when retirees relocate, by Robert Powell, April 14, 2005

“We now know the least and most tax-friendly states for all taxpaying Americans. Maine, New York, Hawaii, Rhode Island and Wisconsin are the least tax-friendly states, according to the Tax Foundation's latest report. And Alaska, New Hampshire, Delaware, Tennessee and Alabama are the most tax friendly, says the Washington-based think tank. See the Tax Foundation's list at its Web site.

“... Fortunately, finding the most personal-income tax-friendly states for retirees is easy enough,... . Seven states – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – don't levy a tax on personal income. New Hampshire and Tennessee collect income tax, but only on interest and dividend income. And several states – Alabama, Hawaii, Illinois, Louisiana, Mississippi and Pennsylvania – exclude in full or in part Social Security and pension benefits from income tax.

“But just because a state doesn't tax personal income or excludes from income Social Security or pension benefits doesn't make it the most tax-friendly place for a retiree to live, says Wetzel. Yes, you may live in a state. But you really live in a city or town or county. And that city, town or country might be clobbering you with property and other taxes.

“... Bankrate.com and Retirement Living provide summaries of the sales and other taxes levied in any of the 50 states on their Web sites. And CCH provides summaries of the various estate-tax laws in each state.

“See the Bankrate Web site. Visit Retirement Living's site. Here is CCHs Web site.

“For her part, Frances Schafer, a senior manager with KPMG's National Tax Practice in Washington says Florida, Nevada, Alabama and California are viewed as estate tax friendly.

“... Besides being tax-friendly, retirees might also want to consider whether their retirement assets are protected from creditors. A recent Supreme Court ruling says IRA assets can be protected from creditors. ...”

Back to Top

Compare State Taxes Before You Move

The Federation of Tax Administrators has compiled the data

Back to Top

Pension Plan Section

Pension Plan Woes

GAO Report Abstract, May 31, 2005

Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules

(emphasis added)

“Pension funding rules are intended to ensure that plans have sufficient assets to pay promised benefits to plan participants. However, recent terminations of large underfunded plans, along with continued widespread underfunding, suggest  weaknesses in these rules that may threaten retirement incomes of these plans' participants, as well as the future viability of the Pension Benefit Guaranty Corporation (PBGC) single-employer insurance program.  We have prepared this report ... to assist the Congress in improving the financial stability of the defined benefit (DB) system and PBGC. ... This report examines: (1) the recent funding and contribution experience of the nation's largest private DB plans; (2) the funding and contribution experience of large underfunded plans, and the role of the additional funding charge (AFC); and (3) the implications of large plans' recent funding experiences for PBGC, in terms of risk to the agency's ability to insure benefits.

“Each year from 1995 to 2002, while most of the largest DB pension plans had assets that exceeded their current liabilities, 39 percent of plans on average were less than 100 percent funded.  By 2002, almost one-fourth of the 100 largest plans were less than 90 percent funded. Further, because of leeway in the actuarial methodology and assumptions sponsors may use to measure plan assets and liabilities, underfunding may actually have been more severe and widespread than reported. Additionally, 62.5 percent of sponsors of the largest plans each year on average made no cash contribution  because the rules allow sponsors to satisfy minimum funding requirements through plan accounting credits that substitute for cash contributions. From 1995 to 2002, only 6 unique plans in our sample were subject to an additional funding charge (AFC), the primary funding mechanism to address underfunding, a total of 23 times. By the time a firm was subject to an AFC, its plan was likely significantly underfunded, and such plans remained poorly funded. By using other funding credits, just over 30 percent of the time sponsors of these plans were able to forgo cash contributions in the years their plans were assessed an AFC. Two very large and significantly underfunded plans terminated without their sponsors owing a cash contribution in the 3 years prior to termination, illustrating further weaknesses in the AFC.  To the extent that financially weak firms sponsor underfunded plans, weaknesses in funding rules create a potentially large financial risk to PBGC and thus retirement security generally.  From 1995 to 2002, on average each year, 9 of the largest 100 plans had a sponsor with a speculative grade credit rating, suggesting financial weakness and poor creditworthiness. Plans of speculative grade-rated sponsors had lower average funding levels and were more likely to incur an AFC than other plans. As of September 30, 2004, PBGC estimated that plans of financially weak companies with a "reasonably possible" chance of termination had plans with an estimated $96 billion in underfunding.”

PDF files of the Highlights of this report and of the FULL REPORT (62 pages) are also available.

