Jane the Actuary Retirement

Forbes post, “Yes, Social Security Is An ‘Entitlement'”

Originally published at Forbes.com on November 5, 2018.

 

No doubt you’ve heard this before, on your Twitter or Facebook, or among your friends:

“Social Security isn’t an entitlement, it’s an earned benefit!”

See, for example, this The Hill opinion piece from late October, the title of which contains the entire thesis:  “Treat Social Security the way President Roosevelt intended, as an insurance program not an entitlement.”  The author, Rep. John B. Larson (D-Conn.), laments that “Republicans have tried to privatize [Social Security and Medicare and] label it as a welfare or entitlement program.”  And as of this writing, a Google search pulls up numerous recent instances of recent letters-to-the-editor, such as this one at the East Oregonian (“The GOP leadership has started referring to Social Security and Medicare as “entitlements” . . . but . . . these are benefits we have earned and paid for with deductions from our paychecks . . . . They are not gifts.”), the Dayton Observer (“It’s their money, not a gift or entitlement from the government.”), and another at the Lynchberg News & Advance, (“Social Security is not entitlement programs [sic] (nor is Medicare); rather that it is a program that folks have paid into all their working lives.”).

Of course, that’s all a bit silly.

An “entitlement,” as a type of federal spending, is a government program in which recipients automatically receive benefits that they’re eligible for based on the applicable legislation.  Social Security is an entitlement because everyone who meets the eligibility criteria (40 “quarters” of eligible earnings) is entitled to a benefit.  No one is dependent on Congress to appropriate spending every year in order to receive their Social Security checks.

SNAP (food stamps) is also an entitlement program.  Here’s GettingSNAP.org:

SNAP is a federal entitlement program. This means anyone who is eligible will receive benefits. You will not be taking away benefits from someone else if you apply.

By comparison, Section 8 housing vouchers are a government program that is not an entitlement.  This doesn’t have anything to do with whether or not it’s a “welfare” program but simply because Congress appropriates a certain sum of money for the program regardless of whether it’s enough to give benefits to everyone who meets the eligibility criteria.  Those hoping to receive benefits end up on waiting lists because the number of people seeking benefits far outstrips the funds available.

Why, then, do Republicans say things like, “we have to consider entitlement reform in order to reduce the federal deficit?”  The same reason that the bank robber gave:  “it’s where the money is.”  Yes, it is true that the government could take in more revenue if Congress chose to re-raise taxes, and it’s beyond the scope of this article to discuss the question of what tax rates should look like.  But federal spending on the “Big Three” of Social Security, Medicare, and Medicaid comprise 48% of federal spending — with the remainder taken up by the military (15%), other mandatory spending like unemployment compensation, federal employees’ retirement benefits, and SNAP benefits (15%), interest on the national debt (7%), leaving only the remaining 15% for non-military discretionary spending such as transportation, education, and housing.  (That’s from 2017, as featured in a handy Wikipedia infographic.) And as a reminder, spending on these programs is forecast to grow dramatically over the next several decades.

This should not be a surprise.

Instead, it seems to have become what you might call a dog whistle, except in reverse.  Conservatives aren’t using “entitlement reform” as a means of speaking to their base that’s invisible to everyone else.  Instead, it’s progressives who hear “entitlement reform” entirely differently, as if conservatives are saying, “these are welfare programs with handouts to lazy layabouts that don’t deserve them.”

I have to admit that this puzzles me.  Perhaps this is like the Yanni/Lauren dispute or the time that my teen enjoyed finding high pitched noises on Youtube and asking me whether I could hear them, but I cannot “hear” the word “entitlement program” as anything other than a straightforward way of categorizing programs where people who qualify are entitled to the benefits rather then Congress appropriating a given amount of money each year and good luck to you if you are stuck on a wait list.

But it does appear that — for, well, People Who Are Not Me, “entitlement” is a pejorative.  For reasons that aren’t entirely clear to me, those who object to the phrase connect it up with a negative sort of behavior, “having a sense of entitlement,” meaning expecting success in life that one doesn’t deserve, for instance, for instance, a stereotypical young man feeling “entitled” to having the woman of his choice go out on a date with him or feeling “entitled” to a good grade in his college class or a pay raise or promotion regardless of effort.

All that being said, I’m very much in favor of discussing the future of Social Security, and of retirement, with a common set of facts and vocabulary.  And I’d be happy to say that if significant numbers of people are misinterpreting the expression “entitlement program,” we should change our terminology.  But I don’t see what alternate expression is on offer that expresses the core challenge of these programs, that the benefits and eligibility are fixed by law in a way that makes it very difficult to modify spending in the future.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes Post, “Social Security, The FICA Tax Cap, And Having Your Cake And Eating It Too”

Originally published at Forbes.com on October 25, 2018.

 

Every time I write about Social Security and its financial woes, I inevitably get comments that the entire shortfall can be solved simply by eliminating the cap on FICA taxes, so that the wealthy pay “their fair share.”  After all, the Medicare portion of FICA has already had cap removed, so why not do the same for Social Security?

