TABLE OF CONTENTS

MESSAGE FROM THE BOARD........................................................................ i

I. THE GOAL OF ECONOMIC SECURITY

IN RETIREMENT ....................................................................... 1

Changes in the Last Century ...................................................................... 1

The Basic Goal of Retirement Security Policy ........................................... 3

Some Common Elements of Retirement Security at the

Beginning of the 21st Century ......................................................... 3

21st Century Challenges .............................................................................. 5

Meeting the Challenges .............................................................................. 9

II. RETIREMENT SECURITY: THE ECONOMIC

AND BUDGETARY CONTEXT ............................................... 12

III. SOCIAL SECURITY ............................................................................. 14

How the Social Security Program Operates ............................................. 14

Contribution to Economic Security of Aged Beneficiaries ....................... 16

Social Security Solvency ........................................................................... 16

Importance of Restoring Solvency ............................................................ 18

Other Social Security Issues ..................................................................... 21

Disability Benefit Issues ........................................................................... 22

IV. PENSIONS AND SAVINGS .................................................................. 24

Pensions as a Source of Retirement Income ............................................. 24

Trends in Retirement Plans ....................................................................... 25

The Shift from Defined Benefit to Defined Contribution Plans ................ 27

Participation in Pension Plans ................................................................. 28

Integration of Pensions with Social Security............................................ 31

Retirement Savings ................................................................................... 32

Household Net Worth and Financial Assets ............................................. 32

Expectations.............................................................................................. 33

Current Issues ........................................................................................... 33

V. LABOR FORCE PARTICIPATION OF THE ELDERLY ................. 37

Earnings as a Source of Income for the Aged .......................................... 37

Labor Force Participation of the Aged .................................................... 37

Possible Reasons for Recent Increase in

Labor Force Participation............................................................ 38

Age of Retirement ..................................................................................... 38

Demand for Elderly Workers .................................................................... 39

Social Security and Other Policies to Encourage

Remaining in the Labor Force ...................................................... 40
VI. HEALTH CARE AS A RETIREMENT

SECURITY ISSUE ..................................................................... 42

Rising Costs of Health Care ..................................................................... 42

The Central Role of Medicare and Medicaid in

Retirement Security ....................................................................... 43

Medicare and Medicaid Financial Problems ........................................... 44

Trends in Private Health Insurance.......................................................... 46

Long-Term Care and Retirement Security ................................................ 47

Conclusion ................................................................................................ 50

VII. SUPPLEMENTAL SECURITY INCOME ............................................ 51

Program Description..................................................................................51

Implications for Potential Changes in Social Security .............................. 53

VIII. CONCLUSION......................................................................................... 55

APPENDIX: Research about Retirement Security ......................................... 56

ABBREVIATIONS KEY ................................................................................... 57

SOCIAL SECURITY ADVISORY BOARD .................................................... 58
Ten years ago Congress enacted the Social Security Independence and Program

Improvements Act of 1994. That legislation made the Social Security

Administration an independent agency and also established the Social Security

Advisory Board. In that Act, Congress gave several directives to the Board

including the task of:

analyzing the Nation’s retirement and disability systems and making

recommendations with respect to how the old-age, survivors, and

disability insurance program and the supplemental security income

program, supported by other public and private systems, can most

effectively assure economic security.

Over the past year, the Board has met with experts in the areas of pensions,

savings, and health care both in Washington and in the course of public hearings

in other parts of the country. We have examined the issues involved and

discussed the roles of Social Security and Supplemental Security Income (SSI) in

the context of those other sources of retirement security. Here we present our

analysis of the issues along with our findings and recommendations.

We intend in this report to focus on the national goal of economic security in

retirement, how it has evolved, what are the major public and private elements that

work together to achieve that goal, what are the gaps that need to be addressed, and

what are the challenges that face these elements in the future.

i

MESSAGE FROM THE BOARD

Hal Daub, Chairman

Dorcas R. Hardy Martha Keys

David Podoff Sylvester J. Schieber
ii
1

The concept of retirement as a typical stage of life, supported by a complex

of public and private institutions of economic security, is very different

at the beginning of the 21st century than it was at the beginning

of the 20th century.

I. THE GOAL OF ECONOMIC SECURITY IN RETIREMENT

Changes in the last century

The concept of retirement as a typical stage

of life, supported by a complex of public and

private institutions of economic security, is very

different at the beginning of the 21st century than

it was at the beginning of the 20th century.

In 1900, there was no national system of

Social Security nor was there a needs-tested

safety-net program for the aged poor. Employersponsored health and pension programs were

rare and covered few workers. Indeed, for most

of society, our current concept of “retirement”

was largely unknown. Most men were still in the

labor force well past their 70th birthday and life

expectancy at age 65 was about 12 years.

Typically, older Americans found it necessary to

work until they died or simply had no remaining

capacity to work. However, older individuals

were not always able to find employment despite

the absence of an alternative system of income

support, and this problem was to become

especially severe in the great depression of the

1930s.

Over the course of the 20th century, the

situation changed markedly.

• The Social Security Act was enacted

into law in 1935 creating both a social

insurance program of retirement

benefits and a Federal matching

RETIREMENT SECURITY

THE UNFOLDING OF A PREDICTABLE SURPRISE

program to encourage and assist States

in providing needs-based assistance to

impoverished elderly persons. Over the

past 70 years the scope and coverage of

these programs were modified and

expanded in many ways.

• In the 1960s, the Medicare program of

health insurance was added to the Social

Security system of social insurance. This

provided on a non-means-tested basis

health benefits for both hospital costs

(Part A), and doctors’ fees and other costs

(Part B) for those over age 65 (later

expanded to also cover the disabled). The

1960s also saw the enactment of the

needs-tested Medicaid program providing

health care coverage under State-set

income eligibility standards for the aged,

the disabled, and low-income families.

• Private pensions, which earlier had

been relatively rare, became much more

common and substantial. This was

especially true for workers employed

by large corporations that came to use

pension incentives partly as a means to

attract and retain employees but also as

a means to influence retirement

decisions.

• Mortality improvements raised the life

expectancy at age 65 by about 50
percent, from under 12 years in 1900 to

over 17 years today.

• Birth rates rose substantially in the

years immediately following World

War II and then dropped and have

apparently stabilized at levels roughly

approximating a long-term replacement

rate.

• The national labor force grew both as a

result of the high post-World War II

birth rates and as a result of a large

increase in the entry of women into the

workforce.

• Although the second half of the 20th

century saw some periods of economic

slowdown and some periods of high

inflation, it was, overall, a highly

productive era with real gross domestic

product, measured in 2000 dollars,

growing fivefold from under $2 trillion

in 1950 to nearly $10 trillion in 2000.

• There were large advances in medical

knowledge and technology and these

were accompanied by very large rates

of health care cost inflation.

• Older Americans were experiencing

longer retirements through a

combination of greater longevity and

earlier withdrawal from the labor

market. The average retirement age for

men dropped from age 70 at midcentury to about 63 in the early 1980s.

• Homeownership rates grew from under

half of all families in the first half of

the last century to about 69 percent

today with homeownership now

exceeding 80 percent where the

householder is age 65 or over.

• In addition to their homes, Americans

also, in varying degrees, have come to

hold a range of financial assets such

as bank accounts, savings bonds,

equities, and insurance contracts. In

the latter part of the last century, a

number of tax incentives were

adopted with the objective of

encouraging increased savings and

investment such as IRAs and 401(k)

plans.

The net result of all these changes was that,

by the end of the last century, the typical adult

life could be viewed as consisting of two

stages—the working years and the retirement

years. There is, of course, a great deal of

individual variability around that typical

picture. Some individuals do not retire; some

retire much earlier than others; some

experience, by choice or necessity, significant

gaps in labor force participation during their

“working years;” some spend all or a portion of

their “retirement years” in partial employment.

Similarly, there is a great deal of variability in

the elements that go into providing economic

...by the end of the last century,

the typical adult life could be

viewed as consisting of two

stages—the working years and

the retirement years.

2

security in retirement. Nearly all American

workers participate in the Social Security

program, but for some of them Social Security

will be the source of 90 percent or more of their

retirement income; for others it will represent a

much smaller share. Some individuals are

covered by private pension plans (or pension and

health benefit plans); others are not. Levels of

individual savings, investment, and other assets

vary widely.
...the objective of an “adequate

income in retirement” in

the Older Americans Act

remains an appropriate

overall goal for retirement

security policy.

Some common elements of retirement

security at the beginning of the 21st

century

Replacement rates.—During the working

years, economic security mostly takes the form

of earnings from employment (or selfemployment). As a general rule, the amount an

individual earns and is able to spend determines

the “standard of living” for that individual and

his or her family. Retirement income policy has,

therefore, tried to measure “an adequate income

in retirement” by looking at how much of the

3

take a comprehensive look at pension policy and

whether workers were making adequate

preparation for their retirement needs.2

Despite the diversity in what constitutes the

retirement part of life for various individuals and

despite the diversity in how different elements of

economic security affect different individuals,

the objective of an “adequate income in

retirement” in the Older Americans Act remains

an appropriate overall goal for retirement

security policy. In this context, income adequacy

has come to largely include elements of both the

concepts spelled out in the prior two paragraphs;

it entails being able to achieve a standard of

living in retirement in rough accordance with

what was achieved while working as long as it is

at least equal to the socially minimal absolute

standard of poverty level income.

1

Department of Health, Education and Welfare, Office of

the Assistant Secretary for Planning and Evaluation, The

measure of poverty: technical paper II, administrative and

legislative uses of the terms, “poverty,” “low-income,”

and other related items (Washington, DC: USGPO,

September 1976), p. 8.

The basic goal of retirement security

policy

In 1965, Congress enacted the Older

Americans Act which includes as an objective:

“An adequate income in retirement in

accordance with the American standard of

living.” The legislation did not specify how to

define the standard of living but other public

policy developments help to do so. One evolved

from the public deliberations about poverty that

occurred during the 1960s. The other evolved

from analysis of the goals that underlay pension

designs in both the public and private elements

of our retirement system.

In the mid-1960s, a methodology was

developed for determining, “in dollar terms a

minimum level of income adequacy for families

of different types in keeping with American

consumption patterns.”1 This minimal income

level came to be known as the poverty line and is

updated annually. It is used to determine what

portion of the population is living on income that

falls short of meeting their minimal income

needs and to target income assistance programs

to help alleviate their predicament.

Beyond meeting minimal absolute needs,

there has generally been a sense in designing

pension systems that retirees should be able to

achieve a standard of living in retirement that is

comparable to the living standard achieved

during their working lives. This concept was

somewhat formally codified by a presidential

commission empanelled during the late 1970s to

2

 President’s Commission on Pension Policy, Coming of

age: toward a national retirement policy, 1981.
At lower income levels, a

higher overall replacement is

needed to maintain the prior

standard of living....

4

those at high earnings levels. At the lowest

levels of earnings, even very high replacement

rates may not be sufficient to provide an

acceptable level of income, and the Social

Security system has attempted to address that

problem through special benefit provisions (such

as the minimum benefit for long-term, low

income workers) and through the needs-based

Supplemental Security Income program.

Health care costs.—In practical terms, the

measure of adequacy of retirement income in

most cases is a matter of how much of the

individual’s working year earnings need to be

replaced to maintain his or her standard of living.

This calculation should include what is needed to

meet the costs of medical care. However,

because health care costs can vary widely and

unpredictably from one individual to the next,

our society has decided to deal with these

separately through the public programs of

Medicare and Medicaid and, to some extent,

through individual and employer-supported

programs of retiree health insurance that

supplement the public programs. Despite the

widespread availability of insurance to cover

much of the cost of health care for the elderly,

older people generally have to pay some portion

At lower income levels, a higher overall

replacement is needed to maintain the prior

standard of living and more of that replacement

has traditionally been provided from Social

Security. The Social Security program

accomplishes this difference through a benefit

formula that replaces a significantly higher

percentage of pre-retirement income for those

who had low working-year earnings than for

individual’s earnings in the working years are

replaced by the various elements of retirement

income.

The “replacement rate” calculation is

complicated by several factors. Consumption

needs in retirement years are often different

than those in working years. Costs associated

with housing, child rearing, work expenses,

and taxes are often less during retirement than

when working. But the cost of maintaining

one’s health is generally higher at advanced

ages. Because some needs are relatively fixed

no matter where one falls in the income

distribution—health is an example—lowerincome individuals are likely to need a higher

replacement of pre-retirement income in order

to have adequate retirement income. Sources

of income also tend to vary across the income

spectrum. Those who have spent their

working lives at low earnings levels generally

are much less likely to have employer-pension

income and personal savings than those who

have had a career at high-paying jobs. Some

will not be able to earn sufficient protection

through Social Security, employment-based

programs, and individual savings and will have

to rely on needs-based safety-net programs that

aim not at replacement but at assuring a

minimum level of income.

While higher income individuals are able

to spend more (that is, enjoy a higher standard

of living) during their working years, they also

are better able to set aside a portion of their

working-years income in accumulating savings

or other assets. This means that those with

higher incomes are likely in retirement to have

significant retirement resources apart from

Social Security to help them meet the goal of

maintaining their pre-retirement standard of

living. It also means that, on a percentage

basis, they will need a lower overall

replacement of pre-retirement income to

maintain the standard of living they had in

their working years (since a significant part of

that pre-retirement income was devoted to

savings rather than consumption).
5

Demographic changes.—In the two decades

following World War II, the Nation experienced

a surge in birth rates giving rise to what is

commonly called the baby boom generation.

This was followed by a period in which birth

rates dropped sharply (to levels below

replacement rates) and then rose again to current

levels (which are approximately at replacement

rates). Most demographic experts expect that

birth rates will continue around or below current

levels. Over the past half-century, older

Americans have experienced increasing length of

life, and demographers expect continuing

increases in longevity in the future.

As a result of these changes, the Nation will

have a relatively larger population of older

persons and a relatively smaller population in the

“working ages” in coming years than we have

had in recent decades. Chart 1 shows the ratio of

people 65 and older to that of the people in the

20-64 “working age” group from 1960 to the

present time and then projected forward for the

next 75 years. This ratio has not varied

appreciably over most of the past half century.

But the ratio is expected to rapidly increase as

the baby boom generation moves into its older

years. Even after the impact of the baby boom,

the increase in this ratio is expected to continue

to rise as length of life increases. Within the

next quarter century, the ratio of the aged to the

working age population will nearly double from

its current level and then continue to rise more

slowly.

Looked at the other way, we now have

approximately five people of working age in our

society for each elderly person. By 2035, we

expect that there will only be 2.7 persons of

As our Nation moves into the

21st century....many new challenges

must be addressed.

of their health insurance premiums and often

incur considerable out-of-pocket expenditures in

meeting their health consumption needs.

The employment link.—Retirement income

analysts and policymakers have looked to the

individuals’ earnings levels in their working

years as an indicator for approximating the

retirement income needed to maintain an

adequate standard of living. In addition, a

substantial part of retirement income has been

financed on an employment-related basis. For

the Social Security programs, this has been

accomplished by imposing employer and

employee payroll taxes on earnings and

determining benefit amounts based on the

average earnings. Similarly, the Hospital

Insurance part of Medicare is financed through a

separate payroll tax. Traditional private and

public employee pension programs have been

seen as a part of the compensation package, and

pension benefits typically bear a relationship to

earnings levels and years of employment. Even

much individual savings and investment has

been facilitated through employment-based

programs such as payroll savings plans and,

more recently, defined contribution (DC) pension

programs such as 401(k) plans.

21st century challenges

As our Nation moves into the 21st century,

the goal that older Americans in retirement

should be able to enjoy an adequate level of

retirement income appropriate to the American

standard of living should be reaffirmed. But, to

meet that goal, many new challenges must be

addressed.

...the Nation will have...a relatively

smaller population in the “working

ages”....
working age for each elderly person in our

society; by 2080 there will be 2.3 persons of

working age for each person aged 65 or over.

This means that programs for the aged which

are financed from the on-going earnings of

workers will face the pressure of relatively fewer

contributors and relatively more beneficiaries.

More broadly, however, total economic

consumption at any point in time must, for the

most part, be produced by the workforce at that

time. In the face of the projected relative decline

of the workforce, maintaining or increasing

living standards will require some combination

of increasing the productivity of the workforce or

moderating the impact of the expected

Chart 1

Source: 2004 OASDI trustees report, Table V.A.2

p.78

An Aging Population

Ratio of People 65 and Older to People 20 to 64

population shift (for example, by encouraging

more workforce participation of older and

disabled workers or through increased

immigration). The use of 65 as a dividing line

between the working age and elderly population

is a useful statistical convention for viewing

demographic trends but is, nonetheless, arbitrary

and may become less appropriate with increasing

longevity and changing labor force participation

patterns. In the section of the report dealing with

Social Security specifically, another common

measure is used; the ratio of covered workers to

beneficiaries (which is now 3.3 workers per

beneficiary but is projected to decline to 1.9 by

2080).

Changing pension realities.—Participation

in employer-sponsored pension programs has

always been far from universal. Still, for a

substantial portion of the population, pension

accumulations are a major factor in assuring an

adequate income in retirement. However, there

has been a shift away from traditional pensions

that typically provided a specified annuity at

retirement under a formula based on factors such

as age at retirement, salary level, and length of

service. The number of these traditional

“defined benefit” (DB) plans has dropped

sharply over the past two decades in favor of

“defined contribution” (DC) plans in which

workers accumulate individual retirement

accounts. These are funded through on-going

pre-tax deductions from wages, often with some

degree of employer matching. At employment

termination, the amount that has been paid into

these accounts (plus any investment earnings) is

transferred in a lump sum to the worker. There

are a number of reasons why this shift has taken

place. Defined contribution plans can reduce

employer costs and risks and involve lower

administrative burdens. The shift to such plans

also reflects changes in the nature of

employment with the result that workers less

frequently stay with an employer for a full career.

Defined contribution plans offer workers greater

retirement savings portability when they

...total economic

consumption at any point in

time must, for the most

part, be produced by the

workforce at that time.

6

1960 1990 2020 2050 2080

Year

Ratio

0.5

0.4

0.3

0.2

0.1

 0
7

termination of employment. The objective of

providing an adequate replacement of earnings in

retirement can be undermined if the lump sum

payouts are used for non-retirement spending.

Even if the lump sum is devoted to replacing lost

income in retirement, the individual bears a risk

of miscalculating his or her longevity.

Depending on the nature of the miscalculation,

the result could be outliving the availability of

funds or reducing his or her standard of living in

an attempt to avoid that result.

