Creation of a State Social Security & Retirement Supplemental Planscstateretirementplan.com/uploads/Final_Paper_PDF.pdf · 2012. 8. 31. · income (which included gov’t pensions,

©Copyright Christopher St. John 2009

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Creation of a State Social Security & Retirement Supplemental Plan

By

Christopher St. JohnCFP®, ChFC©, CASL™, CDFA™, EA

April 24, 2009


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Introduction

During an extremely poor economic time, similar to the one now, our nation tends

to focus on short term or immediate fixes and forgets about the long term, especially as it

relates to finances. Short-term solutions are indeed critical to our financial survival, but

we Americans, specifically those younger than the baby boomer generation, must not lose

focus on our country’s long-term goals. And with the current economic crisis upon us,

we must take steps now to ensure our financial future.

The younger generations of our country face a serious threat to their future

retirement. Social Security is a major source of income for current retirees, and in the

near future the fund is projected to take in less money than it can pay out. Future

recipients face the real prospect of not receiving the Social Security income they have

been told they are entitled. They will instead receive far less than the projected amount

shown on their annual benefit statement. This loss of Social Security funds alone, since it

represents such a large percentage of retiree’s income, will create serious problems for

future generations of retirees.

Along with the shortfall in Social Security income benefits, the shift from Defined

Benefit Pension plans to Defined Contribution plans by companies will add to the

problem of Americans lacking future retirement income. Companies are taking less

responsibility for retirement income while transferring more of it to the individual

employee. Therefore individuals must adequately fund, through savings and good

investments or the individual will not have enough to live on when they retire.

To help prevent this shortfall in future retirement income it is necessary to

implement a system that will allow individuals to make up for some of their “losses.”


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South Carolina should create a State Social Security and Retirement Supplemental Plan

(SSSRSP). This plan will allow individuals to save and invest money tax-free, for

potential growth, and also receive the funds tax-free following retirement. This

privatized retirement system will not negatively affect the current Social Security fund

and could potentially prolong the life of the Social Security Trust fund.

This paper will discuss the background of the Federal Social Security system and

the problems the system is facing. It will detail trends in the retirement plan industry and

the problems associated with these trends while also discussing the income and savings

habits of Americans and what this means for their future. A solution to this potential

crisis will then be presented.


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Background of Social Security

The Old Age and Survivors Insurance Program (a.k.a. Social Security) was passed

by the United States Congress in 1935. This act was put in place to provide workers aged

65 and older retirement income benefits.

In the late 1800’s and early 1900’s, rural Americans, enticed by higher incomes

from industrial employment, left family farms and small towns for big, bustling cities.

This was a monumental shift in the American lifestyle. Despite being raised in spacious,

self-sustaining, agricultural environments, the new urban-dwellers adapted well to the

tight confines of the cities. They found good paying jobs to support their families. The

income allowed them to acquire food and shelter, two necessities that previously would

have been grown or built with their own hands in the country.

During the 1920’s America was in an expansion mode and it seemed like it would

continue nonstop, as companies expanded through the use of debt, and individual

investors wanting to cash in on the growth sought instant wealth through the use of

margin accounts. This growth, however, was strictly on paper. On October 29th 1929,

this overextended period of growth and debt-use came to a screeching halt. Over the next

3 months the stock market lost 40% of its value and banks were suddenly unwilling to

lend money to businesses or individuals. Since banks would not lend money to

companies to purchase goods or pay employees, layoffs began. Fearful of losing their

jobs, individuals were reluctant to buy unnecessary goods, which helped trigger an

economic spiral downturn. Soon banks were being squeezed, as businesses defaulted on

loans because they could not be profitable with stingy consumers. This led to a massive

number of bank failures throughout the nation. The trickle-down effect eventually


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pushed America into a depression over the coming years. The Gross National Product

declined from $105 Billion in 1929 to $55 Billion in 1932 and unemployment swelled

beyond 25% (SSA. Historical Background).

During the crisis, a variety of ideas emerged on how best to resolve the problem

and provide relief to hurting Americans. Examples include Huey Long and Francis

Townsend who drafted two completely different proposals. Long, Governor of Louisiana

in 1928 and later a Senator in 1930 recommended a program entitled “Share Our

Wealth”. This program ensured that every family received a guaranteed, annual income

of $5,000 by the Federal Government for basic necessities. Along with the guaranteed

income, Long wanted to “Socialize” the rest of the country’s money by limiting private

fortunes to a maximum of $50 million, legacies of $5 million and a maximum of $1

million of income per year( SSA. Historical Background).

Francis Townsend’s proposal entailed a guaranteed government pension of $200

per month to every American over the age of 60. The program was to be funded by

revenue from a 2% national sales tax. Eligibility required an individual to be retired,

have a “criminal free” past and the money had to be spent within 30 days of being

received (SSA. Historical Background).

On June 8th 1934, President Roosevelt announced his intention to create a Social

Security program. He formed a committee which was instructed to study the current

economic problem and report its findings and recommendations back to him. In January

1935, the committee gave its report to the President who subsequently presented the

findings to Congress for approval. In July of that same year a bill was passed. On

August 14th 1935 The Social Security Act was signed into law by President Roosevelt

(SSA. Historical Background).


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There were two major sections in the Act: Title I, which supported temporary

state welfare programs for the aged that would ultimately fade away; and Title II (now

commonly known as Social Security), which supported paying retirement benefits to a

family’s primary worker when they reached the age of 65 (SSA. Historical Background).

This was such a drastic change for Americans that the program needed to be

explained to the people, so the Social Security Board was formed. The SSB’s primary

duty was to explain the details of the new program to the public, including employers and

employees. Employers needed to understand how to account for withholding amounts

based on earnings; employees needed to know when they were eligible and how they

could get benefits. A key feature of this process was assigning Social Security numbers

to individuals. This was an enormous but crucial task, as the numbers helped identify

and keep track of eligible beneficiaries.

