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at least 20 percent more of their incomes than current retirees have had to replace. Moreover, since Social Security and Medicare benefits are indexed for inflation, any reduction in those benefits will require an even greater level of savings to protect against inflation. Finally, in the health area workers are likely to face much higher private-sector costs through higher premiums for comparable coverage, increased deductibles and co-payments, and reduced subsidization by employers and the government. Costs for private Medigap insurance will be driven up by Medicare reductions, and those employers that currently offer health insurance to their retirees are likely to continue cutting these programs or requiring greater contributions from the retiree group. The savings rates required to achieve these savings levels can be substantial, even if tax-favored savings vehicles, such as employer-sponsored pension plans, are used. The amount a worker would need to save to last through a retirement beginning at age 65 depends upon when the worker begins saving and the rate of return. At current rates of return, if a worker began saving 20 years before retirement, then 13 percent of wages would need to be saved each year to have enough to replace 20 percent of final earnings, indexed for inflation at 3.5 percent a year. If the worker deferred beginning saving until 10 years before retirement, the percentage would increase to 29 percent. In 1997, the “average” baby boomer is age 40 to 45, so the extra amounts needed to be saved must be started now. Unfortunately, there is no evidence that this is taking place. This example can be translated into dollars. A worker earning $40,000 at final salary (about 60 percent of the Social Security maximum taxable wage) would have to replace about 72 percent ($28,000) of his income at retirement to maintain his preretirement standard of living. If the worker wanted to save 20 percent of this amount through an employer pension plan and began saving at age 45, he would have to save 8.9 percent of pay ($3,571 in the first year) to have enough in a taxsheltered pension program to provide $5,760 a year (about $480 a month) at retirement. The $5,760 was calculated to include a 3.5 percent annual increase to help keep pace with inflation. If the worker began saving 10 years earlier, at age 35, he would have to save only 5.0 percent of pay ($2,016 in the first year) to have $5,760 a year at retirement. Clearly, saving at younger ages is desirable, and delaying saving until after one is 20 years from retirement is very expensive. At age 50, the worker would have to save 13.1 percent of pay ($5,242 a year) to provide the $5,760 annuity for himself and his spouse.

private ones. The need to select among these options is urgent because many of the most attractive ones are long term in nature. If not acted upon soon, they will become too costly or less feasible for other reasons. One reason for long lead times is that it takes many years to substantially increase accumulations of private funds and personal assets. If public programs are to be rebalanced by reducing benefits, as well as increasing funding, it is only fair that workers and their families have a long time to adjust their private asset levels to compensate for the decrease. To encourage higher rates of private savings, then, action should taken soon so that the baby boom generation will have a better idea of what to expect from Social Security and Medicare. Even if the baby boom and generation X ignore this information or do not respond quickly, their employers may, for instance, give workers additional opportunities to save through existing or new pension arrangements. The second reason that long lead times are required is that, without long phase-ins, many reforms would create large differences in benefits between successive generations of retirees. This was the case for the “notch baby” problem caused by the 1977 Social Security amendments. It would also be the case for initiatives like substantially raising the eligibility age for full benefits or switching from an unfunded to a funded system. If reforms are not made well in advance, the only avenue open will be legislation that focuses on cash-flow fixes that increase funding or reduce benefits quickly, like increasing tax rates or cutting back cost-of-living adjustments. The 1997 Medicare revisions are a good example of legislation that focuses on cash-flow fixes rather than long-term structural reform.

Increasing Financial Literacy As part of bringing public programs into fiscal balance and encouraging expansion of private savings options, the task force believes the government should consider placing greater emphasis on public education about retirement-related issues. Tax policy, the traditional tool for influencing private savings, may not by itself be sufficient to address current low savings rates. To be fully effective, tax policy may need to be coupled with educational campaigns on how savings translate into retirement income. Tragically, even though many Americans expect less from public programs in the future, far fewer understand the level of assets needed to support a given retirement income, how much must be saved to achieve that level, and how to factor investment return and time into asset accumulation. Congress’s recent enactment of the Savings Are Vital to Everyone’s Retirement (SAVER) Act is a welcome development, but much more may be needed to improve the financial literacy of American families.

Urgency of the Need for Action As the above examples indicate, many in the baby boom generation have already reached an age where it would be difficult to substantially increase their potential retirement income from private sources. And, if those who follow the baby boom are to provide more for their retirement, they too will need to begin saving soon. Although the situation is urgent, it is far from hopeless if action is taken now. The task force has enumerated a long list of options and potential approaches for addressing the current imbalance in public programs and the shortcomings of

Improving the Policy-Making Environment In the course of its research, the task force noted three changes that might possibly expedite policy making in the area of retirement income policy. 32


The Problem and Options for Change PublicPolicyMonograph 1998 No. 1 A MERICAN A CADEMY of A CTUARIES