Back to Top

Chart from GAO Showing Defined Benefit Plan Funding Levels Have Been Worsening

This chart appears in the full report in black and white. To view just the chart as it appears, click here. Chart will open in a new window.

The GAO recommends that “The Congress should consider broad pension reform that is comprehensive in scope and balanced in effect. However, if features of current regulation are retained, Congress should consider measures to strengthen the AFC [additional funding charge] and limit the use of funding standard account credits to substitute for cash contributions.”

Back to Top

Here is a very negative assessment of the outlook for pension plans as a way of life. If DiMartino's predictions prove true, it would not mean that existing pension plans would suddenly vanish. Rather, other forms of retirement planning would have to take the place of pension plans. -- Leslie Grey Harper

– Column in The Dallas Morning News - September 29, 2005 –

Get Ready for the Demise of Pensions

by Danielle DiMartino

The latest airline bankruptcies offer more evidence that our system of private pensions is crumbling.

It's inevitable that Delta Air Lines and Northwest Airlines will argue to their bankruptcy judge that they must jettison their pension obligations onto the Pension Benefit Guaranty Corp., the public's insurer.

Then, American Airlines and Continental – the only two carriers that offer pensions and aren't in bankruptcy – will say that they have no intention of doing the same, but that it sure is unfair for them to have this burden while their competitors don't.

And eventually, every airline will be like Southwest and won't offer a pension plan.

That's just the way it will be.

More disincentive

Meanwhile, to cover the shortfalls caused by this rush, pension providers soon may have to pay more into the insurance fund. That would be further disincentive for companies offering pensions to 40-odd million Americans.

Yet another disincentive looms.

The Financial Accounting Standards Board dictates the way corporate America keeps its books. In a long-overdue act, the FASB is expected to add pension reform to its agenda this fall.

The reason for the extended delay is self-preservation. The FASB likes being around.

Lobbyists for the corporations that treasure their legal right to obfuscate the health of their pensions could make life very difficult for the standards board. (Recall that the battle over stock options expensing nearly killed the FASB.)

The FASB could propose doing something radical – such as requiring companies to show the market value of pension assets and the future costs of pension obligations on their balance sheets.

It may come as a surprise to know that these hard promises have always been kept off the balance sheet.

The reason it happens gets to the heart of why Enron failed to reflect all its debts on its books – the truth would have revealed the company for what it really was, an unattractive investment.

The fact is, pension accounting reform is the right thing to do.

Plans down the drain?

But Credit Suisse First Boston accounting analyst David Zion predicts it will toss many a retiree into the cold.

“A big change in pension accounting could be the tipping point that sparks significant changes in behavior by companies that sponsor defined-benefit pension plans,” he wrote recently.

These changes include a shift in assets – probably to bonds – plan restructurings, more plans being frozen or all-out dumping of plans.

The good news for workers is that these battles typically drag on for years.

That should give soon-to-be retirees a chance to take advantage of accelerated contributions to new retirement plans, such as Individual Retirement Accounts, before employers shutter their pension plans.

E-mail ddimartino@dallasnews.com

[scroll for full text]

Back to Top

Pension Plans

AARP Policy Institute on Taxation of Pension Plans

“Pension Coverage Lessons for the United States from Other Countries,” by Martin Rein, MIT and John Turner, AARP Policy Institute, Introduction, page 2

(emphasis added>

“... Three fundamental principles apply to the taxation of most pensions in the United States and most other countries taking this approach:

“1. Contributions are tax exempt (excluded from income) or tax deductible (E, signifying exempt).

“2. Pension investment earnings are tax exempt (E), and

“3. Pension benefits are taxable (T, signifying taxable).

“This general approach of taxation of pensions is sometimes called the EET model.In the United States, for most types of pension plans, employee contributions are not tax deductible, the 401(k) plan being an exception. ... in effect tax payments are deferred until benefits are received in retirement.

“This approach results in lost tax revenue to the national government.It can be an inefficient use of revenue because it induces higher-income workers simply to shift their other savings to tax-favored accounts.With a progressive tax system, under which lower-income workers have lower marginal tax rates, there may be little incentive for low-income workers to participate.A criticism of this approach is that it targets incentives to higher-income workers because they have higher marginal tax rates.There is a trade-off between the cost to the government from the tax incentives offered and the amount by which pension participation is increased.Also, there may be a tradeoff between encouraging low-income workers to participate and providing too much in incentives to higher-wage workers, who are more likely to participate in any case.”

