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EPI BRIEFING PAPER
EcoNomIc PolIcy INstItutE
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NovEmBER 20, 2007
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BRIEFING PAPER #204
For most o the last century, American retirement incomepolicy supported a combination o programs—SocialSecurity and ederal tax subsidies or traditional dened-benet 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 liestyle 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 thatail to promote retirement savings and penalize dened-benet plans. Regulations avor, and tax subsidies in-creasingly go to, the wrong kinds o retirement programs. As a result, 401(k) plans and other dened-contributionplans
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that were designed to supplement, not replace, traditional pensions are growing at the expense o dened-benetplans 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 shit savings to tax-avored accounts rather than increase
Guaranteedretirement accounts
tw y
by tErEsa gHilarDucci
table o contents
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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 Centeround 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 aconuence 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 workorce, 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 dened-benet 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 dened-benet pension system and a strongSocial Security system. ax breaks or 401(k)-style plansand IRAs will be converted into at tax credits to osetthe 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 dened-benet pension to enroll in a GRA,a plan that borrows the best eatures o dened-benetand dened-contribution plans, including guaranteedretirement benets that last a lietime, 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 lie annuities upon retire-ment. Along with Social Security benets, 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 deined-beneit system. Mostdened-benet plans yield a much higher benet 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 dened-benetplans. Employers who are now considering convertingtheir dened-benet plans to 401(k)s to save money willnd that option much less attractive without tax benets,and will thereore be more likely to retain their dened-benet plans. Meanwhile, employers currently oering401(k)s as a recruitment and retention tool may switchto deined-beneit plans, since particular employerscannot distinguish themselves by oering 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 theth answers questions about the plan. Te nal sectioncompares the plan to other reorm ideas, such as auto401(k) enrollment and raising the retirement age.
Hw G ra wk
Structure
. Guaranteed Retirement Accounts are like uni-versal 401(k) plans except that the government, as betsa 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 dened-benet plans where contributions areat least 5% o earnings and benets take the orm o lieannuities.
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,
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and workers and employers havethe option o making additional contributions with
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post-tax dollars. Te contributions o husbands and wivesare combined and divided equally between their individualaccounts.
Reundable tax credit
. Employee contributions are o-set through a $600 reundable tax credit, which takes theplace o tax breaks or 401(k)s and similar individualaccounts and is indexed to wage ination. Eligibility orthe tax credit is extended to part-time workers, caregiverso children under age six, and those collecting unemploy-ment benets. 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 Trit 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 axed 3% rate o return adjusted or ination, 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 retirementbenets at the same time as Social Security, and thereoreno earlier than the Social Security Early Retirement Age.Funds cannot be accessed beore retirement or any reason other than death or disability.
Retirement benets.
Account balances are converted toination-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 $10,000 (whichever ishigher), or to opt or survivor benets in exchange ora lower monthly check. A ull-time worker who works40 years and retires at age 65 can expect a benet equalto roughly 25% o pre-retirement income, adjusted orination, assuming a 3% real rate o return (see
Table 1
).Since Social Security provides the average such worker with an ination-adjusted benet equal to roughly 45%o pre-retirement income, the total replacement rate orthis prototypical worker will be approximately 70%.
Death benets.
Participants who die beore retiring canbequeath hal their account balances to heirs; those whodie ater retiring can bequeath hal their inal accountbalance minus benets received.
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Social Security, pensions and personal savings are otenreerred to as the three pillars o the U.S. retirement system.
G r a (Gra) (2006$)
* ae wke wk 40 e d ee 65. i-djed ed 5% e, 3% e e e, 3.5% -, 3.5% e, d expeed e he rP2000 m te rep.
souRcE:
Jh W. Ehhd d sze t, e m,
Analysis of Guaranteed Retirement Accounts
(2007).
table 1
Hgh avg lw
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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