There are some important advantages to the

defined contribution approach. In our current

mobile workforce, workers may change jobs

either before their defined benefit participation

has vested or before they have attained sufficient

length of service to benefit substantially from

typical benefit formulas. For some workers the

ability under defined contribution plans to gain

early access to their accounts through lump sum

disbursements or loans may enable them to better

manage their lifetime stream of income to meet

important needs such as education or

homeownership. At retirement, they may have

options to choose annuities or investments to

better protect against inflation as compared with

traditional non-indexed pension annuities.

Growing health care costs.—Because health

care costs vary widely from one individual to the

next, it makes sense to treat them as a separate

part of retirement security and handle them

essentially on an insurance basis where the

individually unpredictable risk is spread broadly

so that the costs of financing become predictable.

This makes it possible for policymakers to

determine how much of the costs of health care

in retirement should be financed from payroll

taxes on current workers, how much through

general revenues, and how much through

premiums, deductibles, and other payments by

individuals. That, in turn, makes it possible to

bring health costs in retirement into the context

of an overall objective of an adequate

replacement of pre-retirement earnings.

Traditional defined benefit plans typically

provide a pension in the form of an annuity at

retirement while defined contribution plans

typically provide a lump sum payout at

...there has been a shift away from

traditional pensions that typically

provided a specified annuity at

retirement....The shift to the defined

contribution approach creates

additional challenges in meeting the

goal of assuring adequate earnings

replacement in retirement.

change jobs, while defined benefit plans are now

less effective in discouraging worker mobility.

The shift to the defined contribution

approach creates additional challenges in

meeting the goal of assuring adequate earnings

replacement in retirement. Under the traditional

defined benefit approach, workers can calculate

how much the pension will provide them in

retirement leaving the employer the

responsibility of assuring adequate financing to

produce that level of income. The worker is

further protected because defined benefit

pension plans are insured by the Federal

government through the Pension Benefit

Guaranty Corporation (PBGC). Thus, even if

the employer is unable to deliver on the

promised benefits, they will be paid by PBGC.

(However, there are statutory limits on the

amount guaranteed by PBGC. Recently, there

have been several large plan terminations that

have resulted in individuals getting pensions that

are substantially lower than what they had

expected. Moreover, these plan terminations are

causing a growing unfunded long-term liability

for the PBGC.)
In fact, however, the only sense in which

future health care costs are predictable is that

they have been growing—and are projected to

continue growing—at an unsustainable rate. In

their 2004 report, the Medicare Trustees3

 assume

that over the 75-year estimating period per

beneficiary cost will grow at an annual rate that

is 1 percentage point higher than the growth rate

of per capita Gross Domestic Product. This is a

lower growth rate than has been experienced

either over the history of the program or in recent

years. Even so, the public Trustees point out that

the out-of pocket expenses for premiums, copays, and deductibles will rise rapidly and

consume a greater and greater part of Social

Security benefits. As described in more detail

later in this report, out-of-pocket costs for an

aged beneficiary, with Medicare experience that

is typical, are projected to rise from 37 percent of

the average Social Security benefit in 2006 to 49

percent in 2020, and to 97 percent by 2078.

Looked at in this light, rising health costs pose a

threat to retirees’ ability to meet their other

consumption needs and pose a major threat to

their retirement security.

3

The Boards of Trustees for the Social Security and

Medicare trust funds consist of the Secretaries of

Treasury, Labor, and Health and Human Services, the

Commissioner of Social Security, and two public Trustees

appointed on a bi-partisan basis.

...rising health costs pose a threat to

retirees’ ability to meet their other

consumption needs....

There are many other ways in which the

uncontrolled expansion of health care costs

creates challenges to a goal of assuring adequate

retirement income security. In the past, many

employers have provided health benefits for both

workers and retirees. Many employers are now

reducing or eliminating retiree health benefits

and the burden of increased health costs is

affecting the ability to finance pension benefits.

With a larger and older population of retirees

in the future, there will also be an increasing

need for various forms of long-term care: nursing

home, skilled nursing, assisted living, homebased, and hospice care. These are expensive,

and the demand for such care will grow rapidly

as the baby boom generation reaches age 75 in

and beyond 2021. These services are mostly not

covered by Medicare for middle-income

Americans. (For lower-income persons,

Medicaid presently pays these costs.) In looking

at how older Americans can be assured an

adequate retirement income, these looming longterm care expenses also need to be addressed.

Globalization and economic change.—In

seeking to meet the challenges posed by an aging

population and rapidly growing health costs,

many American employers are also facing

increasing domestic and global competition that

is shifting the ways of doing business and

changing employer and employee relationships.

With a stable business model that involved

career employment, it made sense from both the

employer and employee perspective to devote a

significant portion of the compensation package

to pension and health benefits that would be

available in retirement. Now, some of the

promised benefits in industries such as air

transportation and automobile production are

placing established firms that followed the

traditional model at a competitive disadvantage

relative to their newer or global competitors.

The American economy of the 21st century is

increasingly a highly competitive economy with

large and growing connections to the world

economy. We have every reason, however, to

also expect it to be a healthy and prosperous

economy. There is no reason to abandon our

national objective that older Americans should

enjoy an adequate level of retirement income.

However, we need to strengthen our instruments

8
9

...we need to strengthen our instruments of economic security and modify

them so as to assure that they can continue to function

appropriately in today’s economy.

many—earnings from employment. These

elements are all important to retirement income

security. Many of these also serve other policy

objectives and come under the purview of a

variety of public and private policy shapers. It is

crucial that all of those involved—the

Administration and its component agencies,

Congressional leadership and the relevant

Congressional Committees; leaders of the private

sector including labor, the financial services

industry and, indeed, business generally,

advocacy organizations, and academic experts—

focus serious attention on finding ways to work

together to develop a comprehensive and

coordinated approach to meeting the 21st century

challenges to assuring an adequate income for

older Americans. Without such a comprehensive

focus, solutions developed for any one element

may undermine the ability to address other

elements and will likely leave significant gaps in

meeting the overall goal.

A need to strengthen and adapt.—The

Nation, over the past century, has built a

substantial matrix of income security programs

and institutions. This basic structure is being

challenged by the need for our businesses to be

more competitive, by the expected demands of

an aging population, and by unresolved public

policy deliberations. If we are to continue to

achieve the stated goal of the Older Americans

Act, the elements of our retirement system need

to be maintained and strengthened. At the same

time, however, attention needs to be paid to how

these elements of income security can be

modified or supplemented to reflect the ways in

which our 21st century society differs from

American society in the middle of the last

century. Global competitiveness and other

economic changes, for example, have altered

income distributions in ways that may require

of economic security and modify them so as to

assure that they can continue to function

appropriately in today’s economy.

Meeting the challenges

In the 20th century, America underwent many

changes, faced many difficult challenges, and

achieved many great objectives. With respect to

income and health security for older Americans,

it is clear that the 21st century is bringing

significant additional challenges. To meet those

challenges:

The goal is unchanged.—“An adequate

income in retirement in accordance with the

American standard of living.” This was an

appropriate national policy objective when it was

enacted in the Older Americans Act in 1965, and

it remains an appropriate policy goal in the 21st

century. For most Americans that goal will be

expressed in terms of replacement of preretirement income. Much useful research has

been done to better inform policymakers and

individuals as to what replacement is needed to

achieve an adequate level of retirement income

but efforts to improve and refine this knowledge

should continue.

A comprehensive strategy is needed.—The

achievement of an adequate income in retirement

is comprised of many elements which will

combine in different ways for those in varying

income levels and family circumstances. Some

of these elements are the basic Social Security

program, Medicare and Medicaid, employersponsored health insurance, pension, and saving

programs, individual asset accumulation

including savings and home ownership, and—for
new approaches to assuring less skilled, lower

paid individuals a retirement income that is

adequate in terms of the American standard of

living.

Social Security solvency must be restored.—

The basic Social Security program is the central

element of retirement income security for most

of the older population. It is particularly

important for the lower and middle parts of the

income distribution, with 29 percent of aged

households getting 90 percent or more of their

income from Social Security and 59 percent

getting 50 percent or more. The program has a

significant solvency problem that can and should

be dealt with. In prior publications, this Board

has identified a large number of proposals which,

in some combination, could be used to restore

program solvency. A number of other proposals

have recently been advanced representing a

variety of policy perspectives. It is important

that policymakers begin to deal with Social

Security now while there are still many options

and while there is time to phase in changes

gradually. As the Board has pointed out, by

acting sooner rather than later, Congress will be

able to choose among more and less disruptive

options.

It is important that policymakers begin

to deal with Social Security now while

there are still many options and while

there is time to phase in changes

gradually.

Employer-based programs should be

encouraged and strengthened.—Changes in the

workplace and increased competition have made

it more difficult to maintain the kind of

employer-based pension and health coverage that

many workers enjoyed in the past. In response to

these pressures, there has been a significant

move away from providing retiree health

benefits and traditional pensions toward defined

contribution plans and hybrid pension

arrangements. In some cases, these shifts have

been controversial and the legal status of certain

plan modifications has been challenged.

Policymakers have not resolved the

uncertainties, and there are growing signs that

the remaining sponsors of traditional defined

benefit plans are reconsidering their role in our

retirement security system. If we are to fulfill

the goals of the Older Americans Act, it is

imperative that policies be adopted that

encourage existing plans to meet their

obligations and that do not discourage the

formation of new plans. Policymakers also need

to look at defined contribution plans to

encourage wider availability, to improve

participation rates, and to facilitate using the

proceeds from such plans for retirement security

purposes.

Individuals need to understand and accept

their role in retirement security.—Our Nation

has always been one that encourages and relies

on individual initiative and effort as a primary

engine of personal and national well-being. Our

major social insurance programs were designed

with a view to supporting rather than supplanting

the role of the individual. Individuals will

increasingly need to play a major role in meeting

the retirement income security challenges of the

21st century. Policymakers need to find ways to

encourage research and promote education that

will help workers at all ages understand:

• what resources they will need in order to

enjoy an adequate standard of living in

retirement;

• how much of that need they can expect

from public programs such as Social

Security and how much they will need to

accumulate additional resources through

participation in employment-based

programs and personal savings and

investment;

10
11

• the importance of beginning early in life

to plan for and start work on the

accumulation of the resources that will be

needed for a comfortable retirement;

• the significance to the adequacy of

retirement income of choices about when

and to what extent to withdraw from the

labor force in retirement;

• the role that the individual can play in

moderating the impact of growing health

costs by becoming a more informed

consumer and by adopting a healthier

lifestyle.

Health costs must be constrained.—The

challenges posed by health care costs are not

simply a financing issue. If health costs continue

Constraining health costs will not be simple, but neither is it an

impossible challenge.

to grow at existing and currently projected rates,

no rational planning for retirement income

security is possible; indeed, the ability of the

economy to function in today’s highly

competitive global economy may well be

undermined. Constraining health costs will not

be simple, but neither is it an impossible

challenge. Many experts believe that the

projected growth is attributable, in large

measure, to inappropriate incentives, uneven or

inconsistent quality, and new technologies that

do not always add value. We need to look for

ways to change those incentives, improve

quality, and discriminate between more and less

valuable technologies. Government funding for

a comprehensive research effort to assess the

value of new treatments and technologies would

be a major step.
II. RETIREMENT SECURITY: THE ECONOMIC AND BUDGETARY

CONTEXT

We are at an important juncture in the

history of how our Nation assures economic

security for its older citizens. We need to

understand better how the protections provided

by our public income support programs of

Social Security and Supplemental Security

Income interrelate with each other and with the

other public and private elements of economic

security. We need to see how they work

together and what gaps in protection should be

addressed. We also need to think about how

these programs are evolving and how they will

affect the ability of future generations to meet

their economic security requirements.

Planning for lifetime economic security, for

individuals or society, is uncertain but necessary.

Adjustments will always be needed as

circumstances change, but the adjustments are

likely to be larger and more disruptive if we do

not plan ahead as best we can. We know some

things with near certainty such as the relative

size of the “baby boom” and “baby bust”

generations. Other factors we predict with some

confidence but need to continually reassess, such

as the projection that life expectancy at age 65

will continue to increase gradually, but

significantly, that there will be continuing

significant increases in productivity, and that we

will continue to realize the benefits of steady

immigration in the face of declining birth rates in

many of the feeder Nations from whence

immigrants have come in recent years. Still

other factors like sudden natural disasters or

huge technological breakthroughs are not

predictable. Overall, however, current “best

estimates” such as those by the Social Security

Trustees, the Congressional Budget Office

(CBO), and others predict a future which

presents significant challenges. Success in

meeting the challenges of the future will be more

likely if we understand and, at least to some

extent, coordinate the roles of the various public

and private elements that our society looks to for

economic security.

The challenges we will face in meeting the

future economic security needs of America’s

older citizens do not exist in isolation but coexist with all the other needs and capacities of

the larger economy. It is essentially the case that

what individuals consume at any given point in

time has to be produced then by themselves or by

other individuals. An individual who has

withdrawn from productive participation in the

economy whether because of illness, retirement,

or other reasons, necessarily consumes someone

else’s production to meet his or her ongoing

needs. This is true whether he finances that need

by drawing down on his accumulated savings, by

having a need paid for by a third party through

health or other insurance, or by spending his

Social Security or private pension check.

Because of such factors as the baby boom,

increasing longevity, and low birthrates we

project a future in which the size of the

population producing goods and services is

shrinking relative to the overall size of the

consuming population. Regardless of the way in

which individual programs may be financed,

output per worker must increase or average real

per-capita consumption (what we call standard of

living) must fall.

In addition to these demographic pressures,

we also need to recognize and address the

structural changes in our national—and

increasingly international—economy that are

affecting how employment-based programs of

retirement security operate. The model of

...the future economic security needs of America’s older citizens do not exist in

isolation but co-exist with all the other needs and capacities of the larger economy.

12
lifetime work for a large, stable employer, while

never universal, was formerly much more

common. Today, increasing competition—both

domestic and international—results in greater

mobility both for workers and firms. Workers

increasingly need instruments of retirement

security that are portable. They are less likely to

find compensation packages attractive that are

heavily weighted toward meeting the retirement

and health needs of past or future long-time

career employees.

Our national economy has grown in the past,

and substantial economic growth is expected in

the future. The chart below shows a

Congressional Budget Office projection4 of real

Gross Domestic Product from 1960 to 2050 as

shown in its December 2003 publication, The

Long-Term Budget Outlook.

Source: Based on Congressional Budget Office,

Long-term budget outlook, December 2003.

Chart 2

4

The CBO document projected six scenarios. All of them

showed real GDP growth over the 2003-2050 period of

between 182 and 192 percent. The data presented here

are based on CBO’s simulation 5 path, which projects an

intermediate level of increase in spending.

Real GDP in Trillions of Dollars

1960 - 2050

The CBO projection shows real GDP in 2003

dollars rising from a 2003 level of about $10

trillion to about $31 trillion in 2050. This is a

very substantial projected increase, but, as CBO

notes in that report, the future path of

productivity growth is uncertain. There are

many factors that can affect how strongly

productivity grows. One such factor is national

savings. Federal fiscal policy can also affect

national savings. The chart below, again using a

CBO projection from the same publication,

shows the increasing share of Gross Domestic

Product taken by the programs of Social

Security, Medicare, and Medicaid. The health

programs are projected to continue to increase

significantly but by a lower rate than that

experienced in any of the last three decades. The

Social Security projections are based on the

benefits scheduled in present law. The combined

impact of these programs is projected to increase

from 8 percent of GDP now to 18 percent by

2050. Other Federal spending (defense and

domestic, excluding interest) currently consumes

about 10 percent of Gross Domestic Product.

Chart 3

Social Security, Medicare, and Medicaid Spending

as a Percentage of GDP, 1966 to 2050

Source: Congressional Budget Office, Long-term

budget outlook, December 2003.

The projected growth of Social Security,

Medicaid, and especially Medicare will make it

increasingly challenging to accommodate other

budgetary priorities within an overall fiscal

policy that encourages continuing strong

economic growth.

The projected growth of Social

Security, Medicaid, and especially

Medicare will make it increasingly

challenging to accommodate other

budgetary priorities.....

13

1960 1980 2000 2020 2040 2050

35

30

25

20

15

10

5

0

$Trillions

Percent

 1966 1980 2000 2020 2040 2050

20

15

10

5

0

Medicare

Social Security

Medicaid
III. SOCIAL SECURITY

The Social Security program is our Nation’s

foundation for providing economic security for

America’s workers and their dependents in the

event of retirement, disability, or premature

death. Social Security is not intended to be the

sole source of economic security in those

circumstances, but it does serve to establish a

core of social insurance protection around which

individuals can build additional layers of

protection through private insurance,

participation in employer-based programs,

individual savings, and earnings from

employment.

How the Social Security program

operates

Although the Social Security program has

considerable complexity in the details of how

benefits are computed upon retirement,

disability, or death and in the different types of

benefits available for workers and their

dependents or survivors, the basic concept of the

program is straightforward. The worker pays

taxes to support the program (with matching

taxes from employers5) and, by doing so, earns

credits toward eventual benefits for the worker

and his or her dependents or survivors.

Although the program is structured

somewhat like a private insurance or annuity or

investment program, it has a significant social

objective and is therefore classified as “social”

insurance. While the basic benefit level bears a

relationship to the level of earnings on which

5

Economists generally view employer payroll taxes and

other employer-paid benefits as being a part of the overall

compensation package and thus, in most cases,

substituting for what would otherwise be paid in wages.

There is a tax advantage to the worker to the extent that

these amounts are excluded from taxable wages.

the wage-earner previously paid Social Security

taxes, that relationship is weighted. In absolute

terms, higher earners receive higher annual

benefits but in relative terms the formula favors

those who had lower earnings. This weighting of

the formula recognizes the reality that lower

earners will have had less ability to accumulate

other retirement assets and will consequently

need a greater replacement of their prior earnings

in order to maintain a reasonable standard of

living in retirement. The program also provides

additional protection in the form of benefits for

dependents of the worker (dependent spouse,

minor or disabled dependent children) and

provides survivorship benefits and benefits in the

case of disability prior to reaching retirement

age. The redistributive characteristics of the

program in the determination of annual benefits

is somewhat tempered from the perspective of

lifetime benefits because of differences in life

expectancy between individuals across the

income spectrum.

In calculating benefits, the formula is applied

to average earnings in the highest 35 years of

earnings. This is a proxy for “lifetime earnings”

(the number of years between the ages of 21 and

62 after dropping out five low years). In the

early years of the program, earnings were used at

their absolute value but Congress acted from

time to time to change the benefit formula,

which had the effect of increasing benefit

amounts both for those already getting benefits

and for new retirees. Under the current program,

...the formula recognizes the reality

that lower earners will...need a greater

replacement of their prior earnings in

order to maintain a reasonable

standard of living in retirement.

