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Speeches and Testimony
Daniel Clifton's Remarks to the National Association of State Pension Administrators (NASPA)
Portable Public Pensions: The Inevitable Reform August 10, 2004
Daniel Clifton
Chief Economist, Americans for Tax Reform
Executive Director, American Shareholders Association
Good morning. I want to thank Steve for that kind introduction. As Steve mentioned, I
am Daniel Clifton, and I am the Chief Economist for Americans for Tax Reform. I am also the
Executive Director of the American Shareholders Association.
The President of ATR, Grover Norquist, was scheduled to speak to you today but had to
cancel due to a family emergency. He was quite excited to speak to you and is terribly
disappointed. So, instead, he asked for me to fill in, and I am a much less colorful and eloquent
speaker, so not only does he send his apologies, I send mine as well. I hope I put none of you to
sleep this morning.
First, some background on ATR. The organization is a non-profit coalition of taxpayers
and taxpayer groups that oppose all tax increases. The group was created in 1985 to build
support for fundamental tax reform, specifically the Tax Reform Act of 1986. Following
passage of that legislation, ATR sought to keep the provisions of the Act in place by creating the
Taxpayer Protection Pledge, in which politicians sign a pledge not to raise taxes. Currently, 217
members of the House of Representatives, 42 members of Congress, and President Bush have all
signed the Pledge. On the state level, roughly 1300 state legislators have signed as well.
Trying to keep taxes low during slower economic growth has enabled me to give
speeches all over the country and improve my public speaking skills. But when I woke up this
morning, I felt unusually nervous. I attribute this to two factors.
First, I probably hold a different view than most of you in the room on the issue of
defined benefit and contribution plans. It is always tough to speak in front of a crowd with polar
opposite views. However, I also believe my invitation to speak before you is a testament to
NASPA’s unwavering commitment to Retirement Security. For this, I applaud the
organization’s strong commitment. Only through open dialogue and discussion can we work
together to improve the standard of living for all Americans and I think you for this wonderful
opportunity.
A second reason why I am a bit nervous today is something I routinely encounter – is my
appearance. I look so young and people get thrown off balance.
In addition to my job at ATR, I am also the Executive Director of American Shareholders
Association, a non-profit organization which lobbies Congress on behalf of individual
shareholders. My first appointment in this role was to give members of Congress the
organization’s annual Friend of the Shareholder award. I was so excited that I was going to
speak with 100 member of Congress for two minutes for each member. Members of Congress
were excited to be receiving the award, especially in an election year.
Well, Members started entering the room, I went to give them their awards and I could
read their facial expressions perfectly – who is this 14 year old kid? One Member even asked if
Dan was in the bathroom!!!
But in all seriousness, I have devoted my life to improve the financial security of all
Americans. American Shareholders Association gives me the ability to study these issues
everyday, and I hope today we can begin to work together to improve the financial security of
public employees.
As I mentioned earlier, Americans for Tax Reform fully supports moving to a system of
defined contributions. Our angle is slightly different than yours. We are trying to balance the
needs of taxpayers with the growing changes of the nation’s demographics.
Longer life expectancies and increased prosperity have led to a revolution in the way
Americans now approach work and retirement. 100 years ago, life expectancies were 51.5 years
for males and 58.3 for females. Today, males’ life expectancy is 80 years and females’ slightly
more than 84 years. Furthermore, with lifestyle improvements and advances in medical
technology, the average 65 year old is projected to increase his or her life expectancy by 2 years
over the next 25 years.
At the same time, American families are having fewer children. As a result, the 65 and
over population has increased from 8 percent in 1950 to 12 percent today to 20 percent in 2035.
Increasing prosperity has also increased the number of leisure activities being pursued in
retirement. These developments combined require us to reevaluate the country’s existing
institutions that currently provide retirement income for American workers. It is my belief that
these demographic shifts ultimately make defined contributions inevitable.
Demographic and Economic Pressures on the Public Pension System
The debate over defined contribution and defined benefit plans will be shaped in the
future by a number of factors:
First, can public entities maintain their financial position without major tax
increases due to the economic uncertainties of defined benefit plans?
