BLJ W04 #l .gxd
12/16/04
2 :20 PM Page
1
From the Edito r
Rethinking Employee Benefits, art
Seven Retirement Myth s
:
That Need to G®
Tow that the Presidential election is over,Washington is likely to tack 1 ~I le desperately needed reforms to the nation's retirement system .The
panoply of issues includes Social Security funding, our paltry national sav ings rate, and the continuing demise of pension plans .The legislators' first
step should be recognizing seven assumptions that are often-repeated
and rarely questioned-but are false and dangerous . Effective reform will
occur only when these myths are eliminated from the public lexicon .
Myth 1: There Is a Social Security Trust Fun d
The Social SecurityTrust Fund is about as real as the tooth fairy. It is
true that Social Security taxes paid by employees go to the impressive ly named Old-Age and Survivors Insurance and Disability Insurance
Trust Funds . More specifically, tax revenue in excess of what is needed
to pay current retirees' benefits is "invested" in special US Treasury
securities that pay "interest" to the Trust. Since Social Security is a government program, however, the federal government simply is moving
money from one pocket to another .At the end of last year, about $1 .5
trillion in these bonds was held by the Trust . By borrowing from itself,
the government is spending the excess taxes now being . taken in by
Social Security on other items .When Social Security taxes are no longer
sufficient to cover retiree benefits, the difference will have to be raised
through other taxes or borrowing money . That's why the Bush administration proposes to establish individually managed Social Security
accounts funded by employees with their own contributions-real
money-to pay for their own retirement benefits . (See Myth 6 below
for some of the holes in that idea .)
Myth 2: Social Security Is Bankrupt
In fact, for now, the system is fiscally sound-in 2003, Social Security
collected $153 billion more in taxes than it paid out to retirees . It is
predicted, however, that in about 14 years, so many members of the
huge baby boom generation will have retired that Social Security will
begin running at a deficit . (This date has been pushed back by the
Congressional Budget Office (CBO), as previous estimates have turned
out to be overly pessimistic .) If the current Social Security surpluses
were truly being set aside and not spent, the red ink would not begin
to flow until nearly 2045 .
BENEFITS LAW JOURNAL
1
VOL. 17, NO . 4, WINTER 200 4
"This art icle was republished with permission from Benefits Law Jou rnal, Vol. 17, No . 4, Winter 2004), Copyright 2004, Aspen Publishers, Inc . All rights rese rv ed. For more information on this
or any other Aspen publication, please call 800 -638-8437 or visit www.aspenpublishers .com ."
BLJ W04 #l .gxd
12/16/04
2 :20 PM Page 2
From the Editor
Happily, most experts agree that if Congress acts within the next
couple of years, while Social Security is still operating at a surplus, the
system can remain solvent.What is most likely needed is some combination of a higher retirement age and wage base and a sli ght reduction
in the current cost of living formula to better reflect actual inflation .
Unfortunately, while President Reag an had the clout (with an assist
from Alan Greensp an) to help push through me aningful reform, pundits and poli tici ans on both sides of the aisle are predicting that any
att empt to meaningfully reform Social Security is guaranteed to fail .
(]For why, see Myth 7 .)
Myth 3. Retirement Plans Reduce Tax Revenu e
Each time Congress has taken action to enhance retirement plans,
such as raising the 401(k) limit and adding maximum age 50 catch-up
contributions to 401(k) plans in 2002, the change is predicted to result
in higher deductions and lower tax revenue . Similarly, when Congress
has cut back on retirement plans, such as drastically reducing the 415
limits in 1986, a boost in tax revenues is projected.These assumptions
have naturally made Congress reluctant to take any action that will
encourage retirement savings and highly sympathetic to proposed cuts
in benefits, particularly those affecting higher income workers .Yet this
thinking is backward : from both the employees' and the government's
perspective, retirement plans simply are deferred compensation . Every
tax deductible dollar contributed to a retirement plan eventually will
be taxed upon distribution. (Roth IRAs are a recent, but so far statistically insignificant, exception .)
