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The Social Security benefit formula is far more complex than those used for private sector defined benefit pensions. This has two important effects on retirement security. First, most ordinary Americans are incapable of calculating their own benefits, with the result that many people have no idea what their benefit will
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be until the first check arrives. Second, the benefit formula's complexity results in many households with identical lifetime earnings receiving very different benefit levels. This undermines the social insurance value of the Social Security program.
At this event, AEI resident scholar Andrew Biggs will address members of the Savings and Retirement Forum about the present system and propose reforms that could create a more transparent and effective retirement program.
| 8:15 a.m. | Registration | |
| 8:30 | Presenter: | Andrew Biggs, AEI |
| Moderator: | Ike Brannon, Savings and Retirement Forum | |
| 10:00 |
Adjournment |
WASHINGTON, AUGUST 6, 2009--Quickly, how much do you expect to receive from Social Security? If you don't know, you are not alone. Many Americans cannot predict how much they will get, said AEI resident scholar Andrew Biggs.
"Even with a spreadsheet, it would be difficult for most Americans to calculate [their benefits]," Biggs said, due to the remarkably complex benefit formula. The formula requires calculating your average wage-adjusted earnings for your highest-paid thirty-five years, accounting for spousal benefits, inserting it into an additional three-part formula, and adjusting for your retirement age.
One of the big advantages of private defined benefit plans is predictability. Ideally, near-retirees can make well-informed decisions based on their expected earnings. But, Biggs pointed out, the current setup for Social Security does not provide this at all.
Biggs explained that people have very little idea of how much they will receive. According to data from the Health and Retirement Survey, about a quarter of Americans within two years of retirement will not, or cannot, make any guess about their future benefit. Those that do are often wildly inaccurate. Although the median prediction is only off by 3 percent, the distribution is poor: a quarter of Americans overestimate their benefits by at least twenty-eight percent, and a tenth estimate they will receive twice as much as the formula indicates.
Even introducing Social Security statements, mailed to workers annually, only improved prediction slightly. As Biggs showed, any early gains have since disappeared, most likely because people ignore the statements.
The intention of Social Security is to insure against low lifetime earnings, said Biggs. By paying a higher replacement rate to low-income earners, Social Security enables those without high-paying jobs to afford retirement. However, there is huge disparity amongst retirees with the same lifetime earnings, especially amongst low-income earners, which leads to even more uncertainty about the amount of money workers will receive from Social Security.
Biggs proposed a simpler system: a flat dollar benefit combined with a personal savings account. Such a system would resemble New Zealand's successful KiwiSaver program. All retirees would receive a monthly fixed income, say $500, plus a benefit based on their earnings. This solution provides an income floor and allows retirees to make simpler calculations of benefits.
Following the presentation, a questioner called increasing predictability of social security a "fool's errand," saying no matter how predictable Social Security benefits are, people still will not predict them well. Biggs suggested that while this might be true to some extent, a flat benefit would be so predictable it was fool-proof, and just knowing that much would be a great improvement on the current system.
The final question considered the impact that Social Security has on work incentives. Since the marginal tax rate fluctuates over time, spiking as one attains the ten-year vesting requirement and even becoming negative after thirty-five years of work, many workers see their contributions as a pure tax. Biggs noted that by removing spousal benefits, his plan would eliminate some distortions upon the decision, partially of married women, to work but that older workers could still face negative rates of return. In addition to improving work incentives, Biggs' reform plan would greatly improve the insurance function of Social Security
Speaker biographies
Andrew G. Biggs is a resident scholar at AEI, specializing in Social Security and retirement policy. He previously served as the principal deputy commissioner of the Social Security Administration (SSA), where he oversaw SSA's policy research efforts and led the agency's participation in the Social Security Trustees working group. In 2005, he worked on Social Security reform at the White House National Economic Council, and in 2001, he was on the staff of the President's Commission to Strengthen Social Security. Mr. Biggs has written about Social Security reform for numerous publications including the Wall Street Journal, the Washington Post, and the Christian Science Monitor. He is also the author of AEI's Retirement Policy Outlook series.
Ike Brannon serves as the director of the Savings and Retirement Forum. He is senior policy adviser for the Republican Policy Committee for the U.S. Senate. He previously worked as senior policy advisor and chief economist for John McCain 2008. Prior to the campaign he was senior adviser for tax policy at the U.S. Treasury. Before that he served Congress as the principal economic adviser for Senator Orrin Hatch on the Senate Finance Committee and chief economist for the Joint Economic Committee. Before coming to the Senate he was an associate professor of economics at Indiana University and the University of Wisconsin.
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