examining retirement security chief of staff retreat february 20 – 22, 2009 copies of this...
TRANSCRIPT
Examining Retirement Security
Chief of Staff Retreat
February 20 – 22, 2009
copies of this presentation can be found atwww.antolin-davies.com
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Defined Benefit vs. Defined Contribution
Operative difference is one of risk.
Defined benefit plan puts risk on the plan provider.
Defined contribution plan puts risk on the worker.
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Defined Benefit vs. Defined Contribution
Since returns are commensurate with risk:
Defined benefit plan yields a lower return (generally).
Defined contribution plan yields a higher return (generally).
* Warning: Defined benefit plans can hide risk. There are limits on PBGC and legal challenges are possible.
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Since 1985, defined contribution plans have displaced defined benefit plans.
Aged unit = Husband and wife age 65 or older, or a single person age 65 or older.
Asset income = income generated from savings, CDs, stocks and mutual funds, real estate.
Pensions include both defined benefit and defined contribution plans.
Asset Income
Pensions
Social Security
Public Assistance
Wage Earnings
Proportion of “Aged Units” Receiving Each Income Type
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90% of aged units obtain income from private retirement accounts.
Share of Aged Income by Source
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Asset income = income generated from savings, CDs, stocks and mutual funds, real estate.
Pensions include both defined benefit and defined contribution plans.
Private retirement accounts generate 33% of the aged’s incomes.
Aged unit = Husband and wife age 65 or older, or a single person age 65 or older.
White
Non-married
Married Couples
Black
Median Real Income of Aged Units
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Share of Aged Income by Source and Income Level
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Private retirement accounts generate 40% of income.
Private retirement accounts generate 6% of income.
Earnings account for a large share of income.
Who pays the Social Security tax?
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10
Statutory Burden vs. Economic Burden
The statutory burden is shared by the employer and the employee (6.2% each). What is relevant is the economic burden.
Example
If a gallon of gas sells for $1.75 when there is no tax, but $2.00 (including tax) when the government requires the seller to pay a $0.50 tax per gallon, then the statutory burden is on the seller, but the economic burden is shared equally by the buyer and seller.
In response to the tax, the seller lowered his price by $0.25.
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Demand
Supply
$1.75
$1.50
$2.00
$0.50 tax
Seller pays $0.25 per unit
Buyer pays $0.25 per unit
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Demand
Supply
No Tax Price
Price
Price plus Tax
Worker pays this
Employer pays this
Workers supply labor.
Employers demand labor.
If the economic burden of the Social Security tax were the same as the statutory burden, the economic burden would look like this.
Jobs
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Demand
Supply
No Tax Price
Price
Price plus Tax
Demand becomes more elastic (i.e., “buyers become more sensitive to price changes”) when there are more alternatives to buying this product.
Jobs
Worker pays more
Employer pays less
Intuitively: The more alternatives to hiring (e.g., spread the work load to other workers, automation, etc.) the employer has, the more able the employer is to pass on the tax to the worker in the form of lower wages.
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Demand
Supply
No Tax Price
Price
Price plus TaxWorkers supply labor.
Employers demand labor.
Jobs
Worker pays this
Employer pays this
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Demand
Supply
No Tax Price
Price
Price plus Tax
Supply becomes less elastic (i.e., “sellers become less sensitive to price changes”) when the seller has fewer alternatives to selling.
Jobs
Worker pays more
Employer pays less
Intuitively: The fewer alternatives to employment the worker has, the more able the employer is to pass on the tax to the worker in the form of lower wages.
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Who Bears the Social Security Tax Burden
The full economic burden (12.4%) of the Social Security Tax is more likely to fall on the worker when:
1. The employer has more alternatives to hiring the worker.
2. The worker has fewer alternatives to working for the employer. Lesser skilled workers are more likely to bear the entire cost of the Social Security tax.
Studies suggest that almost all workers bear the entire cost of the Social Security tax.
What are Social Security retirement benefits worth?