As chief economist for Americans for Tax Reform, I have spent the past two and one half
years working with the governors and state legislators to help balance their budgets without
raising taxes during the economic slowdown. I can tell you two common themes emerged – one
from the revenue side and the other from the spending side. Reliance on non-wage income such
as capital gains revenue needs to end. With the stock market run up in the 1990’s, increases in
volatile and temporary sources of revenues were used to increase permanent spending. But when
the stock market declined in March 2000, these revenues disappeared and taxes were raised on
working families to make up the difference.
And on the spending side, mandatory increases of spending for health care and pensions
are hand-cuffing state governments. State taxpayers were being asked for billions of dollars to
prop up public pension systems hit by stock market losses. The current pension system requires
more tax revenue at exactly the worst time – when revenues are declining. Falling assets and
increasing liabilities are a recipe for financial disaster. State Courts have ruled time and time
again that taxpayers must pay all promised benefits, regardless of a state’s fiscal situation. This
may be good news for pension holders, but it is also very bad news for taxpayers during times of
slower economic growth. These perverse incentives inherent in the system is a precursor for
major tax increases and if this broken system continues state taxpayers will demand change over
time.
A second and related factor shaping the debate over defined contribution and
defined benefit plans is the aging of the baby boomers. Can taxpayers maintain additional
payments due to people living longer while fewer workers are available to pay for retirees?
The retirement of the boomers will have an enormous impact of the nation’s economy
and demographics. It’s been widely reported of the coming brain drain on federal and state
government as the baby boomers get set to retire. These same baby boomers will be collecting
pensions. At the same time, however, the current gap between assets and liabilities nationally
will need to be corrected. If not, the natural strain on the pension system coupled with the
financing gap will force a demand on the system to change. Taxpayers will not foot the bill for
mismanagement.
The third factor applying pressure on the public pension system is the acceleration
of the number of middle class families owning shares of stock. How will public employees
respond when they are the only people left in America not sharing in America’s prosperity
resulting from the stock market?
This country has undergone one of the most fundamental demographic shifts in American
history. In 1980, just 17 percent of American’s richest families owned shares of stock. Today
more than 50 percent o families own stock, 60 percent of adults, and 67 percent of voters. This
has transformed America’s economic and political landscape.
In 1989, just 30 percent of a family’s financial assets were stocks; today, it’s 56 percent.
Clearly, the stock market has become much more important to family balance sheets.
I can shout off statistics all day, but what does this really mean? Simply put, the four fold
increase in the number of defined contribution participants in the private sector and the growing
popularization of mutual funds has opened the doors to widespread investing of the American
public. Specifically, the 401(k) plan has opened up new opportunities for middle class families
to own stock. But workers have not just stopped at their employee plan. Surveys have
consistently shown the work related retirement plans are just a first step towards investing.
Seeing their funds accumulate, workers then start purchasing their own shares of stock and
mutual funds for more immediate savings. Public employees have yet to share in this experience,
unlike workers in the private sector.
My boss equates this phenomenon to a cell phone. If everyone has a cell phone and not I,
I ask why don’t I?
Public employees will take notice of their friends watching their stocks and talking about
with other people in social circles. Over time, public employees will gradually demand that they
too have control over their own retirement funds just as their friends do. This adds additional
pressure to further enact defined contribution plans.
The fourth and final factor is the changing nature of the labor market. With more
people working different for a number of different employers over their lifetime, how does
the rigid portability rules of defined benefit plans survive?
Old time manufacturing jobs have been replaced by newer high technology companies,
which are now some of the largest employers in the country. Most of these companies have
never had a defined benefit plan for their workers.
Furthermore, the nation’s shift to a knowledge based economy has altered the labor force.