Here are some key facts:

  • In 2019, the maximum taxable earnings for Social Security will be $132,900, according to recently-released figures.  Below this level, all Americans pay 6.2% of their earned income into Social Security, and their employer pay another 6.2%.  Self-employed workers pay 12.4%.
  • According to The Social Security Game, by the American Academy of Actuaries (it’s fun; you should try it), if the cap were eliminated and earnings above the cap were not credited with Social Security benefit accruals, it would make up for 88% of the shortfall.  If high-income workers did receive accruals based on their above-cap pay, it would only make up for 71% of the shortfall.
  • The Social Security benefit formula is structured to be “progressive” — that is, lower-income earners accrue benefits at a higher rate relative to their income than higher-income earners.  Here’s how it works:  all of your income as recorded by the Social Security Administration is indexed, which means it’s adjusted to 2018 based on national average wage increases since the year you earned it.  Then the highest 35 years are averaged together (if you had less than 35 years of work, there are 0s included in the average), and then your benefit is 90% of the first $11,112 of your average indexed earnings, 32% of the next level of earnings up to $66,996, and 15% of earnings higher than this level.  (See The Motley Fool for these updated-to-2019 figures.)  It’s the same idea as marginal tax rates, except in reverse.  Which means that, while it goes without saying that if high-paid workers simply paid in more taxes without any new accrual, the additional taxes collected simply subsidize everyone else, it’s also the case that even if higher earners accrued benefits on this income, they would still be heavily subsidizing lower earners — otherwise this wouldn’t be remedying the shortfall.
  • Removing the ceiling is consistently popular in polls.  For example, a 2017 poll by the National Committee to Preserve Social Security and Medicare found that 61% of likely voters “strongly” and 13% “not so strongly” favored a proposal to “gradually require employees and employers to pay Social Security taxes on all wages above $127,000, which they don’t do now” and an even higher percentage — 69%/10% — favored a proposal to “increase Social Security benefits by having wealthy Americans pay the same rate into Social Security as everyone else.”  An admittedly-leading question in a  2016 poll found that 72% of respondents supported “increasing — not cutting — Social Security benefits by asking millionaires and billionaires to pay more into the system.”  And a more academic but somewhat older analysis from 2014 found that 39% of Americans strongly favored and 40% somewhat favored eliminating the cap.

Looking at this can make it appear as if it’s a no-brainer to remove the cap.  Only the rich pay, and everyone else benefits.  Yes, they might whine that their taxes go up by 12.4% with nothing to show for it and they’re already paying higher rates, but better that than raise taxes across-the-board or force the elderly to cope with benefit cuts.

But what about the conventional wisdom that says that we need to keep the payroll tax cap (and in addition reject means testing) in order to get broad support of the system as one in which everyone contributes their fair share and has earned their benefits rather than receiving welfare?

How can such large proportions of Americans support making a change that fundamentally undoes this “earned benefits” design to Social Security, especially when the conventional wisdom is that Americans believe that, not only have they earned their benefits, but that the money they contributed was set aside to fund their own personal retirement benefits (or, alternately, would have been had Congress not “stolen” it)?

Is this cognitive dissonance?  Are Americans foolishly, even ignorantly, clinging to their belief that they earn their benefits fair-and-square even when their support of removing the cap says they believe the rich should pay for everyone else?  Do they want to have their cake and eat it too, by collecting subsidies while still insisting they’ve stood on their own two feet all along?

I don’t think so.

After all, a 2017 poll found that 48% of Americans support the idea of a universal basic income, up from only 10% a decade ago, when described as a way to help people who lose their jobs due to AI.  Another poll found 38% somewhat or strongly supported a $1,000/month government check paid for with a tax hike on those earning $150,000 or more.

These UBI supporters are still in the minority, but the idea’s popularity is increasing, and it appears to be just one way out of many in which people are growing increasingly comfortable with the idea that the middle-class should receive government benefits, not (just) the poor.  And once people are comfortable with the idea of “middle class welfare,” then it stands to reason that they’d consider the right solution to the funding deficit to be one requiring the wealthy to top up the system however much is needed?  In such a case, they might be viewing their benefits as “earned” in a more metaphorical/symbolic sense, in which they have a right to them by having been a hardworking American during their working lifetime, regardless of what the math shows.

If the payroll tax cap is removed, it will not be a matter of having the wealthy pay “their fair share.”  It will be a shift towards, or a recognition of (depending on your perspective) FICA taxes being taxes, nothing more or less.  And in that case, why not integrate it all into our regular income tax structure, with the same marginal tax rates, deductions, taxation of investment income, and the rest?

Side note:  I tried to find polling on the extent to which Americans understand that Social Security is fundamentally a pay-as-you-go system with modest reserves having been built up by past surpluses, rather than a genuinely prefunded system, and is a system with significant subsidies from one group to another (not just by the benefit formula, but subsidies from singles to families and from dual-earner to single earner couples, as well), but there’s not much out there.  Polls intending to determine Social Security knowledge, such as this Mass Mutual survey, ask about such practical items as retirement ages and spousal benefits.  One 2010 survey does ask a more basic question and finds that roughly a quarter of Americans believe that benefits are based on contributions plus interest, one half either answer correctly or a rough approximation of the correct answer — that is, either an average of the highest 35 years of earnings or a private pension-like 5 year average pay times working years — and one quarter don’t know; it does not ask whether people think the system is funded or pay-as-you-go, or whether they think their benefits are proportionate to their income.  But without more survey questions, we’re left to draw conclusions from such sources as viral Facebook posts, including one, a variant on a Snopes-fact-checked version, that came across my Facebook feed recently and insisted, “This is NOT a benefit. It is OUR money , paid out of our earned income! Not only did we all contribute to Social Security but our employers did too ! . . .  This is your personal investment.”