Finally, a CBO report released this past May confirms that taxdeferred retirement plans will actually increase tax revenue slightly
over the next 75 years . Specifically, as baby boomers start drawing
down their retirement benefits, tax revenues are expected to grow by
about 0 .5 percent of gross domestic production, with more than half
the gain coming over the next 25 years . While the effect on total tax
collections will be relatively small, it is unquestionably positive, not
negative . Moreover, this deferred tax revenue will arrive when the gov ernment needs it most-as retiring baby boomers strain the Social
Security system, they also will add to the government's coffers as they
make taxable withdrawals from their retirement plans . The next time
the Congress thinks about tampering with existing tax-deferred retire ment plans, it should recognize that they offer a means for taxpayers
and the government to both prepare for the future .
Myth 4. Normal Retirement Age Is 65
Legislators need to focus on an appropriate retirement age for the 21st
century. A number of fiscal issues confronting our national retiremen t
BENEFITS LAW JOURNAL
2
VOL . 17, NO. 4, WINTER 2004
BLJ W04 #1 .gxd
12/16/04
2 :20 PM Page 3
From the Edito r
system would be alleviated by recognizing that, for most people, 65 is
too young to retire . There is nothing special, sacred, or even normal
anymore about retiring at age 65 . Chancellor Bismarck is sometimes
credited with establishing the notion of an official retirement age at
the end of the nineteenth century, picking workers' sixty-fifth birthdays . (Of course, only 4 percent of German workers were expected to
make it to retirement .) Around the same time, railroads in the United
States chose 65 as a mandatory retirement age for their employees .The
American milestone ultimately was adopted by the railroads' pension
plans, the Railroad Retirement Act, Social Security, company pensions,
and the Internal Revenue Code as the "normal" age of retirement .
This retirement age made sense up until the early 1960s, when a 65year-old man was likely to live only another 14 years . Today, a 65-yearold has a 19-year life expectancy, and many people are living well into
their 90s .Although Social Security has long since been phasing in age
67 as the new standard retirement age for younger boomers, 65 has lin gered in the public's mind as the usual age of retirement . Moreover,
assuming a life expectancy of 84, most 65-year-olds cannot afford to
retire . By delaying retirement by even one year, that worker could safely
reduce the size of his retirement nest egg by about 5 percent . If the
worker postpones retirement for two years, the nest egg can be
trimmed by closer to 10 percent . Age 70 seems to make sense for both
Social Security and pension plans, reflecting not only growing life
expectancies but the fact that most work is much less physically
demanding . Moreover, there is also the issue of simple demographics : if
baby boomers all retire at age 65, there will not be enough workers left
to plow the fields, make the widgets, and water the golf courses .
Myth S' Discrimination Rules Make the System More Fair
Periodically, Congress changes the tax code in an effort to encourage
employers to provide higher benefits to their rank-and-file workers .
Invariably, these moves backfire .A prime example is the 1986 Tax Reform
Act, which sharply reduced defined contribution and benefit plan limits,
limited the amount of compensation that retirement plans can take into
account in computing benefits, capped 401(k) contributions at $7,000
annually, and completely revamped the nondiscrimination tests . By flattening out retirement plans' benefit structures, the Congress intended to
create an incentive for employers to increase benefits for all employees
to maintain benefits for their executives . In fact, the legislation resulted
in a general erosion of retirement benefits, particularly for pension plans,
when companies decided that enhancing rank and filers' benefits to
maintain the status quo for executives was too expensive . Instead, they
turned to SERPs and other nonqualified vehicles (including stock
options), to help make up the difference in executives' retirement
planning needs . As qualified plans began funding less of executives '
BENEFITS LAW JOURNAL
3
VOL. 17, NO . 4, WINTER 2004
BLJ W04 #l .gxd
12/16 /04
2 :20 PM Page 4
From the Edito r
retirement security, the benefits for qualified plans started being
reduced .When equity became a key component of executive pay programs during the 1990s, cutting employee benefits also became a way
to raise earnings and thereby boost share prices .
