The Economics of Growing Old in the United States

Security was attained in the earlier days through the interdependence of members of families upon each other and of families within a small community upon each other. The complexities of great communities and of organized industry make less real these simple means of security. Therefore, we are compelled to employ the active interest of the Nation as a whole through government in order to encourage a greater security for each individual who composes it.…This seeking for a greater measure of welfare and happiness does not indicate a change in values. It is rather a return to values lost in the course of our economic development and expansion.
—Franklin D. Roosevelt, Message of the President to Congress, June 8, 1934

The economic status of older Americans is more varied than that of any other age group. Even though many older adults have limited resources, others are well off. Nonetheless, as a whole the older population in the United States has a lower economic status than the overall adult population. Upon retirement most rely in some part on Social Security and are supplemented by pensions and assets. Some also must depend on Supplemental Security Income (SSI), a federal income maintenance program that provides a base of support for older adults.

With fixed incomes and sharply limited potential to improve their incomes through employment, many older people become vulnerable to circumstances such as the loss of a spouse, prolonged illness, or even economic variations (e.g., inflation) that further compromise their financial well-being, sometimes plunging them into poverty. One common scenario is a couple that has planned well for retirement but then runs through all their assets to pay the health-care costs of a long-term illness. When the ill partner dies, the surviving spouse is impoverished.

THE ECONOMIC WELL-BEING
OF OLDER ADULTS

There are two important measures of an individual's or household's economic well-being. One is income—the flow of money earned through employment, interest on investments, and other sources. The other is asset accumulation or wealth—the economic resources (property or other material possessions) owned by an individual or household.

Income Distribution

According to Older Americans Update 2006: Key Indicators of Well-Being (May 2006, http://www.agingstats.gov/agingstatsdotnet/Main_Site/Data/2006_Documents/OA_2006.pdf) by the Federal Interagency Forum on Aging-Related Statistics, the trend in median (the middle value—half are higher and half are lower) household income of the older population has been positive, and fewer older adults are living in poverty. From 1974 to 2004 the proportion of older adults living in poverty declined. Figure 2.1 shows that since the late 1970s poverty rates have been comparable among people aged eighteen to sixty-four and adults aged sixty-five and over.

In 2004 about 10% of the older population lived below the poverty threshold, compared to about 14% in 1974. (See Figure 2.1.) The proportion of the older population in the low-income bracket also fell, from approximately 50% in 1974 to 40% in 2004. (See Figure 2.2.)

According to the U.S. Administration on Aging, in A Profile of Older Americans: 2006 (March 2007, http://www.aoa.gov/PROF/Statistics/profile/2006/2006profile.pdf), the median reported income for all older adults in 2005 was $15,696—$21,784 for males and $12,495 for females. Figure 2.3 shows the distribution of income among older adults. Households headed by people aged sixty-five and over had a median income of $37,765 in 2005, whereas individual median income for older adults that year was $15,696. (See Figure 2.4.) Even though more than half of households headed by an older adult (53.9%) had incomes of $35,000 or more, 9.2% had incomes less than $15,000. Median household income was highest among Asians ($49,163), followed by non-Hispanic whites ($39,402), African-Americans ($27,279), and Hispanics ($26,681).

Sources of Income

Unlike younger adults, who derive most of their income from employment, older adults rely on a variety of sources of income to meet their expenses. Since the 1960s Social Security has provided the largest share of income for older Americans. In 2004 Social Security benefits were a major source of income—providing at least 50% of total income—reported for two-thirds (66%) of older adult beneficiaries. (See Figure 2.5.) For more than one-third (34%) of Americans over age sixty-five in 2004, Social Security accounted for 90% of total income.

As reported in Older Americans Update 2006, most older adults' income comes from four sources. In 2004, besides Social Security, which accounted for an average of 39%, earnings provided 26%, pensions contributed 19%, and asset income accounted for 13% of the older population's income. (See Figure 2.6.)

For older Americans in the lowest fifth of the income distribution in 2004, Social Security accounted for 83% of aggregate income (total income from all sources) and public assistance for another 8%. (See Figure 2.7.) High-income older adults' aggregate income was about one-fifth each of pension, Social Security, and asset income, and nearly two-fifths were derived from income. Among people aged eighty and over, aggregate income was largely composed of Social Security and asset income, with earnings contributing a much smaller proportion, compared to the youngest population of older adults, those aged sixty-five to sixty-nine.

Pension (Retirement) Funds

Many large employers, along with most local and state governments and the federal government, offer pension plans for retirement. In the United States American Express established the first private pension plan—an employer-run retirement program—in 1875. General Motors Corporation provided the first modern plan in the 1940s.