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Yes, Social Security Does Indeed Add To The Federal Deficit”

Originally published at Forbes.com on October 22, 2018.

 

Let’s start with an old joke, attributed to Abraham Lincoln:

How many legs does a dog have if you call his tail a leg? Four. Saying that a tail is a leg doesn’t make it a leg.

and an adage:

If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck,

which has been given the name, the “duck test,” as a form of logical reasoning.

Both of which are useful perspectives for the question of “does Social Security add to the deficit?”, to which fellow Forbes contributor Teresa Ghilarducci asserted the answer is an unquestionable “no.”

After all, she writes,

But Social Security can’t, by law, add to the federal deficit. Medicare and Medicaid can, but not Social Security. Social Security is self-funded.

And Congress did declare in 1990 that Social Security spending and its build-up with reserves are not a part of the federal budget (see this Wikipedia article for background).  As the nonpartisan Tax Policy Center writes,

The budget brings together the spending and receipts of virtually all federal activities, from paying doctors who treat Medicare patients to financing the Environmental Protection Agency to collecting income taxes to selling oil leases on federal land. In two cases, however, Congress has separated programs from the rest of the budget. The Postal Service Fund and the disability and retirement trust funds in Social Security are formally designated as “off-budget,” even though their spending and revenues are included in the unified budget.

Lawmakers created this special accounting to try to wall off these programs. For the Postal Service, the intent was to free the agency to pursue more efficient practices than the conventional budget process allows. But that has not helped it avoid financial difficulties.

With Social Security, the intent was to protect any surpluses from being diverted into other programs. The two Social Security trust funds have accumulated large surpluses since 1983. Those surpluses will eventually be drawn down to pay future benefits. It was therefore argued that those surpluses should be separated from the surplus or deficit of the rest of government. Congress hoped that this separation would induce greater fiscal discipline in the rest of the government.

But think about that joke:  Saying that a tail is a leg doesn’t make it a leg.

Congress decreed that Social Security deficits or surpluses would not be included in its calculations of budgetary spending or calculations of deficits or surpluses whenever the federal government publishes these calculations.  And its motive was well-intentioned enough, but it wasn’t a matter of applying broad accounting principles.

Other “off-budget” federal activities are very different; for instance, Fannie Mae and Freddie Mac are government-sponsored enterprises with private ownership.  And in other instances, the exclusion is because “the government plays a limited role in what is otherwise a private activity,” to quote from the Tax Policy Center again.

But Medicare is on-budget even though its financing, with respect to Part A, is functionally the same as Social Security:  dedicated payroll taxes and a trust fund.  And even an entity such as the PBGC, the provider of “insurance policies” to protect workers’ pensions if their employer goes bankrupt, is on budget, which resulted in the premiums that plan sponsors are required to pay being increased in 2015, at least in part in order to boost government revenue for a budget deal.  And if economists were evaluating the government finances of some other country, they would hardly accept its legislature’s definition of budget deficits or surpluses in performing their analyses.

So just because Congress has decreed that, in its reporting, Social Security finances are to be excluded from budget reporting, doesn’t make it so, in terms of real-world analysis and economic impact.

Which means we need to apply the duck test.

Deficits, after all, don’t matter in isolation.  What matters is the impact of ongoing deficits on the national debt.  How much money does the United States need to borrow?  How does that affect the economy?  Does purchase of government bonds reduce the amount of money going into private investments that would grow the economy?  Can we manage the national debt in such a way as to avoid turning into another Weimar Germany, printing money and producing inflation?  I recognize that there are many people comfortable with the mantra that “deficits don’t matter” and fully confident that politicians can walk that fine line of spending money for programs on their wishlist without crossing over into inflationary spending; that strikes me as risky hubris.

At the same time, what matters is not the total national debt, but the net debt after excluding intragovernmental debt, which is what the Trust Fund is.  Activists might repeat “the government bonds in the Trust Fund are real assets” until they’re blue in the face, but each dollar of FICA surplus, back when it existed, decreased the degree to which the federal government needed to borrow from outside, and each dollar of Trust Fund bond redeemed, is another dollar which the requires the issuing of more bonds.

What’s more, while the Trust Fund bonds are “real” and the government would no more default on them than they would default on any other bonds, a default is wholly unnecessary.  All that’s needed for the government to keep the Trust Fund bonds “unspent” is to reduce Social Security spending, in whatever manner it chooses:  a boost in the retirement age, a benefit phase-out based on other income, an across-the-board haircut, or whatever other mechanism it chooses.  If Congress changed the law tomorrow, all of those beautiful Trust Fund bonds could be kept in perpetuity, never to be redeemed.

Which means that my assessment of the duck test is that in a practical sense based on the plain meaning of words and the impact of the system, regardless of Congress’s labels, Social Security deficits are a real part of the overall governmental spending picture .

So let’s address, then, the final item:  does Social Security add to the deficit, as opposed to simply being a part of government spending?