Myth 6• Individual Accounts Are Better Than Pensions
From an employer's perspective, individual account plans indeed d o
beat pension plans (some myths are partially true) . Individual accounts
pass on most of the investment responsibility to the employees, are
easier to explain, cost less to administer (no complicated actuarial and
FAS reports to worry about), and offer predictable and generally lower
costs than for a pension plan because the benefits are smaller . Some
companies preferred cash balance plans, even though they are subject
to all of the vagaries and administrative complexities of traditional
pensions, because workers like the idea of having an individual plan
account, even if it is just a bookkeeping fiction . At least until they near
retirement, many workers also like the control offered by an individual account plan and believe they can invest their funds as well as or
better than any one else . Many also like the ability to watch their retire ment funds grow, take it with them (or spend it) when they change
jobs, and pass on it on to their heirs when they die .
This preference for individual accounts has smoothed the way for the
move from pension plans to 401(k) plans and other savings plans, and it
also lends life to the Bush administration's proposals to replace the
defined benefit Social Security program with a defined contribution
plan . The trouble is, given the same level of employer (or government)
spending, people are much better off being in a pension plan than managing their own accounts, whether it is through an employer retirement
plan or Social Security private accounts . First, pension plans offer profes sional money management-meaning greater expertise, attention, and
objectivity for lower fees than an individual choosing among a menu of
funds or with a self-directed brokerage account . Money managers also
are more likely to establish and maintain a target asset allocation, rather
than chasing hot funds or trying to time the market . Second, and often
overlooked, but of key importance, pension plans offer participants a
mechanism to share their mortality risks at low costs . Since nobody
knows when they will die, with an individual account each retiree needs
"extra" funds to ensure to protect against outliving his or her nest egg .
It is absurd to think that individuals man aging their own accounts,
whether through an employer retirement plan or a Social Security
account, can outperform a professionally run investment pool . Poor
financial judgment-whether it is saving too little and spending too
much, making bad investment decisions, or ignoring finances entirely,
crosses all economic, educational, and social boundaries . The
Congress should take into account our nation's profligate ways i n
BENEFITS LAW JOURNAL
4
VOL . 17, NO . 4, WINTER 2004
BLJ W04 #1 .gxd 12 /16/04 2 :20 PM Page 5
From the Edito r
making retirement reforms, including thinking very carefully before
leaving too much to the individual . Most pension plan participants will
not realize until long after their invitation to join HARP arrives in the
mail at age 50 that they were far better off in a pension program than
with an individual account .
Myth 7- People Are Dumb
Is the average worker insufficiently sophisticated, or too busy, to
understand the issues surrounding Social Security or an employer spon sored retirement plans? Our nation's financial IQ is certainly low, mainly
because little effort has been made to educate the public . This will be a
critical shortcoming as more and more workers are asked to assume
responsibility for their own retirement savings . Yet, with effort, people
can learn to understand the issues we face today and take part in the
process of reform . Support for meaningful reform of Social Security need
not be political suicide . As the Congress faces the problems of demographics, a low savings rate, the retreat from pension plans, and eventual
Social Security funding issues, the legislators should help the public to
understand these issues so they will support real solutions that involve
some pain and effort, rather than expecting a quick fix .
CONCLUSION
The process of effective reform starts with honest financial disclosure
of retirement programs. First off, Congress should end the shenanigans
of pretending to sock away money in a Social SecurityTrust Fund, while,
in reality, spending the surplus on other projects . On the other hand, the
"sky is falling" rhetoric that Social Security is bankrupt is not helpful . In
the long run, tax deferred retirement plans benefit participants and the
government alike . Also, there is no use pretending that most people
should set their sights on retiring at age 65, or even earlier . Populist
notions of what level of retirement benefits for the high-paid are fair
deny human nature and only hurt the nonhighly-paid . Human naturehow people invest, save, and spend-also must be factored into the
debate over whether and to what extent to promote pension plans over
self-directed individual accounts . The issues may be complicated, but
that does not mean the American public cannot deal with them . They
just need facts and figures, not myths .
David E. Morse
Editor-in-Chief
Kirkpatrick & Lockhart LLP
Nezv York, N Y
BENEFITS LAW JOURNAL
5
VOL . 17, NO. 4, WINTER 2004