I wanted to share this with you; it came from my benefits provider
Cap Would Aid Greatest Portion of Workers March, 2005Employee Benefit Research Institute
WASHINGTON—A far greater portion of all current and future Americans would have a higher initial retiree benefit from the current Social Security program than from an individual account plan if the existing $90,000 wage cap was eliminated and all local, state, and federal workers were brought into the program to fill the projected funding deficit, a new analysis of various Social Security options shows.
However, the study also shows that more of today’s younger workers would have a higher initial retiree benefit from an individual account plan than if nothing is done to reform the currently projected underfunded program.
The new analysis, by the nonpartisan Employee Benefit Research Institute (EBRI), examines in detail how Americans in different age groups would fare under different Social Security reform options. It examines the complete distribution of possible earnings histories and job patterns Americans have during their careers. It also demonstrates that the percentage of Americans within various birth cohorts that have higher initial benefits and ratios of retiree benefits to taxes under any Social Security reform will depend on how old you are, how much you earn, your investment risk and returns, administrative costs in an individual account, and other factors. The EBRI report, available on EBRI’s Web site at www.ebri.org, underlines the dangers of taking no action to reform Social Security.
“There is no easy answer to ‘winners and losers’ in Social Security reform: The current system is unsustainable under current assumptions without either benefit or tax changes, and whatever is done—including nothing at all—will affect different people in different ways,” said Dallas Salisbury, EBRI president. “This new analysis from EBRI underlines the advantages of moving sooner rather than later on reform, while at the same time shedding light on how Americans would fare in terms of benefits under an individual account plan versus three alternative options for addressing the projected Social Security program deficit.”
Using a unique computer model similar to that used by the nonpartisan Congressional Budget Office, EBRI looked at the “Model 2” individual account reform option that was presented in the President’s Commission to Strengthen Social Security (PCSSS) report in 2001, which is the closest to what President Bush has been discussing for a framework for an individual account plan (Model 2 is actually more generous than the administration’s most recent suggestion, as its offset rate is a 2% real rate of return compared with the recently mentioned 3% real rate of return on investments in order for individual account holders to get a greater benefit than the underlying Social Security defined benefit). EBRI’s analysis assumes that everyone would opt for the individual account and is able to simulate a full range of random investment outcomes for the
EBRI looked at three options and compared the benefit outcomes to Model 2’s benefits:
“Tax All Earnings”—This option is used as a proxy for maintaining the current level of
promised benefits, and would do so by increasing revenue (specifically, by removing the current $90,000 annual income cap on taxable Social Security wages) and by including all currently exempt local, state, and federal government employees in the Social Security system. EBRI found that for those born between 1955 and 2015, between 67% and 84% would get higher benefits from this approach (“Tax All Earnings”) than from the Model 2 individual account plan.
EBRI also reported on the differing effects by lifetime earnings. Contrary to what one might think (that the highest earners would always have higher benefits with individual accounts), the higher one’s earnings, the higher one’s benefits would be from the tax-all-earnings approach relative to the benefits from Model 2 individual accounts. This is primarily because of the $1,000 per year contribution limit in Model 2 and the higher benefits for higher earners when the age cap is removed.
“Do Nothing”—This option would make no change in the Social Security system until
2042, when the Social Security Trust Fund is projected to be exhausted, and then cut benefits by 38% to bring the program into balance with available revenue. (EBRI assumes a higher level of cuts than in the Social Security Trustees Report, since the EBRI model assumes prospective benefit cuts after 2042 while the Trustees report assumes across the board cuts.) On the one hand, this approach underlines that the program will not actually stop paying benefits in 2042; on the other, it underlines that either more money is needed or future cohorts will be faced with reduced benefits.
Under this option, beneficiaries born in 1955, 1965, and 1975 would have a similar likelihood of having higher benefits than under Model 2 as those in the “Tax All Earnings” scenario, but the percentage would plunge to less than 3 percent for those born in 1985—a vivid demonstration of the impact on this age group of not addressing the projected deficit sooner. Under this scenario, benefits in relation to Model 2 would begin to rebound in future years, but under Model 2 those in these cohorts would be likely to do better assuming equity market rates comparable to historical returns: Just over 30 percent of those born in 2015 would receive higher benefits under the “Do Nothing” scenario, compared with Model 2 benefits. However, when accounting for risk, the youngest cohorts are not as likely to have higher benefits under Model 2. A key underlying point made by these results is acting sooner rather than later, whatever is done, will be better for today’s young workers.
“Gradual Reduction”—This option would gradually cut Social Security benefits
between now and 2042 to provide a smoother result; nevertheless, of those born in 1985, only
27.5% would have a higher initial retiree benefit than under Model 2, when assuming historical equity market returns. Those born after 1955 would see a lower likelihood of having higher benefits under this option, with more than half of all those born after 1975 having higher benefits under Model 2, when assuming historical equity returns, than a gradual reduction approach.
The EBRI analysis finds that under the Model 2 plan, middle-income earners would receive a larger portion of their Social Security benefit from the individual account (as opposed to the defined benefit formula), whether accounting for the risk of equity investments or not; both higher- and lower-lifetime earners would receive about the same percentage of their total benefit from the defined benefit portion of Social Security, with the middle lifetime earners receiving the highest percentage. This is because higher-income individuals would be limited by the $1,000
annual contribution limit, and lower-income individuals would be limited by their earnings.
The EBRI research also showed the impact that management fees and administrative costs would have on beneficiaries’ monthly checks if they elected to participate in a system of individual accounts. Not surprisingly, plans with higher fees would take a bigger bite out of benefits than would lower fees. Looking at the 2015 birth cohort (which would be past the transition period for individual accounts), those receiving the highest level of benefits would see their payments cut by roughly 8% and 14% under two higher-cost assumptions, compared with the base cost assumption. Salisbury noted these findings underscore the importance of minimizing administrative costs, either by “riding” the current payroll tax collection process and/or by “mirroring” the federal Thrift Savings Plan’s limited investment options and processes.
As a nonpartisan research institute, EBRI does not take a policy position on any Social Security reform proposal, and used the three options only for illustrative purposes. Salisbury said the EBRI research is unique because it looks at the full population, examines age groups that are not yet born, considers wide swings in investment returns that are likely to take place, and includes all possibilities of anticipated work and earnings patterns for current and future workers.
Craig Copeland, Ph.D., director of EBRI’s Social Security Reform Evaluation Research Program, is the chief author of the study. His work was based on assumptions contained in the 2004 Social Security Trustees report, the final report of the President’s Commission to Strengthen Social Security (issued in December 2001), and through the use of GEMINI, a computer-based dynamic microsimulation model designed to analyze the lifetime implications of Social Security policies for a large sample of the population born in any one year that was developed by the Policy Simulation Group.
The new analysis builds on extensive work done by EBRI modeling earlier individual account proposals, including the so-called “Gregg-Breaux-Kolbe-Stenholm,” “Archer-Shaw” and other legislative plans. In addition, EBRI has published an extensive analysis of the administrative issues involved in adding individual accounts to Social Security, as well as how various economic and demographic factors affect the program’s actuarial balance. EBRI’s complete list of Social Security program work is available on the Internet at www.ebri.org/SSProject/index.htm