14
prior to determining an average, each year’s

earnings are indexed to reflect wage growth in

the economy between the year of the earnings

and the year the worker reaches age 60. An

adjustment is also made to the benefit formula to

recognize increasing average earnings. These

adjustments have the effect of increasing benefit

levels for new retirees from year to year to keep

them up to date with changes in the national

standard of living as measured by increases in

average wage levels.

Once the benefit rate has been calculated, it

becomes a lifetime annuity (paid on a monthly

basis) to the worker and any eligible

dependents.6 This annuity (benefit payment) is

then adjusted each year for inflation as measured

by the increase in the Consumer Price Index.

Benefits under the Social Security program

are payable without regard to other income

except that prior to the attainment of the Normal

Retirement Age (NRA), benefits are reduced or

eliminated if earnings exceed certain levels. At

NRA an adjustment is made to increase the

monthly benefit rate to compensate for withheld

benefits. Not reducing benefits because of other

income is consistent with the nature of the

program as providing a basic core of retirement

income support while maintaining incentives for

individuals to build additional layers through

employer-based programs and individual

savings. At the lowest levels of income,

however, it is difficult to balance the objectives

of providing for income needs, avoiding

excessive program costs, and maintaining

appropriate incentives. Under current law, the

Social Security program has a special minimum

benefit which is payable only to those who have

significant earnings over a period of 11 to 30

years. This special minimum benefit, however,

now applies to very few individuals since it is

based on an unindexed amount of $11.50 per

6

Subject to their continuing eligibility; e.g., a dependent

minor child who is not disabled would lose eligibility

upon reaching majority.

month multiplied by the number of qualifying

years. For those aged individuals who have very

little Social Security eligibility (or none at all), a

minimum income is provided through an

income-tested program of Supplemental Security

Income. This program provides payments which

bring an aged individual’s income up to $579 per

month (2005 rate). For an aged couple, the

monthly SSI income support level in 2005 is

$869.

Until the 1980s, the Social Security program

operated on essentially a pay-as-you-go basis in

which taxes upon employment and selfemployment were established by law with a view

to covering each year’s benefit costs and

building up a small contingency fund. The

contingency fund of approximately one year’s

benefits would allow the program to deal with

routine economic variations and provide some

time for Congressional action in the case of

unforeseen program imbalances. The 1977 and

1983 amendments to the Social Security Act

provided for a temporary departure from this

approach. By 2015, the 1983 amendments

provided for a substantial fund build-up to about

five-and-a-half years’ outgo. The accumulated

fund would then be drawn down to roughly a

year’s benefit by 2058—the end of the 75-year

estimating period. Current estimates indicate a

somewhat smaller build-up with the fund being

drawn down to roughly a year’s benefit by 2038

and to zero by 2042.7

In many ways the Social Security program

operates as it was intended. Its coverage is

nearly universal, extending to well over 90

percent of all paid employment. Nine out of 10

persons over age 65 receive benefits. Nine out

of 10 covered workers would be eligible for

benefits in the event of disability; survivorship

7

The 2004 Trustees Report intermediate projections show

the funds reaching a high of 448 percent of a year’s

benefits in 2015, declining thereafter to exhaustion in

2042. Under the most recent CBO estimates the funds

would be drawn down to zero in 2052.

15
8

Moore, James F. and Olivia S. Mitchell, “Projected

retirement wealth and savings adequacy,” in Olivia S.

Mitchell, P. Brett Hammond, and Anna M. Rappaport,

eds., Forecasting retirement needs and retirement wealth.

protection for workers with young children

exceeds 95 percent of covered workers aged 20-49.

Contribution to economic security of

aged beneficiaries

Economic security in retirement comes from

a variety of sources: Social Security, private

savings, pension plans, housing equity, and

continuing earnings. Chart 4 shows the

aggregate distribution of various income sources

for the aged; however the relative importance of

each of these is not uniformly distributed among

the population. For example, one study

published in 2000 and based on a 1992 survey of

those approaching retirement age found that the

wealth attributable to Social Security for the top

30 percent of the population represented a

quarter or less of total wealth while for the

bottom 30 percent it represented well over half.

At the median, it represented about 40 percent

with the remaining 60 percent about evenly

divided among housing, financial, and pension

wealth.8

While Social Security does play its intended

role of providing a solid basis of retirement

income security, it is clear that for many

beneficiaries the additional layers of protection

that should be available to supplement the basic

Social Security benefit are missing. For 29

percent of aged households, Social Security is all

or nearly all (90 percent or more) of the

household’s income. Even with Social Security,

21 percent of aged beneficiary households in

2001 had annual income below $10,000, which

places them near or below the poverty level.9

9

SSA, Office of Policy: Income of the population 55 or

over, 2000 and Income of the aged chartbook, 2001. In

2001, the census poverty threshold for those aged 65 or

over was $8,494 for a single individual and $10,715 for a

two-person household.

This should be an important consideration as

deliberations about Social Security reform begin

to unfold. Any reform options that include

potential benefit reductions could have a much

greater impact on the retirement income levels of

some beneficiaries than others. While there are

important issues to be faced in dealing with the

Social Security program, there is also a need to

find ways to have other parts of the Nation’s

economic security institutions do a better job of

providing additional layers of protection around

the core benefits that Social Security provides,

particularly for those at the lower half of the

income spectrum.

Aggregate Income of the Aged by Source

Other

3%

Social

Security

39%

Pensions and Assets

33%

Earnings

25%

Source: SSA, Income of the population 55 or older,

2002

Chart 4

Social Security solvency

Social Security is and will continue to be a

core element in retirement security protection

both for those now receiving benefits and for

those who are still working but who need to plan

ahead for their retirement years. To play this role

effectively, however, the Social Security program

needs to be soundly and believably financed.

This is not now the case.

...the Social Security program needs to

be soundly and believably financed.

This is not now the case.

16
The Social Security Act establishes a Board

of Trustees to oversee the Social Security trust

funds and to report annually on the status of

those trust funds. This Board of Trustees

consists of the Secretaries of Treasury, Labor,

and Health and Human Services, the

Commissioner of Social Security, and two public

Trustees appointed on a bi-partisan basis. In

addition, the Social Security Advisory Board

periodically convenes a panel of expert

economists, actuaries, and demographers to

examine and make recommendations for

improving the assumptions and methodology

used by the Trustees. For the past several years,

each of the annual reports by the Trustees has

warned that the Social Security program, by a

large margin, does not meet the standards for

long-range actuarial soundness. A separate

analysis by the Congressional Budget Office

reaches the same conclusion. This does not

mean that the Social Security program is about to

collapse or that it will go bankrupt and cease

paying any benefits. What it does mean is that,

according to the best estimates that can be made

to project the future income and outgo of the

system, the program will not have sufficient

resources to enable it to meet in full the benefits

that are payable under the rules and formulas

now in the law.

The size of the solvency problem is

significant. According to the 2004 report by the

Trustees, the program’s expected cost over the

next 75 years will substantially exceed the

program’s projected resources for covering that

cost. At the present time, Social Security’s tax

revenues are sufficient to meet all benefit costs

and still contribute to a build-up in trust fund

balances. Within just a few years, however, the

size of these surpluses will begin to decline. By

2018, the program will no longer have an excess

of tax revenue over outgo but will have to begin

using some of its interest earnings to meet

benefit obligations. By 2028, it will be necessary

to start drawing down the principal of the trust

fund balances. In the absence of changes, the

trust funds will be completely drawn down by

somewhere around mid-century (2042 under the

Trustees projections, 2052 under the CBO

analysis.) At that point, substantial revenues

would still be coming into the program but they

would be significantly less than what would be

needed to pay the benefits provided for in current

law. Under the Trustees’ projections, at the point

the trust funds are drawn down, the program

would have sufficient income to meet 73 percent

of program costs and this would decline over the

next 40 years to 67 percent of program costs.

There are several different ways to measure

the projected solvency of Social Security.

Traditionally the Social Security Trustees have

reported the actuarial balance by comparing

average income over the next 75 years with

average costs over the same period. Costs and

income are expressed as a percentage of the total

payroll subject to Social Security taxes.

(Adjustments are made to income and cost to

reflect the starting trust fund balance and a goal

of having an ending trust fund balance equal to

one year’s outgo.) Under this traditional

measure, program costs will exceed program

income by an amount equal to 1.89 percent of

taxable payroll. Another way of stating this

same deficit is that the unfunded obligations of

the program over the next 75 years have a

present value of $3.7 trillion or the equivalent of

0.7 percent of the Nation’s Gross Domestic

Product over that same period.

These traditional measures of program

solvency, however, are averages of very different

situations at the start and the end of the period.

The current situation shows a large trust fund

balance which, for a few more years, is expected

to continue increasing. At the end of the period,

the program will have ongoing deficits that are

much larger than the projected 75-year average

deficit. In the 75th year, the projected income

rate falls short of the projected cost rate by an

amount equal to 6 percent of taxable payroll. In

the 2004 Trustees Report, alternative measures

are used showing the unfunded obligations over

the infinite horizon, including:

17
• a present value of $10.4 trillion—the

amount of money that would have to be

put into the fund now to assure that all

the benefits currently scheduled in the

law could be paid into the indefinite

future without any increase in tax rates or

other revenues apart from the trust funds

and their interest earnings, or

• 3.5 percent of taxable payroll—the

immediate increase in the tax rate (from

12.4 percent to 15.9 percent) that would

generate sufficient additional revenues to

pay all scheduled benefits into the

indefinite future, or

• 1.2 percent of Gross Domestic Product—

the average amount (as a percent of

GDP) over each year in the future that

benefits would have to be reduced from

those currently scheduled or taxes

increased or some combination of the

two in order for income and outgo to

match.

Projections of the future status of Social

Security, like all projections of the future, have a

significant degree of uncertainty. The ultimate

situation may turn out to be better or worse than

now projected. The official estimates represent

an intermediate path between more or less

optimistic scenarios. These central estimates of

the future status of Social Security made by the

Trustees indicate that the program will, by a

substantial margin, lack sufficient resources to

meet its benefit obligations. (A separate estimate

by CBO shows a somewhat smaller average

deficit but confirms the basic conclusion of a

program moving from present-day surpluses to

substantial and continuing long-run deficits.)

The fundamental elements driving these

projections are facts that are already known or

assumptions that are widely accepted. The baby

boom generation exists and is starting to retire.

The number of workers per beneficiary—now

3.3—will decline to 2.6 by 2020, to 2.2 by 2030,

and to 1.9 by 2080. Mortality among older

Americans is expected to continue declining,

increasing the number of years that benefits will

be paid. The level of economic growth is less

predictable; however, the sensitivity to economic

factors is somewhat reduced by the fact that

major program elements are indexed to changes

in wage and price inflation.

Importance of restoring solvency

The Social Security program is fundamental

to the retirement security of the Nation and its

workforce. Because it plays this fundamental

role, Congress has established it on a selffinancing basis to emphasize its importance and

assure its stability. Even though the Social

Security program has adequate funds to meet

scheduled benefits for many years into the future,

the confidence of both current retirees and

current workers in the program is impaired if, as

is presently the case, the system is inadequately

financed to meet the benefit obligations that

those now paying into the program are

accumulating. In previous reports, the Social

Security Advisory Board has pointed out that

there are many options for how the program can

be brought back into long-run financial solvency.

Among the many proposals10 that might, in some

combination, be part of a plan to address the

issue are:

...there are many options for how the program can be brought back into long-run

financial solvency.

10See our report: Social Security: why action should be

taken soon, July 2001 for a more detailed discussion of

various proposals. This report and a 2005 memorandum

updating the estimated impact of the proposals are

available on our website: www.ssab.gov.

18
• increasing Social Security revenues

through rate increases, increasing the

amount of wages subject to Social

Security taxes, or expanding program

coverage to all new State and local

government employees;

• decreasing benefit costs through any of a

variety of options such as reduced costof-living increases, modifications to the

Social Security benefit formula and

computation rules, increasing the Normal

Retirement Age, or limiting benefits for

higher income persons;

• changing the program and its financing in

other ways such as investing trust fund

reserves in equities, replacing part or all

of Social Security with individual

accounts on a mandatory or voluntary

basis, or using general revenues to meet a

part of program costs.

The choices among these and other options

will have to be resolved by America’s elected

policymakers, but there are important reasons

why the process of making those choices should

begin soon. It will get harder to finance

promised benefits as the size of the workforce

decreases relative to the size of the older

population because of the retirement of the baby

boom generation and the continuing increases in

longevity. The longer we wait, the fewer the

choices and the more radical the needed changes.

The longer we wait, the fewer the

choices and the more radical the

needed changes.

Acting soon will offer more options and

allow for gradual rather than abrupt

changes.—Within just about one year from the

point in the future where the trust funds are

drawn down to zero, the program will move

from a situation in which full scheduled benefits

can be paid to a situation in which system

resources are approximately 25 percent short of

what is needed. Dealing at that point with

deficits of that magnitude leaves no options that

do not involve sharp and disruptive changes of

direction: tax increases, benefit reductions, or

general revenue infusions that in turn require

increased public borrowing or cuts in other

priorities.

The experiences of 1977 and 1983 are

instructive. In part because the program was

operating then on more of a pay-as-you-go basis

without a large reserve account, there was less

time available to implement changes in advance

of the point where there would be insufficient

financing to meet benefit obligations. Even

though the size of the projected shortfall was

smaller in both of those cases, the necessity for

quick action left limited options for a gradual

phase-in. In 1977, Congress found it necessary

to change the method for indexing the benefit

formula because the method that had been

adopted in the early 1970s interacted with

economic conditions in a way that Congress and

other policymakers had not anticipated. This

created large deficits that would have exhausted

the disability insurance trust funds by 1979 and

the retirement fund by 1983.11 Because there

was insufficient lead time, Congress did not have

the option of adopting a gradual transition but

instead approved a change in the benefit formula

that significantly reduced the benefits payable to

individuals who were then within just a few

years of retirement and may have based their

plans on the earlier formula.

In 1983, Congress found it necessary to

address Social Security financing in a context

where inability to meet benefit obligations was

imminent. It adopted a number of provisions

that had the effect of reducing benefits. Some of

the provisions, such as the increase in the

11

1977 OASDI Trustees report.

19
Normal Retirement Age from 65 to 67 were

deferred and gradually phased in, but others,

such as the permanent deferral of a scheduled

cost-of-living increase, became effective

immediately and reduced anticipated benefits for

everyone including those already receiving

Social Security.

Individuals need to know what they can

expect.—Social Security is intended to provide a

core of retirement income security around which

individuals can build additional layers to provide

a more adequate retirement. In order to plan

rationally for such additional layers of

protection, workers need to know how much of

their income will be taken for Social Security

taxes during their working years and how much

retirement income they can expect the Social

Security program to deliver. Retirement

planning by individuals should and, to a

considerable extent, must be a long-range

process. Elsewhere in this report, we point out

that too few American workers understand the

importance of timely planning and actual saving

for their income needs in retirement, and we urge

increased efforts to promote financial education

and retirement planning. It is inconsistent with

this important objective to leave the future status

of the Social Security program in a state of

uncertainty with the result that those now in the

workforce cannot reliably estimate their likely

future benefits.

...workers need to know how much

of their income will be taken for Social

Security taxes during their working

years and how much

retirement income they can expect the

Social Security program to deliver.

Other elements of income security policy

depend on a predictable Social Security

system.—Both public policymakers and those

who shape private sector programs such as

pensions and health insurance need to

understand what the core retirement security

program upon which they must build will look

like. The importance of re-invigorating the

defined benefit private pension program and of

addressing incentives for defined contribution

plans will, to some extent, depend on what the

Social Security program will look like in the

future. Similarly, there are important

interactions between health coverage and Social

Security. In planning Medicare’s future, it will

be important to know how much capacity Social

Security beneficiaries will have to meet out-ofpocket costs.

Meeting multiple challenges in an

uncertain future.—Over its history, the United

States has had to deal with many large challenges

and opportunities. In the last century alone,

there were four major wars, a great depression,

and a devastating flu epidemic; but there were

also large advances in technology and medical

science, a growing and better educated

workforce, and very large increases in national

production. We already know some of the

potential challenges that lie ahead including an

aging population, increasing medical costs,

environmental issues, and a continuing need to

deal with terrorism. There will undoubtedly be

unforeseen issues as well as unforeseen

opportunities over the course of the 21st century.

Developments in the future may well have an

impact on Social Security, and it is likely that the

program will need changes and adjustments from

time to time in the future. Nonetheless, it makes

sense to act now to put the program on a sound

footing according to our best ability to project

what the future will look like. That approach

provides the best hope of assuring that changes

needed in the future can be accomplished

incrementally rather than disruptively. It also

...it makes sense to act now to put the

program on a sound footing according

to our best ability to project what the

future will look like.

20
will enable us to coordinate the changes in

Social Security with the changes in other

institutions so as to allocate our resources in the

most rational and desirable ways.

Program support and confidence.—The

purpose of the Social Security program is to

assure a base of economic security that workers

and their families can count on in old age and

also in cases of disability or premature death.

That assurance was made more believable by

designing the program so that it would be able to

generate sufficient resources to pay its own

benefits without the need to depend on annual

discretionary appropriations. The assurance is

undermined, however, by the current situation in

which the internal financing of the program is,

by the best projections available, inadequate by a

significant margin to assure the benefits the

program seems to promise. This lowers

confidence in the program by seeming to imply a

lesser commitment to the principle of adequate

financing. It can also undermine confidence

because some workers, not knowing how much

of Social Security they can count on, may tend to

question whether they can count on it at all. A

May 2004 Roper survey conducted for AARP

found that only 44 percent of those aged 38-42

were confident that Social Security will still be

available when they retire.

Other Social Security issues

While solvency is the most pressing issue

facing the Social Security program, there is also

a need to examine whether the program

continues to be well targeted to meeting

economic security needs of older Americans. In

basic design, the program is intended to

recognize that those at the lower end of the

income scale may have less ability to save and

participate in supplementary programs such as

employer-based pensions. Program features

aimed at meeting that need include the weighting

of the benefit formula, and the provision of

dependency and survivorship benefits. Despite

these features, significant numbers of aged

Social Security beneficiaries have incomes at the

poverty or near-poverty level. This, as shown in

Chart 5, is particularly true for aged women who

are single, divorced, or widowed. Also, as

shown in Chart 6, there is a very large

discrepancy in the income levels of younger and

older retirees. As our Nation deals with the

solvency issue, it should simultaneously review

Chart 5

Chart 6

Poverty Rate for Women Age 65 and Older

by Marital Status

2000

Source: SSA, Income of the population 55 or older,

 2000

Source: SSA, Income of the aged chartbook, 2001.

As our Nation deals with the solvency issue, it should simultaneously review other

aspects of program design with a view toward improving the protection provided to

the most vulnerable of the aged.

