Do we have a retirement savings crisis or a retirement income crisis (or neither)?

I’d like to set some facts up on the board:

• In 1966, prior to the Johnson Administration’s “War on Poverty,” 28.5% of Americans over the age of 65 were living below the poverty line. In 2012, just 9.1% were;
• Since 1978, the number of workers covered by defined benefit pension plans has been in steady decline.
• in 2013, 39.5% of new female filers and 35.6% of new male filers claimed Social Security’s old age benefit at age 62, in the year they first became eligible.

If you knew nothing else about the world, you could arrange these facts in different ways in order to draw different conclusions. For example, it might be that early Social Security filers are disproportionately high-income individuals who accumulated a lot of private savings during their working lives, and so don’t need to rely on Social Security in retirement, while low-income individuals without private savings wait to claim their higher old age benefit at full retirement age or later, making up for their lack of private savings and lower lifetime earnings.

Alternatively, it may be that while defined benefit pension plans have been in overall decline, they remain concentrated in low-income sectors, so early Social Security filers have their retirement incomes “topped up” by defined benefit pension plans.

Of course, in reality low-income workers are much less likely to have defined benefit pension plans and much more likely to claim Social Security old age benefits as soon as they’re eligible. But elder poverty has still been in decline for the last 50 years.

Social Security replaces a large share of low-paid workers’ income

Unpacking this mystery requires a little knowledge of Social Security’s old age benefit calculation. Consider a worker making the federal minimum wage of $7.25 an hour at age 62, and assume their annual income has only kept up with wage inflation for the last 35 years. That lets us use the worker’s current monthly income of $1,256 as their average indexed monthly income, which produces a primary insurance amount of $915 (90% of $885 plus 32% of $371). That’s their monthly benefit at their full retirement age of 66 (assuming they were born in 1954 and turned 62 in 2016), and it replaces about 73% of their gross income. Note that since they won’t be paying FICA taxes on their old age benefit, it replaces closer to 79% of their net income.

If the worker starts collecting at age 62 instead, their benefit will be reduced by 25%, to $686, a 55% gross or 59% net replacement rate. On its own, a $7,872 annual benefit is not enough to put our new retiree above the poverty line (neither would their full retirement age benefit of $10,980).

Social Security benefits are only taxable for relatively high earners

High-income workers are often advised to delay claiming their old age benefit, for three good reasons: the longer you continue working the more high-income years you can add to your Social Security work record, the longer you delay claiming the fewer penalty months or more bonus months you’ll receive on your ultimate benefit, and some Social Security benefits are taxable for high-income households.

How do these considerations apply to low-income workers?

With respect to the first, we know that wages have been stagnant for lower-income Americans for decades. If you’re low-income at age 62, there’s no reason to believe your next year’s income is going to “roll off” a low-income year in your youth. In fact, thanks to the way the wage-inflation-adjusted federal minimum wage has bounced around in the last 35 years, you may be earning less in wage-inflation-adjusted terms than you were in your youth!

As shown above, the second consideration still applies, with your benefit increasing each month you delay filing for your old age benefit.

But the third consideration is irrelevant: Social Security old age benefits are only taxable to the extent that your adjusted gross income, plus half your old age benefit, exceeds $25,000. In the case of our minimum wage earner, that sum only comes to $19,188, well below the taxable threshold.

That means at age 62 a low-income worker can claim their old age benefit completely tax-free while continuing to work. The old age benefit doesn’t replace their income, it supplements their income. You can see this clearly in Chart 5 of this report, showing that among Social Security recipients aged 62-64 (by definition “early” filers), in 2009 Social Security made up about 31% of income, while earnings represented about 38% (older age groups also show significant earnings but the report doesn’t separate early filers from full retirement age filers in the older age groups).