Employers are not required to provide pensions, and pension plans do not have to include all workers; they may exclude certain jobs and/or individuals. Before 1976 pension plans could require an employee to work a lifetime for one company before becoming eligible for pension benefits. As required by the Employee Retirement Income Security Act of 1974 (ERISA), starting in 1976 an employee became eligible after ten years of service. By the early 2000s most plans required five years of work before an employee became vested (eligible for benefits). In companies that offer pension plans, employees are eligible to begin receiving benefits when they retire or leave the company if they have worked for the requisite number of years and/or have reached the specified eligibility age.

The Social Security Administration (SSA) reports in Fast Facts & Figures about Social Security, 2006 (November 2006, http://www.socialsecurity.gov/policy/docs/chartbooks/fast_facts/2006/fast_facts06.html) that the proportion of older adults' income from pensions grew rapidly during the 1960s and 1970s but leveled off between the 1980s and 2002. In contrast, the portion contributed by earned income declined until the mid-1980s and increased incrementally through 2004. The proportion of income from assets peaked in the mid-1980s and has declined since then.

DEFINED BENEFIT PLANS AND DEFINED CONTRIBUTION PLANS.

There are two principal types of pension plans: defined benefit plans and defined contribution plans. Traditionally, employers offered defined benefit plans that promised employees a specified monthly benefit at retirement. A defined benefit plan may stipulate the promised benefit as an exact dollar amount, such as $100 per month at retirement. More often, however, benefits are calculated using a plan formula that considers both salary and service—for example, 1% of the average salary for the last five years of employment, for every year of service with the employer.

A defined contribution plan does not promise employees a specific amount of benefits at retirement. Instead, the employee and/or employer contribute to a plan account, sometimes at a set rate, such as 5% of earnings annually. Generally, these contributions are invested on the employee's behalf, and the amount of future benefits varies depending on investment earnings.

An example of a defined contribution plan is the 401(k) plan, which allows employees to defer receiving a portion of their salary, which is contributed on their behalf to the plan. Income taxes are deferred until the money is withdrawn at retirement. In some instances employers match employee contributions. Created in 1978, these plans were named for section 401(k) of the Internal Revenue Code.

Increasingly, employers are offering defined contribution plans, which stipulate how much the worker, and perhaps the employer, will contribute over time without specifying the exact amount of benefits at retirement. In "Trends in Retirement Plan Coverage over the Last Decade" (Monthly Labor Review, February 2006), Stephanie L. Costo observes that in 1992–93, 32% of private industry workers participated in defined benefit plans and 35% participated in defined contribution plans. (See Figure 2.8.) By 2005 the number of workers with defined benefit plans had decreased to 21%, whereas the proportion participating in defined contribution plans rose to 42%.

Since the mid-1990s many employers have converted their defined benefit plans to hybrid plans that incorporate elements of both defined benefit and defined contribution plans. Cash balance plans, for instance, are based on defined contributions of pay credits—based on an employee's compensation rate—and interest credits deposited annually by the employer into an account, the balance of which serves as the defined benefit.

PRIVATE PENSIONS AND PUBLIC PENSIONS.

In Fast Facts & Figures about Social Security, 2006, the SSA notes that in 1962 private pensions from employers accounted for just 3% of older adults' income. By 2004 private pensions supplied 10% of the income of older adults. Government employee public pensions contributed 9% of the total income of the older population.

Unlike Social Security and many public plans, most private pension plans do not provide automatic cost-of-living adjustments. Without these adjustments many retirees' incomes and purchasing power erode. Military, government, and Railroad Retirement pensioners were more likely to receive cost-of-living increases than were pensioners in the private sector.

FEDERAL PENSION LAWS.

Pension plan funds are often invested in stocks and bonds, much as banks invest their depositors' money. When the investment choice is a good one, the company makes a profit on the money in the fund; bad investments result in losses. During the early 1970s several major plans were terminated before they accumulated sufficient assets to pay employees and their beneficiaries retirement benefits. These asset-poor plans were unable to make good on their promises, leaving retirees without benefits despite their years of service.

To protect retirement plan participants and their beneficiaries from these catastrophic losses, ERISA was passed in 1974. ERISA established a new set of rules for participation, added mandatory and quicker vesting schedules, fixed minimum funding standards, and set standards of conduct for administering plans and handling plan assets. ERISA also required disclosure of plan information, established a system for insuring the payment of pension benefits, and created the Pension Benefit Guaranty Corporation (PBGC), a federal corporation, to provide uninterrupted benefit payments when pension plans are terminated.

