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Guaranteed Retirement Accounts, Theresa Ghilarducci

Guaranteed Retirement Accounts, Theresa Ghilarducci

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Economic Policy institutE • 1333 H strEEt, nWsuitE 300, East toWErWasHington, Dc 20005202.775.8810WWW.EPi.org
EPI BRIEFING PAPER
EcoNomIc PolIcy INstItutE
NovEmBER 20, 2007
BRIEFING PAPER #204
For most o the last century, American retirement incomepolicy supported a combination o programs—SocialSecurity and ederal tax subsidies or traditional dened-benet pensions and or voluntary personal retirementaccounts—that enabled many people to stop working andto maintain their living standards in retirement, whilereducing old-age poverty rates.But the American retirement income security systemis breaking down. I current trends continue, poverty rates among the elderly will increase and middle-classretirees will nd that their retirement income will notpay or the liestyle they achieved while working. Tis willbe the rst time since World War II that the standard o living o elderly Americans declines while that o prime-age workers increases.Tis reversal is due to tax and regulatory policies thatail to promote retirement savings and penalize dened-benet plans. Regulations avor, and tax subsidies in-creasingly go to, the wrong kinds o retirement programs. As a result, 401(k) plans and other dened-contributionplans
1
that were designed to supplement, not replace, traditional pensions are growing at the expense o dened-benetplans that provide secure supplemental income to Social Security.ax breaks or 401(k) plans amounted to $110 billion in 2006, most o which went to households in the top taxbrackets. Tese tax breaks mostly cause wealthy households to shit savings to tax-avored accounts rather than increase
Guaranteedretirement accounts
 
tw   y
by tErEsa gHilarDucci
table o contents
Hw G r a wk 
.........................2
ovvw  h  y
....................................................3
sgh  wk  h  y
...............
4
Hw h Gra p  h  h  y
..................................................................8
Q  G r a
........11
Hw  G a pwh h  ?
.......................................................15
c
............................................................................................17
www.shedPpe.
 the EP iee  hh he e  he pe.
 
EPi briEfing PaPEr #204
 
novEmbEr 20, 2007
 
PagE 2
overall savings (Chernozhukov and Hansen 2004; Engenand Gale 2000)—thus the paradox that taxpayers aregiving up more and more revenue to promote retirementsavings while retirement security declines.In act, the Urban-Brookings ax Policy Centeround that income tax expenditures or retirementplans were actually larger than personal savings in2003, including contributions to retirement plans (Bell,Carasso, and Steuerle 2004). Tis occurred despite aconuence o actors that should have boosted savingsgrowth, including a sharp increase in the amount o money people could shelter rom tax in accounts that areintended or retirement savings, an older and more edu-cated workorce, and an economy in which the wealthy, who tend to save more, have received the lion’s share o recent income increases.Tis paper proposes a rescue plan or the Americanretirement income security system, based on a mixedsystem composed o Social Security, employer dened-benet pension plans, and a new type o personal retire-ment savings account called a Guaranteed Retirement Account (GRA). Tis rescue plan will not work withouta strong dened-benet pension system and a strongSocial Security system. ax breaks or 401(k)-style plansand IRAs will be converted into at tax credits to osetthe cost o these new accounts, so the plan will improvethe retirement security o most Americans withoutcosting taxpayers more than the current system.Te plan calls or all workers not enrolled in an equiv-alent or better dened-benet pension to enroll in a GRA,a plan that borrows the best eatures o dened-benetand dened-contribution plans, including guaranteedretirement benets that last a lietime, low administra-tive costs, and steady contributions. With GRAs, workers will accumulate savings in investment unds that earna rate o return guaranteed by the ederal government.Tese unds will be converted to lie annuities upon retire-ment. Along with Social Security benets, these will replaceapproximately 70% o pre-retirement earnings or thetypical retiree.Guaranteed Retirement Accounts eliminate the regu-latory and tax law avoritism that not only gives 401(k)-type plans wide discretion and little scrutiny, but does soat the expense o the deined-beneit system. Mostdened-benet plans yield a much higher benet thaneven Guaranteed Retirement Accounts, though they typi-cally also require average contributions o over 6% o pay-roll or sustainability.Te Guaranteed Retirement Account plan will helpreverse the slide in employer-provided dened-benetplans. Employers who are now considering convertingtheir dened-benet plans to 401(k)s to save money willnd that option much less attractive without tax benets,and will thereore be more likely to retain their dened-benet plans. Meanwhile, employers currently oering401(k)s as a recruitment and retention tool may switchto deined-beneit plans, since particular employerscannot distinguish themselves by oering GuaranteedRetirement Accounts (as with Social Security).Te rst section o this paper describes GRAs. Tesecond and third sections provide an overview o thecurrent system and describe how it increasingly ails tomeet 10 standards o a good retirement security system.Te ourth section explains how the Guaranteed Retire-ment Account plan would address these ailures, and theth answers questions about the plan. Te nal sectioncompares the plan to other reorm ideas, such as auto401(k) enrollment and raising the retirement age.
Hw G ra wk 
Structure 
. Guaranteed Retirement Accounts are like uni-versal 401(k) plans except that the government, as betsa large and enduring institution, will invest and managethe pooled savings.
Participation
. Participation in the program is mandatory except or workers participating in equivalent or betteremployer dened-benet plans where contributions areat least 5% o earnings and benets take the orm o lieannuities.
Contributions 
. Contributions equal to 5% o earningsare deducted along with payroll taxes and credited toindividual accounts administered by the Social Security  Administration. Te cost o contributions is split equally between employer and employee. Mandatory contribu-tions are deducted only on earnings up to the SocialSecurity earnings cap,
2
and workers and employers havethe option o making additional contributions with
 