Initial benefits distributed from 1937 to 1940 were handed out in annual, lump-

sum payments. The sole purpose of this was to provide some benefit to those Americans

who had contributed to the Trust Fund but due to their age would not participate long

enough to be vested for any monthly benefits. The average lump sum benefit during this

period was $58.06 (with the smallest payment being $.05) (SSA. Historical Background).

Amendments to this program have continued over the years. In 1939 a survivor

and dependent benefit was added to help those who relied on the income of the insured.

If the insured died, dependents and survivors, previously ineligible, would now be

eligible for benefits based on the benefits of the insured’s. In the 1950’s, Social Security

coverage was broadened to cover not just a limited number of jobs, but rather most of

them in the economy. In 1956 a disability benefit was added to help those who were

eligible for Social Security benefits at their full retirement age but became disabled


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before they were age-eligible. In 1965 Medicare was created which would now provide

federal health insurance for those of age. This program was later changed in 1972 to

assist people under age 65 who were disabled. In 1972 a Cost of Living Adjustment

(COLA) was added to the Social Security program to help protect benefits against rising

inflationary costs. In 1972 a Supplemental Security Income (SSI) was added which

provides a national uniform floor of income protection for the aged, blind, and disabled.

SSI provides monthly payments which are supplemented by individual states based on

regional standards of need. SSI is a program that is funded from general Federal

revenues, not from Social Security taxes (SSA Why Social Security).

The major accomplishments of the Social Security program in its first three years:

More than 39 million people had signed up for Social Security retirement accounts; more

than 25 million workers had been covered by unemployment compensation. Close to 1.7

million people were already receiving monthly cash disbursements. Over $47 million

had been paid to support dependent children by the Federal Government. More than

39,000 needy blind persons were receiving monthly cash disbursements (The Wisconsin

Connection).

Current key statistics:

In 2006, 40.5 million beneficiaries received benefits from the Social

Security program, which is projected to increase to 43.8 million in 2010

and to 78.9 million in 2040 and to 96.6 million in 2080 (EBRI FACTS

The Basics of Social Security)

Current assumptions OASDI trust fund expenses are expected to exceed

income from taxes in 2017 and expected to exceed income from taxes and


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interest in 2027, and the Trust fund is expected to be exhausted by 2041

(EBRI FACTS The Basics of Social Security).

Under a low cost assumption the OASDI expenses are expected to exceed

income from taxes in 2022. However, the fund is expected to remain

solvent throughout the next 75 years (EBRI FACTS The Basics of Social

Security).

Under a high cost assumption the OASDI expenses are expected to exceed

income from taxes by 2014 and will be exhausted by 2031(EBRI FACTS

The Basics of Social Security).

As the number of retired workers continues to grow, the ratio of people

receiving benefits to the number of workers paying into the Social

Security Trust Fund is projected to fall from 3.3 to 1 in 2007 to 2.7 to 1 in

2017 and will fall to 2.1 to 1 in 2034 (Facts and Figures about Social

Security 2008).

In 1962 Social Security benefits represented 30% of total aggregate

income (which included gov’t pensions, private pensions, asset income,

earnings, misc, and Social Security income). By 2006 that percentage had

jumped to 37% (Facts and Figures about Social Security 2008).

The Social Security Trust fund obtains its income from three sources. The first

and most significant is the collection of taxes. Employees and employers each

currently pay 6.2% of an employee’s income up to $106,800 (in 2009) while self

employed persons pay 12.4% out of their earnings. The second source of income

for the trust fund is the interest it earns. The trust fund is invested in non-tradable

government bonds which earns a comparable interest rate to tradable government


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bonds. The third source of income for the trust fund is from the taxes it collects

on the social security benefits that are paid out to beneficiaries (EPI Facts at a

Glance). In 2007 the OASDI Trust fund had income of $785 billion of which

$656 billion was from contributions, $19 billion from taxation of benefits, and

$110 billion from interest earned. The Trust fund had expenditures of $595

billion of which $585 was in the form of benefits (SSA News Release).


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Retirement Plans

There are a number of retirement plans used jointly by employers and employees

today. Most of these fall within two broader plans: The Defined Benefit Pension Plan

and The Defined Contribution Plan. Although the ultimate goal of these two plans is the

same—to provide the employee with income when they retire—there are fundamental

differences as it relates to contributions, distributions, risk, and responsibility, that effect

employers and employees.

In a Defined Benefit Pension Plan, the employer is primarily responsible for

retirement benefits. Through Defined Benefit Pensions employers usually provide a

monthly payment to an employee following his or her retirement. The monthly amount is

calculated by a set formula. There are several formulas often used by employers,

including the Flat-benefit, Career-benefit, and Final-pay formulas.

The Flat-benefit formula calculates benefits by multiplying the employee’s salary

at retirement by the total number of years worked, and then multiplying that by the

accrual rate. The final amount can either be paid to the employee in monthly installments

or one lump-sum amount (the latter places the responsibility of retirement income on the

employee) (Wikipedia).

A little more flexible, the Career-average formula can determine benefits two

ways. First, the benefits can be based on average compensation by reviewing the

employee’s entire work history; second, benefits can be based on a percentage of each

year’s salary. For example, the company would take one percent of the each year’s

salary (Daniels).


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The last, but most widely used, is the Final-average pay formula, which

determines retirement income by averaging the final years (usually the last 5) of the

employee’s income (Wikipedia).

A Defined Benefit Pension plan is either “funded or unfunded”. A funded plan

has specific assets put aside by employers that are invested for future benefits. Since

investments are not guaranteed and returns fluctuate, regular reviews and valuation of the

plan and the plan’s assets are required. Unfunded plans, like our Social Security Program

and most Defined Pension Plans in the United States and European countries, have no

assets set aside for future benefits but rather work through a “pay as you go” system.