21

Married Widowed Divorced Never Married

25

20

15

10

 5

 0

4%

17%

20%

23%

Median Income of Aged Units

2001

Married

Couples

Nonmarried

Men

Nonmarried

Women

 65-69 70-74 75-79 80 or older

Thousands of Dollars Percent

45

40

35

30

25

 20

15

10

5

0
other aspects of program design with a view

toward improving the protection provided to the

most vulnerable of the aged.

Other areas of the program also deserve some

reexamination. As beneficiaries enjoy longer and

healthier lives, there are for many of them an

increased ability and opportunity for continued

participation in some work activity. As discussed

in more detail elsewhere in this report, this is a

development that can contribute to more adequate

income for the individuals and increased tax

receipts for the program. It can also contribute to

meeting the needs of the economy. Program rules

should be looked at to see if programmatic

changes could better encourage this trend.

1970 7.30 1.10 8.40 1.2 9.60 7,800 7,800

1971 8.10 1.10 9.20 1.2 10.40 7,800 7,800

1973 8.60 1.10 9.70 2.0 11.70 10,800 10,800

1974 8.75 1.15 9.90 1.8 11.70 13,200 13,200

1978 8.55 1.55 10.10 2.0 12.10 17,700 17,700

1979 8.66 1.50 10.16 2.1 12.26 22,900 22,900

1980 9.04 1.12 10.16 2.1 12.26 25,900 25,900

1981 9.40 1.30 10.70 2.6 13.30 29,700 29,700

1982 9.15 1.65 10.80 2.6 13.40 32,400 32,400

1983 9.55 1.25 10.80 2.6 13.40 35,700 35,700

1984 10.40 1.00 11.40 2.6 14.00 37,800 37,800

1985 10.40 1.00 11.40 2.7 14.10 39,600 39,600

1986 10.40 1.00 11.40 2.9 14.30 42,000 42,000

1988 11.06 1.06 12.12 2.9 15.02 43,800 43,800

1990 11.20 1.20 12.40 2.9 15.30 51,300 51,300

1994 10.52 1.88 12.40 2.9 15.30 60,600 all

1997 10.70 1.70 12.40 2.9 15.30 65,400 all

Social Security Tax Rate Changes: 1970 to Present

(combined employer-employee rates in percent; maximum earnings for year in dollars)

Disability benefit issues

In this report, the Board focuses primarily on

the issue of retirement security for older

Americans. An important part of the Social

Security program, however, is the protection it

provides to workers against the loss of earnings

capacity as a result of disability. We have, in

other reports, addressed both the significant

administrative issues involved in the Social

Security disability programs and the broader

issue of whether the program needs basic

redirection and possibly a change of definition—

one that better meets society’s current goals of

encouraging and assisting those with

impairments to attain maximum independence

and self-sufficiency.

Cash Medicare

Retirement benefits hospital Total Cash Hospital

 Year and survivors Disabiltiy total tax rate Insurance tax rate programs insurance

Source: SSA, Annual statistical supplement to the Social Security bulletin, 2003.Table 2.A3

*Table shows only years with rate changes; some years with maximum earnings changes are not displayed.

Maximum for cash programs is $90,000 in 2005.

22

Table 1

Maximum earnings

subject to taxation*
It is important to recognize, however, that

there are interrelationships between the

retirement and disability aspects of Social

Security. In theory, the disability program is

supported by a specific portion of the payroll tax

that is allocated to a separate disability insurance

trust fund. Unanticipated growth in disability

benefits, however, has required on several

occasions a shifting of a portion of the overall

tax from supporting the retirement and survivors

program to supporting the disability program.

And it appears likely that this will be necessary

again. The 1985 Trustees Report projected that

the program would now be paying benefits to

about 6 million disabled workers and their

families. According to the 2004 Trustees Report,

the actual number of such beneficiaries is a third

greater than that projection—about 8 million,

and the disability program is projected to be

unable to meet benefit obligations in full by

2029, 13 years sooner than the retirement

program. As shown in Table 1, the disability

program tax rate has increased from 1.1 percent

in 1970 to 1.8 percent today. In order to meet

program costs over the next quarter century, the

Trustees estimate in their 2004 report that an

additional increase of approximately 0.18

percentage points would be needed.

Even apart from the direct financial impact

on the overall Social Security program of

disability benefit costs, there are significant

reasons why the disability program is related to

retirement income security. One challenge

facing the future of Social Security arises from

the changing ratio of workers to beneficiaries.

This would be lessened to the extent that policies

are adopted which make the disability program

more responsive to the desires of impaired

individuals to attain maximum self-sufficiency.

Also, in considering proposals aimed at

increasing labor force participation of older

persons, policymakers will need to recognize

that disability tends to become more prevalent

with advancing age.

One challenge facing the future of Social Security arises from the changing

ratio of workers to beneficiaries. This would be lessened to the extent that

policies are adopted which make the disability program more responsive

to the desires of impaired individuals to attain maximum self-sufficiency.

23
Pensions and savings are important elements

in retirement income security. Unfortunately,

despite legislation to encourage both savings and

pension participation, the rate of pension

participation has not changed much since the

passage of the Employee Retirement Income

Security Act (ERISA) in 1974, and, for many,

savings inadequately supplement other

retirement income.

IV. PENSIONS AND SAVINGS

 Saving is important not just to

individuals’ retirement security but to

the future of the American economy.

14The Analytical Perspectives volume of the President’s fiscal year 2005 Budget explains present-value estimates in this

way: “The present-value estimates represent the revenue effects, net of future tax payments, that follow from activities

undertaken during calendar year 2003 which cause [tax] deferrals or other long-term [revenue] effects. For instance, a

pension contribution in 2003 would cause a deferral of tax payments on wages in 2003 and on pension earnings on this

contribution (e.g., interest) in later years. In some future year, however, the 2003 pension contribution and accrued

earnings will be paid out and taxes will be due; these receipts are included in the present-value estimate. In general, this

conceptual approach is similar to the one used for reporting the budgetary effects of credit programs, where direct loans

and guarantees in a given year affect future cash flows.” (p. 286)

The private pension plan system is voluntary.

Employers decide whether to establish a plan

and determine the design of the plans they decide

to sponsor. Pensions are a tool to attract, retain,

motivate, and manage the flow of workers.

Federal tax law provides favorable treatment to

pension plans provided that the plans qualify for

such treatment by meeting standards laid out in

law and regulations. Employer contributions are

deductible as a business expense. Participants in

qualified plans typically do not pay taxes on their

employer’s or their own contributions or on the

earnings on those contributions until they receive

benefits. After deducting for the present value of

future tax payments, the revenue loss for 2003

due to the pension system was $184 billion, an

amount equivalent to 40 percent of the payroll

taxes collected to support Social Security

retirement benefits in that year.14

Pensions as a source of retirement

income

Employer-sponsored pension benefits are an

important source of income to retired people.

Survey data from 2002 indicate that 41 percent

of aged households report receiving retirement

benefits other than Social Security, but that

percentage understates the impact of employersponsored retirement programs. Such programs

increasingly pay benefits in lump sum

distributions that may be rolled over into

individual savings or insurance contracts, and

reported in surveys as asset income. Fifty-five

percent of aged households receive asset income,

part of which represents income derived from

contribution accounts and other retirement

24

...for many, savings inadequately

supplement other retirement income.

Saving is important not just to individuals’

retirement security but to the future of the

American economy. Increasing national saving

would help prepare for the inevitable budgetary

pressures caused by the retirement of the baby

boomers. Increased saving could boost

productive capacity, enabling the workforce of

the future to support the consumption of a

growing retiree population. National saving

consists of both public and private saving.

Federal budget surpluses, as long as they do not

come at the expense of private saving, would be

one approach to increasing national saving.

Strategies to encourage private saving would be

another.
accounts. Together, pension and asset income

make up 33 percent of the income of aged

households, and over two-thirds of aged

households receive income from pensions,

assets, or both. Since participation in employersponsored retirement programs is significantly

greater for workers at middle and upper earnings

levels,15 such programs represent an even larger

part of total retirement income for such

workers.16

Trends in retirement plans

Over the last 25 years, private pensions have

significantly shifted from defined benefit plans

to defined contribution plans. In 1980, there

were 148,096 DB plans covering 39 percent of

the workforce. The number of DB plans grew to

over 170,000 in 1986, but has since declined to a

1999 level of just under 30,000 plans covering

21 percent of workers. DC plan assets have,

since 1997, exceeded those in DB plans.17

Defined benefit plans use a formula to

determine the pension benefit that participants

are ultimately entitled to receive. Benefit

formulas typically involve the employee’s final

average pay or career average pay in

combination with years of service. Traditionally

these plans have paid benefits as an annuity, or a

series of payments over a specified period or for

the life of the participant, beginning at an age

specified in the plan. This life-long annuity plan

is similar to Social Security except that private

pension plans are ordinarily not indexed for

inflation. The annuity type of payout assures that

participants will not outlive their income. The

flexible structure of defined benefit plans also

allows employers to tailor benefits to the needs

of specific populations. For example, subsidized

early retirement benefits may be especially

important to workers in physically demanding

jobs. In recent years there has been a substantial

move toward offering participants in these plans

a lump sum benefit option, and anecdotal

evidence suggests that the vast majority of

workers that are offered this option take it when

they terminate employment covered by the plans.

Through the Pension Benefit Guaranty

Corporation, the Federal government stands

behind employers’ promises of defined benefit

pensions. The PBGC protects about 34.6 million

workers and retirees in single-employer pension

plans and 9.8 million workers and retirees in

multi-employer plans. (Multi-employer plans

are set up by collective bargaining agreements

and include a number of employers, usually in

the same industry.) The PBGC is funded by

premiums from plan sponsors, money from

investments, and funds from pension plans it

takes over. The maximum pension benefit

guaranteed by law, currently $3,801.14 per

month for a person who retires at age 65 from a

single-employer plan, is set by law and adjusted

annually. Guaranteed amounts are less for

workers who retire before age 65, workers

covered by multi-employer plans, and workers

who select a joint and survivor annuity.18

The PBGC estimates that it is operating with

a substantial long-range deficit, which is likely to

grow. As of the end of September 2004, the

PBGC reported a deficit of $23.3 billion. In

other words, while it currently has sufficient

funds to meet on-going benefit payments, it will,

in the absence of some sort of reform legislation,

ultimately be unable to pay benefits in full.

However, its situation is less predictable since its

long-range deficit could worsen as it takes over

additional funds as a result of plan terminations.

Overall, the private defined benefit pension

15See Table 2 on page 30.

16Data in this paragraph based on SSA’s, Income of the

population 55 or older, 2002, Table 3.6. 17See U.S. Department of Labor, Employee Benefits

Security Administration, Private pension plan bulletin,

Summer 2004.

18See http://www.pbgc.gov/about/default.htm; http://

www.pbgc.gov/press_release/2004/pr05_14.htm#chart.

25
system is underfunded. In its Fiscal Year 2004

Performance and Accountability Report, the

PBGC estimated, as of September 30, 2003, that

there was a $350 billion gap between assets and

liabilities in the private, single-employer defined

benefit system. As of September 30, 2004

PBGC estimated the gap at $450 billion,

including $96 billion in plans that the agency

viewed as reasonably possible of termination.

While the private pension funding situation

may be somewhat akin to the Social Security

situation, it is important to keep in mind that

there are also distinct differences. According to

the Federal Reserve Board’s Flow of Funds

Accounts, private defined benefit plans held

assets worth $1.7 trillion at the end of 2003. If

these plans were underfunded by $350 billion as

the PBGC estimated, the combined totals suggest

that total obligations at the end of 2003 would

have been $2.1 trillion. Assuming that is the

case, the $1.7 trillion in funding would represent

about 80 percent of the total obligations. By

comparison, as of the end of 2003 the Social

Security trust fund had assets of $1.5 trillion but

accrued obligations of approximately $15

trillion.19 In other words, approximately 10

percent of obligations are “funded” in the Social

Security case. It is important to understand that

while pension programs are expected to have a

fund sufficient to cover accrued obligations, the

Social Security program was designed to meet

benefit obligations primarily from ongoing tax

receipts. Thus the computation of “unfunded

obligations” in the annual Social Security

Trustees Report measures whether the amount in

the fund plus expected future tax revenues will

be sufficient to meet existing accrued benefit

obligations plus obligations which are projected

to accrue in the future. As indicated in the Social

Security section of this report, the 2004 Trustees

Report finds that the Social Security program,

using that standard, is underfunded by a present

value of $3.7 trillion over the next 75 years (the

equivalent of 1.89 percent of taxable payroll) and

by $10.4 trillion over the infinite horizon (the

equivalent of 3.5 percent of taxable payroll).

The underfunding of Social Security poses a

risk, albeit a manageable one, to all of the future

participants in the program. The underfunding

of private pensions, on the other hand, tends to

be concentrated in a relatively small number of

plans that are underfunded. The participants in

these plans are at substantial risk because they

face the prospect of receiving benefits

substantially below those defined in their plan

formulas if their plan sponsors cannot deliver on

promised benefits and the plans are turned over

to the PBGC. This is an important retirement

security issue for the workers and retirees

potentially affected. Many plans in the system,

however, are adequately funded and their

participants should receive benefits in

accordance with the plans’ formulas.

Participants in defined contribution plans,

such as 401(k)s, have individual accounts to

which the employer, the employee, or both make

periodic contributions. Benefits are based not on

a formula but on the contributions to and

investment returns (gains and losses) on those

accounts. The employee bears the investment

risk and often has some control over how

individual account assets are invested. By

contrast with defined benefit plans, in which the

biggest accruals occur toward the end of a career

with a given employer, defined contribution

19Social Security Administration, Office of the Chief

Actuary, Actuarial note 2004.1. Table 2 shows the

“maximum transition cost” at the end of 2003 as $13.5

trillion. This is the amount of accrued obligations

computed as though the program were to be terminated

less the value of assets. (An adjustment is made to

recognize that the program would have received the

proceeds of taxation on future benefits.)

The underfunding of private

pensions...tends to be concentrated

in a relatively small number of

plans that are underfunded.

26
plans allow more level accumulation of

retirement assets over a career with several

employers. Workers leaving an employer can

roll over their balances to the new employer’s

plan or to an Individual Retirement Account, or

they can cash out their balances. At retirement,

the worker receives the account balance.

The shift from defined benefit to

defined contribution plans

As these charts20 show, there has been a major

shift from the traditional defined benefit type of

pension plan to plans in which workers have

individual accounts that accumulate assets

through defined contributions by employers and

employees.

20Charts 7-9 are based on U.S. Department of Labor, Employee Benefits Security Administration, Private pension

plan bulletin, Summer 2004.

The number of active participants in defined

benefit plans dropped by a quarter between

1980 and 1999, while the number in defined

contribution plans nearly tripled.

27

Source: See footnote 20

Source: See footnote 20

Chart 7

Chart 9

60

50

40

30

20

10

0

Active Participants by Type of Plan

1980 - 1999

Defined Contribution Defined Benefit

1980 1984 1988 1992 1996 1999

Pension Plan Assets by Type of Plan

1980 - 1999

Trillions of Dollars

1980 1984 1988 1992 1996 1999

Millions

Defined Contribution Defined Benefit

2.5

2.0

1.5

1.0

0.5

0

The value of assets in defined benefit plans increased

by a factor of five between 1980 and 1999, while those in

defined contribution plans increased nearly fifteen-fold,

exceeding those in defined benefit plans in 1997.

Source: See footnote 20

Chart 8

Pension Plan Contributions by Type of Plan

1980 - 1999

200

150

100

50

0

Billions of Dollars

1980 1984 1988 1992 1996 1999

Defined Contribution Defined Benefit

Contributions to defined benefit pension

plans fell by more than a quarter between 1980

and 1999, while contributions to defined

contribution plans increased nearly eightfold.
Hybrid plans combine certain features of DB

and DC plans. The most common type of hybrid

plan is the cash balance plan. Cash balance plan

formulas regularly credit a percentage of salary

or compensation for each participant into a

hypothetical participant account. Investment

earnings are credited to these accounts at a rate

specified by the plan, and the employer bears the

investment risk. Participants who separate from

their employers before retirement generally can

take their current account balances as a lump

sum. Since these are technically defined benefit

plans under ERISA, hybrid plans are required to

offer eligible participants an annuity payable at

retirement age, but virtually all plans offer

retiring workers the option of a lump sum

benefit. Most workers retiring under these plans

choose to take the benefit in a lump sum.

The increased importance of defined

contribution pensions poses some challenges

for workers. The first is the decision to

participate.—Defined benefit plans cover all

qualified workers, but coverage is not automatic

in most defined contribution plans. Workers

must also decide how much to contribute. Along

with control over how their pension funds are

invested comes the financial market risk

associated with those investments. When

workers change jobs, they must decide what to

do with their accumulated balances. They must

also decide whether to borrow from their

accounts for purposes other than retirement.

The fact that defined contribution

distributions are typically available only as a

lump sum (and that hybrid plan distributions

typically are taken as a lump sum) also presents

challenges to workers. They may not understand

that they are assuming another form of risk—

longevity risk. Annuitized payouts can ensure

that retirement benefits last a lifetime, but

workers who receive a lump sum have to find a

way to make it last for a generally unpredictable

remaining lifetime.

Participation in pension plans

There is no single answer to the question,

“What percentage of workers participate in

pension plans?” Answers will vary depending

on what data source is used and how the

population is defined. For example, including

government workers in the population will result

in a higher percentage, as will restricting the

population to ages 25 to 64 or to fulltime

workers. While participation is automatic for

workers covered under DB plans, it is usually

optional under DC plans.

The following figures are from an Employee

Benefit Research Institute (EBRI) analysis of the

March 2004 Current Population Survey21 and

look at wage and salary workers between the

ages of 21 and 64. In 2003, there were 125.4

million such workers. Of these, 74.7 million

worked for an employer that sponsored a pension

plan and 60.7 million participated in an

employer’s plan. The following chart shows

percentages since 1987 of wage and salary

workers ages 21 to 64 whose employers

sponsored a plan and of workers who

participated in a plan.

...workers who receive a lump sum

have to find a way to make it last for a

generally unpredictable

remaining lifetime.

21Copeland, Craig,“Employment-based retirement plan

participation: geographic differences and trends,” EBRI

issue brief no. 274, October 2004.

28
Over this period, sponsorship and

participation have been fairly flat in terms of

percentage of workers. Both have fallen since

2000.

Breaking down the overall rate into

subgroups shows considerable variations. The

following table shows for subgroups of wage

Chart 10

Worked for employer that sponsored a plan

Participated in employer’s plan

Percent

Source: Copeland, Craig, “Employment-based retirement plan participation: geographic

 differences and trends,” EBRI issue brief no. 274, October 2004.