In addition to rapidly changing jobs, in which a career means 10+ jobs, workers are becoming
self employed, evidenced by the substantial new registrations of limited liability corporations
and the fact that the Department of Labor’s two employment surveys find in one survey that 2.2
million jobs over the past 3.5 years were created and the other survey findings show there were
1.3 million jobs lost over the same time period. The Household survey picks up self employees
workers much easier than the payroll survey.
With greater labor mobility the rigid rules of defined benefit plans just will not work.
State and local governments will not be able to recruit highly skilled and highly specialized
workers without helping them accumulate their own wealth that they control in the future. The
defined contribution alternative is the only way we can ensure qualified workers enter public
service in future years. This market shift in the labor force will apply enormous pressure on state
governments to change course for new workers with defined contribution plans.
America’s Changing Retirement Philosophy
The four changes I just outlined have fundamentally altered the view of retirement
security in this country. Forty years ago, a one-size-fits-all policy left employers and
government responsible for workers’ retirement. This philosophy has shifted. Increasingly,
emphasis is now that it is up to individuals to provide for their own retirement and this view is
likely to dominate in the decades ahead.
The best example of the changing philosophy of retirement security is the current debate
over Social Security. There is no question that Social Security is a broken system and solvency
is threatened by the same factors affecting the pension system, albeit more intensely: more
workers receiving benefits than paying in, declining fertility rates, increased life expectancies,
and a failure of leadership among politicians.
Under the current system, anyone born after 1970 will not receive any money they paid
into the system. In 1950, there were 16 workers per beneficiary. By 1960, that number had
declined to 5 workers per beneficiary to 2 workers per beneficiary today. Clearly, this model is
unsustainable.
In the next decade, the revenues entering the system will fall below benefit payouts.
Unfunded liabilities easily exceed $11 trillion, requiring a 35 percent cut in benefits or a 50-80
percent increase in taxes. Each year we wait, the problem gets worse.
In the 2000 presidential election, then Governor George W. Bush became the first major
political candidate to take the issue by the horns and proposed Personal Retirement Accounts, a
major shift away from the traditional defined benefit plan.
This action, in some pundits’ view, was political suicide since Social Security was the
third rail of politics. Bush not only touched the third rail, he fondled it with no backlash. In fact,
polls show more than 60 percent of Americans support this initiative. Older Americans hate the
idea; they came from a time of the New Deal era. Conversely, younger workers, who believe
they are more likely to see UFOs than receive Social Security payments, love the idea.
These younger workers reflect the changing view of individuals controlling their
retirement, not the government or their employers. As these younger workers increase in
numbers, Personal Retirement Accounts are inevitable and so is the shift toward defined
contribution plans, under this shifting philosophy.
Boosting the Three Stools Needed for Retirement Security
The debate over defined benefit and contribution plans has been framed as one versus the
other. I would argue given the new demographic and economic realities facing this nation,
advocates of retirement security should be focused on boosting all three stools of a person’s
retirement, individual savings, Social Security, and pensions, in the most efficient manner. Only
by boosting savings in all three factors can we have real financial security for all working
Americans give the new demographic and economic realities.
Individual Savings
The nation needs to move forward on reducing the impediment to savings. Savings starts
with the individual first and foremost and as such getting individuals to save by removing the
current hurdles facing workers is a top priority of American Shareholders Association
I often hear opponents of defined contribution plans saying Americans do not save
enough for retirement and that is why we should not adopt these plans. These plans are not the
causal factor for low savings. It’s horrendous public policy that continues to bias
consumption over savings.
Current tax policy at the federal level favors consumption over savings. If I earn a
paycheck, I am taxed as part of the income tax system. If I go out and spend my after-tax
income, I am generally free of paying federal taxes. If, however, I want to save that money, I am
punished through the capital gains tax, the dividend tax, and, when I die, the government will
take more than half through the Death Tax. Why should I save it I am going to be punished?
IRAs and 401(k)s seek to remove the impediment to savings through tax incentives, yet they are
limited.