This means there is no reserve set aside for future promised benefits (Wikipedia).

There are many disadvantages for employers and employees associated with

Defined Benefit Pension plans. Occasionally employees are subjected to “age bias,” an

unwritten “rule” that states they have to remain with the same employer for a lengthy

period of time before any “real” benefits accrue, as the present value of the employee’s

benefit grows more slowly during the earlier years when salaries are usually much

smaller. Portability is a problem employees encounter also, since they are typically

prohibited from moving their retirement funds if they leave a company. Another

criticism of Defined Benefit Plans is that the future lifestyles of employees are basically

dictated by companies as a result of the income directly provided by the pension plans

(Wikipedia).

There are some distinct positives for employees, however, such as knowing

exactly what their future retirement income will be, and that the responsibility of saving

for retirement belongs to the company. Also, pension plans can be constructed so they

can be transferred to a spouse in the event of a pensioner’s death (although this option


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generally results in a lower monthly payment passed on). Finally, if a company was

unable to pay the retirement benefits, or was to go out of business, the employee’s

pension plan would be covered by the Pension Benefit Guarantee Corporation (PBGC).

One significant issue associated with a Defined Pension Plan from an employee’s

perspective is the fear that a company will be unable to pay the future benefits or will go

bankrupt. If that was to happen the pension fund will then be turned over to the PBGC.

Despite the security the PBGC provides, the retirement amount paid out by it is lower

than what the employee would have received from the company. If the employee has not

put other money away to make up for this potential shortfall, then their financial future

may be compromised.

The Pension Benefit Guaranty Corporation (PBGC) is a federally created program

designed to protect Defined Benefit Pension plans albeit at a lower amount. The PBGC

was initially created by the Employee Retirement Income Security Act of 1974 (ERISA).

The PBGC receives operating income from insurance premiums set by Congress which

are paid by the Defined Benefit Pension plan sponsors, investment income, and any

potential recovery from companies who were formally responsible for the plan.

(PBGC.gov)

The PBGC insures two types of pension plans: single-employer plans and the

multiemployer plan. If the PBGC takes over a pension plan from a company, the PBGC

will pay monthly retirement benefits up to a guaranteed maximum amount. The

maximum guaranteed monthly amount of benefits is based mainly on one’s age on the

plan termination date. As shown on the table on the following page, based on their age

what ones maximum guaranteed monthly income amount would be.


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PBGC Maximum Monthly Guarantees for 2008

Age 2008 Straight-Life Annuity 2008 Joint and 50% Survivor Annuity

65 $4,312.50 $3,881.25

64 $4,010.63 $3,609.57

63 $3,708.75 $3,337.88

62 $3,406.88 $3,066.19

61 $3,105.00 $2,794.50

60 $2,803.13 $2,522.82

59 $2,630.63 $2,367.57

58 $2,458.13 $2,212.32

57 $2,285.63 $2,057.07

56 $2,113.13 $1,901.82

55 $1,940.63 $1,746.57

54 $1,854.38 $1,668.94

53 $1,768.13 $1,591.32

52 $1,681.88 $1,513.69

51 $1,595.63 $1,436.07

50 $1,509.38 $1,358.44

49 $1,423.13 $1,280.82

48 $1,336.88 $1,203.19

47 $1,250.63 $1,125.57

46 $1,164.38 $1,047.94

45 $1,078.13 $970.32

(PBGC.gov maximum monthly amount)

If an employer decides to end a pension plan they must do so by going through a

process called a “planned termination”. There are two types of plan terminations:

Standard Termination and Distressed Termination. A Standard Termination takes place

only after the plan sponsor demonstrates to the PBGC that they have enough assets to pay

all benefits owed to participants. The plan must then either purchase an annuity to

guarantee these payments or pay a lump-sum payment that will cover the entire benefit.

A Distressed Termination is a termination of the pension plan when it is under-funded

and the employer is in financial distress. To accomplish this, the sponsor must show the


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bankruptcy court or the PBGC that it will not be able to remain in business unless the

plan is terminated (PBGC.gov termination).

Under certain circumstances the PBGC may decide to initiate the ending of a

pension plan. This is done to protect both the PBGC as well as the participants in the

pension plan (PBGC.gov termination).

For employers, providing predictable retirement income is beneficial in a couple

of ways. It relieves the employee of the stress associated with saving for retirement and

allows them to focus on their work, which employers hope will result in better

productivity. It also helps the employer assess and budget the necessary monetary funds

for the pension plan. The biggest drawback of a Defined Benefit Plan for an employer is

the cost, as they bear the burden of securing an income stream of retirement benefits to

employees.

Defined Contribution Plans rely on monies paid annually or periodically into an

employee’s individual retirement account. Limited contributions are made by the

employee, employer, or both and invested in a variety of different investments such

things as mutual funds to help the account grow. The amount of an employee’s

retirement benefit is determined by the amount of contributions as well as the

performance of the investments within the plan. Many types of defined contribution

plans currently exist, such as Savings or Thrift plans, Profit-sharing plans, Money

Purchase plans, Employee Stock Ownership plans, or 401k plans.

A Savings or Thrift plan sets up an account for each participating individual. The

individual then makes contributions, usually on an after-tax basis, to that account. The

employer can choose to match the contribution partially, fully, or not at all.


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Individual accounts are also used in Profit-Sharing plans. Employer contributions

are generally based on company profits from the previous year, and although companies

are not required to make an annual contribution, most do; some contribute even if they

fail to make a profit in the previous year. The contribution is usually a predetermined

amount that is divided among employees in proportion to their salaries. Profit-sharing

plans can motivate employees seeking more for retirement and help a company improve

productivity and profit margins.

