Pension Reform: What Can
the United States and
Australia Learn from Each
Other?
by Jon Forman
Alfred P. Murrah Professor of Law
University of Oklahoma
Sixth Annual
Labor and Employment Law Colloquium
Los Angeles, California
September 16, 2011
Outline




Life Cycle Model
Social Security/ Age Pension
Private Pension/ Superannuation
Supplemental Savings
2
People are Living Longer:
Americans
Year
1960
2000
2040
2080
Life expectancy
at birth
Life expectancy
at age 65
Men
66.7
74.0
79.0
82.4
Men
12.9
15.9
18.8
20.8
Women
73.2
79.4
82.6
85.6
Women
15.9
19.0
20.9
22.8
3
But People Are Retiring Earlier:
Percentage of Workers Electing Social
Security Benefits at Various Ages
Year
Age 62
1965
1975
1985
1995
2004
23.0
35.7
57.2
58.3
57.5
Ages Age 65
63-64
17.7
23.4
24.5
31.1
21.1
17.7
19.5
16.3
19.0
18.6
Ages
66+
35.9
8.7
4.0
6.0
4.8
Average
age
65.9
63.9
63.6
63.6
63.7
4
U.S. Life Expectancies at Birth versus
Social Security Full Retirement Age
90
85
80
Age
75
70
65
60
Life expectancy at birth, females
55
50
45
40
1900
Life expectancy at birth, males
Full retirement age for people born
that year
1940
1980
Year of birth
2020
2060
5
Stages of the Simple Economic Life Cycle
Income
$
Consumption
Birth
Age
20-25
Age
60-65
Death
6
U.S. Social Security
 Social Security taxes
 Workers pay
 6.2% of their earnings for Social Security, and
 1.45% of their earnings for Hospital Insurance
under Medicare (Part A)
 Employers pay an equal amount
 The total is 12.4% for Social Security and
2.9% for HI
 20011 tax base is $106,800 in 2011
Social Security Administration, 2009 Social Security Changes,
http://www.socialsecurity.gov/OACT/COLA/cbb.html.
7
Worker Benefits
 Workers over 62 are eligible
 If they have worked 10 years
 Benefits are based on a workers earnings
history
 Career-average earnings
 Average Indexed Monthly Earnings (AIME)
8
Replacement Rates for Retired Worker Age 65, 2011
$120,000
$100,000
$80,000
$106,800
Past Wages
Benefits
$70,000
$60,000
$41,800
$40,000
$20,000
$0
$18,800
55%
$10,400
"Low"
Board of Trustees, 2011: Table VI.F10.
41%
$17,100
"Medium"
34%
$22,700
"High"
Earnings Level
25%
$27,000
"Maximum
taxable"
 90% of people 65 and older get Social Security.
 Nearly 2 in 3 (64%) get half or more of their
income from Social Security.
 About 1 in 3 get almost all (90% or more) of
their income from Social Security.
SSA, 2010a: Table 9.A1.
10
Medium Earner’s Replacement Rate at 65
After Medicare Parts B and D Premiums
Percent of Prior Earnings
45
40
39%
37%
35
32%
30
25
20
15
10
5
0
2005
Ruffing and Van de Water, 2011.
2010
2030
11
The Australian Age Pension
 funded from general revenues
 2011, a maximum of $670.90 every
fortnight for singles and $1,011.40
for couples
 The single benefit is designed to
provide about 25% of average male
earnings
 Benefits are reduced by both an asset
test and an income test
12
Two Basic Types of Pensions
 Defined benefit plans
 Defined contribution plans
13
What is a Defined Benefit Plan?
 Employer promises employees a
specific benefit at retirement
 To provide that benefit, the employer
makes payments into a trust fund
and makes withdrawals from the trust
fund
 Employer contributions are based on
actuarial valuations
14
Defined Benefit Plan
 Employer bears all of the investment
risks and responsibilities
 Typical plan provides each worker
with a specific annual retirement
benefit that is tied to the worker’s
final average pay and number of
years of service
15
Defined Benefit Plan
 For example, a plan might provide
that a worker’s annual retirement
benefit is equal to 2% times years of
service, times final average pay
 B = 2% × yos × fap
 Final-average-pay formula
16
Defined Benefit Plan
 Worker with 30 years of service
would receive 60 percent of her preretirement earnings
 Worker earning $50,000 would get
$30,000-a-year pension




B = $30,000
= 60% × $50,000
= 60% × fap
= 2 percent × 30 yos × $50,000 fap
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What is a Defined Contribution
Plan?
