A Predictable Surprise: The Unraveling of the U.S. Retirement System

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If you think it’s harder for the average American to build a financially secure retirement today than it was a few decades ago, you’re probably right. But the usually cited culprits—the ongoing demise of the defined benefit pension plan, the failure by many individuals to adequately fund their defined contribution plans—aren’t solely to blame. So too, says Sylvester Schieber, is the shaky state of the Social Security system, which will pay most Baby Boomers less than they put into the system.

Schieber is a former chairman of the Social Security Advisory Board and the author of The Predictable Surprise: The Unraveling of the U.S. Retirement System (Oxford University Press, 2012). Speaking in April at the 2014 SVIA Spring Seminar, Schieber noted that an average-earning single male retiring in 1975 at the age of 65 could expect to collect, on average, $108,838 more in Social Security benefits than he had paid into the system, in 2013 dollars. By contrast, an average-earning single male retiring at age 65 this year can expect to collect $85,011 less than he paid into the system—a swing of nearly $200,000. For a high-earning couple, the difference could be nearly a million dollars.

Franklin Roosevelt, Schieber said, tried to warn us. When the Social Security Act passed in 1935, it was written so that Social Security would be a fully funded program in which the government held reserves adequate to pay out future benefits—an approach Roosevelt strongly endorsed. Liberals soon balked, though, because they didn’t want to wait 40 years to build up reserves; they wanted to start paying benefits immediately. Conservatives weren’t enthusiastic either. “They worried about what kind of malarkey future Congresses could get into with all those assets sitting around,” Schieber noted. As a result, Congress repeatedly rolled back Social Security’s funding provisions, and by the early 1950s the program was operating on a pay-as-you-go basis.

That worked for a while, because there were more people contributing to the system than there were collecting benefits. But by the mid-1970s that ratio had inverted, putting the whole program under increasing financial strain. In 1977 Congress cut Social Security benefits and raised taxes, and in 1983 it raised taxes again and initiated taxation of Social Security benefits. But it did not move nearly far enough to put the system on sound financial footing. Today the program would need an immediate injection of about $10.5 trillion to operate smoothly for the next 75 years, Schieber said. It will need about $35 trillion to be kept alive that long on a pay-as-you-go basis.

Of course, even as the Social Security system was weakening, the private retirement system was changing too. Increasingly unwilling or unable to support defined benefit pension programs, employers in the 1990s began phasing them out in favor of defined contribution plans funded to a large degree by employees rather than employers. By 2011 there were 16.5 million active participants in defined benefit plans, Schieber said, down from 30.1 million in 1984.

All this has meant is that Americans today must devote a far higher percentage of their income to retirement savings than they did in the past if they want to be financially secure after they stop working. Why might you ask? When Social Security was designed, most workers life spans did not extend to Social Security’s eligible retirement age, which made it highly unlikely that the majority of workers would collect Social Security benefits. Today, the Social Security Administration estimates that today’s retirees, those who have reached age 65 starting in 1990 will receive Social Security benefits for a little more than 15 years if male and almost 20 years if female.

In 1955, Schieber calculates, workers had to contribute 2.1% of their earnings via payroll taxes to fund Social Security, and save another 4.6% on their own—a total of 6.7% of their income—to support themselves in retirement. Today, he estimates, they must contribute 15.3% in the form of payroll taxes (half provided by employers) and save another 7.5% on their own, for a total of 22.8%. By 2035, he projects the equivalent numbers will be 19.9% and 8.5%, for a total of 28.4% of lifetime earnings. “This is why financing our retirement system today seems so much harder than it did when I was starting in business,” Schieber said.

There is good news on the retirement income front, Schieber said, today’s retirees are in better shape than popularly cited statistics would suggest. The official yardstick of economic status in the U.S. is based on the Census Bureau’s Current Population Survey (CPS), which is used to analyze the potential impact of policy decisions in Washington. Schieber contends that the CPS doesn’t fully capture the income received by retirees. In 2008, for example, the survey showed that people receiving Social Security benefits also received $5.6 billion in IRA distributions and $222.2 billion in pension and annuity income. But those same people, on their federal tax returns, reported receiving $110.9 billion in IRA distributions—excluding income from Roth IRAs—and reported another $457.3 billion from pensions and annuities.

Still, Schieber concluded, it’s important that the country take steps to improve both its public and private retirement systems. In addition to strengthening Social Security, he said, individuals will have to rethink the work/retirement cutoff point and perhaps stay in the workforce longer.

“The system is out of balance,” he concluded. “We have to do something to get it rebalanced, and the sooner we can the better we will be. We have to be extremely careful not to delay this until the only way we can deal with this issue is by levying taxes on the next generation—because they’re going to face exactly the same thing we’re facing. It’s not clear their real incomes are going to be any bigger than ours. All we’re talking about is passing along a substantial burden that we’ve not been willing to pay ourselves.”