A Money-purchase plan is yet another individual retirement account for the

employee. However, unlike profit-sharing plans, where the employer is not obligated to

make an annual contribution to the account, it is mandatory in money-purchase plans—

unless the company has no income to do so. Contributions are set amounts and allocated

to individual accounts based on a proportionate percentage relative to an employee’s

salary.

Employee Stock Ownership plans (ESOP) offer the worker a “stake” in the

business, given that employer contributions made to an individual’s retirement account

are reinvested in company stock. Contributions are made on a proportionate percentage

of salary method and do not have to be made on a yearly basis. Similar to profit-sharing

plans, employees are encouraged to do their jobs well because their retirement is directly

related to the company’s productivity.

The most commonly used Defined Contribution Plan is the 401k. It allows

employees to defer part of their salary into individual accounts through an after-tax

contribution or a pre-tax contribution. The investment earnings within the account

accumulate tax free until they are withdrawn. 401k participants have the option of

investing in various mutual funds within the plan for diversification and potential growth.


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Employers can also make a contribution to the individual plan. They usually match the

employee’s contribution up to a certain percent. The Roth 401k, a slight variation of the

Traditional 401k, was introduced in 2006. The Roth lets the employee make after-tax

contributions and allows the earnings to grow on a tax-free basis and when distributions

are taken they are tax free. The employer is not obligated to offer the plan or contribute

to it. If the employer does contribute, however, it will be a on a tax-deferred basis.

During the last 30 years, employers have moved away from offering Defined

Benefit plans and have gravitated toward Defined Contribution plans. This change is

primarily due to the employer’s desire to save money by shifting management fees from

the company to the employee. Along with this added cost, the employee has also been

delegated responsibility for their future retirement, releasing the company from the

obligation of providing steady income following retirement. Even though employers are

saving money on administrative costs, they may not necessarily pass those savings on and

contribute as much to the Defined Contribution plan as they would have in a Defined

Benefit plan (Daniels).

Looking at a graph of companies that offered Defined Benefit plans, Defined

Contribution plans, or a combination of both, we can see the shift in usage. Thirty years

ago 62% of companies had only Defined Benefit Pension Plans while 16% had Defined

Contribution Plans. Ten years later, by a slim margin, Defined Contribution Plans were

used more often than Defined Benefit Plans, 36% to 33%. By 2005 a complete reversal

has taken place, with Defined Contribution plans representing 63% and Defined Benefit

plans representing just 10% (Fast Facts from EBRI June 2007).


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.(Fast Facts from EBRI June 2007).


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In 1997, Defined Contribution plans had $1.85 Trillion in assets compared to 1.78

Trillion for Defined Benefit plans.

(Fast Facts EBRI Feb 2006)

Age is a factor when it comes to participation in retirement plans. According to

the EBRI, when a company does offer a 401k plan roughly 20 percent of eligible

employees do not enroll. These employees tend to have lower incomes, usually because

they are young (Powell).

Older employees tend to participate more often than younger ones. This is

consistent even when comparing younger and older workers with similar earnings.

Employees in the age group 21 – 24, who are full-time, full-year, wage and salaried

employees, have a 29.3 percent participation rate in their company’s retirement plan. If

you include all workers in this age group from both the public and private sectors, the

rate drops to 19.5 percent. However, among employees aged 55 – 64 these percentages


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jump to 60.1 percent and 49.0 percent respectively. The table below shows a gradual

increase in the percentage of participation relative to the age of the employee.

(Fast Facts EBRI Jan 2008)

The average 401k account balance for a participating employee in their 20’s in

2004 was $31,844, while the average for those in their 40’s was $100,106, and those in

their 60’s was $136,400. (Fast Facts EBRI Oct 2005). There is a considerable difference

in the account balance of someone in their 20’s and someone in their 40’s. Even though

there is an increase in the average 401k balance of workers in their 60’s compared to

those in their 40’s, one might expect the increase to be much higher since older workers

tend to contribute more and have a longer time period to do so. But employees in their

60’s may have eased up on their contributions or even taken withdrawals as they

approach retirement. The average 401k account balance for all participants at the end of

2004 was $56,878, which was up from $51,569 in 2003 (Fast Facts EBRI Oct 2005).

Asset allocation has a significant role in determining an account balance. At the

end of 2004 the average 401k asset allocation for someone in their 20’s was as follows:

52 percent invested equity funds; 13 percent invested balanced funds; 12.6 percent

invested company stock; and 20.1 percent invested fixed income funds. For someone in

their 60’s the allocation was: 37 percent invested in equity funds; 9.5 percent invested in

balanced funds; 12.6 percent invested in company stock; and 38.1 percent invested in


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fixed income funds. (Fast Facts EBRI Oct 2005). After reviewing these two

allocations, we find older employee, with the exception of company stock, is invested

more conservatively than the younger.

From 1999 through 2006, the average account balance for 401k plans increased

from $67,760 to $121,202 (EBRI Issue Brief August 2007). Even though 2000-2002

were terrible years for equity performance, the graph below suggests that 401k

participants continued to invest in their plans, as the account values in those years

remained relatively stable and then later grew.

(Fast Facts EBRI Oct 2005).

Figure 7 shows, the next table (below) breaks down the previous table by age

group which shows that not only did the younger participants have smaller account

balance but they also had the greatest return over the eight year period. (Fast Facts EBRI

Oct 2005). Because younger participants did not have much invested and continued to


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invest when the stock market had negative returns for 2000 – 2002, they were poised for

the greatest potential growth.

(Fast Facts EBRI Oct 2005).

This growth can be attributed to the specific asset allocation of the participants.

Equity funds dominate the allocations (Fast Facts EBRI Oct 2005). More exposure to

equity funds—especially when the stock market is growing by double-digits—produces

better portfolio performance.