What many people do not realize is that younger workers face a different constraint on
their savings. Retirement is so far away, why should I save for it, they often ask? Yet, these
younger workers have a need to save for owning their own homes and building their families that
are subject to severe double taxation in the tax code. New incentives to get young people saving
will ultimately help build retirement savings in the future when assets are rolled over. This is the
concept behind the Bush Administration’s Lifetime and Retirement Savings Account proposals
and American Shareholders Association’s top legislative priority.
Working together to boost individual savings helps all American workers, including
public employees. The removal of double taxation on savings and investment clearly should be a
priority of any organization concerned about financial security.
Social Security
In explaining how defined contributions are facing demographic and economic pressures
I went in detail about the problems facing Social Security. So in short, moving from a defined
benefit, pay as you go system, toward pre-funded personal retirement accounts will increase a
workers return on investment three-fold. This will obviously boost the savings of working
Americans, but it will also transfer trillions of new dollars to capital markets which boost
economic growth and investment and ensures solvency of the program in the future. This is an
absolute must for any organization concerned about financial security of workers in retirement.
Pensions
An aging population, increased labor mobility, perverse incentives of the public pension
system, and taxpayer frustration over continual contributions to the system has led to a new
reality facing pension systems. Defined contribution plans are the natural alternative to meet
these changing needs.
Moving to a defined contribution plan brings greater certainty toward the budgeting
process. Phasing out the defined benefit plan allows government retirement expenses to be fixed
and more certain. The removal of risk further benefits taxpayers and the costly political
grandstanding with the system will be over. As the economy moves through the business cycle,
downturns will not kick in the perverse effects requiring larger amounts of tax revenue at
precisely the worst times.
The number of workers in defined contribution plans has soared by more than four times
since 1975. It now totals close to 50 million workers.
By contrast, traditional defined benefit (DB) employer plans have actually declined.
Under these plans, the employer promises a specified retirement benefit and saves and invests
the funds in a common pool to finance those benefits. The number of workers in defined benefit
plans has fallen from 33 million in 1975 to 23 million today.
As a result, more than twice as many private-sector workers are now in defined
contribution plans as are in defined benefit plans. Moreover, almost twice as many private-sector
employers offer defined contribution plans as offer defined benefit plans.
The states have now begun to shift public employer pensions towards DC plans as well.
But with budget difficulties many states have now stopped the shift, but the market forces will
ultimately force these public entities to reevaluate their structure in the coming decade.
The benefits to workers and taxpayers are wide ranging.
Benefits to Workers:
• The DC plan is fully portable. Workers are able to take the funds paid into their
accounts wherever they go. Those who work for a few years in the public sector and then
move on, as most now do, would not lose all of their employer pension contributions, as
with typical defined benefit plans;
• The funds in the DC plan are under the control of each worker. Individuals don't
have to worry about politicians mishandling the funds, accumulating unfunded liabilities,
or playing politics with the pension fund.
• Higher Returns for Workers. Short- and medium-term workers would get higher
benefits through DC plans because DB plans almost always distribute benefits away from
them to the long-term workers. But with the funds under worker control consistently
earning average returns over the long run, even the longer-term workers may well earn
higher benefits through a DC plan than promised in a traditional DB plan; and
• Worker Empowerment. Workers have maximum freedom of choice with the DC plans
because they own the money in their own accounts. They can structure their investments
and benefits to best suit their needs and preferences as well as those of their families.
Benefits to Taxpayers:
• Less Government Risk. The defined contribution plan avoids the risks of having the
government responsible for investing huge pools of retirement funds. Instead, the
government's expenses are fixed as a percentage of payroll each year, with no investment
risk or danger of unfunded liabilities;
• Administrative Cost Reduction. The simple DC plan saves the employer large amounts
in administrative costs, and possibly funding costs as well. The employer just pays the
regular contributions into the workers' accounts. Because workers can get such high
benefits relative to pre-retirement income at just average long-term returns, employers
could possibly provide a fully beneficial plan with somewhat less in contribution costs
than under a DB plan; and
• Enhanced Worker Recruitment Ability. Because of the above benefits of DC plans for
workers, such plans will help public employers recruit the best workers, particularly
short- and medium-term workers, who may be well-paid experts from the private sector
or professionals with lots of other opportunities they will ultimately pursue.