Plan Availability and Participation

and salary workers ages 21 to 64 the percent who

work for an employer who has a pension plan and

the percent of each subgroup that participates in a

plan. Participation percentages are based on all

workers in each subgroup, including both those

whose employers offer a plan and those whose

employers do not offer a plan.

29

70

60

50

40

30

20

10

0

1987 1989 1991 1993 1995 1997 1999 2001 2003
Age

21-24

25-34

35-44

45-54

55-64

Race/Ethnicity

White

Black

Hispanic

Education

No HS diploma

HS diploma

Some college

Bachelor’s degree

Grad/prof degree

Marital Status

Married

Widowed

Divorced

Separated

Never married

Health Insurance

None/not own employer

Through own employer

Health Status

Excellent

Very good

Good

Fair

Poor

Annual Earnings

Less than $5,000

$5,000 to $9,999

$10,000 to $14,999

$15,000 to $19,999

$20,000 to $29,999

$30,000 to $39,999

$40,000 to $49,999

$50,000 or more

Sector

Private sector

Public sector

40.2

55.3

61.8

66.8

64.2

64.0

57.9

39.4

31.6

54.2

61.2

69.8

77.2

63.7

61.6

61.8

49.8

49.6

36.2

75.2

62.5

60.9

56.1

51.4

45.2

29.4

35.0

36.9

44.6

58.1

69.1

74.3

78.8

54.8

84.8

18.6

41.6

51.6

59.0

56.7

52.9

45.0

29.2

21.9

42.6

48.0

59.3

69.8

54.3

50.5

49.9

36.4

34.4

22.6

65.6

51.4

50.2

44.1

39.2

31.8

 8.4

14.2

19.8

29.7

45.6

59.9

67.8

74.5

43.2

75.8

Source: Copeland, Craig, “Employment-based retirement plan participation: geographic

differences and trends,” EBRI issue brief no. 274, October 2004.

30

Availability of and Participation in Pension Plans in 2003

Wage and salary workers Employer has pension plan (%) Participate in plan (%)

Table 2
While most of those workers who are not

covered by a pension plan have jobs in which no

plan is offered, there are also workers who work

in jobs offering a plan but who do not yet meet

the age and service requirements for

participation, and there are workers who are

eligible to participate in an employer-sponsored

plan but do not choose to do so. One recent

analysis of data from the Current Population

Survey indicated that the main reason given by

those who are eligible but choose not to

participate was that they could not afford to do

so. Recent research has shown that the “default”

provisions of 401(k) plans have a great influence

on whether workers participate and how much

they contribute. When enrollment is automatic,

many more employees participate. And when the

default contribution rate is higher, the average

contribution is higher.22

The figures above are for individual coverage

at a point in time. The chart below shows that

pension coverage over a lifetime on a household

rather than individual basis is more widespread.

Researchers for the Center for Retirement

Research at Boston College calculated these

lifetime pension coverage rates by income

quintile for households with a head aged 59 to 69

in 2000.

22Wise, David A., “Economics of aging program report,”

http://www.nber.org/aging.html.

Chart 11

Lifetime Participation in a Pension Plan

By Income Quintile

A study published in 2000 by the Investment

Company Institute showed that, for those

participating in the most common type of

defined contribution plan (401(k), the percentage

of wages contributed rose with household

income. Those with a household income below

$30,000 had a median contribution of 5 percent

of wages, while those with incomes of $100,000

or more had a median contribution of 10 percent

of wages. The median plan balances for those

participating rose with the length of their

participation. Those with one year or less in the

plan had median balances of $1,600. Those with

two-to-five years had median balances of

$10,000. And those with six or more years had

median balances of $50,000. The median

balance for all participants was $14,000.

Integration of pensions with Social

Security

Employers have the option of coordinating,

or “integrating,” the benefits of their pension

plans with Social Security benefits. Social

Security benefits for lower-paid workers

represent a higher percentage of earnings than

those for higher-paid workers. Integration

allows employers to take into consideration their

contributions to Social Security and reduce the

pension benefits of lower-paid workers in order

to provide retirement income that represents the

same percentage of pay for lower-income and

higher-income workers. Tax rules define how

this integration may take place. A recent study23

estimates that about one-third of DB plans and

one-quarter of DC plans are integrated.

To some extent, pensions and Social Security

are complementary. For those with low incomes,

Social Security benefits replace a larger

percentage of their income and pensions replace

Source: Munnell, Alicia, James G. Lee, and Kevin B. a smaller portion. For those with higher

Meme, An update on pension data, July 2004

31

23Perun, Pamela, “Social Security and the private pension

system: the significance of integrated plans,” Center for

Retirement Research working paper 2002-2, p. 2.

100

80

60

40

20

0

77.3% 78.5%

60.8% 68.7%

55.0%

24.7%

 Top Second Third Fourth Bottom All

Income Quintiles

Percent
32

earnings, Social Security replaces a smaller

portion of their earnings, while pensions replace

a higher percentage.

Retirement savings

Because of the trend away from defined

benefit plans, much of the responsibility of

preparing for retirement has shifted to workers.

Workers whose employers sponsor savings and

investment plans, like 401(k) plans, can build

retirement savings on a tax-deferred basis. Most

people with earned income can also contribute to

a tax-favored Individual Retirement Account.

Because of the trend away from

defined benefit plans, much of the

responsibility of preparing for

retirement has shifted to workers.

Age of Percentage of

head of families holding Median

household retirement accounts Value

Less than 35 45.1 $6,600

35-44 61.4 $28,500

45-54 63.4 $48,000

55-64 59.1 $55,000

65-74 44.0 $60,000

75 or older 25.7 $46,000

Table 3

Under the Federal employees’ Thrift Savings

Plan, $55,000 for a participant retiring at age 65

would currently purchase a level, single-life

annuity paying approximately $400 per month.

(This is a unisex annuity. Commercially

purchased, gender specific annuities would

typically pay larger annuities for men than for

women because of the life expectancy

differential.)

Such plans will continue to increase in

importance as more workers have more years of

accumulated savings. The ratio of retirement

plan assets to wage and salary earnings has

increased more than fivefold since 1975.

Researchers have debated how 401(k) accounts

and similar plans have affected other saving.

Some claim that two-thirds or more of the money

in 401(k) accounts is new saving. Others argue

that contributions to 401(k)s come largely from

other saving and only one-third or less

contributes to net saving. They agree that 401(k)

plans are likely to increase savings for low- and

middle-income workers and less likely to do so

for high-income workers.

Household net worth and financial

assets

Many households own other assets that could

be used to pay expenses in retirement. For many

people, their most valuable asset is their home.

However, the literature does not show clearly the

extent to which retirees liquidate their housing

wealth to support consumption in retirement.

The 2001 Survey of Consumer Finances found

that for households headed by individuals ages

65 to 74, 83 percent owned their home and the

median equity value for those who did was

$103,000.

...for households headed by

individuals ages 65 to 74, 83 percent

owned their home and the

median equity value for those

who did was $103,000. Source: Federal Reserve Board, 2001 survey of

consumer finances

Retirement Account Holdings

The 2001 Survey of Consumer Finances (SCF)

has data on retirement accounts. The SCF

definition of retirement accounts includes IRAs

as well as employer-sponsored defined

contribution plans and “Keogh” plans for the

self-employed. Note that in the table below the

median values are only for families that have

retirement accounts.
Other assets they may own include financial

assets, other real estate, and other valuables that

may generate income or may be sold to pay for

their needs during retirement. Net worth is the

difference between assets and liabilities. The

Survey of Consumer Finances also has data on

the financial assets (bank accounts, stocks,

bonds, mutual funds, and so on) of the 93

percent of all households that had financial

assets. The value of Social Security or defined

benefit plans is not included in either net worth

or financial assets. The following table, based

on that data, shows the median net worth and

median financial assets of households (for the 93

percent that had financial assets) in the United

States in 2001, by the age of the head of

household.

Age of Median Median

head of net worth Financial

household Assets

Under 35 years old $11,600 $6,300

35-44 $77,600 $26,900

45-54 $132,000 $45,700

55-64 $181,500 $56,600

65-74 $176,300 $51,400

75 or older $151,400 $40,000

All households $86,100 $28,000

Net Worth and Financial Assets

Table 4

Source: Federal Reserve Board, 2001 survey of

consumer finances

Expectations

Given the low median levels of saving and

pension eligibility even among those who have

pensions and savings, one might expect a

growing sense of unease as increasing numbers

of people approach retirement. Survey data from

the Employee Benefit Research Institute,

however, indicate that few workers seem to

know how much they would need to live

comfortably in retirement. Only about 40

percent report having tried to calculate how

much they would need to save in order to live

comfortably in retirement, and a third of those

say they do not know the outcome of that

calculation. One of the most striking results of

the survey is that almost half of those who have

not saved for retirement are at least somewhat

confident of having a comfortable retirement.

...few workers seem to know how much

they would need to live comfortably in

retirement.

Displaying a blissful optimism that

something will turn up, some expect to save

later, others to rely on Social Security or on

family and friends. On the other hand, the

survey also indicated that retirement education

can change the behavior of at least some

workers. More than 40 percent of those who

reported trying to calculate their savings needs

said that the exercise changed their retirement

planning. Almost 30 percent of those who

received retirement education through their

employer changed their retirement plans.

Current issues

Social Security is and will remain a

fundamental part of how this Nation provides

economic security in old age. But it is not

intended to be the sole source of income in

retirement. For many Americans—but

nonetheless too few—employment-based

pensions and individual savings and investment

play a substantial role in supplementing Social

Security to provide a more adequate level of

retirement income.

By definition, private pensions and private

savings and investment are not subject to the

type of uniformity of application and

participation that is found in a governmental

program like Social Security. Employers and

individuals will appropriately utilize these

elements of economic security in different ways

33
and provide different levels of protection

according to their individual needs, desires, and

abilities. But public policies can and should be

structured to encourage private pensions and

savings and, in particular, to encourage them to

better address the economic security needs of

those with low to moderate incomes.

...public policies can and should be

structured to encourage private

pensions and savings....

Defined benefit plans.—The shrinkage in the

prevalence of traditional employer-sponsored

pension plans is to a considerable extent a

reflection of changes in the economic structure

and, in particular, the relationship between

employers and their workforce. Career

employment with a single firm is no longer

common. There is less inclination on the part of

employers to see pensions as a tool for managing

the replacement of an aging workforce. Pensions

no longer provide the recruiting and retention

incentives they once did, and the movement to

DC plans has shifted the investment risk from

the employer to the employee. Still, defined

benefit pensions continue to cover a large

number of workers and retirees. They can

provide significant advantages for those

businesses and employees who do participate in

them. As we face a future with possible labor

shortages, this type of plan may again become

more attractive. Public policies should be aimed

at encouraging the continuation and growth of

traditional plans for those who find them

appropriate. The unresolved issues surrounding

hybrid pensions should be resolved so employers

understand the requirements and can decide

whether to make an ongoing commitment to this

form of plan or an alternative. While regulation

is needed to protect plan participants and avoid

abuses, attempts should be made to simplify the

regulatory burden involved in establishing and

maintaining private pensions.

Funding standards should be reexamined and

modified as necessary to encourage practices

which will strengthen the funding of pension

plans and to eliminate incentives for plan

termination. Current policies that prohibit the

build-up of surpluses in good times so as to

reduce the burden of meeting funding

requirements in downturns (and therefore also

reduce the risk of termination) are too restrictive

and make little financial sense. Similarly, the

structure of how plans are insured through the

Pension Benefit Guaranty Corporation needs to

be reexamined so that well-funded plans can be

established without the expectation that they will

be unduly burdened with the costs of bailing out

risky plans. One avenue that might be explored

is to encourage the adoption of pooled plans for

multiple employers, not necessarily in the same

industry, similar to those being proposed for

health insurance.

Defined contribution plans.— There has

been strong growth in recent years in defined

contribution plans such as 401(k)s. There are

many reasons why this is an encouraging

development. The lesser regulatory and financial

burden such plans place on employers has

undoubtedly encouraged many of them to make

defined contribution plans available in cases

where no other retirement plan would otherwise

have been established. To the extent defined

contribution plans have been substituted for

traditional pension plans, however, the results

are likely lower participation especially among

younger and lower-income employees. Defined

contribution plans also provide opportunities for

participants to gain access to the accumulated

savings in such plans through loans and lump

sum termination distributions. In some respects,

this feature is consistent with the individualized

nature of such plans, and it may provide some

positive incentives for participation. On the

other hand, lump sum distributions both before

and at retirement can undermine the basic

retirement security objective of these plans.

34
35

Policymakers need to carefully review the

considerable body of research that is being

conducted on these issues and consider

incentives to improve the levels of participation

and to encourage the appropriate use of defined

contribution pension accounts. Some recent

research indicates that participation would be

increased if employers would make participation,

rather than non-participation, the default option

for new employees. Similarly, consideration

should be given to ways to encourage the

retention for retirement and ultimate

annuitization of plan distributions. Again setting

appropriate default options might be one

approach. Another might be the development of

incentives for financial institutions to create a

more robust market for individual and group

annuity contracts.

Household Savings as Percent of Income

Source: Bureau of Economic Analysis, National

Income and Product Accounts, Personal

income and its disposition, Table 2.1, 2004.

Individual savings.—Over the past several

decades, there have been a number of attempts to

encourage increased individual savings through

such tax incentives as individual retirement

accounts and the savers’ credit. Despite those

efforts, personal savings rates (which include

pension contributions) have, as shown in Chart

12, dropped precipitously over the last quartercentury from over 10 percent in the 1980s to a

low of 1.4 percent in 2003. There is also broad

agreement that financial assets, especially for

moderate to low income persons, are well below

what they are likely to need to supplement their

Social Security income in retirement. There is a

clear need to improve the level of personal

savings both to build up the wealth

accumulations that current workers will need to

assure their own future economic security and to

help the national economy prepare for the

coming demographic imbalances. These

imbalances may, to some extent, see the baby

boom generation substantially draw down

existing stocks of personal savings to meet their

retirement income needs. Policymakers

therefore need to look for ways to strengthen

current incentives for individual savings. In

doing so, particular attention is needed to the

development and implementation of policies that

will encourage and facilitate the participation in

individual savings plans by moderate and lower

income workers. In designing any changed

incentives, it is important that Congress take into

account the overall need to address economic

security and adopt changes which will

complement and not undermine the incentives

for improved protection through other forms of

retirement savings such as employment-based

pensions and health insurance.

Financial education and retirement

planning.—While the Social Security program is

a crucial element in the retirement security of

Americans, it is clear that, more than ever

before, workers at all age levels will need to take

responsibility for planning ahead so that they do

not enter retirement with insufficient resources to

adequately supplement their Social Security

benefits. It is also clear that far too small a

portion of the population actually does such

planning, let alone act upon it. To some extent,

this reflects a failure of our society to educate us

about the need for such planning and to provide

us with the tools to carry it out. There have been

some commendable public and private efforts to

address this problem such as those of the

Department of Labor and the Employee Benefit

Research Institute. The Social Security

Administration in partnership with the American

Savings Education Council (an EBRI-sponsored

Chart 12

12

10

8

6

4

2

0

 1970 1974 1978 1982 1986 1994 1998 2002

Percent
36

nonprofit national coalition of public- and

private-sector institutions) has carried out

educational campaigns aimed at raising the

awareness of the need to save. Under the

“Savings Are Vital to Everyone’s Retirement Act

of 1997,” a National Summit on Retirement

Savings was convened by the Department of

Labor in 1998 and again in 2002, with a third

summit scheduled for 2005 or 2006.

Important as such actions are, they are

insufficient. Promoting the need for lifetime

retirement planning and making financial

education widely available must become a

national priority. Congress should consider

incentives or possibly even requirements to

assure that basic financial planning becomes part

of the core curriculum in our Nation’s schools.

The Social Security Administration has

undertaken efforts to help workers plan how they

will supplement benefits, but increased efforts

are needed.

Given the agency’s resource constraints,

some useful activities would necessarily depend

on the availability of additional resources;

however, even within current resources, the

agency might find ways to improve its support

for retirement education. As part of its

communications efforts, it should encourage and

assist employers in putting on retirement

planning workshops for their employees. It

should also better utilize the Social Security

Statements sent out to workers each year so as to

emphasize the need for retirement planning at all

ages and to inform them of how to find resources

to help with such planning. The current

Statement contains a single sentence noting the

need for additional retirement resources to

supplement Social Security. The SSA website

contains links to some resources for financial

planning, but these are not prominently located.

They are likely to be reached only by those who

are already thinking about their retirement needs.

SSA should find ways to address the need for

financial planning more strongly. It might

occasionally include an insert in the annual

Social Security Statement specifically targeted to

this issue.

The Board recognizes that efforts to educate

and motivate individuals to understand and plan

ahead for their income security needs in

retirement face the same kinds of obstacles as

efforts to encourage healthier nutrition and

lifestyles. Employers have told the Board of the

frustrations they face, even when they make

substantial efforts, in motivating employees to

become actively involved in retirement planning.

Younger workers often have many immediate

needs and concerns that crowd out the seemingly

distant concern about providing for their older

years. Still, the Board believes that, as a Nation,

we can and should do a better job of encouraging

workers of all ages to recognize and act on the

need to plan ahead for their retirement security.

Promoting the need for lifetime retirement planning and making financial

education widely available must become a national priority.
37

In addition to what we normally think of as

retirement benefits for the elderly (e.g., Social

Security, pensions, and savings) another

important source of income for this group is

earnings from work. As the demography of the

U.S. population changes, it could become even

more important. The participation of the elderly

in the labor force is not only important to

individuals’ income, but can also be a vital part

of the national economy that supports public and

private retirement benefits.

V. LABOR FORCE PARTICIPATION OF THE ELDERLY

The participation of the elderly in the

labor force is not only important to

individuals’ income, but can also be a

vital part of the national economy....

...leaving the labor force simply because

one reaches an arbitrary age is a fairly

recent phenomenon.

individuals 65 or over, the income from earnings

may reflect to some extent the earnings of a nonretired spouse under age 65.

Labor force participation of the aged

The concept of leaving the labor force simply

because one reaches an arbitrary age is a fairly

recent phenomenon. In the past it was quite

common for people to remain in the labor force

as long as they were physically able to do so.

Even as recently as the late 1940s nearly half of

the men age 65 and over were still in the labor

force. As can be seen from Chart 13 below, this

percentage declined steadily until the early

1990s, when it reached a low of around 16

percent. Since that time there has been some

slight increase, with the rate at just under 19

percent in 2003. A similar pattern can be seen in

the labor force participation rates for men age

60-64. From a low of around 53 percent in the

mid-1990s, the rate has risen to more than 57

percent in 2003.