((Fast Facts EBRI Oct 2005).


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As you can see in the table below, younger 401k participants have a much greater

exposure to equity funds then older participants, making there allocation more aggressive

which can lead to higher returns in good times and higher losses in bad times. (EBRI

Issue Brief August 2007).


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Retirement Info

As Americans age, their sources, abilities and desire to earn income tend to

change at the same time. Younger American’s income sources tend to be from earnings,

where older American’s income sources tend to be from pensions, assets, and social

security. As can be seen in the table below, the sources of income for different age

groups for individuals change dramatically from ages 55 – 64 to 65+ for the amount of

income derived from earnings and the amount of income from Social Security. This

would only seem natural as most people are retiring or thinking about retiring during this


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time frame.

(Purcell).

In the table below, the sources of income are shown however, this table is not

based on individuals and their earnings sources but rather entire households. The trend is

basically the same as it is with individual earning sources especially the changes from the


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age group of 55 – 64 and 65+ with respect to the drop in earnings and the increase in the

social security.

(Purcell)


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In the pie chart below, the sources of individual income for the “top quartile”

(income of more than $32,160) of people over age 65 are broken down by percentage.

As you can see, Social Security represents 18.5 percent of their total income while

Earnings and Pensions represent 58.1 percent of total income.

(Purcell).

In the pie charts below for the “second quartile”, incomes of individuals (incomes

between $17,382 - $32,160) you can see that Social Security now represents 54.1 percent

of total income, while earnings and pensions have decreased percentage wise to represent

33.9 percent of income for this category. As you can see, as the total individual incomes

decrease, there is a major shift in where the income sources are derived. In this case,

individuals rely on Social Security for more then half of their income.


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(Purcell).

In the following two pie charts for the “third and fourth quartiles” for individual

income sources (3rd quartile $10,722 - $17,382 and 4th quartile less then $10,722) the

trend continues. For both the “third and fourth quartiles” Social Security represents over

80 percent of income for individuals.

(Purcell).


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(Purcell).

Changing from individual income sources to household income sources, the

percentages for reliance on Social Security are a little different; however, the trend is still

the same. The lower the amount of household income, the bigger the percentage Social

Security is for the total income source. As can be seen in the four piece charts below the

breakdown for household income sources for the four different quartiles of total income.


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(Purcell).

(Purcell).

(Purcell).


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(Purcell).

In the table below, you can see how vital Social Security is for many Americans.

The table shows what percentage of income for an individual that is made up of Social

Security, and what percent of Social Security recipients that represents. For example,

Social Security makes up 100 percent of income for 28 percent individuals receiving it.

(Purcell).


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The following table details the same information as the table above Social

Security is shown as a percentage of “household” income, rather then to individual

income.

(Purcell).

American’s savings and investments are being utilized more and more for

retirement income sources especially since Defined Benefit Pension plans are

disappearing. In the table below you can see that Americans aged 25 and older have less

than $25,000 in savings and investments (not including their primary residence or defined

benefit retirement plan).

(EBRI Fast Facts April 2006)


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When looking at what Americans think they are going to need as far as additional

assets for retirement, 30 percent believe that they will need less then $250,000. The table

below further breaks down what Americans thinks they are going to need for assets to

supplement or provide their future retirement income.


The information above detailing what Americans believe they are going to need

for assets to supplement or provide their future retirement income is further broken down

in the table below by household income. Those believing they will need less then

$250,000 in assets makeup the largest percentage – 26 percent. That 26 percent is then

broken down further by income ranges: those with less then $35,000 in household income

represent 43 percent of the 26 percent, those with incomes between $35,000 - $74,000

represent 28 percent of the 26 percent, and those with incomes above $75,000 represent

13 percent of the 26 percent. This table’s information basically shows that the more

income households earn the more assets they believe they are going to need to either

supplement or provide their future retirement income.


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Solution

American workers, younger ones especially, are saving less than ever before and

inadequately preparing for retirement. This lack of saving, combined with the possibility

of the federal social security program paying less then expected (or worse going broke)

could have devastating consequences. Action must be taken now to minimize the impact

this future retirement problem could have on future retirees, taxpayers and Americans in

general. Creating a State Social Security and Retirement Supplemental Program

(SSSRSP) will boost savings and future retirement income while helping avoid a looming

financial crisis.

Unlike the Federal Social Security program, which is a credit based system,

contributions made into an SSSRSP will be cash oriented. A cash contribution system

would be more transparent and allow participants to view the actual savings they will be

entitled to withdraw in the future. This will be far more appealing to employees, as it is

not just a promise of payment from the state government.

Start up costs for the SSSRSP program would include (but not be limited to): the

designing of the software, purchase of hardware, publicity, consultation fees, hiring of

new employees, leasing of space, compliance regulations, and any other miscellaneous

costs. Ongoing costs would include (but not limited to): rent or leasing costs, salaries,

compliance, consultation fees, upkeep of software and hardware, accounting expenses,

oversight of Index funds, and any other miscellaneous costs. This program should be

internet based, using a paperless statement system and limiting the number of phone calls

participants could make to the home office regarding the SSSRSP. Going paperless will

save on printing costs and completely eliminate mailing costs. Limiting the number of

phone calls per participant will require fewer employees staffing the home office and


35

save on salaries. The biggest savings will come as a result of investing contributions in

Index Exchange Traded Funds, as opposed to mutual funds. The typical mutual fund

expense ratio (that is the amount to “run” the fund) averages around 1.5 percent, whereas

the typical S&P 500 Exchange Traded Fund averages .18 percent.

Since employees have a poor record of taking advantage of retirement programs,

participation in this program will be mandatory for anyone under age 55 that has earned

income in the state of South Carolina. Participation for everyone aged 55 and older will

be optional.

