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Solutions to the Middle Class Retirement Crisis

As I have noted in three recent posts, retirement security for those currently or recently in the middle class is no sure thing. 49% of the private work force has neither defined benefit (traditional pensions) or defined contribution (401(k)) retirement plans, while public sector pensions are coming under increasing attack. The United States has the highest elder poverty rate, 25% (measured as 50% of median income), of any industrialized nation bigger than Ireland. An estimated $6.6 trillion shortfall in retirement savings shows how the shift from traditional pensions to 401(k) plans has been totally inadequate to meet people’s future needs.

Yet what passes for wisdom among the Very Serious People (VSP) is that we need to make a stealth cut to Social Security via a less generous inflation adjustment, while Republican plans for Medicare would shift an astounding $34 trillion in medical costs on to seniors whose income would be falling in real terms. This is a recipe for disaster.

So what do we really need to do now? Several different proposals are currently in the mix, all of which would address the income shortfall to varying degrees.

Iowa Senator Tom Harkin, chair of the Health, Education, Labor and Pensions (HELP) Committee, released a report in July 2012, “The Retirement Crisis and a Plan to Solve It.” It proposes a fairly small increase to Social Security benefits (about $60 monthly to the lowest earners) and replaces the current inflation factor (CPI-Urban wage earners) not with the chintzy “chained CPI” the VSP want, but with the more generous CPI-Elderly, which recognizes that seniors consume a larger share of rapidly rising cost products, most obviously health care. The other innovation in the Harkin plan is the introduction of “USA” (Universal, Secure, and Adaptable) retirement funds which would require both employer and employee contributions, with special tax credits for low-income workers. These funds would provide what might be called a “semi-defined benefit” that could be adjusted downward if there were a prolonged stock market slump, but otherwise would provide a predictable level of benefit to its recipients.

As pension expert Jane White contends, this proposal is vague when it is not simply inadequate. She argues for a plan like the Australian “Superannuation” plan, where employers are required to put in 9% of the worker’s income. Her proposal for the U.S. would be a 9% contribution for large companies and 6% for small firms. It would be portable among companies, and employees would immediately own their employer’s contribution (vesting), in contrast to the current situation where that can take years. She argues that the big problem with U.S. pensions isn’t that not enough people have 401(k)’s (though with 49% of private workers not having one, I’m not sure I’m persuaded), but that the employer contribution is so small. By contrast, Harkin’s USA plan does not specify a level of employer contributions, which is definitely a drawback when the savings shortfall is so severe.

Of course, White’s proposal still subjects retirement funds to market risk that Social Security does not, and gives Wall Street a huge new pool of funds to play with. One logical alternative is simply a dramatic expansion of Social Security. Obviously, it is already portable between employers, and companies already have to deduct FICA and Medicare taxes, so there would be no difference administratively from what firms already do.

The funding would come from an end to the cap on earnings subject to the Social Security tax, currently $113,700 for 2013. A little-known fact is that while the payroll tax is regressive (flat to the cap, then 0), the payout structure counteracts this by reducing the share of earnings replaced in retirement the greater the person’s income. As the Harkin report  explains:

The replacement factor for a person’s first $767 of Average Indexed Monthly Earnings (“AIME”) is 90%. The replacement factor drops to 32% for AIME between $767 and $4,624 and 15% for AIME between $4,624 and $8,532.

 The report goes on to propose a replacement factor of just 5% for income over the current cap. It further reports that Social Security only replaces an average of 40% of people’s pre-retirement income, rather than the 65-85% that is widely recommended for retirees.

This suggests an obvious solution: increase the replacement factor substantially for middle-income people. While the numbers would need to be worked out precisely, middle class workers would be much more secure with, for example, 100% replacement of their first $2000 per month in income, 50% replacement of their next $2000 per month in income, 25% for the rest up to the current cap, and then Harkin’s proposed 5% over the current cap.

When I say “obvious,” that’s not to say that it will be easy. Republicans still want to gut Social Security, even though it is supported by most Americans. But a deeper problem is that few people realize just how severe the retirement crisis will be, first for younger Baby Boomers, but much more so for their children and grandchildren. As a first step, you should follow White’s suggestion to contact Harkin’s committee asking for hearings on the coming crisis. The email is Retirement_Security@help.senate.gov

But we will need many more steps to ensure that the crisis is solved in our lifetimes.

Cross-posted from Middle Class Political Economist.

Comments (10) | |

Comments (10)

  1. My fear of any plan that supports using the private investment system is not that the markets will crash, but that there is nothing to prevent the employer from making the payments out of the already decreased share of productivity the 99% have.

    Nothing in our economy can be fixed until we face up to the reduction of productivity to the 99% and then do something to move it back toward the more equitable distribution we had of 1 to 1.

    Of course, this does not mean the VSP won’t keep trying with their “if only(s)…”

  2. Dan, Is there any way to tell or infer that the payroll tax holiday was seen by employers as an excuse to ignore pay raises? (in other words, the worker paycheck was higher therefore he already got a raise)

    If that happened then people would have lost more ground in a permanent sense than they gained in the tax holiday.