The Retirement Equity Act of 1984 requires pension plans to pay a survivor's benefit to the spouse of a deceased vested plan participant. Before 1984 some spouses received no benefits unless the employee was near retirement age at the time of death. Under the 1984 law, pension vesting begins at age twenty-one, or after five years on the job, and employees who have a break in employment for reasons such as maternity leave do not lose any time already accumulated.

SWEEPING REFORM OF PENSION FUNDING RULES.

Fears in the early 2000s about the ailing airline industry and other troubled companies prompted the White House and Congress to overhaul the pension-funding rules to prevent a crisis comparable to the pension fund collapses of the 1970s. In 2005 the White House proposed an overhaul of regulations dating to the 1974 establishment of ERISA and the PBGC. The White House proposal called for an increase in the PBGC premiums paid by employers and rewrote rules that have allowed companies to use favorable stock trends and interest rates to conceal inadequacies in underfunded plans. President George W. Bush (1946–) signed the Pension Protection Act into law in August 2006. The bill not only aims to strengthen traditional defined-benefit plans and require companies to tell workers more about the health of their pension programs but also prods workers into putting more money away for their own retirement.

Personal Savings

One of the most effective ways to prepare for retirement is to save for it. In the issue brief The Retirement System in Transition: The 2007 Retirement Confidence Survey (April 2007, http://www.ebri.org/pdf/briefspdf/EBRI_IB_04a-20079.pdf), Ruth Helman, Jack VanDerhei, and Craig Copeland report on the results of the 2007 Retirement Confidence Survey that was conducted by the Employee Benefit Research Institute, the American Savings Education Council (ASEC), and Matthew Greenwald & Associates. Helman, VanDerhei, and Copeland note that even though 60% of workers claim they are currently saving for retirement, the amounts they have saved are low. Helman, VanDerhei, and Copeland indicate that in 2006 nearly half (49%) of workers reported having total savings and investments, excluding the value of their homes, of less than $25,000. Even though this level of savings will render them woefully unprepared for retirement, 27% of workers are "very confident" and an additional 43% are "somewhat confident" that they will have enough money in retirement. Helman, VanDerhei, and Copeland determine that workers would find themselves better prepared for retirement by curbing their spending habits and eliminating consumer debt.

One popular way to save for retirement is to contribute to individual retirement plans. Individuals fund these retirement plans themselves. The money that they contribute can be tax deductible, the plans' earnings are not taxed, and contributors determine how the money is invested. Since 1974 one of the major types of individual retirement plans has been the individual retirement account (IRA). IRAs fall into several different categories, but the two most common types are traditional IRAs (deductible and nondeductible) and Roth IRAs; a variety of factors determine which kind of IRA best serves an individual's needs. Profit-sharing plans for the self-employed (formerly called Keogh plans) are another type of individual retirement plan.

Family Support

Older adults may also rely on their families for financial support and other types of assistance, such as transportation, shopping, and housekeeping. It is difficult to quantify the scope and extent of this support, though many studies document the responsibilities adult children assume for their aging parents. According to survey results reported in April 2004 by the National Alliance for Care-giving and the AARP, in Caregiving in the U.S. (http://www.caregiving.org/data/04finalreport.pdf), 79% of the estimated 44.4 million caregivers in the United States provide care for an older adult aged fifty or over. Excluding those caring for a spouse, 54% of the survey respondents reported contributing financial support to their care recipient. Caregivers providing financial support to an older adult typically contributed an average of $200 per month.

NET WORTH

Because the economic well-being of households depends on both income and wealth, assessment of income alone is not the best measure of older adults' financial health. To draw a more complete economic profile of the older population, it is necessary to evaluate older households in terms of measures of wealth, such as home equity, savings, and other assets and liabilities. For example, a household may be in the top one-fifth of the income distribution but be saddled with a large amount of debt.

Net worth is a measure of economic valuation and an indicator of financial security that is obtained by subtracting total liabilities from total assets. Greater net worth enables individuals and households to weather financial challenges such as illness, disability, job loss, divorce, widowhood, or general economic downturns.

According to Figure 2.9, the median net worth has increased since 1984. However, this increase has been substantially greater for older white adults than for older African-American adults. During this period the median net worth of households headed by older white adults increased by more than 54%, from $117,800 to $215,000. Even though the median net worth of households headed by older African-American adults grew from $26,600 in 1984 to $42,600 in 2001, it dropped to a record low of $26,300 in 2003.