Funding the SSSRSP will be done through a “payroll tax withholding system”.

Employers will be required to withhold 5 % of the gross income of each paycheck an

employee receives. Employers will then submit this amount to the SSSRSP the exact

same way they pay payroll tax to the government. To keep costs down for employers,

this amount should be paid on a monthly basis (as opposed to weekly) to the SSSRSP.

The state government along with the SSSRSP will be responsible for overseeing this

process. This will be an additional accounting cost for employers. However, if the

payment to the SSSRSP is done similarly to the payroll tax system the costs should be

minimal. This is not a replacement of the Social Security tax currently taken out of

employee checks; this will be a separate, additional amount removed.

Participants will be allowed to make additional contributions on top of the

mandated 5 %, but no more than a combined total of 8 %. Allowing an unlimited

percentage to be contributed could unintentionally turn the SSSRSP into a “tax shelter”

for the wealthy. Once a year participants will be able to adjust the percentage of their

contributions. All employees wanting to make adjustments should be required to do so

within a window time frame to make it easier for employers.


36

An employee who chooses to increase their contribution percentage will be given

a “matching” incentive from the Federal Government. This “matching” incentive will

not be free taxpayer money but rather a cash deposit into the individual’s SSSRSP. In

exchange for the cash deposit, the individuals would relinquish some of their future

Federal Social Security benefits.

According to my Social Security statement, currently I am expected to receive 78

cents for every dollar of scheduled benefits from the Federal Social Security program. If

I were to give up 28 cents and only receive 50 cents for every dollar of scheduled

benefits, the Federal Government would make a cash deposit into my SSSRSP of a

certain percentage or dollars. Individuals would still be required to pay Federal Social

Security tax, though, so current beneficiaries would not be affected. The amount or

percentage of this cash deposit from the federal government will be contingent upon the

voluntary contributions made by participants.

For example, someone age 31 making $30,000 in salary per year is scheduled to

receive $1,121 monthly in Federal Social Security benefits at age 66. Under the

SSSRSP, this person will be required to contribute 5% of their salary ($1500) every year.

Along with this mandatory percentage, they’ll have the option of contributing an

additional 1%, 2%, or 3%. The potential match from the federal government will depend

upon these additional percentages—the higher the percentage, the greater the cash deposit

from the federal government. Coinciding with the increased percentages and potentially

larger cash deposits, however, the individual will see a reduction in their future Federal

Social Security dollars. Suppose our 31 year-old participant voluntarily contributes an

extra 1% on top of the mandatory 5%. The individual would be adding another $300. At

the same time, the federal government would “match” this contribution with a deposit of


37

$120, which would be deducted from the individual’s future Social Security benefits.

This particular participant, by contributing an additional 1%, would concede $1,620 per

year in future Social Security benefits. The scale below details the correlation between

the percent of voluntary contributions, federal cash deposits, and surrendered Social

Security benefits based on the 31 year-old with a yearly salary of $30,000.

Gross Salary $ 30,000.00

Mandatory Contribution

5% Mandatory $ 1,500.00

Voluntary ContributionTotal Participant

Contribution

1% Voluntary $ 300.00 $1,800.00

2% Voluntary $ 600.00 $2,100.00

3% Voluntary $ 900.00 $2,400.00

Potential Match from Federal Government Total Contribution (Mandatory, Voluntary,

Match)Based on VC % monthly amount yearly amount

1% $ 10.00 $ 120.00 $1,920.00

2% $ 17.00 $ 204.00 $2,304.00

3% $ 25.00 $ 300.00 $2,700.00

Future Federal Social Security Benefit

$ 1,121.00

Amount of Future Federal Social Security Benefits Given up Yearly Amount

$ 135.00 (1%) $ 1620.00

$ 150.00 (2%) $ 1,800.00

$ 175.00 (3%) $ 2100.00

Continuing on with our participant, the life expectancy at age 66 is 20.2 years and

the February applicable federal rate (AFR) rate (110%) is 3.26%. The calculations in the

table point out the savings to the Social Security system as well as the “matching” value

of some of the future benefits given up by the participant. By voluntarily contributing

1%, the participant will lose $135 of future monthly Social Security benefits. The

Federal Government will use $10 of that money to match (with cash) the individual’s


38

SSSRSP. Still, in this case, the Social Security system will save $21,944, and the future

value of the “match” from the Federal Government will be $7,632.28.

Calculations based on VC of 1%

Future Savings of Future Benefits Given up (age 66) ($21,944.00)

(if give up 135 then govt gives back 10 to match into SSSRSP)

FV of Matching Amount by Gov't (at Feb AFR rate) ($7,632.28)









The SSSRSP approach benefits both individuals as well as the Social Security

system. The savings by the Federal Social Security system will allow it to live longer.

Since individuals will continue paying into the Federal Social Security Trust Fund,

current beneficiaries would not be affected. Although it will not be as much as currently

projected, SSSRSP participants will still receive future Social Security income. They

will be less reliant on it and have more control over their future retirement income which

has the potential for greater growth.

A participant in the SSSRSP will be allowed to start withdrawing income from

their plan once they reach age 66. Distributions from the SSSRSP will be automatically

deposited into checking accounts on a monthly basis. The amount of distribution should

be 4% of the account balance which will be recalculated on a yearly basis. There will be


39

neither state nor federal tax on the withdrawals from the SSSRSP. A special 1099 tax

form will be sent (via email) to all participants taking withdrawals which they will have

for tax reporting purposes, even though these distributions will be non-taxable.