This is just math, and the Social Security Administration has helpfully done most of the math for us, with projections of the program cost in 2018 dollars (that is, adjusted for inflation) and as a percent of projected GDP.  I’m not going to dispute their calculations — except to observe, as I have in the past, that the projections assume that the U.S. birth rate returns to a “replacement level,” which may or may not happen.

Here are the numbers, based on their intermediate forecast:

From 2007 to 2017, spending on Social Security (old-age and disability combined) increased by an inflation-adjusted 36%.

From 1997 to 2017, the increase was 70%.

From 1987 to 2017, 214%.

From 2017 to a projected 2028 value, it’s another 40% increase.  And to 2033, when this particular table’s projections stop because the trust fund is exhausted, the increase is 60%.

As a percent of GDP, the figures aren’t quite as unsettling, though it’s harder to really grasp the significance of these figures.

From 2007 to 2017, combined spending as a share of GDP increased 19%.  From 2017 to 2027, the projected increase is 15% and from 2017 to 2037, 24% — from 4.91% of GDP to 6.07%.

Now, readers, this is where I stop for today.  I am not interested in making the case today that a move from 4.91% to 6.07% is catastrophic, or no big deal, or somewhere in-between, nor am I keen on arguing about the reasonability of the Trustees’ Report’s assumptions.  And I am furthermore not keen, in this article at any rate, on arguing for the right level of taxation or identifying where Social Security fits in with other spending priorities.

But this is the bottom line:  sometime between now and a forecasted 2034, Congress will need to pass some sort of Social Security legislation.  Most cynically, it can simply declare that general revenue funds will supplement FICA revenues, but Americans would be better off if at some point between now and then we had a real, meaningful re-think of the best way to structure our retirement system.  And when that happens, it is vital that policymakers base their recommendations, and Congress, its laws, on real data rather than rhetoric.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes Post, “Is A Hike In Social Security Retirement Age Really Just A Benefit Cut?”

Originally published at Forbes.com on October 5, 2018 and October 4, 2018.

 

You’ve heard this before, with respect to the prospect of raising the Full Retirement Age in Social Security:

“Raising the retirement age amounts to an across-the-board cut in benefits, regardless of whether a worker files for Social Security before, upon, or after reaching the full retirement age.”  Paul N. Van de Water and Kathy Ruffing, Center on Budget and Policy Priorities.

“[R]aising the full retirement age is nothing more than a benefit cut on future retirees.”   Sean Williams, The Motley Fool.

“Raising the full retirement age may sound innocuous. But it is nothing more than a benefit cut, and one that puts low-paid workers at risk.”  Alicia H. Munnell, director of the Center for Retirement Research at Boston College, writing at MarketWatch.

And these are just the top three search-engine results.

But here’s where my observation yesterday that the United States is in the minority of Western countries with respect to our Social Security benefit structure, comes into play.  Other countries are much more likely to either have a fixed retirement age with no early retirement option, or to allow early retirement only with a very extensive work history and, in that case, without reductions.

Here’s why this matters:

In the U.S. Social Security old-age retirement benefit system, taking into account its existing plan design permitting retirement at a range of ages, and considering the way the hike in the “full retirement age” was implemented, in which both the minimum age and the age of maximum benefit stay unchanged and the benefit level at any given year is reduced, yes, the 1983 “full retirement age” increase was indeed  functionally a benefit cut.

And if we followed the same pattern, with a range of retirement ages from 62 to 70 but with the age for so-called “full retirement” moved up to 68 or even later, then we would be implementing a further benefit cut.  This may nonetheless be a part of an overall Social Security reform package, and may be reasonable and appropriate to the extent that the combination of increasing health of and decreasing physical demands on older workers pair together to mean that individuals are able to work longer without undue hardship.  However, unless workers are able to continue to boost their benefits via late-retirement increases beyond the age of 70, even workers who plan to retire late to make up the difference will be unable to fully do so.

But that doesn’t mean that any such retirement age increase is necessarily a benefit cut.

Consider the Danish system, in which the retirement age increases to 68 in 2038 and is scheduled to increase based on further life expectancy increases since then.  Clearly, there is no way in which a worker reaching the age of 67 in 2038, and obliged to defer retirement another year, has had a “benefit cut” in the sense of a percentage reduction of monthly benefit payments.

At the same time, yes, in principle, one could say that the total value of benefit payments received over one’s lifetime has been reduced.

Consider that a man reaching age 65 today can expect to live 19.3 more years; a woman,  21.7.

This means that, from that age 65 standpoint, ignoring any time-value of money considerations, one can expect to collect 193,000 or 217,000, respectively from a hypothetical $10,000 benefit starting at age 65.  If the retirement age was raised by a year, then, again based on this simplistic calculation, one’s lifetime benefit would be 183,000 or 207,000, about a 5% decrease.

But this sort of “total future benefits” calculation (even disregarding the fact that actuaries the world over are cringing at the math) is simply not a reasonable calculation unless one also takes into account increasing life expectancy.  Most retirement systems do that implicitly in assuming that their retirement age increases pair with historic and forecast future life expectancy; the Danish system explicitly builds this in explicitly, with the intention that the average length of time in retirement stays constant at 14.5 years.