Civilian Labor Force Participation Rate

Of Men 65 years or Older

Earnings as a source of income for the

aged

According to the Social Security

Administration, in 2001, earnings accounted for

nearly a quarter of aggregate income to the

population 65 and over. About 22 percent of all

aged units had some income from earnings.

Since “aged units” are married couples in which

at least one person is 65 or over or single

Chart 13

Source: Bureau of Labor Statistics, Labor force statistics from the current population survey, available at

www.bls.gov.

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

50

40

30

20

10

Percent
38

24

The “Normal Retirement Age” is the age at which an individual retiring at that age can receive unreduced benefits.

For those who reached age 62 prior to 2000, the Normal Retirement Age was age 65. For those reaching age 62 in

2000-2005, it increases by two months each year to age 66 for those reaching age 62 in 2005-2016. Starting with those

reaching age 62 in 2017, it will again increase by two months per year until it reaches age 67 for those who reach 62 in

or after 2022. Prior to the year of reaching Normal Retirement Age, benefits are reduced by one-half of the excess of

earnings over the “exempt amount,” which is $12,000 in 2005. No reduction for earnings is made for the month of

reaching Normal Retirement Age or any subsequent month. However, benefits in the year of reaching Normal

Retirement Age (but prior to the month that age is reached) are reduced by one-third of the excess of those earnings over

a separate exempt amount ($31,800 in 2005).

25"Song, Jae G., SSA, Evaluating the initial impact of eliminating the retirement earnings test,” Social Security bulletin,

vol. 65 no. 1, 2003/2004.

Possible reasons for the recent increase

in labor force participation

While it is not entirely clear why the labor

force participation rate of the aged has increased

in recent years, there are several factors that may

have had some impact. One of these is the

repeal, beginning in 2000, of the Social Security

earnings test for beneficiaries past the age of

eligibility for full benefits. Prior to that time,

Social Security benefits were reduced by a

portion of earnings over a specified amount

($15,500 in 1999). The earnings test still applies

to beneficiaries below “Normal Retirement

Age.”24 It seems reasonable to assume that the

repeal of the earnings test would encourage

workers to stay in the workforce even after

beginning to draw Social Security benefits.

However, one recent study has raised doubts

about this hypothesis.25

A second factor that may have induced older

workers to remain in or return to the workforce

is the decline in the stock market in recent years.

The actual and anticipated lowering of the value

of retirement investments likely persuaded some

workers of the need to supplement other forms of

retirement income with additional earnings. If

this has been a major contributor to the recent

increase in labor force participation among older

workers, then a recovering stock market could

slow or even reverse the pattern.

Another factor may be the changes in

employer-sponsored retirement plans. The shift

from defined benefit plans, which frequently are

structured to encourage retirement at a specific

age, to defined contribution plans which are

neutral in terms of when one retires is removing

one of the incentives for early retirement. Since

contributions to and, usually, the value of

investments in defined contribution retirement

accounts increase over time, such plans almost

always represent an incentive to remain on the

job.

The erosion or threat of erosion of defined

pensions and retiree health benefits from some

employers has likely made many workers less

confident that these benefits will be available as

anticipated.

Yet another factor that is commonly cited is

the enactment of legislation prohibiting

employers from establishing mandatory

retirement ages for their employees.

Age of retirement

Applying for Social Security retirement

benefits is not necessarily the same thing as

leaving the labor force. Nevertheless the age at

which people first receive benefits can give a

rough indication of their retirement patterns.

Prior to 2000, nearly half of all male workers
being awarded Social Security retirement

benefits received them at age 62; only about 15

percent waited until 65. Since 2000, there has

been a slight increase in the percentage waiting

until 65 to receive benefits.

There are some indications that current

workers plan to stay in the workforce longer than

previous generations. A survey of baby boomers

by AARP found that nearly 80 percent intended

to work in some capacity during their retirement

years, either for enjoyment or because they

thought that they would need the money.26

Another survey, EBRI’s 2004 Retirement

Confidence Survey, found that current workers

expect to retire at somewhat older ages than did

current retirees. More than half indicated that

they intended to retire at 65 or later (or not at

all). However, the survey also found that 37

percent actually leave the workforce sooner than

intended, primarily for reasons of health or

because of downsizing at or closure of their

employer.27

Demand for elderly workers

If we want older persons to continue in or

return to work, it is not enough to consider

policy changes designed to encourage them to

want to work. It is also necessary to examine the

question of whether there will be jobs available

for them.

Some changes have already taken place in

the private sector to remove impediments to

workers staying in the labor force. One of these

noted above is the shift from defined benefit to

defined contribution retirement plans. Another is

the elimination of mandatory retirement in the

mid-1980s. Nevertheless, there are still

problems in hiring or retaining older workers for

39

26Baby boomers envision retirement II-key findings:

survey of baby boomers’ expectations for retirement;

May 2004.

27"EBRI, Will Americans ever become savers? The 14th

retirement confidence survey, 2004,” Issue brief no. 268,

April 2004.

28General Accounting Office, Older workers: employment

assistance focuses on subsidized jobs and job search, but

revised performance measures could improve access to

other services, GAO-03-350, January 2003.

profit-oriented companies. One problem is that

older workers frequently are more expensive

than younger workers. Salaries and benefit

packages tend to grow with seniority. Older

workers are also more likely to use more health

services, thereby increasing the cost of employersponsored health insurance plans.

If older workers are going to increase their

participation in the labor force in the future both

they and their employers will likely need to make

some adjustments. Employers may need to offer

part time and shared positions and be more

flexible on issues such as work hours and

locations. Workers may need to be willing to

accept lower rates of pay and fewer benefits in

order to be more acceptable to employers.

If older workers are going to increase

their participation in the labor force

in the future both they and their

employers will likely need to

make some adjustments.

Population shifts suggest that we are moving

toward an era of labor shortages. As the baby

boom generation moves into retirement and the

“baby bust” generation becomes the core of the

labor force, there will be a significant change in

the supply of labor. A GAO report in January

2003 noted that some economists predict a labor

shortage of as many as 35 million workers by

2030.28 Such a drastic labor shortage could have

a significant negative impact on economic

growth and seriously compromise the Nation’s

ability to fulfill its current obligations in terms of

both private and public retirement benefits.

There are relatively few potential pools from

which to draw the additional workers that will be
40

needed. A major source of labor force growth

over recent decades has been the entry of women

into the labor force. However, following several

decades of steady growth, the percentage of

women entering the labor force began to level

off in the 1990s and has even declined slightly

from its peak of around 60 percent in the late

1990s. The 2004 Trustees Report projects that

the labor force participation rate for women will

change little from the current rate.

Another potential source is immigrants. A

2002 study estimates that new immigrants

contributed more than 50 percent of the growth

in the U.S. labor force in the 1990s.29 There is

considerable uncertainty about the rate of

immigration in the future. If a serious labor

shortage develops, national policy may

encourage greater immigration. However, other

social, cultural, and economic effects of very

high levels of immigration may restrain such

efforts.

A third pool of potential workers in the event

of a labor shortage is older workers who would

otherwise be retired. Older workers would have

both advantages and disadvantages for

employers. They are generally seen as having

good work habits and would, in many cases,

already have developed needed work skills. On

the other hand, they are frequently more

expensive and are seen as being less adaptable to

changing circumstances.

Social Security and other policies to

encourage remaining in the labor force

For each individual, the decision about how

and when to retire is a very complex issue

involving, in part, the amount of available

retirement income and assets and also such

factors as job satisfaction, availability and

desirability of work opportunities, and personal

and family health circumstances. It is an

important part of national retirement income

policy to encourage and assist with the

accumulation of sufficient retirement resources

through public and private programs to assure

economic security in retirement. But, national

policy also needs to recognize that continued

labor force participation of older workers can:

• assist the national economy in meeting

labor force imbalances that are now

foreseen as our population ages;

• assist individuals to have a more

adequate income during their older years

by postponing the point at which they

begin to draw down on their savings or

by supplementing their retirement income

with some continued earnings; and

• benefit both the worker and his employer

by continuing to utilize the skills and

abilities of the individual.

As policymakers review Social Security and

other aspects of retirement security, they should

try to assure that program rules and other

policies facilitate and encourage continued labor

force participation of older workers wherever

such participation would be possible and

beneficial.

29National Business Round Table, Immigrant workers and

the great American job machine: the contribution of new

foreign immigration to national regional labor force

growth in the 1990s, August 2002.

...policymakers...should try to assure

that program rules and other policies

facilitate and encourage continued

labor force participation

of older workers....

Social Security policy can have both an

economic and a psychological impact on

people’s concept of the appropriate time to retire.

A number of changes have been made that seem

likely to have some impact. However, the rules

are sufficiently complicated that it is not clear

how well their combined effect is understood.
Until the mid-1950s (and until 1962 in the

case of male workers), benefits were not available

until age 65. When the age of first eligibility was

dropped to 62, benefits taken before age 65 were

reduced on an actuarial basis so that, on average,

the same lifetime benefit total would be paid out

regardless of whether benefits were taken at or

before age 65. Moreover there was an earnings

test that, until age 72, reduced, and in many cases

eliminated, benefits for those who continued to

have substantial earnings. Concern over the

fairness and work incentive impact of the

earnings test, particularly for those over 65 (who

suffered a permanent loss of benefits by

continuing to work), led to several changes in the

law:

• on several occasions the amount that

could be earned without loss of benefits

was increased, with larger increases (and a

lesser reduction rate) for those who

reached age 65;

• a “delayed retirement increment” was

instituted to partially (and, when fully

effective, completely) offset the foregone

benefits after 65;

• the age at which the earnings test ceased

to apply was reduced, first from 72 to 70

and later to the Normal Retirement Age.

The Normal Retirement Age itself, under

provisions of the 1983 amendments, is increasing

in steps from 65 to 67 for those reaching age 62

from 2000 to 2022 as described earlier.

From an actuarial standpoint, the continued

application of the earnings test prior to the

Normal Retirement Age creates no particular

incentive or disincentive for continued

employment since, at least on average, lifetime

benefits are not affected. However, it is not clear

how well this is understood by potential

beneficiaries. The elimination of the earnings test

for those who have reached the Normal

Retirement Age has removed a clear economic

disadvantage to continued employment.

41

While some studies have been undertaken, it

is too early to measure with great confidence the

impact on retirement decisions of the changes in

the earnings test and the Normal Retirement Age.

The increase in the Normal Retirement Age is

still being phased in. The elimination of the

earnings test after that age became law in 2000

and may have had limited impact on those who

had already made retirement plans.

It is important that individuals deciding when

to retire should have a thorough understanding of

how that decision affects their Social Security

benefits. The Social Security Administration’s

website does provide extensive information

about this aspect of retirement planning.

However, the rules are complicated and the

agency should continue to review its efforts to

disseminate information that will help

individuals and those who advise them to

understand the impact of those rules on their

decision to retire from or remain in the

workforce.

In considering changes to Social Security and

other policies, policymakers need to give

attention to the impact of changes on incentives

for continued employment and on making those

incentives as understandable as possible. There

are many changes which, directly or indirectly,

could affect employment incentives. Major

changes such as modifying benefit levels or the

age of eligibility would have obvious impacts,

but other changes could also be considered. For

example, employment past age 60 is fully subject

to Social Security taxes but often has little or no

effect on the individual’s benefit entitlement.

This is often true even for workers who continue

to work at or somewhat above their prior

earnings levels, but it is especially true for those

who wish to partially retire. If policymakers

think it is desirable to encourage continued labor

force participation, consideration might be given

to providing some reward in the system for such

continuing contributions to the program.

Elimination of the earnings test for those under

the Normal Retirement Age would have costs but

also might affect participation in the labor force.
42

VI. HEALTH CARE AS A RETIREMENT SECURITY ISSUE

Health care, as a retirement security issue,

swamps all of the other retirement security issues

in our country because of rapidly rising health

care costs and the growing share of our national

economy expended on health care. This section

of our report illustrates the magnitude of health

care expenditures in relation to the rest of the

economy and discusses their impact on

retirement security.

Rising costs of health care30

The U.S. spends more on health care than

any other Nation in the world. In 2002,

Americans spent nearly $1.6 trillion on health

care. That is roughly $5,440 per capita or about

15 percent of GDP (about one-seventh of the

American economy). As illustrated in Chart 14,

our private health insurance system pays about

36 percent of the total. Medicare—the largest

individual payer and a program that is vital to the

economic security of American retirees—

currently pays about 17 percent of the Nation’s

health care tab. Payments from other

government programs (at the Federal, State and

local levels) total about 28 percent. Out-ofpocket payments account for about 14 percent of

the total. Taken together public programs at all

levels account for 45 percent and private

programs (including individual out-of-pocket

costs) account for 55 percent of health spending.

Health care...swamps all of the other

retirement security issues....

Chart 14

Who Pays the National Health Care Tab

30Data in this section and chart are based on Centers for

Medicare and Medicaid Services, National health care

expenditure projections, 2003-2013.

Source: Centers for Medicare and Medicaid Services,

National health care expenditure projections,

2003-2013.

A number of factors affect the rate of growth

in health care costs in our economy. Among

them are increasing life expectancy, the

development of more expensive treatments and

medical technology, the over-utilization of

certain medical services, and the fact that

consumers of health care are often ill-equipped

to distinguish between more and less useful

treatments and, to the extent payment is made

through health insurance, have little incentive to

make economically rational health care choices.

therapies proliferate and the population ages.

According to the Centers for Medicare and

Medicaid Services (CMS), national health

spending is projected to grow 2.5 percent per

year faster than GDP between now and 2013, at

which time health care will constitute about 18.4

percent of GDP. To put these figures in

perspective, over the last 50 years, total Federal

income tax collections have averaged about 11

percent of GDP.

In addition, health costs are expected to grow

rapidly over the coming decades as new ...health costs are expected to grow

rapidly over the coming decades as

new therapies proliferate and the

population ages.

Private Health

Insurance

36%

Out-of-pocket 14%

Other Private

Sources

5%

Medicare

17%

Other

Federal

15%

State & Local

13%
The 15 most costly medical conditions

accounted for half of the overall growth in health

care spending between 1987 and 2000. Four out

of the top five of the most costly medical

conditions—heart disease, pulmonary disease,

cancer, and hypertension—are heavily correlated

with unhealthy lifestyle choices and potentially

more easily prevented. In addition, some experts

believe that a significant part of the growing cost

of medical care is related to such causes as the

delivery of poor quality care and the treatment of

conditions that may not warrant the expensive

procedures or medications that are devoted to

them.

The central role of Medicare and

Medicaid in retirement security

In 2003, Medicare provided coverage to

approximately 41 million Americans, including

35 million aged and about 6 million non-elderly

persons with disabilities.31 An individual is

eligible for Medicare if he or she is age 65 or

older or receives Social Security disability

benefits (with a two year waiting period for

Medicare) or suffers from End Stage Renal

Disease; i.e., permanent kidney failure requiring

dialysis or a kidney transplant. (For Medicare

Part A—Hospital Insurance (HI)—eligibility also

requires that the individual be a Social Security

beneficiary or be fully insured for Medicare by

virtue of employment covered by the Medicare

payroll tax.)

Eligibility for Medicaid is somewhat more

complicated. There are currently about 42

million persons enrolled in Medicaid programs,

including 4.3 million low-income aged

individuals and 7.9 million qualified on the basis

of blindness or other physical or mental

impairment, and about 20 million in low-income

families with children. In some cases, Medicaid

eligibility flows directly from eligibility for

another program such as SSI (in most States). In

312004 Medicare Trustees report.

other cases, specific Medicaid eligibility

requirements must be met and evaluated. These

may include age; whether the individual is

pregnant, disabled, or blind; income and

resources (like bank accounts, real property, or

other items that can be sold for cash); and status

as a U.S. citizen or a lawfully admitted

immigrant. The rules for counting income and

resources vary from State to State and from

group to group. There are special rules for those

who live in nursing homes and for disabled

children living at home.

Of all of the components of our national

healthcare system, Medicare, in particular, is

critically important to the financial well-being of

older Americans and persons with disabilities.

This program pays just under one-fifth of the

Nation’s total health care tab. However, until

recently, Medicare paid more than half of the

health care costs for the 41 million Americans

enrolled in the program. And with the passage of

the new Medicare prescription drug program in

2003, Medicare will become even more central

to the economic security of beneficiaries. Nearly

65 percent of Medicare beneficiaries have annual

incomes below $25,000. Of the nearly 12

million Medicare beneficiaries who live alone,

about 15 percent are over the age of 85, about 72

percent are female, and about 56 percent have

annual incomes below $15,000. These

beneficiaries are also more likely to suffer from

one or more debilitating diseases or chronic

conditions that require regular care.

Medicaid, the second tier of health support

for many aged and disabled Americans, pays for

medical assistance and long-term care services

for certain persons with low incomes and limited

Of all of the components of our

national healthcare system, Medicare,

in particular, is critically important to

the financial well-being of older

Americans and persons with disabilities.

43
resources. Some Medicare beneficiaries who do

not meet the requirements for full Medicaid

eligibility but do meet less stringent income and

resource requirements may get help with

Medicare premiums and cost-sharing payments

through one of several programs available

through their State Medicaid program.32 CMS

estimates that Medicaid provides some level of

supplemental health coverage for about 6.5

million Medicare beneficiaries who qualify for

dual eligibility or premium/co-payment

assistance on the basis of low income and

limited resources. Medicaid is funded jointly by

the Federal and State governments (including the

District of Columbia and the territories). For

many low-income retirees, Medicaid is the

largest source of funding for medical, long-term

care, and health-related services.

Medicare and Medicaid financial

problems

Like the programs financed through Social

Security’s Old-Age, Survivors, and Disability

Insurance (OASDI) trust funds, Medicare is

facing long-term financial shortfalls. But

Medicare’s financial shortfalls will occur sooner

and be much larger—and more difficult to

resolve—than those of Social Security. This

deterioration is mainly due to higher than

expected hospital expenditures, lower than

expected taxable payroll, and new legislation

that has added significant new costs to the

program.

Since the release of the 2003 Trustees Report

(which preceded the enactment of the Medicare

Prescription Drug, Improvement and

Modernization Act of 2003), there has been a

significant deterioration in the financial outlook

of the Medicare program.

32Qualified Medicare Beneficiaries (QMBs), Specified

Low-Income Medicare Beneficiaries (SLMBs), Qualified

Disabled and Working Individuals (QDWIs), and

Qualifying Individuals (QIs).