If a participant passes away before all funds are withdrawn, these funds will not

revert to the state. ALL remaining funds will be passed on to a beneficiary. The funds

will be placed in a separate account and the beneficiary will be able to “stretch” the

account and take distributions based on their own life expectancy in a way that closely

resembles how a non-spouse inherited IRA operates. If this “second” beneficiary dies

before all the funds are withdrawn, then the remainder of the account will pass on to

another beneficiary. However, this “third” beneficiary will have to withdraw the funds

based on the previous beneficiary’s life expectancy. For example, someone has a balance

of $100,000 in their SSSRSP and passes away leaving the remaining balance to their 50

year-old beneficiary. That beneficiary must now start taking withdrawals from that fund

(which is separate from their own SSSRSP) based on their own life expectancy. That

beneficiary takes withdrawals from this account for five years but passes away at the age

of 55. They have named a new beneficiary of this inherited SSSRSP. The new

beneficiary then takes over this SSSRSP, which will be placed into a separate account

again, and they must immediately start taking withdrawals based on the previous

beneficiary’s life expectancy, not their own. The use of this “stretch” method will at

some point completely drain accounts and eliminate the prospect of legacies.

Investment options for contributions will consist of two Exchange Traded Funds

(i.e. Index funds) and one money market fund. Investing in mutual funds or individual

stocks, which is more expensive to do, will be prohibited and thus save on overall costs.

The two Exchange Traded funds will be an index fund of the S&P 500 and a Treasury


40

Inflation Protected Bond Index fund (TIPS). Furthermore, to reduce risk, the SSSRSP

will have an equal allocation among the asset classes. This means 1/3 of the SSSRSP

will be invested in the S&P 500 index, another 1/3 in the TIPS index, and the final 1/3 in

a money market fund. A bearish or bullish market could alter this 1/3 allocation,

therefore a participant’s SSSRSP will be rebalanced either quarterly, semi-annually, or

annually so that it reasonably maintains its 1/3 allocation format. The participant will

decide when (quarterly, semi-annually, or annually) the rebalance will occur upon

registration for their SSSRSP.

Any growth, dividends, or interest earned inside a participant’s SSSRSP will be

non-taxable to the participant, mirroring the Roth IRA and all the benefits that come

along with it. The SSSRSP will not be allowed, however, to “roll over” or move to

another firm. These plans will stay intact in the state they are “housed.” This will help

reduce on the potential for fraud by dishonest financial advisors or insurance agents.

The following tables possess “sample portfolios” for the period beginning January

1, 2000 and ending December 31, 2008. The use of these dates is crucial because there

was severe volatility in the equity markets during this period. Choosing a timeline to

evaluate a portfolio’s performance is important since the market data can make a

portfolio appear productive when in fact that may not be true. During the selected time

frame there were tremendous swings to the upside and downside in the equity and bond

markets. In early 2000, the equity markets peaked and then subsequently dropped

dramatically causing significant losses for most equity investors. Recovery did not begin

until early in 2003 when, from this point until late in 2007, equity investments rebounded

and had tremendous growth. Thereafter, investors saw another dramatic decline in equity

values.


41

The second series of tables and graphs shows that an allocation following the 1/3

format (1/3 Money Market; 1/3 TIPS; 1/3 S&P 500) used during this volatile period

would not only have outperformed the Benchmark index, but done so with overall lower

risk as measured by the standard deviation. Four portfolios beginning with the exact

same 1/3 allocation shown below will illustrate.

Rebalanced Quarterly:

The portfolio balanced quarterly had a positive annualized return of 2.6% and a

standard deviation of 5.43 while the Benchmark (S&P 500) returned a negative 3.06%

with a 15.20 standard deviation.

The graphs below analyze both the Sample Portfolio and the Benchmarks

annualized returns and standard deviations for one year, three year, five year, and 10 year

time frames. The longer the time frame, the higher the annualized rate of returns and the

smaller the standard deviation decreases.


42

The graphs below show the return of the Sample Portfolio and the Benchmark

Index as measured by annualized returns and standard deviations. The Sample Portfolio

during this time frame is not only less risky then the Benchmark Index, but also has a

better annualized rate of return as well.

The graphs below show the cumulative returns for both the Sample Portfolio and

the Benchmark Index. As the graph shows the Sample Portfolio not only has a better rate

of return, but is also less volatile.


43

The graphs below break down of each asset class inside the Sample Portfolio by:

the annualized returns, annualized standard deviations, and cumulative returns.

Rebalanced Semi Annually:

As you can see by the tables below, the annualized return for the sample portfolio

is 2.74 percent, where the annualized return for the Benchmark (which is the S&P 500)

was -3.08 percent. The standard deviation for the Sample Portfolio during this time

frame was 5.39 while the Benchmark’s standard deviation was 15.20.


44

Rebalance Annually

As you can see by the tables below, the annualized return for the sample portfolio

is 2.94 percent where the annualized return for the Benchmark (which is the S&P 500)


frame was 5.25, while the Benchmark’s standard deviation was 15.20.


45

No Rebalancing:

As you can see by the tables below the annualized return for the sample portfolio

is 3.13 percent, where the annualized return for the Benchmark (which is the S&P 500)


frame was 4.89, while the Benchmark’s standard deviation was 15.20.


46

Each Sample Portfolio performed better in both categories of risk and return,

compared to the Benchmark Index. The Sample Portfolios performed a little different

from each other due to the frequency of rebalancing observable in the table and graphs

below. The portfolio with no rebalancing actually performed the best of the four Sample

Portfolios, however this portfolio is now completely out of balance from it’s original


47

investment allocation, which is not what we want to happen in the SSSRSP. When

comparing the other three Sample Portfolios’ standard deviations, annualized returns, and

cumulative returns, rebalancing on an annual basis performed the best. This could be due

to the time frame of this Sample Portfolio, and it should be noted that in some instances

rebalancing on a quarterly basis may perform the best of the three.

