The U.S. retirement income system has two main components ó Social Security and publicly subsidized and regulated employer plans. The federal government created Social Security in the Great Depression, when the problem of old-age poverty was especially severe. Social Security is an employmentbased social insurance program that assures older workers a basic replacement income they can no longer work. Contributions are proportional to earnings up to a maximum level; benefits are based on a workerís earnings and contribution history, with a significant redistributive twist to assure a basic old-age income to low-wage workers. Employer plans emerged in the late nineteenth century, but only became widespread after the Second World War when they grew to cover about half the U.S. labor force. These plans were overwhelmingly defined benefit pension plans that firms and unions used to shape the employment relationship: a pension induced workers to contribute a career of long and faithful service. Employer plans and Social Security then helped sever employment relationships at age 65 through ìtake it or lose itî benefits that gave workers little additional net income if they continued on the job. In the decade 1965-1974, the creation of Medicare, a major increase in Social Security benefits, and a thoroughgoing revamping of employer-plan regulation expanded and strengthened the retirement income system. Many firms and unions then added additional sweeteners to reduce the supply of excess workers. The result was a significant increase in old-age incomes and a reduction in the average retirement age for men to 63. Since 1980, reform efforts have focused on two key issues: solvency problems, caused primarily but not entirely by the transition to lower fertility and greater longevity, and the need to realign the system to shifts in the labor market. Policymakers addressed the solvency problem in Social Security by raising the normal retirement age (to reduce benefits at any age) and by accelerating scheduled tax increases and building up the Social Security trust fund. They shored up weak employer pension plans by tightening funding and benefit insurance requirements. Despite these initiatives, major solvency problems remain. In the labor market, the need for mobility among higher-income workers ó the primary participants in employer plans ó undercut the appeal of defined benefit pensions. As a result, they were replaced by defined contribution savings plans that allow mobility and make limited demands on employers. Changes in the labor market also redefined Social Security away from its initial insurance function. Due to improved health and extended longevity, essentially all workers expected to claim a pension while still capable of finding employment. They came to view the benefit not as insurance, but as compensation for a lifetimeís contribution to the system. Policymakers responded by giving beneficiaries greater freedom to claim benefits and supplement their income through work or to increase their pensions by delaying retirement. These reforms eliminated most of the key severance incentives in the U.S. retirement income system. Looking ahead, policymakers must address the continuing solvency problems in Social Security and employer defined benefit pension plans. In addition, the level of income provided by the retirement income system will clearly emerge as a serious concern. Future Social Security benefits will replace a smaller share of pre-retirement income. Employer defined benefit plans are becoming rare. And the limitations and risks in the employer defined contribution system all but guarantee that many retirees will not have the income they need to maintain living standards. As the income provided by the retirement income system recedes, continued work must become a far more important source of support for older Americans. The reforms in both public and private programs facilitate continued full-time or part-time employment by reducing severance incentives and by allowing workers to shift their ìretirement wealthî to older ages. The key to retirement income security will thus be the response of workers ó and employers ó to this new reality.
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Paper provided by Center for Retirement Research in its series Issues in Brief with number
gib_1.
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