Raising the full retirement age is the worst way to “save” Social Security

I’m not a fan of the “Social Security in crisis” narrative ginned up periodically to justify attacks on the welfare state (today’s entry in the genre). The United States is a woefully undertaxed country and modest tax increases would solve a slew of problems, including the financing of Social Security. But maybe you’re an enthusiast for this crisis narrative! If you think the solvency of the Social Security trust fund in 2033 is a pressing national issue, you might be familiar with some of the options people float to “save” Social Security:

• raise or eliminate the cap on taxable earnings, increasing the amount of money flowing into the Social Security trust fund;
• investing the Social Security trust fund in riskier assets, hopefully improving its long-term returns;
• use a chained inflation measure for cost-of-living adjustments instead of the current unchained CPI, which would represent a modest cut in benefits over time;
• raising the full retirement age.

Of these options, raising the full retirement age is the one that targets the income of the elderly poor most directly. Increasing the full retirement age from 67 to 68 would represent a cut of 9.3% to the old age benefit of someone filing at age 62 (reducing their benefit from 75% to 70% of their primary insurance amount). This would be a permanent reduction in the retirement income of the lowest-income elderly, who are by definition the marginal elderly who have been pulled out of poverty by the program in the last 50 years.

It would be hard to come up with a plan more narrowly targeted at the people who need Social Security the most.

What is a retirement savings crisis?

The finance industry has gone to great lengths to convince American policymakers that the country is undergoing a “retirement savings crisis.” There are two reasons they’ve done this:

• the finance industry is in the business of managing money, so the more urgency they can gin up about the savings rate, the more money they can convince people to save;
• the finance industry is populated by the kinds of wealthy individuals who receive the majority of the benefit of the tax-advantaged savings vehicles they’ve convinced policymakers to create.

Now to be clear, I don’t have anything against saving a high percentage of your income; I save a high percentage of my income. But there are other things you can do with money as well, like using it to pay down debts. But using your savings to pay down debts instead of invest is a double-whammy to the finance industry: fewer assets to manage and less debt to charge interest on!

In fact, it does not seem to me that we have a retirement savings crisis. We have a glut of tax-advantaged savings vehicles, and consequently a shortage of collected tax, which is certainly a problem, if not a crisis. We also have a fairly extensive scam economy featuring things like reverse mortgages, deeply conflicted financial advice, and variable indexed annuities. Those are real problems we could come up with policy solutions to, but they’re primarily problems of elder abuse, not elder poverty (although elderly people can certainly be impoverished by abuse).

A retirement income crisis demands retirement income solutions

What is true is that we have a retirement income problem, which is real but manageable. As mentioned above, 9.1% of those over the age of 65 were living below the poverty line in 2012. Obviously age 65 is too late to build a Social Security earnings history or save enough money to live on in retirement. I’m not familiar with the exact composition of this group, but there’s no difficulty imagining how someone would fall into this category:

• Workers whose earnings weren’t reported because they worked off the books, or were improperly reported due to employer fraud. They may have a spotty official work history and underreported wages that produce a lower old age benefit than they’d otherwise be eligible for.
• People who didn’t work and don’t have a spouse’s work history to rely on. This may be as complex as not wanting to attract attention to an undocumented spouse or child, or as simple as being in a gay relationship and losing your partner before gay marriage was legalized.
• The long term disabled elderly who lost the ability to work before accumulating a sufficient work history and don’t have family to rely on.
• Low-income workers like the one described above who file for an old age benefit and leave the workforce at age 62.

This is a disparate group with different needs, none of which are tax-advantaged savings vehicles:

• Workers whose income isn’t being properly reported need vigorous enforcement of our labor laws (and not to fear deportation). We also need a streamlined system for reporting household and casual workers’ income, so employers have less incentive to hire people off the books.
• Developing a way for unmarried couples to claim their partner’s work record would need to be carefully thought out to prevent potential fraud.
• The long-term disabled elderly are a unique problem that can probably best be solved with simple cash payments.
• Low-income early retirees can be easily helped by lowering the full retirement age back to 65 (thereby reducing the penalty for early retirement) or following Canada’s example and supplementing the earnings-based old age benefit with a fixed payment to all retirees, taxable at your marginal income tax rate (Canada’s is a bit more complex than that).

What all these solutions have in common is that they address the real problem of insufficient retirement income, rather than the imaginary problem of insufficient retirement assets.