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Three ways to evaluate the benefit of an investment
1. Internal Rate of Return
2. Net Present Value
3. Breakeven Point
* Technically, Social Security is neither a defined contribution plan because tax receipts are not earmarked for the individual, nor is it a defined benefit plan as Congress can unilaterally alter the terms at any time.
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Internal Rate of Return
The effective interest yield after accounting for monies paid in, monies received, and the timing of each.
Example
Pay $100 each year for 10 years and receive back $1,500 at the end of the 10th year.
IRR = 10%
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Net Present Value
The “cash in hand” equivalent value of a stream of future payments.
Example
Pay $100 today and receive back $200 at the end of the year (suppose you can earn 10% on your money elsewhere).
NPV = $74 the deal is equivalent to someone giving you $74 right now.
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Breakeven
Time required for accumulated benefits to offset accumulated costs.
Example
Pay $100 today and receive back $10 at the end of each year.
Breakeven = 10 years
What are Social Security retirement benefits worth?
Internal Rate of Return
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Expected Annual Cash Flows from Social Security (HS Education)
Cash flows are in 2006 dollars and assuming median wages, median probability of employment for white males, and economic burden on the worker.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Effective real rate of return = –1.8%
Decline in benefits is due to mortality. Upon death, an individual’s Social Security benefits cease.
Expected Annual Cash Flows from Social Security (College Education)
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Effective real rate of return = –3.4%
Cash flows are in 2006 dollars and assuming median wages, median probability of employment for white males, and economic burden on the worker.
Decline in benefits is due to mortality. Upon death, an individual’s Social Security benefits cease.
What are Social Security retirement benefits worth?
Net Present Value
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Net Present Value of Social Security by Race, Gender, and Education
NPV is at age 20 and assumes retirement at age 66, economic burden on the worker, median wages, median probability of employment, 2% real rate of return, and 1% real discount rate.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
NPV is more negative for blacks than for whites due to differences in mortality.
NPV is more negative for college graduates than for high school graduates.
What are Social Security retirement benefits worth?
Is NPV positive for anyone?
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Net Present Value of Social Security at Age 18 Wage (shared burden)
NPV assumes retirement at age 66, median wages, median probability of employment, 2% real rate of return, and 1% discount rate.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Assuming that the employer and worker equally share the tax burden, Social Security has a positive net present value only for workers with starting incomes under $25,000.
Net Present Value of Social Security at Age 18 Wage (burden on worker)
NPV assumes retirement at age 66, median wages, median probability of employment, 2% real rate of return, and 1% discount rate.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Assuming that the worker bears the entire tax burden, Social Security has a positive net present value only for workers with starting incomes under $6,000.
What are Social Security retirement benefits worth?
Breakeven Point
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Cumulative SS Benefits Less Payments (shared burden)
Assumes retirement at age 66, median wages, median probability of employment for white males, economic burden on the worker.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
The median white male with a high school education breaks even at age 83.
Shared Burden Burden on EmployeeHigh School Education
White Male 17 NeverBlack Male Never NeverWhite Female 13 NeverBlack Female 16 Never
College EducationWhite Male Never NeverBlack Male Never NeverWhite Female Never NeverBlack Female Never Never
DemographicYears Into Retirement
Breakeven Point for Social Security Benefits
Assumes retirement at age 66, median wages, median probability of employment, economic burden on the worker.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
How does a 401(k) compare?
(it depends)
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Expected Annual Cash Flows from Social Security and 401(k) (HS Education)
Cash flows are in 2006 dollars and assuming median wages and median probability of employment for white males, and a 2% real rate of return on the 401(k).
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Average withdrawal from privatized account is 4 times the average Social Security payment. (1.7 times ignoring mortality)
Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Expected withdrawals if 12.4% of the employee’s wages had been invested in a private retirement account.
Expected Social Security benefits.
Expected Annual Cash Flows from Social Security and 401(k) (College Educ.)
Cash flows are in 2006 dollars and assuming median wages and median probability of employment for white males, and a 2% real rate of return on the 401(k).