Defined Contributions in a New Era of Retirement Security
So how do defined contribution plans fit into this new economic and demographic
picture?
Portability
First, the defined contribution plan is fully portable. Workers are able to take the funds
paid into their accounts wherever they go. Those who work for a few years in the public sector
and then move on, as most do now, would not lose all of their employer pension contributions, as
with typical defined benefits. This feature helps, not hurt, state and local governments recruit the
best employees. As I mentioned earlier, the labor markets have moved to a more specialized
system. Government benefits from recruiting these specialists into their system.
The best example of this was the quality of staff working for President Clinton the day he
left office. His staff was highly qualified, people who worked just several years for the federal
governor because they possessed a particular knowledge in their field. Having a portable defined
contribution allowed these workers to take significant pay reductions by accumulating new
wealth in their retirement plan This benefited the nation as a whole by making it easier to recruit
these very highly skilled workers.
Opponents of defined contribution plans respond that these plans lead to less retirement
security so portability really does not matter. First, I am not of the opinion that defined
contribution plans lead to “less” security, but even if that was the case, retirement plans must
respond to the changing nature of the labor market, not the other way around. In other words,
even the most secure retirement program will not alter the growing labor mobility of American
workers. It’s a fact of life, it’s here, and it is not changing anytime soon. As such, any retirement
benefit must be portable. Defined Contribution plans are fitted exactly for the changing labor
market dynamics.
Individual Control and Empowerment
By far the greatest benefit for workers is individual control. Politicians place taxpayers
and public employees at risk. I read once that politics plays no part in the pension fund. This
has to be the most absurd statement ever. While it is true, pension funds are guided by the
prudence principle and that all benefits must be paid out, politicians often find ways to
manipulate the fund for their political gain. And while most pension administrators have the best
intentions, political pressure does play into the system. Two examples: First, politicians can use
the pension fund to carry favor with powerful interest groups, just as they do with the state
budget. I admit the pension fund is much more limited than the budget, but it does happen.
Case in point. In 2001, a Republican governor was seeking to neutralize the inherent
advantage Democrats have with public employees and teachers. He increased the benefit payout
and changed the funding formula. Talking with career staffers affiliated with the retirement
program, they knew the increase was too great for the system to handle, but political pressure
ultimately won out.
Here’s how this occurred. After an unprecedented boom in the 1990s bull market, the
pension fund accumulated substantial assets. The Wilshire 500 Index, the broadest measure of
all stock holdings, increased more than 20 percent three years in a row. Seeing the build up of
assets, lobbying began to increase benefit payouts.
A legitimate case could be made that increases were needed, but the change in formula
was extravagant and continual. Moreover, the stock market had steadily declined for 15 months
when the change went into effect by legislative measure. Long-run returns always regress back
to the average. The previous 20 percent plus returns will offset lower returns in three years.
Three months later, the horrific attacks of September 11th occurred, corporate scandals
were uncovered, and markets went into shock. The downward trending stock market continued
for a full two years following passage of the legislation and these benefits need to be paid. The
governor and legislators in key legislative districts were able to send letters to the homes of these
public employees and taxpayers have been stuck with the bill.
The prosperity of the 1990s was not used as a dividend to ensure continued stability of
the system. Instead, the prosperity was used to score political points. This was BS without a
question, a misuse of public funds. And as a side note, that state has not made a pension
contribution since 1996, and the politicians are exacerbating the problem. In no way will they
cut the newly received benefit and are too scared to tell taxpayers they need to foot the bill with
higher taxes to pay for their mistake.
Playing politics with the pension fund
The newest phenomenon is politicians pursuing social public policy objectives with
company owned stock in the pension funds. Private and public union pension funds have
increased their activism at corporate board meetings. Wile some of this activism is corporate
governance specific, a number of them have turned into political grandstanding contests for their
favorite public policy issues. The problem, however, is that he public policy goals they are
advocating will reduce the value of their own pension holdings, thus lowering returns for public
employees.