The median net worth of households headed by college-educated older adults rose from $224,900 in 1984 to $376,500 in 2003, a 67% increase, compared to $57,400 in 1984 to $59,500 in 2003, a 4% increase, for households headed by an older adult without a high school diploma. (See Figure 2.10.) The 2003 net worth of homes headed by older adults with some college or more was more than six times greater than those headed by older adults without high school diplomas.

POVERTY

Poverty rates are measures of the economic viability of populations. Poverty standards were originally based on the "economy food plan," which was developed by the U.S. Department of Agriculture (USDA) in the 1960s. The plan calculated the cost of a minimally adequate household food budget for different types of households by age of householder. Because USDA surveys showed that the average family spent one-third of its income on food, it was decided that a household with an income three times the amount needed for food was living fairly comfortably. In 1963 the poverty level was calculated by simply multiplying the cost of a minimally adequate food budget by three. Later, the U.S. Census Bureau began comparing family income before taxes with a set of poverty thresholds that vary based on family size and composition and are adjusted annually for inflation using the Consumer Price Index (CPI; a measure of the average change in consumer prices over time in a fixed market basket of goods and services).

According to Table 2.1, the poverty rate of adults aged sixty-five and over in 2005 (10.1%) was essentially unchanged from the previous year and represented 3.6 million older adults living in poverty. The rates recorded for eighteen- to sixty-four-year-olds (11.1%) and children under age eighteen (17.6%) both exceeded that of older adults. Census Bureau data reveal that in 1959 the poverty rate for people aged sixty-five and over was 35%, well above the rates for the other age groups. The lowest level of poverty in the older population occurred in 1999, when the rate fell to 9.7%. (See Figure 2.11.)

Poverty Thresholds Are Lower for Older Adults

The Census Bureau measures need for assistance using poverty thresholds—specific dollar amounts that determine poverty status. Each individual or family is assigned one out of forty-eight possible poverty thresholds. Thresholds vary according to family size and the ages of the members. The thresholds do not vary geographically, and they are updated annually for inflation using the CPI.

One assumption used to determine poverty thresholds is that healthy older adults have lower nutritional requirements compared to younger people and therefore require less money for food. This assumption has resulted in different poverty thresholds for both the old and young. For example, in 2006 the poverty threshold for a single person under age sixty-five was $10,488, as opposed to $9,669 for a person aged sixty-five or older. (See Table 2.2.) The 2006 poverty threshold for two people including a householder under age sixty-five was $13,500, compared to $12,186 for two people including a householder aged sixty-five years or older.

This method of defining poverty fails to take into account the special financial and health challenges older adults may face. For example, no household costs other than food are counted, even though older adults spend a much greater percentage of their income on health care than younger people do. Also, the dollars allocated for food only consider the nutritional needs of healthy older adults; many are in poor health and may require more costly special diets or nutritional supplements.

WELL-OFF OLDER ADULTS

More older Americans live comfortably today than at any other time in history. Those in their seventies and eighties were children of the Great Depression, which began in 1929 and continued through the 1930s. The enforced Depression-era frugality taught them to economize and save. This generation returned from World War II (1939–1945) to inexpensive housing and GI bills (legislation that made available for veterans low-interest loans for homes or small businesses and free or inexpensive college educations). During the 1940s and 1950s, their peak earning years, they enjoyed a period of unprecedented economic expansion. Since then, many have raised their children, paid off their home mortgages, invested wisely, and become eligible to receive Social Security payments that are larger than ever.

Even though these factors have contributed to a more favorable economic status for this cohort (a group of individuals that shares a common characteristic such as birth years and is studied over time) of older adults than they would have otherwise enjoyed, most older people are not wealthy. Figure 2.12 shows that in 2005 less than one-fifth (18.3%) of households headed by older adults had total incomes of $75,000 or more, and just slightly more than 10% of individuals aged sixty-five and over reported incomes more than $50,000.

CONSUMER EXPENSES

On average, older households spend less than younger households because they generally have less money to spend, fewer dependents to support, and different needs and values. The U.S. Bureau of Labor Statistics reports that the annual per capita expenditure for people aged sixty-five to seventy-four was $38,573, whereas those aged seventy-five and older spent just $27,018. (See Table 2.3.) Those under the age of twenty-five were the only group with a smaller expenditure, spending $27,776 per capita annually. The greatest amounts were spent on housing (including utilities), food, transportation, and health care. Not surprisingly, older adults spent more on health care than any other age group, both in actual dollars and as a percentage of expenditures. Older adults spent less on tobacco and smoking products, alcoholic beverages, apparel, and food away from home than other age groups.

Smaller Households Are More Expensive to Run

Most older adult households contain fewer people than younger households. Even though larger households, in general, cost more to feed, operate, and maintain, they are less expensive on a per capita basis.