The bottom line is this:  we need a better, more targeted, solution for those unable to work up to their official Full Retirement Age, let alone maximum benefit age, than the existing method of allowing early retirement at the cost of significant benefit reductions.  And creating and implementing this solution will allow us to consider the appropriate retirement age/Social Security benefit commencement age, for the majority of the population, in a more sensible manner.

****

Bonus content:  how does the US retirement age compare globally?  

In the news yesterday:  despite public protests on the matter, Russian President Vladimir Putin signed into law a pension reform bill which increases the retirement age, formerly age 55 for women and 60 for men, to age 60 and 65, respectively.  (See Radio Free Europe for coverage.)

From an American point of view, one might be surprised that the retirement age was ever this low in the first place, or that retirement ages were and still remain different for men and women.  (This is not unusual, as I wrote back in March.)  One might have even a bit of sympathy for Russian men, though, whose life expectancy is a mere 66 years; the Independent (UK) reports that 40% of men will not live to retirement age under the new law.

But here’s something else readers might not notice:  there is no early retirement option available to Russian retirees.  In fact, the Moscow Times reports that the government attempted to mitigate concerns over livelihood in those pre-retirement years by criminalizing the firing of workers in the five years preceding retirement.

In contrast, American workers in the years prior to normal retirement age who exhaust their unemployment benefits, or those who consider themselves likely to die young because of family history or their own poor health, are likely to simply start receiving Social Security benefits with the early retirement penalties.  In fact, our system, despite the official “full retirement age” of 67 for by now most workers, actually provides “full” or maximum benefits at age 70, with reductions or de facto reductions for benefit commencement prior to that age — a provision that’s either a bug or a feature, depending on your perspective:  it provides greater flexibility but at a cost in lost benefits that may create financial hardship down the road.

And here’s what’s worth knowing:  the Russian system with a fixed single retirement age, is actually the norm.  Our system is unusual, as other countries which allow for early retirement generally pair that with substantial work history requirements.  Here’s a listing of Western European countries, from Social Security Programs Throughout the World:

Belgium:  age 65, rising to age 67 in 2030, or age 63 with 41 (42 in 2019) years of coverage (work history).

Denmark:  age 65, rising to age 68 in 2038 with further life-expectancy increases afterwards.  No benefits prior to this age.

France:  the “normal retirement age” is 62, but only with those with 41 years of coverage, rising to 43 years by 2035 (“coverage” also includes 2 years’ bonus per child and unemployment benefit periods); those without sufficient work history can retire at age 62 with a reduction of 5% for each year of missing work history, or can retire at age 67 in any case.

Germany:  age 65 and 7 months, increasing to age 67 in 2029, or age 65 1/2, increasing to age 65 in 2029, with at least 45 years of contributions.

Ireland:  age 66, increasing to age 68 by 2028.  No benefits prior to this age.

Netherlands:  age 66, rising to age 67 and 3 months by 2022.  No benefits prior to this age.

Switzerland:  age 65 for men or age 64 for women; early retirement is available at age 63/62 with a reduction of 6.8% per year.

United Kingdom:  age 65 for men or age 63 for women, rising to 67 for both in 2028.  No benefits prior to this age.

So I invite readers to contemplate this list of retirement ages and imagine that when Congress had increased the normal retirement age from 65 to 67 in 1983, they had likewise increased the early retirement age a corresponding amount, or removed the option entirely, or added a similar work-history requirement.  What would have happened?  Would Americans have adjusted their retirement patterns accordingly, and would employers have adjusted their expectations for when a worker is “too old” to hire or to stay employed?  Does the “safety net” element of early retirement for those who are unable to find work or are in ill health but not to such a degree as to qualify for disability benefits, come at too high a cost, in terms of benefit reductions, compared to other ways of providing those benefits, such as extended unemployment benefits for near-retirees or partial-disability benefits?

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “The New ‘Expand Social Security’ Caucus Says That Social Security Is Insurance. No, It’s Not.”

Originally published at Forbes.com on September 13, 2018.

 

[Edited on September 14 to correct the 125% poverty level figure]

In the news today, the Democrats have announced that they’ve formed an “Expand Social Security” caucus to promote bills such as the one introduced as “Social Security 2100 Act” earlier this year.  As I wrote back in April, the bill

applies Social Security taxes to income over $400,000 (with no apparent inflation adjustment) with trivial benefit accruals. . . . The proposal also includes other changes including setting a minimum benefit at 125% of the single individual poverty line, that is, $15,175, for a 30-year working lifetime with average-wage increases afterwards, increasing employer and employee contributions by 1.2 percentage points in a graded fashion, and merging the Old Age and Disability Trust Funds into a single Trust Fund.

Now, for years and years, the talking point in favor of keeping Social Security benefits unchanged had always been that those benefits had been earned, fair and square, by the contributions workers paid in over their working years.  But now people generally understand that’s not the case.  The system is more-or-less pay-as-you-go, with a reserve built up from excess contributions paid in by Baby Boomers, which is now being spent down until it’s gone entirely.

So Social Security expansion supporters have changed their talking points.  The announcement of the new caucus at Common Dreams quotes Rep. John Larson (D-Conn.):

Social Security is not an entitlement. It’s the insurance that American workers have paid for.

To be sure, it is true enough that Social Security is an important safety net for Americans too old to work, and my personal preference is for a flat benefit that’s sufficient to keep all Americans out of poverty, but with other solutions for helping middle-class Americans preserve their middle-class-ness.