Back to Top

401(k) discussion

Building Wealth:  The advantages of a qualified retirement plan

by Richard Powell, J.D., Ph.D., CPA

Fall 2000 issue, The Graziado Business Report of Pepperdine University Graziado School of Business and Management

Shows how a 401(k) could permit substantially greater accumulation of assets than investing the same money in equities. In-depth discussion of present and future tax issues with formulas for calculations at the bottom.

AFSCME Fact Sheet on Defined Benefit Plans

DEFINED BENEFIT vs. DEFINED CONTRIBUTION PENSION PLAN

This statement favors defined benefit plans.

(emphasis in original)

“Much has been made of the growth of defined contribution (401K type) pension plans for American workers. Despite claims to the contrary, defined benefit pension plans still provide the best benefit to retired workers and to workers planning their retirement. Defined benefit plans are not only better for employees, but are also better for employers, and are simply better public policy.

Defined Benefit Pension Plans are Better for Employees

  • Defined benefit pension plans provide guaranteed income security to workers for their retirement; no matter what happens in the stock market, how long an employee lives after retirement, or whether he or she becomes disabled.
  • Employees are not subject to investment risk. Pension funds invest assets with an optimum mix of growth potential and risk. Studies show that individuals responsible for their own retirement income typically invest too conservatively, and thus do not adequately protect their retirement benefits from inflation.
  • Retirement benefits are not dependent on employees’ ability to save. Lower-income workers and workers facing declining incomes lose twice under defined contribution plans, where employer contributions are often tied to employee savings. While defined benefit plans often have mandatory employee contributions, their contributions provide workers a secure retirement.
  • Defined benefit plans provide cost of living adjustments and pension formulas that are tied to the highest-paid years, which protect employees from inflation while they save throughout their working lives.
  • Death and disability insurance, which are typically provided under definded benefit plans, provide income security for participants. Defined contribution plans provide no insurance benefit in case of an employee’s death or disability; employees must purchase this coverage at additional cost.
  • Defined benefit plans provisions can allow for portability with shorter vesting periods, reciprocity agreements, and buybacks for prior or related service. Defined benefit plans may also allow employee borrowing.

Defined Benefit Pension Plans are Better for Employers

  • Defined benefit plans allow employers to set and to guarantee income-replacement goals for their workforce. Employees with inadequate retirement income may work longer at higher wage rates than their younger replacements, negotiate higher employer contributions to their 401K type pension plans, or even sue employers for not providing enough investment and retirement-planning education.
  • Employers benefit from the favorable investment performance of pooled pension fund assets. The wide range of investment options open to large funds makes it possible for employers to provide adequate benefits to employees while limiting contributions. Studies of some pension funds show that investment earnings have exceeded both actuarial assumptions and the interest credited to employee accounts over the last two decades.
  • Defined contributionplans are not a "magic pill" to solve employers’ budget constraints. Defined contribution plans are not more efficient at providing benefits equal to defined benefit plans. Comparable benefits often require comparable employer contributions. Plus, features such as employee loans, investment options, education and information obligations, and periodic statements can make defined contribution plans expensive to administer.
  • Employers face high costs to switch to defined contribution plans. For example, Michigan offered early retirement to employees — at a cost of $270 million — to win support for a switch to a defined contribution plan. The high cost of defined benefit plans today is often the result of large, unfunded liabilities accumulated for years, that still have to be paid even if the employer switches to a defined contribution plan. This is why states like West Virginia, which moved certain employees to a defined contribution plan, now favor switching back.
  • Defined benefit plans offer an incentive for government employees to stay in public service. Many valuable employees, who would earn a higher salary in the private sector, stay in public service because of the guarantee of income security when they retire.
  • Defined benefit plans are not hard to budget. Actuarial projections are made each year and announced months in advance, allowing employers adequate time to budget the expense. Pension liability in mature, ongoing plans typically changes little from year to year.

Defined Benefit Pension Plans are Better Public Policy

  • Defined contribution plans shift the cost of administration onto employees. Employees pay significant management fees to mutual funds and other plan services directly out of their retirement savings, whereas pension funds use their own managers.
  • Defined contribution plans can create other social costs. Individuals who fare poorly investing their defined contribution plan account, or who outlive their retirement benefit, may use more social services and need financial assistance such as Medicaid and welfare benefits in their retirement years, offsetting any perceived "savings" to taxpayers.
  • Defined benefit plans promote retirement savings among lower-income workers, by mandating a single, low level of employee contribution to participate.
  • Many defined contribution advocates resent pension fund power and influence on corporate governance issues. Corporations and executives who don’t like pension fund activism hope to use defined contribution plans to erode investor power, by breaking up large pension plans into small pools of individuals’ savings.”