Home maintenance, such as replacing a roof or major appliance, costs the same for any household, but in larger households the per capita cost is lower. Purchasing small quantities of food for one or two people may be almost as costly as buying in bulk for a larger household. Because older adults often have limited transportation and mobility, they may be forced to buy food and other necessities at small neighborhood stores that generally charge more than supermarkets and warehouse stores. Larger households may also benefit from multiple incomes.

AGING CONSUMERS—A GROWING MARKET

Older adults have proven to be a lucrative market for many products. Robert Brown and Ruth Washton, in The U.S. Market for 55 + Consumers: Attitudes and Lifestyles in the New Retirement Paradigm (2005), conclude that in 2005 the sixty-four million consumers aged fifty-five and over wielded an estimated $2.4 trillion in purchasing power. Older adults are redefining aging—only a minority of Americans expects to retire as their parents did. Older adults are now more likely to continue working, and working out, rather than retiring to the shuffleboard court or rocking chair on the front porch. As a result, they are considered an important market for an expanding array of services besides those traditionally marketed to older adults—such as health and life insurance plans and burial plots.

Baby Boomers—The Emerging "Silver" Market

The aging baby boomers (people born between 1946 and 1964) have been dubbed "zoomers" to reflect the generation's active lifestyle. Market researchers believe that the sheer size of the boomer cohort and its history of self-indulgence, coupled with considerable purchasing power, ensure that this group will be the most voracious older consumers ever.

The information in this section was drawn from the Boomer Marketing Report, a quarterly survey of fourteen hundred consumers by the Boomer Project/Survey Sampling International, which aims to determine how this generation thinks, feels, and responds to marketing and advertising messages, and from 50 Things Every Marketer Needs to Know about Boomers over 50 (2005). Included among the many insights that the Boomer Project research reveals are the following:

• Boomers at age fifty perceive themselves as twelve years younger, and they expect to live thirty-five more years. They consider themselves to be in early "middle age" and view seventy-two as the onset of old age. (See Figure 2.13.)
• Boomers reject any and all age-related labels to describe themselves. They do not want to be called "seniors," "aged," or even "boomers," and they do not want to be compared to their parents' generation or any previous cohort of older adults.

• Boomers over age fifty do not want to reverse or stop the signs of aging, they simply want to postpone or slow the process. They are intent on seeking health rather than youth—feeling younger is as important as looking younger for boomers eager to age "on their own terms."
• Boomers want more time, which means that services that offer them free time to pursue work and leisure activities are likely to be in great demand. Examples of these include cleaning, home maintenance, and gardening services.

• Boomers are becoming less interested in material possessions and more interested in gaining a variety of experiences. Rather than embracing the premise that "he who has the most toys wins," boomers believe "he who chalks up the most experiences wins."
• Once dubbed the "me generation," boomers operate on the premise that they are entitled to special treatment, not because they have earned it by virtue of age, but simply because they deserve it. They want products and services that are relevant to them personally. They remain motivated to fulfill their own needs, whether these needs are for community, adventure, or a spiritual life.
• Boomers are life-long learners. Continuing education classes and opportunities to learn and enrich their lives through travel are important to this generation.
• Boomers are still interested in promoting social change. The generation known for protesting the Vietnam War (1955–75) and questioning authority and traditional American social mores continues to support global and local humanitarian and environmental action.
• Boomers do not want to relocate to traditional retirement enclaves and communities; instead, they prefer to "age in place" in their present home or nearby. Having witnessed the institutionalization of their parents in nursing homes and other assisted living facilities, boomers are intent on remaining in their homes, and in the community, for as long as they can.

The Boomer Project predicts that adults over age fifty are poised to transform a variety of industries, including travel and tourism, health clubs, home improvement and maintenance services, apparel, personal care and beauty, financial services, education/learning, and family restaurants.

Pharmaceutical companies and health-care providers will also rise to meet increasing demand from this generation. Boomers are more interested in health and in postponing aging than any generation before. They are purchasing a wide range of prescription and over-the-counter antiaging treatments, as well as vitamins, supplements, pharmaceutical products, and medical treatments to reduce the signs of aging and promote vitality.

SOCIAL SECURITY

We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.
—President Franklin D. Roosevelt on signing the Social Security Act

Social Security is a social insurance program funded through a dedicated payroll tax. It is also known as Old-Age, Survivors, and Disability Insurance (OASDI), which describes its three major classes of beneficiaries.

