1. Reforming the Second Tier of the U.S. Pension System: Tabula Rasa or Step by Step? Sandy Mackenzie & Jon Forman for Savings and Retirement Institute Washington, DC May 9, 2013 1

2. Figure 1. How Benefits Compare to Earnings (2012 dollars & percentage of final wages) 2

3. Figure 2. Initial Social Security Replacement Rates for Retired Workers (1970s birth cohort, percent) 3

4. The Private Pension System Types of Pension Plans – Defined benefit plans » e.g., a final average pay plan (where B= 2% × years of service × final average pay) – Defined contribution plans » e.g., a 401(k) plan Retirement Savings are Tax-Favored Dominance of Defined Contribution Plans 4

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6. Table 1. Share of Workers Participating in the Pension Plans, 2011 (percent) by AGE Worker characteristicSponsorship rate Percentage participating Age 20 or younger20.43.9 21–2434.216.2 25–3447.736.4 35–4452.845.3 45–5455.349.0 55–6456.249.9 65 and older40.831.4 6

7. Table 1. cont’d by ANNUAL EARNINGS. Worker characteristicSponsorship rate Percentage participating Annual earnings Less than $10,00021.16.9 $10,000–$19,99929.616.1 $20,000–$29,99944.332.4 $30,000–$39,99954.345.7 $40,000–$49,99962.255.6 $50,000–$74,99968.262.7 $75,000 or more69.966.7 7

8. Table 1. cont’d by EMPLOYER SIZE Worker characteristicSponsorship rate Percentage participating Employer size Fewer than 10 employees13.811.3 10–49 employees29.623.0 50–99 employees43.433.4 100–499 employees54.542.5 500–999 employees60.647.8 1,000 or more employees65.351.4 Public sector79.370.6 8

9. Table 2. 2008 Replacement Ratios (married couple, ages 65/62, one working) Pre- retirement income Replacement Ratios From Social Security From private and employer sources Total $20,00069%25%94% $30,00059%31%90% $40,00054%31%85% $50,00051%30%81% $60,00046%32%78% $70,00042%35%77% $80,00039%38%77% $90,00036%42%78% 9

10. Table 3. Lump Sum Amounts Needed at Retirement from Private and Employer Sources as a Multiple of Final Pay Pre- retirement income Baseline replacement rate needed (% of final pay) Equivalent Lump Sum Needed (as a multiple of final pay) MaleFemale $20,00025%4.44.5 $30,00031%5.05.5 $40,00031%5.05.5 $50,00030%4.85.4 $60,00032%5.25.7 $70,00035%5.66.3 $80,00038%6.16.8 $90,00042%6.87.5 10

11. Criteria for a Good Second Tier Broad, albeit not necessarily universal coverage of the working population. Adequacy of pension, including its provision of longevity insurance. Appropriate assignment of risk between sponsor and members. Portability. Appropriate degree of transparency and complexity and their distribution between sponsor and members. 11

12. How the United States Stacks Up Coverage: broader than some advanced countries, narrower than many. Adequacy: the median size of DC balances suggests many retirees will not have enough. Risk assignment: risk is increasingly borne only by plan members. Portability: the bright spot. Transparency and complexity: for plan members, excessive. 12

13. Reform of the Second Tier Starting from a Tabula Rasa A strengthened first tier, with an increased replacement rate for low-income workers. Compulsory individual accounts on top of the first tier. Annuitization of balances, either required or as a default setting and subject to guidelines. 13

14. Starting from a Tabula Rasa, cont’d Social Security might act mainly as a conduit by channeling contributions to financial institutions providing retirement products or play a more active role as an investor. It could provide annuities itself, or leave that to Wall St. None of these options, desirable or not, is realistic in the current political climate. Broad coverage is very feasible technically, but not politically. Reform must be incremental. 14

15. An Incremental Approach to Reform “ We shall deal with our economic system as it is…not as it might be if we had a clean sheet of paper to write upon.” (Woodrow Wilson, in his second inaugural address.) The decline of the traditional pension is not likely to be reversed. It may however, be possible to broaden coverage by default settings and encourage plan sponsors to graft DB features onto their 401(k) plans. 15

16. Incremental Reform: Some Policy Options Require plan sponsors—if they choose to offer a plan—to adopt an affirmative default. Encourage small employers to act as conduits (the auto IRA approach). (More radical) adopt California’s approach requiring employers to channel contributions to a state fund, not necessarily the existing state system, as in California. 16

17. Policy Options, cont’d Make a concerted effort to improve financial education. Boost saving by encouraging employer 401(k) plan matches with threshold effects and by moving to a refundable tax credit system. Reduce the instability of investment returns by encouraging minimum rate if return guarantees. 17

18. Policy Options, concluded Assuage liability concerns of plan sponsors offering lifetime income products by enacting appropriate safe harbors. (Necessary if sponsors are required to provide annuity options, or if annuities become a default option.) Amend the RMD rules to encourage the market for longevity insurance (annuities whose payments begin many years after the premium is paid). 18

19. Concluding Observations Rather than setting forth a grandiose scheme, we have proposed a set of measures that we believe could materially improve the lot of older Americans. Coverage of the workforce would increase, as would retirement wealth and the share of that wealth in the form of an annuity. 19