American Federation of State, County and Municipal Employees, AFL-CIO
[included here as representative of a body of government workers]

Back to Top
Back to Top

Pension Reform Proposals

Information Sites:

The Administration's Proposal for Pension Reform at EBSA, Department of Labor

This site is the official location for all Administration documents pertaining to President Bush's pension reform proposal as to single employer defined benefit pension plans. It includes all Federal Agencies as well as Department of Labor and is kept up to date.

{More to Come}

Back to Top

Other Options

Working after Retirement Age

Senate Special Committee on Aging, April 27, 2005

  • Prepared Speech of US Senator Gordon Smith, R-Oregon, Committee Chairman

    • (Excerpts - bullet points in original)

    • As the baby boom generation approaches retirement, significant changes will occur with respect to the makeup of the American workforce.
    • According to the Census Bureau, the portion of the American population that is age 65 and older will increase from 12.3 percent in 2002 to 18.2 percent in 2025.
    • Furthermore, the number of Americans between the ages of 55 and 64 will grow by about 11 million from 2005 to 2025. While the number of Americans between the ages of 25 and 5 4– the age group with the highest labor force participation 4– will only increase by about 5 million during the same period.
    • These trends may result in future labor shortages 4– which could hurt both the competitiveness of many American businessse and our economic growth as a whole.
    • Furthermore, with the number of baby boomers that will be retiring shortly, we must also be concerned with the “brain drain” that may occur. Our workforce will be losing some of our most experienced workers 4– many of whom have skills that simply are not replaceable.
    • The effects of these trends can be lessened if older workers decide to stay in the workforce longer. And it appears from recent data that this is occurring.
    • For example, according to the Census Bureau, from 1995 to 2004, the percentage of 62 to 64 year old men employed in March of each year rose from 42 percent to 48 percent. There was even more growth with respect to women.
    • In line with this trend of working longer, a 2004 AARP survey found that 79 percent of baby boomers plan to work in some capacity during their retirement years.
    • . . . Unfortunately many Americans have not saved enough to retire without continuing to work.
    • . . . the AARP study also found that the desire to stay mentally active, the desire to stay physically active, and the desire to remain productive or useful were also major reasons for working in retirement.
    • . . .
    • According to the 2005 AARP survey, of all the working respondents, 38 percent indicated that they would be interested in participating in phased retirement. Of those workers who expressed interest . . ., 78 percent expect that . . . such a plan would encourage them to work past their expected retirement age.
  • Prepared Statement of Barbara Bovbjerg, Director, Education, Workforce and Income Security, US Government Accountability Office (GAO) which includes a prepared report by the GAO and charts to be presented at this hearing:  "REDIFINING RETIREMENT: Options for Older Americans"

    • (click charts to see PDF version of Statement)

  • class=bigger>(Not government) CNNMoney gives pro-early-retirement case

Percentage of GDP of Cost of Each Program: Social Security, Medicare, Medicaid, 2000-2080

Percentage of Persons Age 55 and Above Participating in Labor Force, 1970-2004

Back to Top

May 16, 2005    United States Senate – Republican Policy Committee – A Broader Perspective on Social Security Reform Retirement-Income Security:  Reducing the Disincentives for Working in Retirement

(all emphasis in original PDF version)

Executive Summary

  • With Social Security reform a top priority, President Bush has opened a debate on a critical aspect of a much broader issue – ensuring that Americans can provide adequate income for their retirement.
  • At its inception, Social Security was viewed as one leg of a "three-legged stool," with personal savings and pension benefits making up the vast majority of retirement income. Today, it is the primary source of retirement income for two-thirds of beneficiaries.
  • With more Americans choosing to continue working past retirement age in recent years, a new "fourth" leg of that stool has emerged – income from working past retirement age.
  • As the baby-boom generation begins to retire over the next decade and is succeeded by a significantly smaller generation, research shows a potential labor shortage of more than 6 million qualified workers by 2012, increasing to 35 million workers by 2030.
  • Without the continued participation of older individuals in the workforce, U.S. companies are likely to loose [sic] more experienced, skilled employees than they can readily replace, which could have far-reaching effects on productivity and economic growth.
  • Significant financial disincentives face older workers considering whether to remain in the workforce, including the two-tier tax imposed on Social Security benefits, which can affect a beneficiary making as little as $13,367 in wages from continued employement, and the Social Security earnings limit, which penalizes many banaficiaries between the ages of 62 and 65 who continue in the workforce.
  • Several options exist for Congress to address these disincentives, including:
    • partial or complete repeal of the tax on an individual's Social Security benefits.
    • repeal of the Social Security earnings limit, which can result in an effective tax rate of more than 100 percent in certain cases in which individuals elect early Social Security benefits and choose to remain working.