During the Great Depression poverty among the older population escalated. In 1934 more than half of older adults lacked sufficient income. Even though thirty states had some form of an old-age pension program in place, by 1935 these programs were unable to meet the

growing need. Just 3% of the older population received benefits under these state plans, and the average benefit amount was about sixty-five cents a day.

As advocated by President Franklin D. Roosevelt (1882–1945), social insurance would solve the problem of economic security for older adults by creating a work-related, contributory system in which workers would provide for their own future economic security through taxes paid while employed. By the time the Social Security Act was signed into law by President Roosevelt on August 14, 1935, thirty-four nations were already operating some form of a social insurance program—government-sponsored efforts to provide for the economic well-being of a nation's citizens.

A ccording to the SSA, in "Social Security Basic Facts" (January 31, 2007, http://www.ssa.gov/pressoffice/basicfact.htm), in 2007 more than nine out of ten people aged sixty-five and over received OASDI. Retired workers and their dependents accounted for more than two-thirds (69%) of total benefits paid, whereas survivors of deceased workers accounted for 14% of the total, and disabled workers and their dependents rounded out the total with 17% of benefits paid. An estimated 96% of the U.S. workforce was covered by Social Security.

Even though Social Security was not initially intended as a full pension, 21% of married older adults and about 43% of unmarried older adults relied almost exclusively on the program in 2007. The SSA reports that the program enabled an estimated forty million Americans to live above the poverty level, making Social Security the country's most effective antipoverty program.

Benefits are funded through the Federal Insurance Contributions Act (FICA), which provides that a mandatory tax be withheld from workers' earnings and be matched by their employers. (Self-employed workers also pay FICA taxes.) When covered workers retire (or are disabled), they draw benefits based on the amount they contributed to the fund. The amount of the benefit is directly related to the duration of employment and earnings—people who have worked longer and earned higher wages receive larger benefits.

Workers can retire as early as age sixty-two and receive reduced Social Security benefits, or they can wait until full retirement age and receive full benefits. Until 2003 the full retirement age was sixty-five, but beginning that year it began to increase gradually such that for people born in 1960 or later, retirement age will be sixty-seven. A special credit is given to people who delay retirement beyond their full retirement age. This credit, which is a percentage added to the Social Security benefit, varies depending on the retiree's date of birth. Workers reaching full retirement age in 2008 or later can receive a credit of 8% per year.

Benefits and Beneficiaries

In "Social Security Basic Facts," the SSA notes that in 2006 the program paid benefits to 49.2 million people. The majority were older adults—34 million retired workers and their dependents, along with 6.6 million survivors of deceased workers, and 8.6 million disabled workers and their dependents. The SSA reports in "Status of the Social Security and Medicare Programs" (April 25, 2007, http://www.ssa.gov/OACT/TRSUM/trsummary.html) that in 2006, 162 million people with earnings covered by Social Security paid payroll taxes. Social Security income was $642.2 billion, whereas assets held in special issue U.S. Treasury securities reached $1.8 trillion. Table 2.4 shows the number of beneficiaries of all OASDI programs as well as the total and average monthly benefits paid between February 2006 and February 2007.

Social Security Amendments of 1977

Ever since 1940, the year that Americans began to receive Social Security checks, monthly retirement benefits have steadily increased, but during the 1970s they soared. Legislation enacted in 1973 provided for automatic cost-of-living adjustments (COLAs) that were intended to prevent inflation from eroding Social Security benefits. The average benefit was indexed (annually adjusted) to keep pace with inflation as reflected by the CPI. COLAs were 9.9% in 1979 and peaked at 14.3% the following year. (See Table 2.5.) These increases threatened the continued financial viability of the entire system and prompted policy makers to reconsider the COLA formula.

Some legislators felt that indexing vastly overcompensated for inflation, causing relative benefit levels to rise higher than at any previous time in the history of the program. In an attempt to prevent future Social Security benefits from rising to what many considered excessive levels, Congress passed the Social Security Amendments of 1977 to restructure the benefit plan and design more realistic formulas for benefits. Along with redefining COLAs, the 1977 amendments raised the payroll tax slightly, increased the wage base, and reduced benefits.

The Earnings Test

Legislation enacted on January 1, 2000, changed the way in which the amount that beneficiaries could earn while also receiving retirement or survivors benefits was determined. The retirement earnings test applies only to people younger than normal retirement age, which ranges from age sixty-five to sixty-seven, depending on year of birth. Social Security withholds benefits if annual retirement earnings exceed a certain level, called a retirement earnings test exempt amount, for people who have not yet attained normal retirement age. These exempt amounts generally increase annually with increases in the national average wage index.