But insurance?

I’m an actuary.  I know what insurance is.  Property-casualty insurance companies (and actuaries in particular), to take one example, develop premium rates based on individual circumstances, such as, for homeowner’s insurance, the relative risk a home has of fire or theft or other kinds of damage, and the replacement cost in case of damage, with insurers staying in business by insuring enough people to be able to pay out the claims for policyholders who file them.  If I have a more expensive house, I pay higher premiums.  If I have an anti-theft system at my home, I have lower premiums.  And so on.

Social Security is not insurance.  We do not pay premiums based on our individual risk.  We do not pay “premiums” at all; we pay taxes, and some people pay disproportionately more taxes than their benefit accruals would call for, and subsidize the others — singles subsidize couples, the childless subsidize families, and those paying at rates near the earnings cap subsidize low earners.  The Expand Social Security caucus seeks, in part, to increase everyone’s tax rates, but also to increase the degree to which the wealthy subsidize the poor and the middle class.  This is not insurance.

To be fair, Social Security is social insurance. But social insurance is not insurance. To be fair, Social Security is social insurance.  But social insurance is not insurance.  Social insurance is simply the name given, fairly commonly outside the United States, to government social welfare programs meant to cover the bulk of the population as opposed to the needy, and generally paid for out of payroll taxes which may or may not be given a name like “social charges” or “social contributions.”  Like insurance, social insurance protects against the vicissitudes of life, as they say, such as disablement or the need for health care, but other social insurance benefits don’t “insure” against some misfortune at all, but are simply benefits available to all citizens, in the form of old age state pensions or children’s benefits.

Why does this matter?

In my preferred “flat benefit” Social Security reform, there would be no payroll taxes at all; it’d just come out of general tax revenues.  I’ve also stated that I tend to think, when I’m cynical, anyway, that, in the end, there’s a high likelihood that the end result of the Trust Fund emptying-out will be that amounts will be made up by general tax revenues.   So my complaint isn’t really that it’s unfair that there are subsidies in the system and that the rich pay disproportionately more relative to the benefits they earn, because my proposal would have exactly that result, given the progressivity of our income tax system.

My complaint, rather, is with the dishonestly of telling Americans that they have “earned” their benefits, that they have a “right” to them, that it would be just as unjust for the system to change as it would be for an insurance company to deny a claim based on a fully paid-up policy, especially while at the same time calling for an increase in the degree to which the benefits not just of the poor but also the middle class are subsidized.

So, yes, let’s reform the retirement system, to decrease the degree to which Americans fall through the cracks.  And employer-provided traditional pensions are no longer a real part of our retirement system, so let’s find a consensus about the best path forward for income replacement.  But let’s do so honestly.

 

January 2025 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Social Security And The Consequences Of Uncertainty”

Originally published at Forbes.com on August 27, 2018.

 

Fellow Forbes contributor Kate Ashford wrote an article on Friday, “How To Plan (Or Not Plan) For Social Security In Retirement,” that confirms what most of us already sense: there’s no easy way to figure out how to incorporate Social Security into our retirement plans when there is no certainty around the system’s future.  She cites financial planners who advise their clients to assume that Social Security benefits will be two-thirds, or even only as much as one-quarter, of today’s benefits, or who don’t even build Social Security benefits into the client’s retirement plan at all, treating it as bonus income, should it materialize.

I’ve previously written that my preferred Social Security reform plan is a phase-in of a flat benefit paired with mandatory annuitized retirement accounts, a plan similar to what the United Kingdom is actually phasing in at the present, which is, in fact, a shift from a system that had been very similar to the American system.  I’ve also written that, much as I’d prefer reform, the most likely outcome of the depletion of the Trust Fund will simply be a legislative fix in 2034, or whatever year this event comes to pass, enabling Social Security benefits to be paid out of general revenues rather than solely out of FICA taxes.

But Ashford’s article is striking to me because it highlights the fact that there is real harm being done in that we have an entire generation of workers unable to meaningfully identify savings targets, even if they wished to, because of the uncertainty around Social Security.  And it’s not just a simple matter of the upper middle class planning for a Social Security-less future because they can afford to be cautious.  As of 2015, 64% of 18- to 29-year-olds, and 63% of 30- to 49-year-olds, believed that they would not collect a Social Security benefit, according to Gallup.

Does this poll reflect the percentage of Americans who believe that Social Security will wholly disappear?  Likely not – the poll gives two answer choices, “yes” or “no”, rather than a more common polling format of specifying the degree of confidence one has, so that the “no” could be taken as a general expression of worry.  The question also asked specifically whether the individual thought the Social Security system “will be able to pay you a benefit” (emphasis mine), so some of the “no” responses might well come from people expecting that the system would still exist but be means-tested and they wouldn’t be poor enough to qualify.

To be sure, experts have always pooh-poohed all such concerns as foolish, and have insisted that all we need is a bit of tinkering here and there; some even say that the worries people have about Social Security are entirely the fault of Republicans who, in their narrative, sowed doubts in order to build support for individual account proposals.

But these uncertainties about Social Security have consequences.