Case in point. Recently, a governor, through the state’s investment council, decided to
take on the pharmaceutical pricing issue. Essentially, the state’s large holding in one company’s
stock led to the state seeking a shareholder resolution condemning the pricing practice of the
company. On talk shows, the governor reportedly said he was seeking price controls on
pharmaceuticals. This action will destroy the company’s ability to recoup their return on
investment, which will significantly devalue the stock.
Here’s how it happened. Working as a senior advisor for two governors, I often sat
around conference tables seeking new ways to get a message to voters. The drug pricing issue is
huge and with the signing of the Medicare Prescription Drug law, many people felt the issue was
taken off the table. Yet, the signing of the legislation ignited a new debate: how to lower the
price of the drug. In a state where high concentrations of senior citizens are located, being on the
side of price controls is a winner. Rather than just being an advocate, using the state’s large
pension holding provides a forum for a larger stage.
Now this crafty governor made the argument that without changes to the pricing structure
will harm shareholders, or in this case, beneficiaries of the state pension fund. This allowed the
governor to remain within the prudence rule governing the fund.
Yet this also placed the governor at significant risk and possibly in violation of the
prudence rule. Pharmaceutical stocks have generated a 16 percent rate of return, by far above the
funds return. Thus the stocks were increasing the rate of return for the fund. Yet, if the pricing
structure was placing the fun at risk, he would need to sell the stock, something the state did not
want to do.
Removing those returned would require higher taxes on that state’s residents to offset the
losses. More importantly, price controls without question will reduce the value of the stock.
When Congress debated the Clinton health care plan, just the prospect of price controls sank
biotechnology and pharmaceutical stocks. Now you have a governor advocating a public policy
change with the state pension holdings to reduce the value of the stock. No question, this was
direct violation of his fiduciary responsibility.
Higher Returns for Workers
The defined contribution plan includes no limit on the benefits workers can receive.
Those who achieve strong investment performance in their individual accounts will receive
substantially higher benefits than offered under a standard defined benefit plan. In fact, there is
good reason to believe that on average workers in defined contribution plans will receive
substantially higher benefits than offered by defined benefit plans.
Those managing the common investment pool for a defined benefit plan are investing
only to finance the targeted benefit levels. For career workers, these will range from 30% to 80%
of final salary and cluster around 45%-65%. The managers will not invest more aggressively to
achieve higher benefits, even when that can be done safely. If they do attain higher investment
returns, the employer will likely reduce contributions or withdraw the excess assets.
Americans for Tax Reform has issued a study on returns on investment for defined
contribution and defined benefit plans. All workers at all incomes benefit more under defined
contribution than defined benefit plans.
Contributing a standard 10% of salary each year to a defined contribution plan that earns
the full standard investment returns available in the market will produce higher benefits than
those targeted under a typical defined benefit plan. And those who would benefit the most are the
longest term workers who thought they were getting the most out of the skewed benefits of
defined benefit plans.
The average real rate of return earned in the stock market going back over the last 70 plus
years, all the way back to 1926, is 8 percent. The average real rate of return on corporate bonds
over that period is 3 percent or more. A conservative portfolio with half of each would earn 5.5
percent. Assume a worker who earns around $30,000 per year over his career in constant
inflation adjusted dollars. If 10 percent of that salary is contributed to a personal investment
account for the worker earning a real return of 5.5 percent each year, then after 40 years that
investment account would total $432,357, again in constant, inflation adjusted dollars.
That amount would finance an annuity paying about $60,000 per year each year for the
rest of the worker's career. A defined benefit plan paying 1.5 percent of final salary for each year
of work would pay only $18,000 per year. A defined benefit plan paying 2% of final salary for
each year of work would pay only $24,000 per year. So the defined contribution plan would pay
2 ½ to 3 ½ times the benefits of the defined benefit plan.