Sample

Portfolios

Annualized Standard

Deviation

Annualized

ReturnCumulative Return

Quarterly 5.43 2.68 26.64

Semi-Annual 5.39 2.74 27.25

Annual 5.25 2.94 29.5

No-Rebalance 4.89 3.13 31.62

Annualized Standard Deviation

4.6

4.7

4.8

4.9

5

5.1

5.2

5.3

5.4

5.5

Quarterly Semi-Annual Annual No-Rebalance


48

Annualized Return

2.4

2.5

2.6

2.7

2.8

2.9

3

3.1

3.2


Cumulative Return

24

25

26

27

28

29

30

31

32



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Conclusion

A potentially catastrophic lack of future retirement income is on the horizon and

action to avoid this problem must begin now. Our political leaders have consistently

acknowledged that something needs to be done to protect retirees and future retirees as

well as keeping our current Social Security system from becoming insolvent. Yet

whenever a possible solution is brought forward, our leaders fail to act appropriately and

engage in “politics,” killing the idea before it’s properly examined.

The creation of the SSSRSP may not be a cure-all; however it is a start in the right

direction. By utilizing such benefits as tax-free growth, tax-free withdrawals, employing

the use of investment vehicles such as Exchange Traded Funds, using a strictly

technology based platform, and potentially receiving a “matching” benefit from the

Federal Government, this plan will be extremely beneficial to participants by not only

keeping internal costs low but by increasing their future retirement income.

This proposal leaves room for further discussion and research. It does not cover

the impact the SSSRSP might have on South Carolina’s economy according to

population, tax revenue, business growth and employment. It also does not mention

disability situations or certain tax issues. These are all items that should be addressed as

they may make this proposal even more attractive to the state of South Carolina.


50

Works Cited

Social Security Administration. Historical Background and Development of Social Security. Social Security Online. 11 November. 2008. www.ssa.gov/history/briefhistory3.html

Wisconsin Historical Society. Social Secuirty: The Wisconsin Connection. 11 November. 2008. www.wisconsinhistory.org/topics/socialsecurity.

Social Security Administration. Why Social Security. Social Security Online. 11 November. 2008. www.ssa.gov/kids/history.htm

Social Security Administration. Fast Facts & Figures About Social Security 2008. Social Security Online. SSA Publication No. 13-11785. August 2008. http://www.ssa.gov/policy/docs/chartbooks/fast_facts/2008/fast_facts08.pdf

Economic Policy Institute. Social Security Issue Guide: Facts at a Glance. 8 April. 2008. http://www.epi.org/content.cfm/issueguide_socialsecurityfacts

Employee Benefit Research Institute. The Basics of Social Security. May 2007. http://www.ebri.org/pdf/publications/facts/0507fact.pdf

Social Security Administration. News Release. Social Security Board of Trustees: Some Improvement in Long-Range Financing Outlook but Deficits Continue. 25 March. 2008. http://www.ssa.gov/pressoffice/pr/trustee08-pr.htm

Pension. Wikipedia: The Free Encyclopedia. 21 January. 2009. http://en.wikipedia.org/wiki/Pension.

Daniels, Allison. Pension Plans Defined Benefit Plans vs. Defined Contribution Plans. 21 January. 2009. www.usd.edu/elderlaw/archives/pension_plans.htm

Pension Benefit Guaranty Corporation. 28 March. 2008. www.pbgc.gov

Pension Benefit Guaranty Corporation. PBGC Maximum Monthly Guarantees for 2008. 17 March. 2008. www.pbgc.gov/workers-retirees/benefits-information/content/page789.html

Pension Benefit Guaranty Corporation. How PBGC Operates. 28 March. 2008. www.pbgc.gov/about/operation.html

Pension Benefit Guaranty Corporation. How Pension Plans End. 28 March. 2008. www.pbgc.gov/about/termination.html


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Employee Benefit Research Institute. US Retirement Trends Over the Past Quarter-Century. 21 June. 2007. http://www.ebri.org/pdf/fastfact062107.pdf

Employee Benefit Research Institute. “Traditional” Pension Assets Lost Dominance a Decade Ago, IRA’s and 401ks Have Long Been Dominent. 3 Feb. 2006. http://www.ebri.org/pdf/fastfact020306.pdf

VanDerhei, Jack. Holden, Sarah. Copeland, Craig. Alonso, Luis. Employee Benefit Research Institute. 401k Plan Asset Allocation, Account Balances, and Loan Activity in 2006. August. 2007. http://www.ebri.org/publications/ib/index.cfm?fa=ibDisp&content_id=3838

Powell, Eileen Alt. Changes Ahead in 401k Accounts. 9 August. 2006. http://www.foxnews.com/printer_friendly_wires/2006Aug2009/0,4675,onthemoney,00.html

Employee Benefit Research Institute. Retirement Plan Particpation: Age Differences. 30 January. 2008. http://www.ebri.org/pdf/fastfact01302008.pdf

Employee Benefit Research Institute. 401k Account Balances, Asset Allocation by the Numbers. 3 October. 2005. http://www.ebri.org/pdf/fastfact100405.pdf

Employee Benefit Research Institute. How Much Do Americans Say They Have Accumulated in Savings?. 25 April. 2006. http://www.ebri.org/pdf/fastfact22Savings25Apr06.pdf

Employee Benefit Research Institute. Workers Estimate the Amount They Will Need in Retirement. 26 April. 2007. http://www.ebri.org/pdf/fastfact042607.pdf

Purcell, Patrick. Congressional Research Service. CRS Report for Congress. Income and Poverty Among Older Americans in 2007. 3 October. 2008. http://assets.opencrs.com/rpts/RL32697_20081003.pdf

Documents

Creation of a State Social Security & Retirement Supplemental Planscstateretirementplan.com/uploads/Final_Paper_PDF.pdf · 2012. 8. 31. · income (which included gov’t pensions,