  3. Anna Lee

    you may be sure that games were played.

    my understanding it that workers are not getting raises anyway. and it is certainly the case that older workers are being “let go” because they can be replaced with cheaper younger workers.

    i don’t care much for the solutions proposed here. much as it might be a good idea to raise SS benefits, it would not be a good idea to pay for that by raising taxes on “the rich.”

    that would turn SS into welfare as we knew it.

    if the “middle class” wants a higher retirement benefit, they should either pay for it themselves with a higher SS “tax,” or find a way to create a government run… but not government paid… investment plan like state PERS.

    or, of course, they could just opt for demanding welfare payments. put they need to keep both of these “plans” separate from SS which works exactly because it is not welfare and not subject to “the market.”

    if wages are not keeping up with “productivity,” that is something that needs to be addressed. but the way to address it is by economic policy, not by “permanent universal welfare for all seasons”.

  4. KT, everyone, skip my response to coberly. It is seriously off-topic.

    coberly: “if wages are not keeping up with “productivity,” that is something that needs to be addressed. but the way to address it is by economic policy, not by “permanent universal welfare for all seasons”.”

    Well, I guess I am just hopeless. Addressing such things with “policy” does exactly what you seem to not want. It results in EITC and welfare programs to fill the gap between what a worker needs and what a worker receives. The mantra that “it’s not going to be there for you” drones on through centuries (probably once said by the Greeks and Romans).

    Anyway, it all makes little sense to me. If one person has a steak twice as big as he can eat and four times as big as he needs and another person, a worker, can’t afford to buy food today and no one addresses this issue worldwide, then if welfare feeds the hungry worker when no one else is interested, I see no harm.

    My conclusion is that the resources need to make it to the worker level before the worker can provide for his needs. If his work doesn’t produce this, something else has to step in. Policy is doing little to nothing to tip the balance in the direction of the worker. Even in parts of the world where it seemed the workers had solved this (parts of Europe), there seems to be a decline.

    Before you mention Pollyanna or allude to naive, be aware that I am anything but. Sometimes simplicity is simply the point.

  5. Anna

    i can’t remember ever alluding to pollyanna or calling you naive. But i wish you would read what i wrote more carefully.

    if welfare is necessary to feed the poor, i am all for it.

    but it is a huge mistake to turn Social Security into welfare. This is the most successful anti poverty program in American history exactly because it is not welfare.

    The proposals that Kenneth offers amount to turning SS into welfare by raising the cap. This will kill Social Security.

    Economic policies to return to workers a fair share of national product are not welfare, but they won’t work overnight, nor will they work at all if the only idea that “liberals” have is “more welfare.”

    what is happening to “policy” today is that it is in the hands of the enemy… the big banks. in order to restore policy to benefit the working class you will have to find a way to start winning elections with people who have the integrity to resist the bankers cash, and the imagination to do something besides “more welfare.”

    meanwhile, of course if welfare is needed, lets have more of it. but make it separate from SS, which works because it is not welfare.

    do i repeat myself?

  6. AnnaLee Feb 7, 2013, 2:01:00 PM
    > If one person has a steak twice
    > as big as he can eat and four
    > times as big as he needs and
    > another person, a worker, can’t
    > afford to buy food today and no
    > one addresses this issue
    > worldwide, then if welfare feeds
    > the hungry worker when no one
    > else is interested, I see no
    > harm.

    If you’re suggesting that anyone who thinks YOU have more than you need should be invited to take it from you, kindly provide your home address.

    If you advocate taking steaks from others, but don’t invite others to take from you, then we should be clear about the distinction.

  7. Stuart

    your reply to Anna Lee is exactly the response I expect from the electorate to a “welfare for all” program, whether offered in all seriousness by the democrats, or merely “chanted for” by those who call themselves “progressives” but have no practical regard for the needs of workers, contenting themselves with saying really tough sounding things to the rich people.

  8. coberly, let it go. Anyone can see that I was talking about need with my simple statement and that the Stuart’s response was nonsense.

    Ken, I trashed your post. I am sorry for that.

  9. Anna
    I don’t think you trashed anything.

    Ken was arguing for a welfare solution to the retirement problem. You were agreeing with him.

    I argued against a welfare solution… at least a “turning SS into welfare” solution.

    That is not “off topic.”

    Sometimes it is very hard to sort through what appears to be nonsense to … on a good day… understand what we are actually talking about.

  10. Jack

    Social Security benefits are already significantly reduced for any beneficiaries who have manged to plan to have additional retirement income. The federal tax on 85% of social security benefits kicks in if a couple’s combined income exceeds $44,000 and that includes 50% of the benefits. So if a couple collects near the maximum of approximately $30,000 per year each and they have an additional $14,000 in other income then 85% of those benefits will be taxed. In effect a couple that have paid into the system at the maximum rates can expect to lose about 20%-25% of their Social Security benefits. Worse yet a couple collecting the maximum benefit each is almost certain to have to pay income tax on 50% of that benefit without any other additional retirement income given that $32.000 is the kick off point for that tax calculation. It certainly seems to be a disincentive to save additional retirement funds.

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