A worker's earning $40,000 each year would reach retirement after 40 years of work with
a retirement account total of $576,476, again in constant dollars. That amount would finance an
annuity of $80,000 per year, compared to $24,000 - $32,000 for a defined benefit plan. A worker
earning $50,000 each year would retire with a fund of $720,595, paying about $100,000 per year,
compared to $30,000 to 40,000 for a defined benefit plan. Again, the defined contribution
benefits are 2 1/2 to 3 ½ times the defined benefit plan payments.
Now suppose the worker retires after only 30 years of work. At a salary of $30,000 per
year, the worker would retire with a fund of $313,457, which would pay about $43,000 per year
in benefits compared to $13,500 to $18,000 for a defined benefit plan. The defined contribution
benefits are still 2.4 to 3.2 times the defined benefit plan payments. The $40,000 per year worker
would retire after 30 years with a fund of $ 417,942, paying about $58,000 per year in benefits,
compared to $18,000- $24,000 for the defined benefit plan. The $50,000 per year worker would
retire after 30 years with a fund of $522,428, which would pay about $73,000 per year, compared
to $22,500 - $30,000 in the defined benefit plan. Again, the defined contribution plan pays 2.4 to
3.2 times the defined benefit plan.
Now suppose the worker's retirement account doesn't perform as well as others for some
reason and earns only a 4 percent real return, which is just half the average return in the stock
market over the last seventy years. A $30,000 per year worker would retire after 40 years of
work with a trust fund of almost $300,000. That fund would pay almost $37,000 per year for the
rest of the worker's life, again all in constant, inflation adjusted dollars. The defined benefit plan
would pay $18,000 - $24,000 per year. So the defined contribution plan would pay 50-100%
more.
A $40,000 per year worker would retire after 40 years with a trust fund of almost
$400,000, which would pay almost $50,000 per year, compared to $24,000 - $32,000 for the
defined benefit plan. A $50,000 per year worker would retire with a trust fund of almost
$500,000 per year paying over $61,000 per year, compared to $30,000 to $40,000 for the defined
benefit plan. In these cases, the defined contribution plan again pays 50-100% more than the
defined benefit plan.
Now suppose the worker's retires after only 30 years. The $30,000 per year worker would
retire with a trust fund of about $175,000, paying about $21,000 per year, compared to $13,500
to $18,000 for the defined benefit plan. The $40,000 per year worker would retire with a trust
fund of $233,000 paying about $28,000 per year, compared to $18,000-$24,000 for the defined
benefit plan. The $50,000 per year worker would retire with a trust fund of almost $300,000,
paying about $36,000 per year compared to $22,500 to $30,000 for the defined benefit plan. The
defined contribution benefits are still substantially more than the defined benefit plan payments.
These calculations all assume retirement at the standard Social Security retirement age,
which is 65 today and will rise to 67 over the next 25 years. To the extent workers can receive
retirement benefits under the defined benefit plans at earlier ages those plans would do much
better compared to the defined contribution plans. But such defined benefit plans also require
much higher contribution rates than 10% of salary, which was used as the basis for the defined
contribution benefits alone. At a minimum, however, these calculations show that the longer
term workers would do quite well under defined contribution plans, and would quite possibly
receive significantly higher benefits than under a typical defined benefit plan
Conclusion
Over the next decade, the aging of the baby boomers will place enormous pressures on all
institutions currently providing retirement income. These demographic pressures combined with
a constantly changing economy will force changes to the current retirement systems, including
public pensions.
A strategy needs to be put into place immediately which seeks to increase the three legs
of the retirement stool, which includes Social Security, individual savings, and pensions. As
retirement philosophy evolves from one of employer/government controlled to individual
control, personal retirement accounts for Social Security and the removal of double taxation on
savings is inevitable.
At the same time, we need to reform our public pension system. Moving to a defined
contribution system is ideal to meet the changing demographic and economic pressures.
Moreover, this move will provide better protection for American taxpayers, while ensuring a
higher rate of return for workers.
Clearly, now is the time to move forward before the retirement of baby boomers begins. I
look forward to working with you on these issues in the future.
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