Ashford reports on recommendations to plan as if Social Security doesn’t exist, but given the reports that younger Americans are far from saving at rates appropriate to fund their retirement needs in full themselves, there’s no reason to think this is happening on a large scale.  What seems more likely to me is that rather than boosting motivation to save, the uncertainty around Social Security is sapping motivation, because if it makes the very idea of identifying a savings target too unknowable a venture, and the more unknowable the savings target or savings rate is, the more difficult it is to see this as a real, tangible, achievable goal.  And the less tangible and achievable that goal seems, the more difficulty it’ll have competing with other spending and savings objectives.

Which means that, however clever I might consider myself to be for saying, “Eh, Congress will just pass a ‘Social Security fix’ when the time comes,” there is a real harm done to individuals, and to our retirement system more broadly speaking, when Congress creates this uncertainty by collectively declaring the issue non-urgent and deferring action.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes Post, “Six Things Every American Should Know About Social Security And Retirement”

Originally published at Forbes.com on July 26, 2018.

 

Earlier this week, Marketwatch featured a retirement quiz, “Are you as clueless as the rest of America when it comes to your retirement?” with six questions and the shock claim that only 2% of Americans passed the quiz (that is, got at least four of six correct).  I looked at the quiz and wasn’t much impressed with it (more comments on it at the end of this article), and thought to myself, “self, you could do better.”  So here, with a focus on Social Security, are six key things to understand.

Social Security’s average benefit is just that, an average.

How much can you count on from Social Security?  It’s common to read that Social Security will replace about 40% of your pay, on average (e.g., here, in a February Forbes article) but it’s important to understand that, due to Social Security’s progressive benefit formula, the more you earn, the lower the percent that Social Security benefit checks cover.

According to the OECD’s Pensions at a Glance calculations, an individual earning half the average wage will see a net-of-tax replacement percentage of 60%; the average earner, 49%, and twice the average, 37%.  (The figures not adjusting for tax are 48%, 38%, and 27%.)  These are substantial differences and should be taken into account in retirement planning.

Your benefit level if you wait until age 70 to start, is 75% greater than if you begin at age 62.

Yes, we’re accustomed to thinking in terms of “full retirement age” and that’s the basis on which those OECD values are calculated.  But it’s much better, in terms of understanding the system, to simply think of Social Security as offering the maximum benefit level at age 70, and a substantially reduced benefit level at age 62.  This is true for everyone, regardless of their official “full retirement age.”  And because Social Security offers a guaranteed income, with an annual COLA adjustment, this is a really great deal, and retirees should consider spending down at least a part of their savings, to delay the age at which they claim Social Security, rather than trying to spend their savings evenly throughout their retirement.  (See my April article on the topic.)

Yes, the increase in retirement age really is a benefit cut.  Suck it up.

See my prior point:  the age at which one can begin to take Social Security didn’t change.  The age at which additional benefits for delaying claiming cease, is also unchanged.  What’s changed is that, at any given benefit commencement age, the benefit formula is lower for us young ‘uns (I know, I hardly ought to claim that label these days) than our parents. Which means it’s a benefit cut.

But what are you going to do about it?  Nothing much, really.  It was an unavoidable benefit cut, and we’ll likely see more such cuts in the future.

You can plan on working until 70, 75, or even later, but your body, family circumstances, and the job market may not cooperate.

It is true that the average retirement age is increasing.  But recent research has concluded that it is the better-educated who are retiring later than in the past, in part because less educated workers tend to be in poorer health and to work at physically demanding jobs.  In fact, a recent study by Prudential showed that half of retirees retired earlier than they had previously planned to do so, and for three-fourths of them, this was involuntary, due to job loss, ill health, or other reasons.  So it’s great to plan to work until late in life, and evidence is growing that it actually may help individuals stay in good health, physically and mentally, but you’ll need a Plan B.  And, likewise, it’s great, as a matter of public policy, to want Americans to stay in the labor force longer, but for the working class especially, policymakers will also need a Plan B.

The Trust Fund?  It doesn’t matter.

Yes, I’m going to get back on my soapbox about this.

At some point in the future, the Social Security Trust Fund will likely be exhausted.  According to current law, benefits will have to be cut by about 25%.  Not good.  But the cynic in me says that there’s a good chance that Congress will just pass legislation allowing general revenues to pay Social Security benefits that can’t be paid for from the FICA taxes.

No harm, no foul?  Eh, not so much.  Quite apart from the Trust Fund exhaustion is the question of how our economy can handle the need to spend ever-more money on the needs of the elderly, through Social Security, Medicare, Medicaid long-term care, and so on.  And that’s much more difficult to solve than simply passing new funding legislation.

We are not locked into our 80-some-year-old benefit formula.

This is my final pet peeve, and in fact was the topic of my first published article on retirement.  Many, many other countries have tweaked their formula or even wholly re-written it, and there’s no reason we can’t do the same.  The United Kingdom, Sweden, Norway and Italy have wholly redesigned their systems.  Switzerland, South Korea, Australia, Hong Kong, and others have instituted “Second Pillar” systems.  Other countries have raised the retirement age, or even instituted a formula in which the retirement age automatically increases as life expectancy does.  And in the meantime, the experts insist that the only changes we can make are tweaks around the edges.