EPi briEfing PaPEr #204
 
novEmbEr 20, 2007
 
PagE 3
post-tax dollars. Te contributions o husbands and wivesare combined and divided equally between their individualaccounts.
Reundable tax credit 
. Employee contributions are o-set through a $600 reundable tax credit, which takes theplace o tax breaks or 401(k)s and similar individualaccounts and is indexed to wage ination. Eligibility orthe tax credit is extended to part-time workers, caregiverso children under age six, and those collecting unemploy-ment benets. I an individual’s annual contributionsamount to less than $600, some or all o the tax credit isdeposited directly into the account in order to ensure aminimum annual deposit o $600 or all participants.
Fund management 
. Te accounts are administered by the Social Security Administration and unds are managedby the Trit Savings Plan or similar body. Tough undsare pooled, workers are able to track the dollar valueo their accumulations, as with 401(k)s and otherindividual accounts.
Investment earnings.
Te pooled unds are conservatively invested in nancial markets. However, participants earn axed 3% rate o return adjusted or ination, guaranteedby the ederal government. I the trustees determine thatactual investment returns have been consistently higherthan 3% over a number o years, the surplus will bedistributed to participants, though a balancing und willbe maintained to ride out periods o low returns.
Retirement age.
Participants begin collecting retirementbenets at the same time as Social Security, and thereoreno earlier than the Social Security Early Retirement Age.Funds cannot be accessed beore retirement or any reason other than death or disability.
Retirement benets.
Account balances are converted toination-indexed annuities upon retirement to ensurethat workers do not outlive their savings. However,individuals can opt to take a partial lump sum equal to10% o their account balance or $10,000 (whichever ishigher), or to opt or survivor benets in exchange ora lower monthly check. A ull-time worker who works40 years and retires at age 65 can expect a benet equalto roughly 25% o pre-retirement income, adjusted orination, assuming a 3% real rate o return (see
Table 1
).Since Social Security provides the average such worker with an ination-adjusted benet equal to roughly 45%o pre-retirement income, the total replacement rate orthis prototypical worker will be approximately 70%.
Death benets.
Participants who die beore retiring canbequeath hal their account balances to heirs; those whodie ater retiring can bequeath hal their inal accountbalance minus benets received.
ovvw  h  y
Social Security, pensions and personal savings are otenreerred to as the three pillars o the U.S. retirement system.
G r a (Gra)  (2006$)
* ae wke wk 40 e d ee  65. i-djed   ed   5%  e,  3% e e  e, 3.5% -, 3.5%  e, d expeed e  he rP2000 m te rep.
souRcE:
Jh W. Ehhd d sze t,  e  m,
 Analysis of Guaranteed Retirement Accounts
(2007).
table 1
Hgh avglw 
Earnings at Retirement 
$60,000 $40,000
 
$20,000
GRA accumulation at retirement 
228,143 152,095
 
76,048
 Annuity rom the above GRA* 
15,50010,3665,183
GRA annuity as a percent o pre-retirement earnings
26%26%26%
Social Security benefts as a percent o pre-retirement earnings
35%45%63%
Total replacement ratio with GRA and Social Security 
61%71%89%

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