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Average withdrawal from privatized account is 6 times the average Social Security payment. (2.7 times ignoring mortality)
Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Net Present Value of 401(k) by Race, Gender, and Education
NPV is at age 20 and assumes retirement at age 66, median wages, median probability of employment, 2% real rate of return, and 1% real discount rate.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
Shared Burden Burden on EmployeeHigh School Education
White Male 3 6Black Male 3 6White Female 3 6Black Female 3 6
College EducationWhite Male 5 8Black Male 5 8White Female 5 8Black Female 5 8
DemographicYears Into Retirement
Breakeven Point for 401(k) Returns
Assumes retirement at age 66, median wages, median probability of employment, 2% real rate of return.
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Compiled from data published in 2006 Statistical Abstract of the United States, U.S. Bureau of the Census
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“There’s just no guarantee that when you’re ready to retire you’re going to have the money.”
– A 35 year old project manager in response to the 44% drop in her 401(k) since last year.
“This is the biggest test that the 401(k) plan has seen…and it has failed.”
– A retirement consultant commenting on the 50% loss incurred by some workers close to retirement.
Wall Street Journal, 1/8/09
Source: www.economy.com
3-Month Treasury Bill Rate
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2.3% 5.1%
Source: www.economy.com
6-Month CD Rate
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2.4% 5.6%
Source: www.economy.com
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16% 8.2%
DJIA Growth Rate
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In your dreams.
Social Security(exaggerated)(it’s worse than this)
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The Wrong Discussion
The discussion on Social Security versus private retirement is typically about safety.
This is the wrong discussion on two counts:
1.Where investments are concerned, it’s never about safety; it’s always about the tradeoff of safety versus return.
2.Social Security is not only not safe, it is arguably more risky than equities.
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
Equities BAA Bonds AAA Bonds Treasury Bills Social Security
Average Nominal Rates of Return 1953 to 2003
Compiled from data published in 2003 Statistical Abstract of the United States, U.S. Bureau of the Census, and provided by the Social Security Administration
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Treasury Bills are safer than Social Security retirement benefits, yet the effective rate of return on SS benefits is less than half the rate of return of Treasury Bills.
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The sooner we take action, the less pronounced the action need be.
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Possible Solutions: Tweaks (Diamond and Orszag)
Raise the earnings cap.
Risks reducing work incentive for entrepreneurs.
Increase the retirement age.
Life expectancies have increased by 5 years since 1940.
Reduce benefits.
Benefits have been growing faster than inflation.
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Possible Solutions: Delayed Opt Out
Allow workers to opt-out of Social Security after having paid in for some number of years.
Workers forego all retirement benefits in exchange for diverting the remaining 12.4% tax to private retirement accounts.
A college educated white male is equally well off opting out of Social Security as late as age 55.
A high school educated white male is equally well off opting out as late as age 50.
Examining Retirement Security
Chief of Staff Retreat
February 20 – 22, 2009
copies of this presentation can be found atwww.antolin-davies.com
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Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.
% of Households in Each Income Bracket (2006$)
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From 1980 to 1990, the number of households with purchasing power of at least $75,000 grew while the number with purchasing power less than $75,000 declined.
% of Households in Each Income Bracket (2006$)
Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.
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From 1990 to 2006, the number of households with purchasing power of at least $75,000 grew while the number with purchasing power less than $75,000 declined.
% of Households in Each Income Bracket (2006$)
Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.
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In which world would each person rather live?
(prices are the same in the two worlds)
Household Income in World #1 Household Income in World #2Person 1 $32,000 $40,000Person 2 $33,500 $41,875Person 3 $35,000 $43,750Person 4 $36,500 $45,625Person 5 $38,000 $47,500Person 6 $39,500 $49,375Person 7 $41,000 $51,250Person 8 $42,500 $53,125Person 9 $44,000 $77,000
Person 10 $45,500 $79,625
In world #1, Person 10 earns 10% of all income.
In world #2, Person 10 earns 15% of all income.