Pension Reform: What Can the U.S. and Australia Learn from Each Other?

1. Pension Reform:What Can the U.S. and Australia Learn from Each Other? by Jon Forman Alfred P. Murrah Professor of Law University of Oklahoma Faculty Exchange Lecture Texas Tech University College of Law Lubbock, Texas November 11, 2011

2. Outline • Life Cycle Model • Social Security/ Age Pension • Private Pension/ Superannuation • Supplemental Savings

3. People are Living Longer:Americans

4. But People Are Retiring Earlier: Percentage of Workers Electing Social Security Benefits at Various Ages

7. U.S. Social Security • Social Security taxes • Workers pay • 6.2% of their earnings for Social Security, and • 1.45% of their earnings for Hospital Insurance under Medicare (Part A) • Employers pay an equal amount • The total is 12.4% for Social Security and 2.9% for HI • 2011 tax base is $106,800 in 2011 Social Security Administration, 2009 Social Security Changes, http://www.socialsecurity.gov/OACT/COLA/cbb.html.

8. Worker Benefits • Workers over 62 are eligible • If they have worked 10 years • Benefits are based on a workers earnings history • Career-average earnings • Average Indexed Monthly Earnings (AIME)

9. How Do Benefits Compare to Earnings? Replacement Rates for Retired Worker Age 65, 2011 Board of Trustees, 2011: Table VI.F10.

10. How Many People Rely onSocial Security for Most of Their Income? • 90% of people 65 and older get Social Security. • Nearly 2 in 3 (64%) get half or more of their income from Social Security. • About 1 in 3 get almost all (90% or more) of their income from Social Security. SSA, 2010a: Table 9.A1.

11. Net Social Security Replacement Rates Will Fall Medium Earner’s Replacement Rate at 65 After Medicare Parts B and D Premiums Ruffing and Van de Water, 2011.

12. The Australian Age Pension • funded from general revenues • 2011, a maximum of $670.90 every fortnight for singles and $1,011.40 for couples • The single benefit is designed to provide about 25% of average male earnings • Benefits are reduced by both an asset test and an income test

13. Two Basic Types of Pensions • Defined benefit plans • Defined contribution plans

14. What is a Defined Benefit Plan? • Employer promises employees a specific benefit at retirement • To provide that benefit, the employer makes payments into a trust fund and makes withdrawals from the trust fund • Employer contributions are based on actuarial valuations

15. Defined Benefit Plan • Employer bears all of the investment risks and responsibilities • Typical plan provides each worker with a specific annual retirement benefit that is tied to the worker’s final average pay and number of years of service

16. Defined Benefit Plan • For example, a plan might provide that a worker’s annual retirement benefit is equal to 2% times years of service, times final average pay • B = 2% × yos × fap • Final-average-pay formula

17. Defined Benefit Plan • Worker with 30 years of service would receive 60 percent of her pre-retirement earnings • Worker earning $50,000 would get $30,000-a-year pension • B = $30,000 • = 60% × $50,000 • = 60% × fap • = 2 percent × 30 yos × $50,000 fap

18. What is a Defined Contribution Plan? • Individual account plan • Employer typically contributes a specified percentage of the worker’s pay to an individual investment account for the worker • Owned by employee • Benefits based on contributions and investment earnings

19. Defined Contribution Plans:How Individual Retirement Savings Accounts Work

20. Defined Contribution Plan • For example, employer might contribute 10% of annual pay • Under such a plan, a worker who earned $30,000 in a given year would have $3,000 contributed to her account • $3,000 = 10% × $30,000 • Benefit at retirement based on contributions, plus earnings

21. Australia: A Universal Pension • 1986—industrial agreements for 3 percent of payroll contributions • 1992/1993—superannuation guarantee legislation, eventually mandating 3 percent contributions to individual retirement accounts • Higher levels phased in, reaching 9 percent in 2002/2003

22. Tax Treatment of a Typical Individual Account in Australia – tte

23. IMPROVING NATIONAL SAVINGS AND SUPERANNUATION ADEQUACY • The Government will increase the superannuation guarantee (SG) rate from 9 to 12 per cent over time.

24. Superannuation • GOVERNMENT CONTRIBUTIONS FOR LOW INCOME EARNERS • A new superannuation contribution of up to $500 will be provided by the Government for workers with income up to $37,000. • CATCH-UP CONTRIBUTIONS FOR OLDER WORKERS • The Government will allow individuals aged 50 and over with total superannuation balances below $500,000 to make up to $50,000 in concessional superannuation contributions.

25. Most elderly don’t receive pensions in the U.S. Percent with Employer-Sponsored Pensions All age 65+ 41% Couples 51% Unmarried men 42% Unmarried women 34% Social Security Finances: A Primer , at 10.

26. Tax Treatment of a Typical Individual Account in the U.S. – eet

27. Tax Treatment of a Roth Individual Account in the U.S. – tee

28. Goals for a Pension Plan • First, ensure that every employee earns a meaningful retirement benefit • and that long-time employees are guaranteed an adequate income throughout their retirement years • Second, have a minimum of work disincentives for employees coming in and out of service • Third, be affordable and well-financed

29. Optimal Policies for Maximizing Retirement Income • Contributions • Accumulation • Pay-out (Decumulation)

30. Contributions • Voluntary v. Mandatory • Encourage Saving More • Tax incentives? • Limits? • Defaults

31. Accumulation • Investment Rules • Fiduciary Duties • Distribution

32. Accumulation: Investment Rules • Improve Investment Choices • Minimize Fees

33. Accumulation: Fiduciary Rules • Fiduciaries should: • Act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them; • Carry out their duties prudently; • Follow the plan documents (unless inconsistent with ERISA); • Diversify plan investments; and • Pay only reasonable plan expenses

34. Accumulation: Fiduciary Rules, continued • Impose fiduciary duties on more brokers and financial advisers • Toughen the standards

35. Accumulation:Distribution Rules • Preserve benefits until retirement • Raise the retirement age

36. Pay-out (decumulation) • Improve Individuals’ Understanding about Retirement Income • Encourage life-time income options • Targeted Withdrawals • Require Sponsors to Provide an Estimate of Lifetime Annuity Income on Benefit Statements • Encourage sponsors to offer a default annuity

37. Preretirement Earnings Replacement Rates, 2011

38. Source:http://www.gao.gov/new.items/d11400.pdf.

39. https://guidance.fidelity.com/living-in-retirement/annual-portfolio-withdrawals?ref_ls=lr3007.

40. Source:http://www.gao.gov/new.items/d11400.pdf.

41. About the Author • Jonathan Barry Forman (“Jon”) is the Alfred P. Murrah Professor of Law at the University of Oklahoma College of Law, teaching tax and pension law and the author of Making America Work (Washington, DC: Urban Institute Press, 2006). He was the Professor in Residence at the Internal Revenue Service Office of Chief Counsel for the 2009-2010 academic year. • Jon can be reached at jforman@ou.edu; www.law.ou.edu/faculty/forman.shtml. 41