 Individual account plan
 Employer typically contributes a
specified percentage of the worker’s
pay to an individual investment
account for the worker
 Owned by employee
 Benefits based on contributions and
investment earnings
18
Defined Contribution Plans: How
Individual Retirement Savings
Accounts Work
CONTRIBUTIONS
FUND
BENEFITS
EARNINGS
19
Defined Contribution Plan
 For example, employer might
contribute 10% of annual pay
 Under such a plan, a worker who
earned $30,000 in a given year would
have $3,000 contributed to her
account
 $3,000 = 10% × $30,000
 Benefit at retirement based on
contributions, plus earnings
20
Australia: A Universal
Pension
 1986—industrial agreements for 3
percent of payroll contributions
 1992/1993—superannuation
guarantee legislation, mandating 3
percent contributions to individual
retirement accounts
 Higher levels phased in, reaching 9
percent in 2002/2003
21
Tax Treatment of a Typical
Individual Account in Australia – tte
15% TAX
(payable by the fund)
CONTRIBUTIONS
15% TAX
FUND
ZERO TAX
(from age 60)
BENEFITS
EARNINGS
22
IMPROVING NATIONAL SAVINGS
AND SUPERANNUATION ADEQUACY
 The Government will increase the
superannuation guarantee (SG) rate
from 9 to 12 per cent over time.
23
Superannuation
 GOVERNMENT CONTRIBUTIONS FOR
LOW INCOME EARNERS
 A new superannuation contribution of up to
$500 will be provided by the Government
for workers with income up to $37,000.
 CATCH-UP CONTRIBUTIONS FOR
OLDER WORKERS
 The Government will allow individuals aged
50 and over with total superannuation
balances below $500,000 to make up to
$50,000 in concessional superannuation
contributions.
24
Most elderly don’t receive
pensions in the U.S.
Percent with Employer-Sponsored
Pensions
All age 65+
Couples
Unmarried men
Unmarried women
Social Security Finances: A Primer , at 10.
41%
51%
42%
34%
25
Tax Treatment of a Typical
Individual Account in the U.S. – eet
ZERO TAX
CONTRIBUTIONS
ZERO TAX
TAX
FUND
BENEFITS
EARNINGS
26
Tax Treatment of a Roth Individual
Account in the U.S. – tee
TAX
CONTRIBUTIONS
ZERO TAX
FUND
ZERO TAX
BENEFITS
EARNINGS
27
Goals for a Pension Plan
 First, ensure that every employee
earns a meaningful retirement benefit
 and that long-time employees are
guaranteed an adequate income
throughout their retirement years
 Second, have a minimum of work
disincentives for employees coming in
and out of service
 Third, be affordable and well-financed
28
Optimal Policies for Maximizing
Retirement Income
 Contributions
 Accumulation
 Pay-out (Decumulation)
29
Contributions
 Voluntary v. Mandatory
 Encourage Saving More
 Tax incentives?
 Limits?
 Defaults
30
Accumulation
 Fiduciary Duties
 Diversification and Investments
 Fees
31
Pay-out (decumulation)
 Encourage working longer
 Encourage saving more
 Encourage life-time income options
 Targeted Withdrawals
 Annuities
32
Preretirement Earnings
Replacement Rates, 2011
Source of replacement
rate income
Low earners’
replacement
rate
Social Security
55.2
High
earners’
replacement
rate
33.9
Replacement rate
needed from other
sources to achieve 75
percent replacement
rate
19.8
41.1
33
Source: http://www.gao.gov/new.items/d11400.pdf.
34
https://guidance.fidelity.com/living-in-retirement/annual-portfolio-withdrawals?ref_ls=lr3007.
35
Source: http://www.gao.gov/new.items/d11400.pdf.
36
Policy Options
 Encourage sponsors to offer a default
annuity
 Require Sponsors to Provide an Estimate
of Lifetime Annuity Income on Benefit
Statements
 Improve Individuals’ Understanding
about Retirement Income
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About the Author
 Jonathan Barry Forman (“Jon”) is the Alfred P.
Murrah Professor of Law at the University of
Oklahoma College of Law, teaching tax and pension
law and the author of Making America Work
(Washington, DC: Urban Institute Press, 2006). He
was the Professor in Residence at the Internal
Revenue Service Office of Chief Counsel for the
2009-2010 academic year.
 Jon can be reached at jforman@ou.edu;
www.law.ou.edu/faculty/forman.shtml.
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