Table 2.6 shows the exempt amounts from 2000 to 2007. One dollar in Social Security benefits is withheld for every $2 of earnings more than the lower exempt amount. Similarly, $1 in benefits is withheld for every $3 of earnings more than the higher exempt amount.

What the Public Knows about Social
Security Eligibility

The results of the 2007 Retirement Confidence Survey show that workers' knowledge and understanding of Social Security retirement benefits is incomplete. Most workers surveyed either did not know or were incorrect in their belief about the age at which they would begin to receive full benefits. Half of workers (51%) believe they will be eligible for full benefits earlier than they actually will be and 20% said they did not know when they would be eligible. Just 18% of respondents were able to accurately describe age eligibility requirements for retirement benefits.

SUPPLEMENTAL SECURITY INCOME

Supplemental Security Income (SSI) is designed to provide monthly cash payments to those older, blind, and disabled people who have low incomes. Even though SSI is administered by the SSA, unlike Social Security benefits, SSI benefits are not based on prior work, and the

funds come from general tax revenues rather than Social Security taxes.

In 1972 Congress passed the legislation establishing SSI to replace several state-administered programs and provide a uniform federal benefit based on uniform eligibility standards. Even though SSI is a federal program, some states provide a supplement to the federal benefit.

In "SSI Monthly Statistics" (June 2007, http://www.ssa.gov/policy/docs/statcomps/ssi_monthly/index.html#toc), the SSA reports that of the 7.3 million people receiving SSI benefits in February 2007, over 2 million were sixty-five and older. Even though payments vary by age group, the average monthly benefit received by older adults in 2007 was $384. (See Table 2.7.)

WHAT LIES AHEAD FOR SOCIAL SECURITY?

The Social Security program faces long-range financing challenges that, if unresolved, threaten its solvency (the ability to meet financial obligations on time) in the coming decades. Since the 1980s the program has been collecting more money than it has had to pay out and will continue to do so until 2017. The surplus is not, however, cash that is set aside. Rather, it is loaned to the U.S. Treasury, which places it in the general revenue pool, and it is spent as the government sees fit.

According to the SSA in 2007 OASDI Trustees Report (April 23, 2007, http://www.ssa.gov/OACT/TR/TR07/trTOC.html), without changes to the system, the amount of benefits owed will exceed taxes collected by 2017, and Social Security will have to tap into trust funds to pay benefits. The SSA estimates that the trust funds will be depleted in 2041, leaving Social Security unable to pay scheduled benefits in full to older adult retirees and its other beneficiaries.

To a large extent, demographic changes precipitated this crisis. Social Security is a "pay-as-you-go" program, with the contributions of present workers paying the retirement benefits of those currently retired. The program

is solvent at this time because the number of employees contributing to the system is sufficient. The earliest wave of baby boomers is still in the workforce and at its peak earning years. The large cohort of boomers is funding the smaller cohort of retirees born during the low birthrate cycle of the Great Depression during the 1930s. As a result, there are still fewer retirees depleting funds than there are workers contributing.

In 2008 the seventy-eight million baby boomers will begin to retire, and in about twenty-five years there will be twice as many older Americans as there were in 2005. Gayle L. Reznik, Dave Shoffner, and David A. Weaver of the SSA report in "Coping with the Demographic Challenge: Fewer Children and Living Longer" (Social Security Bulletin, 2005–06) that in 1960 the worker-to-beneficiary ratio was 5.1. This ratio dropped to 3.2 in 1980 and has stayed relatively level since that time. Reznik, Shoffner, and Weaver project, however, that beginning in 2020 the worker-to-beneficiary ration will fall once again, to 2.6, and will continue to decrease. By 2040 they predict that there will be 2.1 workers contributing to the fund for each beneficiary.

Another factor that contributes to the projected shortfall is increased longevity. Along with the anticipated increase in the number of beneficiaries, these beneficiaries are likely to live longer and collect more benefits than ever before. According to the 2007 OASDI Trustees Report, the SSA notes that when monthly Social Security benefits began in 1940, a person at age sixty-five could expect to live an average of about 13.7 additional years; by 2006 the typical sixty-five-year-old was likely to live on average another 17.8 years.

Saving Social Security

There are three basic ways to resolve Social Security's financial problems: raise taxes, cut benefits, or make Social Security taxes earn more by investing the money. It is most likely that restoring Social Security's long-term financial balance will require a combination of increased revenues and reduced expenditures. Ways to reduce expenditures include:

• Reducing initial benefits to retirees
• Raising the retirement age (already slated to rise from sixty-five to sixty-seven by 2027)
• Lowering COLAs
• Limiting benefits based on beneficiaries' other income and assets

Ways to increase revenues include:

• Increasing Social Security payroll taxes
• Investing trust funds in securities with potentially higher yields than the government bonds in which they are currently invested
• Increasing income taxes on Social Security benefits

The 2007 OASDI Trustees Report opines that Social Security could be saved with "an immediate increase of 16 percent in payroll tax revenues or an immediate reduction in benefits of 13 percent (or some combination of the two)."