Taxing Social Security Benefits

Under current law, Social Security beneficiaries are subject to two tiers of taxation on their benefits if their income exceeds certain thresholds. For purposes of determining the thresholds, income consists of three components:  (1) adjusted gross income (e.g., wages, dividends, taxable distributions from pensions and Individual Retirement Accounts), (2) one-half of Social Security benefits, and (3) income from tax-exempt bonds.(fn.13)

As illustrated in Figure 3. [below], single individuals with income above $25,000 (including one-half of their Social Security benefits) are subject to tax on up to 50 percent of their Social Security benefits. Furthermore, to the extent that their income exceeds $34,000 per year, up to 85 percent of their benefits are taxable.

Click for larger image

As a result, in 2005 a 65-year-old individual receiving maximum Social Security benefits who earns as little as $13,367 in wages from continuing in the workforce will exceed the first threshold, and his Social Security benefits will begin to be taxed (up to maximum of one-half of his benefits).(fn.14)  And, to the extent that the individual has non-wage income, such as pension distributions, dividends, or interest on tax-exempt bonds, the amount of wages he can earn without triggering the tax on Social Security benefits declines dollar for dollar.

Thus, earning an extra dollar in wages boosts his taxable income by $1.50 – one dollar of wages plus one-half of each benefit dollar above the first threshold – which translates into an effective marginal tax rate on that extra dollar of 22.5 percent, assuming he is in the 15-percent tax bracket.(fn.15)  Additionally, the individual continues to pay Social Security, Medicare, and state income taxes on his wages,(fn.16), which increases the overall tax burden even further.

To the extent that a 65-year-old individual earns more than $22,367, she triggers the second-tier tax, subjecting up to 85 percent of her Social Security benefits to tax.(fn.17)  In terms of the tax rates, this second-tier tax can result in an effetive tax rate as high as 46.25 percent, assuming the beneficiary is in the 25-percent tax bracket.(fn.18)  At the extreme, with the maximum statutory income-tax rate currently at 35 percent, a Social Security beneficiary who chooses to keep working may face a greater effective tax rate on Social Security benefits than the highest-earning Americans endure on their regular income.

The tax on Social Security benefits for married couples is even more onerous because of the inherent marriage penalty in the tax. As illustrated in Figure 3 [above] (on page 5), the income thresholds for married couples are not double the level applicable to single persons – in fact, they are less than 130 percent of the threshold for singles.

[We recommend reading this informative, 11 page document in its entirety.]

______________

13. Section 86(b) of the Internal Revenue Code (IRC) of 1986 (26 U.S.C. §86(B)).

14. The maximum Social Security benefit for 2005 of $23,268. SSA, "Program Highlights, 2004-2005," – http://www.ssa.gov/policy/docs/quickfacts/prog_highlights/index.html. One half of such benefits ($11,634) plus wages of $13,367, exceeds the 50-percent threshold for single taxpayers by $1.

15. One dollar of wages plus 50 cents of taxable Social Security benefits equals $1.50 of taxable income. At the 15-percent tax rate, such income creates a tax liability of 22.5 cents. Thus, the dollar earned results in an effective tax rate of 22.5 percent (i.e., $0.225/$1.00 = 0.225 or 22.5 percent).

16. Workers pay 6.2 percent in Social Security tax (i.e., FICA) on wages up to $90,000 in 2005; employers are responsible for a matching tax payment. IRC §§3101 and 3111.

17. Assuming the maximum Social Security benefit for 2005 of $23,268, one half of such benefits ($11,634) plus wages of $22,367, exceeds the 85-percent threshold for single taxpayers by $1.

Back to Top

Resources

    Booklets on Retirement Planning and Saving for Retirement
  • Department of Labor - see above booklets

(More Coming Soon)

Back to Top

Haven't Seen Enough Advertising Yet?

We try to avoid patently commercial links, but some patently commercial links have good information. So, if you don't mind ads, try these:

DISCLAIMER: L.G. Harper does not endorse or have any connection with any of the companies linked below (or above, for that matter). Use these links at your own risk.

Back to Top

 Return to Social Security Page 

Google

(Opens new window)        Web        LHEonline's server

To search this page use CTRL-F.