Finally, here’s the original quiz:

  • What is the full retirement age for young workers?  (Answer:  67)
  • What does IRA stand for?  (Answer:  Individual Retirement Account, but knowing the name isn’t especially relevant.)
  • If your full retirement age is 66 and you draw SS benefits early at age 62, by how much is your benefit reduced?  (The answer is 25%.  The choices were in increments of 3 percentage points to make it harder, but the principle is more important to know than the exact number.)
  • These states can tax SS benefits: Colorado, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah and…  (This is the sort of list that seems designed just to elicit dramatic “failure” rates for the quiz.)
  • A Roth IRA allows tax-free withdrawals in retirement.  (true/false)  (Yes, it’s important to know how the two types of IRAs work — but if your employer offers a 401(k) you’re better off with that anyway.  And, incidentally, the “Roth” in “Roth IRA” doesn’t abbreviate anything but was the name of the senator who sponsored it.)
  • Which of the following is NOT covered by Medicare?  (Answer, dental & hearing aids.  More importantly, nursing homes aren’t covered except for short-term rehab stays; perhaps that wasn’t included in the quiz because people generally know that after all.)

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Yes, Let’s Expand Social Security – To Public Sector Employees”

Originally published at Forbes.com on July 23, 2018.

 

In a prior article, I referenced offhandedly the generous nature of the benefits for teachers and other state and local government employees.  Here in Illinois, a teacher hired before 2011, who worked continuously after graduating college, is eligible for retirement, at a 75% pay replacement increasing at a compounded rate of 3% per year, at the age of 56.  This is a benefit level that, even in the days of generous private-sector traditional defined benefit pensions, would have been exceedingly generous.

As it happens, these high pensions, and the inclusion of a generous COLA, are frequently justified by the fact that these participants don’t participate in Social Security, at least in the 15 states in which this is the case (a list which, as far as teachers are concerned, includes two of the most notoriously underfunded plans, Illinois and California; with respect to other public-sector unions, Social Security opt-outs are rarer, or, as in the case of Illinois, some groups do and others don’t participate).

And those retirement plans which stay out of Social Security portray it as the best choice for both plan members and the state.  The Illinois Teachers’ Retirement System says this:

Currently, teachers pay 9 percent of their salary and school districts pay 0.58 percent of its teachers’ salaries to TRS. The federal Social Security tax is 12.4 percent, split evenly between the employee and the employer. For school districts, placing teachers in Social Security would result in a 137 percent increase in total taxes and contributions devoted to retirement. TRS members would see their total retirement contribution rise to 15.2 percent of pay, a 68 percent increase.

Teachers’ Retirement System retirement benefits were significantly better than those offered under Social Security. . . .

Along with the increased cost to local governments for Social Security, adding teachers to the system would not wipe out the $122.9 billion that TRS currently owes all active and retired TRS members for the next 30 years. These are retirement benefits that already have been earned. . . .

A 1999 study by the General Accounting Office found that adding teachers and other public employers from around the country who are not currently in Social Security would create, at best, a temporary surge in revenue for Social Security. Over the long term, adding teachers to Social Security would only increase the System’s total obligations and deepen the program’s long-term funding problem.

But that’s misleading in a number of ways.

In the first place, touting the higher costs to teachers and school districts omits the high cost to the state of funding that portion of teachers’ benefits which is not covered by the small teacher/district contribution.

In the second place, benefits are indeed generous — for full career teachers or state employees.  But, as an explainer video at TeacherPensions.org points out, nearly half of all teachers won’t continue teaching for long enough to vest in a pension, and another third will vest, but with poor levels of benefit accruals.  With respect to other public employees, an analysis showed that about half of plans required five years of service to vest, and another 20% required 10 years; only 16% required less than 5 years.  A teacher who moves from one state to another, or who leaves teaching for another career field, may be as good as starting over, as far as retirement benefits are concerned.

And while vesting requirements are perfectly normal in the private sector — though by law the requirements are less demanding, typically 3 years for a 401(k) employer contribution or 5 years for a traditional defined benefit plan — and it is perfectly ordinary to move employers often enough to accrue low or no benefits in any given employer, Social Security always serves to provide a basic level of benefit, regardless of whatever other pension one might have.  Social Security is always portable, always vests immediately, and, crucially, indexes wages to adjust for inflation when calculating benefits at retirement, unlike frozen benefit accruals when one leaves an employer.

And finally, while the TRS correctly observed that existing liabilities could not be erased with participation in Social Security, it would provide greater financial stability for a state to do so going forward.  To the extent that such a benefit change were to produce a benefit formula integrated with Social Security rather than simply making public sector pensions even more generous, it would shift at least some of the future pension accruals’ cost into predictable contributions and take away the temptation, at least for that portion of the benefit, to defer contributions to future taxpayers.

Having said this, yes, it’s also the case that the federal government cannot force states to participate in Social Security — at least not directly.  But I will remind readers of my longtime pet Social Security reform proposal, in which Social Security as we know it today would be replaced by a flat benefit paired with some sort of mandatory participation in pooled retirement accounts.  And I will further remind readers that this is, in broad outline, the system which has been implemented in the U.K. in recent years.  In such a case, if, in the case of the flat benefit, benefits were funded out of income taxes/general tax revenue rather than a dedicated payroll tax, there would be no way in which states could opt out of the system because there would be no employer role.

And, to be sure, this is only one small piece of a much larger issue, but it is a relevant item to take into consideration.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.