With the aging of the baby boomers and

recent expansions in the program, the number of

people Medicare serves each year is expected to

nearly double, from about 41 million today to

about 79 million by 2030. As a share of the total

population, Medicare beneficiaries are expected

to grow from about 14 percent today to around

23 percent by 2030. At the same time, medical

prices are expected to continue rising much

faster than overall consumer prices. In 2003,

Medicare expenditures represented about 2.6

percent of GDP. But with the enactment of the

new Medicare Prescription Drug benefit, total

Medicare expenditures are expected to rise to 3.4

percent of GDP in 2006. As the Medicare

population continues to grow, its share of the

economy will increase to about 7.7 percent of

GDP by 2035 and to 13.8 percent by the end of

the 75-year valuation period.

Starting in 2004 the Hospital Insurance trust

fund is paying out more than the tax revenue

takes in, thus relying in part on trust fund interest

earnings to meet its obligations. By 2019—just

14 years from now—the HI trust fund is

projected to reach the point at which it is unable

to pay claims in full. The projected 75-year

actuarial deficit for the HI trust fund is now

projected at 3.12 percent of taxable payroll, up

significantly from the 2.40 percent in the 2003

Trustees Report. This deficit is the equivalent of

an immediate increase of 3.12 percentage points

in the payroll tax. As with Social Security, this

representation of the deficit is an average over 75

years. The 2004 deficit is less than a tenth of a

percent of taxable payroll but it grows to 1.51

percent by 2025 and to 9.63 percent by 2080. By

the end of the 75-year valuation period,

scheduled payroll taxes will cover only 25

percent of scheduled benefits.

44
45

Both the Supplemental Medical Insurance

(SMI) Program and the new Medicare

Prescription Drug Program are projected to

remain adequately financed into the indefinite

future since financing for these programs is

automatically adjusted, under statute, on an

annual basis to meet the next year’s costs.

However, these automatic adjustments will result

in a rapidly growing share of general tax dollars

to finance these programs. The general revenue

share of these programs is projected to rise from

just under 1 percent of GDP today to 6.2 percent

by 2078. In addition, substantial increases in

beneficiary premiums are also projected over the

same period.

The rapid increase in the cost of health care

not only drives up the program costs for

Medicare but also increases the extent to which

individuals must expend part of their retirement

income resources to meet costs not paid for by

the program. A table by the CMS actuary’s

office based on the projections in the 2004

Trustees Report (Table 5) shows that out-ofpocket expenses will consume a larger and larger

portion of retirement income.

Table 5

Out-of-pocket Costs as

Percent of Average Social Security Benefit

The rapid increase in the cost of health

care not only drives up the program

costs for Medicare but also increases

the extent to which individuals must

expend part of their retirement income

resources to meet costs not paid for

by the program.

Source: CMS, Office of the Actuary, July 2004. Based

on an example of a 65-year-old beneficiary

paying the standard premium, with average

level of co-payments and deductibles for all

aged beneficiaries, average Social Security

benefit.

Due to budgetary constraints across the

Nation, many State governments plan to

undertake Medicaid cost containment strategies

in the near future. According to a 2003 survey

conducted by the Kaiser Commission on

Medicaid and the Uninsured: 39 States have

indicated that they plan to reduce or freeze

provider payments; 18 States have indicated that

they plan to reduce or restrict Medicaid

eligibility; 17 States have indicated that they plan

to reduce Medicaid benefits; and 21 States have

indicated that they plan to increase recipient copayments. Beginning in 2006, Medicaid

spending is expected to decrease markedly from

earlier projections as the new Medicare

prescription drug benefit goes into effect. Some

offset to these Medicaid savings is expected,

however, due to an increase in spending from a

higher enrollment of dual eligibles. It is

expected that, as Medicare beneficiaries apply

for the Medicare low-income drug subsidy, some

will be discovered to be eligible for Medicaid.

Overall growth in Medicaid spending is expected

to peak at 9.2 percent in 2006 and then slow to

8.3 percent by 2013. This is still substantially

greater than the expected rate of growth for the

economy as a whole.

The Board has heard from the Congressional

Budget Office and the Government

Accountability Office (GAO) that, even without

considering the additional costs of prescription

drugs through Medicare, if current cost trends

continue, the combination of Medicare,

Hospital Supplemental

Insurance Medical Insurance

Part B Part D Total

 2006 2.6 16.0 18.6 37.2

 2010 2.6 15.2 21.4 39.2

 2020 2.6 17.4 28.8 48.9

 2050 4.0 25.1 41.3 70.5

 2078 5.7 34.9 56.4 97.0
46

Medicaid and Social Security expenditures will

reach about 15 percent of GDP by 2030 and will

continue to grow in the years following 2030

reaching (as noted earlier) 18 percent of GDP by

2050. Today, these expenditures account for

about 8 percent of GDP.

...if current cost trends continue, the

combination of Medicare, Medicaid and

Social Security expenditures will reach

about 15 percent of GDP by 2030....

The Medicare Prescription Drug,

Improvement and Modernization Act of 2003

made a number of significant changes to the

Medicare program, including the creation of the

new Medicare Part D prescription drug benefit

that will begin in 2006. At the time the

legislation was enacted, Government estimators

placed the total cost of this legislation at

somewhere between $395 billion (CBO

estimate) and $534 billion (CMS estimate) over

10 years from 2004 to 2013.

Moreover, possible further Medicare and

Medicaid expansions have the potential to drive

the costs of those programs, and health care costs

in general, significantly higher. A number of

future program changes that have been discussed

include expansions in coverage for services and

treatments for Alzheimer’s patients, expansion

for long-term care, and other changes.

Trends in private health insurance

The double digit increases in health care

costs in recent years have also affected private

sector programs. In meetings with economists,

representatives from the business community,

and representatives from organized labor, the

Board has heard unequivocally that one of the

biggest threats to employer-sponsored pensions

is the rising cost of health care and health

insurance, and that the viability of private

retirement systems depends on controlling health

costs. There are three basic pillars to employee

compensation: (1) wages and salaries; (2)

pensions; and (3) health coverage. The amount

of health coverage that employers can provide is

inextricably linked with the wages that are paid,

and the type and generosity of the private

pension system that is offered. Expansions in

one area often necessitate contractions in

another. Because of rapidly rising health care

costs, employers feel that they have to choose

between pensions, health coverage, and

employee pay. This trade-off often results in

higher health care premiums and greater out-ofpocket costs for employees and retirees alike.

...one of the biggest threats to

employer-sponsored pensions is the

rising cost of health care....

For all sizes of employers, retiree health care

premium increases were substantial in 2003,

ranging from about 12 percent to nearly 16

percent. In addition, retirees are now paying a

larger and significant share of these health care

premiums themselves. Many companies are

changing their benefits and premium structures

to control costs. For instance, they are creating

defined contribution-type health care plans,

much like Medical Savings Accounts, that

employees or retirees can choose to spend on

premiums or other health expenses. Many are

also keeping retirees in their health insurance

groups or pools so that they can still get group

rates but with the employer paying for less and

less of the coverage. In addition, many plans are

ending benefits for new hires or future retirees.

Department of Labor officials told the Board

that smaller firms are much less likely to offer

retiree health insurance than larger firms. Even

for larger firms, however, there has been a

significant decline in retiree health benefit

offerings. As shown in Chart 15, the percentage

of medium and large employers that offer a

retiree health plan to active employees has
declined substantially over the past quarter

century, falling from over 80 percent in the late

1970s to about 40 percent in 2001. Moreover, as

indicated above, even those employers who still

offer such plans have, in many cases, limited the

extent of coverage.

47

Chart 15

Percentage of Medium and Large Employers

Offering Active Workers a Retiree Health Benefit

Source:Watson Wyatt Data Services: ECS Survey

Report on Employee Benefits (1995-2002),

Employee Benefit Report (1993), Medical

Benefits for Active and Retired Employees

(1990), Group Benefits Survey (1978-1988).

These surveys were targeted at medium and

large firms.

Long-term care and retirement security

The picture of health care coverage as a part

of retirement security is greatly complicated by

the increasing need for long-term care as the

population ages. It has been estimated by CBO

that about 55 percent of those who are 85 or

older require long-term care.33 The number of

persons in this age category, 4.2 million in 2000,

is projected to grow rapidly to 9.6 million by

2030 and to 20.9 million by 2050.34

The picture of health care coverage as a

part of retirement security is greatly

complicated by the increasing need for

long-term care as the population ages.

33CBO, Financing long-term care for the elderly, April

2004, p. 1.

34Federal Interagency Forum on Aging-Related Statistics,

Older Americans 2004: key indicators of well-being,

2004.

Long-term care has been defined as hands-on

assistance provided to people with chronic

impairments who are in need, over a substantial

period of time, of help with fundamental daily

activities, such as eating, walking, dressing, and

bathing. This type of assistance is labor

intensive and expensive and is typically supplied

by a combination of family, friends, volunteers,

and hired personnel. It can be provided in the

home, in group homes, in adult day-care and

other community-based settings, in a hospice,

and in institutional settings such as nursing

homes or other facilities that offer assisted living

or a continuum of care options. It has been

estimated that in 2004, about 83 percent of

persons needing long-term care services live in

their own homes and the majority—78 percent—

do not hire any outside or professional help. As

such, families, friends, and volunteers play a

critically important part in the delivery of longterm care services.35

Paying the costs of long-term care.36—

According to recent estimates from the

Congressional Budget Office, total national

expenditures for long-term care services

provided in the United States in 2004—

excluding the value of care donated by family,

friends, and volunteers—is expected to be about

$135 billion. Costs per person vary widely.

CBO has estimated that elderly persons receiving

some form of long-term care in 2004 will incur

costs that average $15,000. Private room

nursing home care in 2003 cost an average of

$181 per day ($66,000 per year).

The majority of long-term care recipients rely

heavily on public programs to finance the longterm care services they receive. In 2004, the

portion of total long-term care expenditures paid

by Medicaid and Medicare together is likely to

35 CBO, Financing long-term care for the elderly,

April 2004.

36Except where noted, data in this section based on: CBO,

Financing long-term care for the elderly, April 2004.

100

80

60

40

20

0

1978 1982 1986 1990 1994 1999 2001

Percent
48

The majority of long-term care

recipients rely heavily on public

programs to finance the long-term

care services they receive.

for seniors with professional care would cost

between $50 billion and $103 billion per year.37

Another study published in 1999 indicated that,

when measured in terms of foregone wages,

donated care also costs the families and friends

providing that care about $196 billion per year.38

Changes in demand and supply of longterm care services.—As the population ages

over the next 15 years, the number of people

who need long-term care services is expected to

increase by 30 percent. And soon thereafter, the

number of people likely to need long-term care is

expected to increase even more dramatically.

The U.S. Department of Health and Human

Services and the U.S. Department of Labor

estimate that the number of people needing longterm care services will more than double

between 2000 and 2050.39 These same

government estimators also predict that the

number of people requiring paid long-term care

services—such as those delivered in nursing

facilities or assisted living facilities, or by homecare professionals—could also nearly double,

increasing from 15 million in 2000 to 27 million

by 2050. Over the same period, the U.S.

Department of Health and Human Services and

the U.S. Department of Labor have predicted that

spending on long-term care services could nearly

quadruple in constant dollars to $379 billion by

2050.

37 Department of Health and Human Services, Office of

the Assistant Secretary for Planning and Evaluations,

Informal caregiving: compassion in action, June, 1998.

CBO has updated these figures to 2004 dollars.

38Arno, Peter S., Carol Levine, and Margaret M.

Memmott, “The economic value of caregiving,” Health

affairs, vol. 18, n. 2 (1999). 39U.S. Department of Health and Human Services and

U.S. Department of Labor, The future supply of long-term

care workers in relation to the aging baby boom

generation: a report to Congress, May 14, 2003.

reach nearly 60 percent, or $81 billion. Of these

two large public programs, Medicaid is the

dominant payer for long-term care services. The

Congressional Budget Office reports that, in

1997, 56 percent of nursing home residents were

poor enough to qualify for Medicaid coverage

(with another 15 percent receiving some nursing

home coverage from Medicare). Medicaid

covers the care of people with very low incomes.

However, the program’s eligibility rules also

permit middle-income people—including some

whose income in retirement leaves them fairly

comfortable—to qualify for coverage by

exhausting or “spending down” their income and

assets. In 2004, Medicaid paid for 35 percent,

about $48 billion, of total long-term care costs.

Medicare, like most private health insurers,

covers only limited long-term care services, such

as home health care or nursing home care, that

aid a beneficiary in recovering from a specific

medical condition. It does not cover any longterm care services that are needed because of

non-medical factors related to old age; i.e., it

does not pay for custodial care. Still, in 2004,

Medicare is expected to pay for 25 percent, or

nearly $34 billion, of total long-term care costs.

Most health care financing experts contend

that the value of donated care, which is not

included in the estimates above, exceeds that of

any other category of long-term care financing.

These costs are difficult to quantify precisely in

dollar terms because the data and research

needed to do so are lacking. However, it is

widely agreed that these costs have been

undervalued by policymakers in developing

financing approaches for long-term care. In

2004, the Congressional Budget Office estimated

that replacing donated long-term care services

...the number of people needing longterm care services will more than

double between 2000 and 2050.
Complicating this picture is the likelihood

that there will be considerable challenges in

finding an adequate supply of workers to satisfy

the increased demand for long-term care

occupations. As the baby boom ages, the longterm care sector will increasingly be forced to

compete with the rest of the economy for a

supply of available workers that is growing

slower than demand. Other demographic factors

will also shape the supply of informal caregiving. Aging baby boomers are likely to

demand paid caregivers or rely more heavily on

their spouses for informal caregiving because

they have fewer children than previous

generations, their grown children are becoming

increasingly mobile and often live greater

distances from their aging parents, and both

husbands and wives are living longer, decreasing

the life-expectancy gender gap. However, lower

rates of marriage and higher rates of divorce

could also result in greater numbers of baby

boomers moving into middle and older ages

without a spouse to act as caregiver.

Advance funding of long-term care through

insurance.—According to recent insurance

industry data, since the introduction of private

long-term care insurance into the insurance

market about a quarter of a century ago, the rate

of growth in the number of private long-term

care policies sold has averaged about 18 percent

per year. Yet the cumulative number of private

long-term care policies sold during that same

period did not exceed 10 million. Of those

policies sold in 2002, 68 percent were sold

directly to individuals while 32 percent were

offered as part of employer-sponsored benefit

packages. All premiums for policies purchased

prior to the enactment of the Health Insurance

Portability and Accountability Act of 1996

(HIPAA) qualify for a Federal tax deduction.

However, policies purchased after the enactment

of HIPAA must conform to specific standards

established in the law for their premiums to be

tax deductible. The HIPAA standards for tax

qualification include such things as specific rules

for premium structures and benefit triggers. In

2002, 90 percent of private long-term care

policies sold qualified for the tax deduction.40

This tax benefit is, however, limited to people

who itemize and whose total medical and dental

expenditures exceed 7.5 percent of adjusted

gross income. Despite the tax-advantaged

treatment of some premiums for private longterm care insurance, uptake of long-term care

policies among the general public has been

limited.

Several bills recently introduced in Congress

have proposed new tax incentives to encourage

greater numbers of individuals to purchase

private long-term care coverage and reduce their

reliance on public programs to finance their

long-term care needs.41 These proposals have

recommended changes to the Internal Revenue

Code that authorize “above the line” tax

deductions for all or part of insurance premiums

for qualified long-term care insurance plans.

This change would expand the current taxadvantaged treatment of long-term care

premiums to everyone, not just to those

individuals who itemize and whose total medical

and dental expenditures exceed 7.5 percent of

adjusted gross income. A similar proposal was

also included in the fiscal year 2005 President’s

Budget. In addition, some proposals, both in

Congress and from the insurance industry, have

recommended including accelerated deduction

percentages for persons who are 55 years of age

or older or providing other age-based deduction

schedules that begin at younger ages.42

40America’s Health Insurance Plans, Research findings:

long-term care insurance in 2002, June 2004. 41S. 1335, H.R. 2096, H.R. 1406, and S. 2077.

42LTC Consultants, Legislative backgrounder: long-term

care—the real health crisis in America, 2002.

49
50

Conclusion

Health care is the most intractable of all

retirement security issues because of rapidly

rising health care costs and the growing share of

the economy comprised by health care

expenditures. As with Social Security, the

financial problems of Medicare and Medicaid

cause many people to doubt that these programs

will be able to continue providing the kind of

support for retirees and persons with disabilities

as they have in the past.

Over the past year, the Board has discussed

the escalation in health care costs with many

experts. There are many reasons why health

costs are continuing to increase at a rate that

exceeds the rate of economic growth, and there

is no single, obvious, or simple way to reduce

that growth substantially. Some of the major

reasons for the current and projected growth are

the increase in the size of the aged population,

the development of new technologies and

treatments, and the nature of the systems for

delivering and financing health care. Among the

many suggestions that the Board has heard as to

Health care is the most intractable of all retirement security issues

because of rapidly rising health care costs and the growing share

of the economy comprised by health care expenditures.

how cost escalation might be tempered were:

research efforts to better evaluate the relative

value of new technologies, efforts to improve the

quality of health care so as to reduce wasteful or

damaging practices, making consumers better

informed, and changing incentives inherent in

the system that tend to result in unnecessary or

inappropriate expenditures. Finding ways to

achieve these general objectives will be a longterm process requiring much careful study and

thoughtful policy development by experts and

policymakers. This is an on-going process in

which some progress has already been made but

much more will be needed.

Given the large anticipated demand for longterm care, it is also essential that serious

attention be paid to that aspect of retirement

security. Some efforts have been made to

encourage advance funding of long-term care

needs through insurance including tax incentives

adopted in the Health Insurance Portability and

Accountability Act of 1996, but the results to date

have been minimal. More attractive, age-related,

tax incentive policies for the purchase of longterm health care insurance seem imperative.
51

VII. SUPPLEMENTAL SECURITY INCOME

Program description

Supplemental Security Income is a program

that makes cash payments to aged, blind, and

disabled individuals with low income and assets.

In terms of the overall picture of retirement

security, SSI provides a floor of income support

at a level which society finds to be the minimum

acceptable national standard. The program’s

expenditures are small compared with those of

the Social Security program, but SSI is vitally

important for those aged, blind, and disabled

individuals who qualify for only a very small

Social Security benefit—or none at all—and who

lack alternative means of self-support.

The SSI program establishes a Federal

benefit rate annually. Most States supplement

the Federal SSI payment. Countable income is

compared to this combined Federal-State

payment level to determine eligibility and

payment amount. Many States limit their

supplementation to certain categories of

individuals with special needs, such as special

housing.

The amount of SSI benefits an individual

receives depends on the amount of other income

he or she has available. The first $20 per month

of earned or unearned income does not affect

benefits, but unearned income above that amount

reduces SSI benefits dollar-for-dollar. In

addition to the disregard of the first $20 of any

income, the first $65 per month of earned

income does not affect benefits, but amounts

over that reduce benefits by $1 for every $2

earned. These amounts, referred to as

income disregards, have not changed since the

program was enacted in 1972.