Personal Retirement Accounts

President Bush and his administration favor partially privatizing Social Security by establishing voluntary personal retirement accounts (PRAs) for younger workers, which would give them the opportunity to establish "nest eggs" for retirement. Under his plan workers would be allowed to put as much as 4% of their wages, up to an annual capped amount, into private retirement accounts rather than into the Social Security trust funds. Guidelines and restrictions would help workers invest their money wisely and protect near-retirees from sudden shifts in market conditions. As workers approach retirement, investments would be shifted from high-growth funds, which carry substantial risks, to secure bonds, which yield lower returns but carry less risk. Besides receiving traditional Social Security benefits, the funds in the accounts would be paid out over time once retirement age was reached.

PROS AND CONS OF PRAS.

Advocates of PRAs contend that they can ensure the permanent solvency of Social Security, deliver demonstrably superior benefits to the vast majority of retirees, and allow for increased flexibility in the age of retirement. According to supporters of the plan, PRAs would offer younger workers a measure of ownership and control by providing them with options and allowing accounts to be passed on to others. They also believe that correcting Social Security's problems with the establishment of PRAs would cost far less than other plans.

Critics of PRAs—among them the American Federation of Labor–Congress of Industrial Organizations, a federation of labor organizations, and the AARP—feel that the accounts are excessively risky for workers, subjecting their retirement savings to a volatile stock market. The money in these PRAs would be invested in things such as stocks and bonds that are not guaranteed to make money. It is even possible for them to decline in value if the stock market suffers a downturn. Critics of President Bush's plan say it exposes retirees to too much risk and takes the "social" and the "security" out of Social Security. Another issue centers on the management fees and administrative costs associated with privately managed funds. Some detractors predict that the accounts would be so expensive to administer that any gains from investments would be offset by management fees.

Even though President Bush's critics do believe the long-term funding of Social Security must be addressed, some feel that the Bush administration has overstated the problem, making the situation appear more critical than it actually may be. In fact, according to Jessica Azulay, in "New Social Security Figures Disprove Bush, Critics Say" (New Standard, March 24, 2005), Jason Furman, a senior fellow with the Center on Budget and Policy Priorities, and Robert Greenstein, the founder and executive director of the center, believe that PRAs may ultimately increase the system's long-term shortfall. They contend that moving a portion of tax revenues into such accounts would divert funds necessary to pay the benefits of current recipients, possibly causing the deficit to occur sooner than anticipated. Most critics favor solutions aimed at increasing revenues.

Could PRAs Satisfy Both Sides?

In "A Fix for Social Security?" (Washington Post, November 27, 2006), Sebastian Mallaby suggests that in the effort to ensure the solvency of Social Security, PRAs could end up meeting the needs of Democrats, who have largely been detractors, and of Republicans. Mallaby offers a promising scenario that involves progressively reducing future benefits using a formula designed by the Democrat Robert Pozen (1946–) that funds Social Security without cutting benefits for low-income workers or raising taxes.

Simultaneously raising the cap on the payroll tax, which would affect the top 6% of taxpayers, could generate the necessary additional revenue. This revenue could then, in turn, be invested in a variety of PRAs, including universal 401(k)s, which would offer workers whose employers do not offer 401(k) plans to realize their benefits. Workers would have the opportunity to contribute to their accounts, and the government could add to or match their contributions, with the most generous government contributions reserved for low-income workers.

Mallaby opines that if PRAs are not presented as simply an alternative to Social Security but instead as a way to promote progressive tax reform and help workers build nest eggs, then they may garner bipartisan support.

Retirement Income Expectations Differ between Workers and Retirees

In April 2006 Gallup Organization pollsters asked Americans about their retirement income expectations. They found that nearly half of adults who had not yet retired (47%) anticipated that their retirement savings plans and personal investment accounts would be their major sources of retirement income. (See Table 2.8.) Just one-quarter (25%) named Social security as a major source of retirement income.

In contrast, most current retirees (55%) point to Social Security as their major source of income. Slightly more than one-third (36%) named a work-sponsored pension plan as a major source of retirement income. Less than one-fifth of retirees counted on their personal savings (14%) or investments in stocks or stock mutual funds (10%). (See Table 2.9.)