To receive SSI, applicants must have

countable resources valued at less than $2,000

for an individual and $3,000 for a couple. The

resource limits have been at that level since

1989. Some resources, such as a home and an

automobile, are not countable.

The Federal benefit rate for an individual has

increased from $140 in 1974 to $579 in 2005.

Because benefit rates are adjusted for inflation,

however, benefit rates in constant dollars have

varied only slightly, and Federal benefits have

been about 70 percent of the poverty threshold

for an individual under 65. Since the program

began, an individual receiving Social Security

and SSI would be at about 80 percent of the

poverty threshold, and a couple receiving Social

Security and SSI would be at about 90 percent of

the poverty threshold. (Although the Federal SSI

income standards are below the poverty

thresholds, not all SSI recipients are below the

poverty level. State supplements, income which

is not counted because of disregards, or income

of other household members may keep an SSI

recipient above the poverty line.) Federal

payments in constant 2004 dollars grew from

$14 billion in 1974 to $33 billion in 2003. Over

the life of the program, SSI benefit payments

have ranged from 0.2 percent to 0.3 percent of

GDP.

...SSI provides a floor of income

support at a level which society finds

to be the minimum acceptable

national standard.

Chart 16

Source: SSA, Annual report of the Supplemental

Security Income program, Table IV. B6.

1980 1984 1988 1992 1996 2000 2003

65 and Older

Under Age 65

8

7

6

5

4

3

2

1

0

Millions

SSI Federal Beneficiaries, 1980-2003
52

Table 6

Program Highlights

Benefit Payments

• As of December 2004, 6.7 million

people received Federal SSI benefits,

of whom 1.8 million were 65 or older.

• The Federal monthly income support

level for 2005 is $579 for an

individual and $869 for a couple.

The average individual Federal

payment in December 2004 was

$301.21 for beneficiaries 65 or older.

• Federal payments in 2004 were

approximately $6.9 billion for

beneficiaries 65 or older.

Beneficiaries

• Thirty-six percent of beneficiaries 65

or older have no income other than

SSI. Another 47 percent have no

income other than Social Security and

SSI.

• Ninety-eight percent of beneficiaries

65 or older have Medicaid.

 Source: SSA, data from www.SocialSecurity.gov

The Supplemental Security Income program

is designed as a safety-net or residual program to

meet the very basic needs for income and,

through its categorical relationship to Medicaid,

health care for those who have not accumulated

sufficient protection from Social Security or

other public and private programs. In

Federalizing the public assistance programs for

the aged, blind, and disabled in the 1972

legislation, Congress hoped to assure those

individuals a more adequate level of income

support through a program that would also be

more uniformly and simply administered than

was the case under the pre-existing State and

county welfare programs.

Substantial progress has been made over the

last several decades in the elimination of poverty

among the aged. As Chart 17 shows, the

percentage of children and non-aged adults in

poverty has been relatively stable compared with

the aged who have seen poverty rates decline

from nearly a quarter of the aged population in

1970 to about a tenth in 2003.

Substantial progress has been made

over the last several decades in the

elimination of poverty among the aged.

Chart 17

Percent of Population in Poverty

1970 to 2003

Source: U.S. Census, Income, poverty, and health

insurance coverage in the United States: 2003

Several factors have contributed to this

decline including growth in Social Security

benefit levels and growth in the proportion of the

aged receiving Social Security benefits. After

adjustment for inflation, the average Social

Security benefit for a retired worker grew by

over 60 percent between 1970 and 2003. As of

1999, there were 3.2 million aged individuals

with incomes lower than the poverty level, and

about 900,000 of these were SSI recipients.

However, an additional 400,000 aged individuals

would be in poverty but for their SSI payments.

30

25

20

15

10

5

0

1970 1980 1990 2003

Percent

Children Adults Age 65

and over
53

Ad hoc increases in Social Security benefit

levels in 1972 undoubtedly contributed

substantially to reducing the proportion of the

aged who would otherwise have been receiving

SSI. The number of SSI recipients aged 65 and

over was relatively stable over the past quarter

century even though the population in that age

group grew by 40 percent.

Chart 18

SSI Federal Beneficiaries 65 and Older

1980 to 2028

Source: SSA, Annual report of the Supplemental

Security Income program, Table IV. B6.

In part this may be explained by the fact that

many of the oldest of those recipients had been

of working age at a time when Social Security

coverage was not as nearly universal as it now is.

Consequently, the more recent cohorts of

potential recipients would be more likely to have

sufficient Social Security coverage to prevent

their needing SSI. Also, the indexing of Social

Security initial benefits to wage growth meant

that many potential SSI recipients would likely

have had higher Social Security benefits that

raise their income above SSI eligibility levels.

As shown in Chart 18, the situation will change

over the next quarter century with the projected

absolute number of older SSI recipients

increasing by about 1 million. One reason is an

even larger growth in the aged population as a

result of increasing longevity and the baby boom.

The number of individuals aged 65 and over will

grow by about 80 percent between now and

2027. The increase in the Normal Retirement

Age for Social Security benefits may also

contribute to a rise in SSI-aged recipiency. Older

individuals with low incomes are likely to take

Social Security benefits at age 62, and the

increased NRA translates into age-62 benefits

which will ultimately be 70 percent rather than

80 percent of the full benefit rate. The large

increases in the number of SSI disability

recipients also may have implications for the

growth in the SSI-aged rolls as these individuals

reach age 65.

As policymakers address changes in Social

Security and in policies affecting pensions,

savings, and health care, they need to be aware

of how these policies affect those at the safetynet level and whether the changes can include

features that reduce the need for older persons to

rely on needs-based programs. The interaction

between policy goals for SSI and those for other

programs can, however, be complicated.

Implications for potential changes in

Social Security

Proposals for reforming Social Security

could impact the SSI program. For example,

reductions in Social Security benefit levels or

As policymakers address changes in Social Security and in policies affecting

pensions, savings, and health care, they need to be aware of how these policies

affect those at the safety-net level and whether the changes can include features

that reduce the need for older persons to rely on needs-based programs.

Millions

4

3

2

1

0

1980 1988 1996 2004 2012 2020 2028
54

increases in the Normal Retirement Age,

resulting in reduced benefits at a given age,

would increase the number of SSI recipients

unless the proposals were structured to limit the

reductions only to individuals with higher levels

of benefits or to affirmatively increase lower

level benefits in order to reduce SSI dependency.

In considering changes to Social Security that

might have the impact of making more

individuals eligible for SSI, policymakers should

also take into account the fact that a large

number of those currently eligible do not apply

for SSI benefits. Researchers who have studied

the participation rate of people eligible for SSIaged benefits have estimated it at between 45

and 63 percent. The reason for this low

participation rate is not clear. Some have

suggested that it results from a lack of

knowledge about the program and eligibility

standards. Others have suggested that the

difficulty of applying or the stigma of receiving

needs-based benefits are obstacles. Recent work

indicates that eligible individuals who are close

to the income and resource limits are less likely

to apply than other potential eligibles, and that

participation increases with need and with the

availability of State supplements.

Proposals involving individual accounts

would need to deal with the likelihood that

potential SSI eligibility would have an impact on

incentives. For example, likely SSI beneficiaries

would have an incentive to accept high levels of

risk, since they would be unaffected by losses

and unlikely to realize gains with moderate risk.
55

Over the course of the 20th century, America

faced and overcame many challenges and made

many great advances. In the area of income and

health security for our older population, the

Nation established the social insurance programs

of Social Security and Medicare. These form a

solid core of economic security around which

other layers of protection are added through

employment-based private programs, individual

savings, and continuing participation in the

workforce. And we also have established

important safety-net programs including SSI and

Medicaid. All of these elements will continue to

be important parts of economic security for

today’s retirees, for those now of working age

who need to prepare for their future, and for

generations yet to come. As we move into the

new century, we face new challenges that must

be addressed so that these institutions on which

older Americans rely for economic security can

continue to carry out that mission. The future is

never perfectly predictable. We are likely to

encounter both problems and opportunities that

we cannot now foresee. But, we can address

those challenges and issues which we now do

foresee, and, by doing so, position ourselves

better to deal with whatever else the future will

bring.

These are the challenges that we can predict

and that we need to address:

• The Social Security Old-Age, Survivors,

and Disability Insurance program is the

Nation’s fundamental program of income

security for older Americans. The best

current projections show that it has

significant long-range deficits. These

need to be remedied soon so that

confidence in the program can be

maintained and so that individuals and

employers can rationally plan how to

supplement it.

VIII. CONCLUSION

• Health care costs are clearly on an

unsustainable path that is undermining the

financial stability of the Medicare

program and also placing great stress on

individuals, employer-based health and

pension programs, and the Federal budget.

Major attention is needed to find ways to

rationalize the health care system,

constrain its costs, and improve the quality

of care.

• Employer-based pensions are undergoing

major changes for a variety of reasons

including changes in the needs of

employers and workers in our modern

economy and regulatory burdens and

uncertainty. Policies need to be shaped to

assure that these pensions continue to

contribute to economic security in

retirement and to expand their coverage to

better fill gaps in protection, particularly

for lower-income workers.

• Americans are living longer and enjoying

better health in their older years and the

relative size of the older and younger

population groups is changing in ways

likely to increase the need to expand the

workforce through greater participation by

older workers. Policymakers should

examine the rules and incentives provided

by public programs and regulations with a

view to facilitating and encouraging

continuing labor force participation of

older workers.

• As a Nation, we need to do a much better

job of educating ourselves about economic

security. While some commendable

efforts have been made by public and

private entities in encouraging workers to

plan for retirement and to encourage

increased savings, the results thus far are

clearly inadequate. This needs to become

a major national priority.
56

APPENDIX: Research about Retirement Security

Policymakers depend on research to inform

them of the likely consequences of policy

changes. There is much that they need to know

about the dynamics of retirement choices. For

example, on the macroeconomic level, analysis

is needed on the potential effect on savings of

various approaches to strengthening Social

Security. Further work is also needed on the

relationships between Social Security and other

government-sponsored income security

programs, the national economy, and

socioeconomic factors. Policymakers also need

research that will help them consider the

distributional effects of choices they may make

on the whole spectrum of economic and

demographic groups in our society. They also

need insight into the administrative impacts of

potential changes to the retirement security

system. And the fairly new field of behavioral

economics can be expected to shed additional

light on the choices that people make and why

they make them.

SSA conducts research to provide

policymakers with information on the economic,

distributional, and administrative aspects of

potential new directions for retirement security.

SSA is also helping to provide the research that

policymakers need through its Retirement

Research Consortium. The Consortium consists

of research centers housed in three institutions

(Boston College, the University of Michigan,

and the National Bureau of Economic Research)

and is funded by SSA. The main goals of the

Consortium are to conduct research and develop

research data, to disseminate information on

retirement and SSA-related social policy, and to

train scholars and practitioners. We commend

SSA for undertaking this effort and encourage

the agency to guide this effort so that it produces

new research that is useful to policymakers.

Microsimulation models are tools to estimate

the consequences of proposed changes on groups

of beneficiaries. SSA has a microsimulation

model that matches actual earnings records with

survey data and can conduct a distributional

analysis of proposed changes to the Social

Security program. SSA’s Office of the Chief

Actuary provides program projections, analyzes

proposals for program change, and provides

useful information to policymakers. The

Congressional Budget Office has also developed

models that provide both financial projections

for the program and distributional analyses for

potential changes to the program. We encourage

both SSA and CBO to continue with this

important work.

There are a number of datasets that collect

survey data that have proven to be valuable

resources to researchers. Linking these datasets

to SSA’s administrative records expands their

usefulness and broadens the range of questions

that the data can address. Privacy concerns limit

the availability of this matched data, however.

SSA is working on making public use files

available that match survey data with

administrative files in a way that does not

disclose the identity of individuals. This is a

useful step forward. It is in the public interest to

make matched data available to qualified

researchers to the greatest extent possible,

consistent with privacy concerns.
ABBREVIATIONS KEY

AARP Originally named the American Association for Retired Persons,

 now known simply as AARP

BLS Bureau of Labor Statistics

CBO Congressional Budget Office

CMS Centers for Medicare and Medicaid Services

DB Defined Benefit

DC Defined Contribution

EBRI Employee Benefit Research Institute

ERISA Employee Retirement Income Security Act

GAO Government Accountability Office (formerly the General

 Accounting Office)

GDP Gross Domestic Product

HI Hospital Insurance

HIPAA Health Insurance Portability and Accountability Act of 1996

IRA Individual Retirement Account

NRA Normal Retirement Age

OASDI Old-Age, Survivors, and Disability Insurance

Part A Medicare Hospital Insurance

Part B Medicare Supplemental Medical Insurance

Part D Medicare Prescription Drug Program

PBGC Pension Benefit Guaranty Corporation

QDWI Qualified Disabled and Working Individual

QI Qualifying Individual

QMB Qualified Medicare Beneficiary

SCF Survey of Consumer Finances

SLMB Specified Low-Income Medicare Beneficiary

SMI Supplemental Medical Insurance

SSA Social Security Administration

SSAB Social Security Advisory Board

SSI Supplemental Security Income

The Board of Trustees for the Social Security trust funds consists of the Secretaries of

Treasury, Labor, and Health and Human Services, the Commissioner of Social Security,

and two public Trustees appointed on a bi-partisan basis.

57
Hal Daub, Chairman

Hal Daub is currently President and Chief Operating Officer of the American Health Care

Association and the National Center for Assisted Living, and Of Counsel with the law firm of

Blackwell Sanders Peper Martin in Omaha, Nebraska and Washington, D.C. Previously, he

served as Mayor of Omaha, Nebraska from 1995 to 2001, and as an attorney, principal, and

international trade specialist with the accounting firm of Deloitte & Touche from 1989 to

1994. Mr. Daub was elected to the United States Congress in 1980, and reelected in 1982,

1984, and 1986. While there he served on the House Ways and Means Committee, the Public

Works and Transportation Committee, and the Small Business Committee. In 1992,

Mr. Daub was appointed by President George H.W. Bush to the National Advisory Council

on the Public Service. From 1997 to 1999, he served on the Board of Directors of the

National League of Cities, and from 1999 to 2001, he served on the League’s Advisory

Council. He was also elected to serve on the Advisory Board of the U.S. Conference of

Mayors, serving a term from 1999 to 2001. From 1971 to 1980, Mr. Daub was vice president

and general counsel of Standard Chemical Manufacturing Company, an Omaha-based

livestock feed and supply firm. A former U.S. Army Infantry Captain, Mr. Daub is a graduate

of Washington University in St. Louis, Missouri, and received his law degree from the

University of Nebraska. Term of office: January 2002 to September 2006.

Dorcas R. Hardy

Dorcas R. Hardy is President of DRHardy & Associates, a government relations and

public policy firm serving a diverse portfolio of clients. After her appointment as Assistant

Secretary of Human Development Services, Ms. Hardy served as Commissioner of Social

Security from 1986 to 1989 and was recently appointed by President Bush to chair the Policy

Committee for the 2005 White House Conference on Aging. Ms. Hardy has launched and

hosted her own primetime, weekly television program, “Financing Your Future,” on

Financial News Network and UPI Broadcasting and “The Senior American,” an NET

political program for older Americans. She speaks and writes widely about domestic and

international retirement financing issues and entitlement program reforms and is the author

of Social Insecurity: The Crisis in America’s Social Security System and How to Plan Now

for Your Own Financial Survival, Random House, 1992. Ms. Hardy consults with seniors’

organizations, public policy groups and businesses to promote redesign and modernization of

the Social Security, Medicare and disability insurance systems. Additionally, she has chaired

a Task Force to rebuild vocational rehabilitation services for disabled veterans for the

Department of Veterans Affairs. She received her B.A. from Connecticut College, her

M.B.A. from Pepperdine University and completed the Executive Program in Health Policy

and Financial Management at Harvard University. She is a Certified Senior Advisor and

serves on the Board of Directors of The Options Clearing Corporation, Wright Investors

Service Managed Funds, and First Coast Service Options. First term of office: April 2002 to

September 2004. Current term of office: October 2004 to September 2010.

SOCIAL SECURITY ADVISORY BOARD

58
Martha Keys

Martha Keys served as a U.S. Representative in the 94th and 95th Congresses. She was a

member of the House Ways and Means Committee and its Subcommittees on Health and

Public Assistance and Unemployment Compensation. Ms. Keys also served on the Select

Committee on Welfare Reform. She served in the executive branch as Special Advisor to the

Secretary of Health, Education, and Welfare and as Assistant Secretary of Education. She

was a member of the 1983 National Commission (Greenspan) on Social Security Reform.

Martha Keys is currently consulting on public policy issues. She has held executive

positions in the non-profit sector, lectured widely on public policy in universities, and served

on the National Council on Aging and other Boards. Ms. Keys is the author of Planning for

Retirement: Everywoman’s Legal Guide. First term of office: November 1994 to September

1999. Current term of office: October 1999 to September 2005.

David Podoff

David Podoff was a senior advisor to the late Senator Daniel Patrick Moynihan on Social

Security and other issues while serving as Minority Staff Director and Chief Economist for

the Senate Committee on Finance. While on the Committee staff he was involved in major

legislative debates with respect to the long-term solvency of Social Security, health care

reform, the constitutional amendment to balance the budget, the debt ceiling, plans to balance

the budget, and the accuracy of inflation measures and other government statistics. Prior to

serving with the Finance Committee he was a Senior Economist with the Joint Economic

Committee and directed various research units in the Social Security Administration’s Office

of Research and Statistics. He has taught economics at the Baruch College of the City

University of New York, the University of Massachusetts and the University of California in

Santa Barbara. He received his Ph.D. in economics from the Massachusetts Institute of

Technology and a B.B.A. from the City University of New York. Term of office: October

2000 to September 2006.

Sylvester J. Schieber

Sylvester J. Schieber is Director of the Research and Information Center at Watson Wyatt

Worldwide, where he specializes in analysis of public and private retirement policy issues

and the development of special surveys and data files. From 1981 - 1983, Mr. Schieber was

the Director of Research at the Employee Benefit Research Institute. Earlier, he worked for

the Social Security Administration as an economic analyst and as Deputy Director at the

Office of Policy Analysis. Mr. Schieber is the author of numerous journal articles, policy

analysis papers, and several books including: Retirement Income Opportunities in An Aging

America: Coverage and Benefit Entitlement, Social Security: Perspectives on Preserving the

System and The Real Deal: The History and Future of Social Security. He served on the

1994 - 1996 Advisory Council on Social Security. He received his Ph.D. from the

University of Notre Dame. First term of office: January 1998 to September 2003. Current

term of office: October 2003 to September 2009.

59