Retirement Income Security Programs
Avoiding the Train Wreck
by Scott D. Miller and Carol R. Sears
With defined benefit plans disappearing, Social Security in doubt,
and retirement savings potentially inadequate, future retirees
worry about outliving their incomes. Retirement income security
programs help take some of the want and terror out of old age.
An actuarial train wreck is fast
approaching. The wreck will occur when
the dearth of defined benefit pension
plans, coupled with the lack of adequate
retirement savings, collides with ever-improving
life expectancies of our nation's
baby boomer and future retiree generations.
We foresee a time in which our elderly
will be out of income options and
devoid of income protection insurance.
No legislative initiatives or other approaches
address this real problem.
Legislators try to apply band-aids to the
current broken defined benefit pension
and Social Security systems, but that's
not the answer. Actuaries and other
pension professionals need to define the
real problem and use their combined intellect
and experience to build the best
forward-thinking retirement program
system that will truly protect our growing
Retirement Today and Beyond
Traditional defined benefit pension plans treat retirement as a cliff
transition from working one day to not working the next.
This is no longer true. People are living longer, healthier lives
than ever before. Longevity for many 65-year-olds will soon exceed
40 more years. This improved longevity, combined with
low retirement savings in 401(k)s and other voluntary plans, will
result in retirement incomes dismally inadequate to maintain
acceptable living standards after full work stops at customary
retirement ages. Not very many people will be able to afford to
completely retire on accumulated savings.
Adding to the problem, traditional retirement plans are being
frozen or terminated for a number of reasons:
- Most employees don't appreciate the value of defined benefit
pension plans, and they offer little resistance to plan terminations
or ceasing of future benefits accruals.
- FASB 87, 88, and 132 obligations and disclosures are too unpredictable,
and their effects too draconian. Existing FASB rules
truly affect the ability to run a business well.
- Ever-increasing longevity has made providing full benefits for
such a long time too expensive.
- Post-retirement accrual rules make it financially unattractive
for companies to retain workers beyond age 65 in traditional plans
because additional accruals at high ages significantly affect FASB
and real costs in a negative way. There is a strong disincentive to
let trained employees stay, even though they need, and often want,
to continue to work on a diminishing basis. This disincentive is
not logical when we know that there is an upcoming employment
dearth and people can't afford to fully retire at traditional ages anyway.
Just as we do for health, life, and disability,
tomorrow’s retirement programs should treat
as an insurable event. Generally,
people choose to insure
risks that would
throw their lifestyles into financial crisis.
We need a new approach to retirement, one that accepts that
there must be a transition period from full work to full retirement,
allowing the elderly to continue working well past the traditional
retirement age. Already a significant and growing percentage of
people over the age of 65 continue to work, either full time or part
time, in their old jobs or in new ones.
Our culture needs to change to accommodate retirement income
packages that don't have to pick up full income needs until
full work cessation. This diminishing need for full financial support
during the transition period can be recognized in the program
design and help to make it feasible for an employer to provide for
the catastrophic benefits really needed after full work stops.
Since retirement savings programs will no longer have to last a
lifetime, their goals can be finite and determinable. Workers can
worry less about the adequacy of their pre-retirement savings
and be more comfortable about prudently spending down their
accounts in retirement.
Even though a recent AARP survey of 1,200 baby boomers found
that more than 80 percent expect to work at least part time in their
retirement years, no one can work forever. Post-customary-retirement-
age work gradually decreases as the individual ages. Cessation
of all work-based income doesn't occur until perhaps the early
70s or later for a fast-growing percentage of the retirement-age
population. The three-legged stool of retirement income (personal
savings, Social Security, and income from employer-sponsored
retirement programs) has become a four-legged stool with the
addition of continued part-time employment income.
Current post-retirement accrual, existing funding requirements,
and Financial Accounting Standards Board (FASB) accounting
rules make it nearly impossible for an employer to afford
a traditional defined benefit program. Our Social Security program
is also suffering. Recently announced legislative initiatives
only exacerbate the funding problems.
This predicament is particularly vexing because the future
workforce isn't large enough to replace the baby boomers. So
why let willing employees who have advanced training and valuable
experience fade into the sunset? Instead, employers should
be finding ways to entice dedicated, skilled workers to remain on
the job past their customary retirement age.
Because careers and work may continue for more than 50
years in the new working world, it's important to build careerenhancing
and family-life-care-needs income into the retirement
programs of the future.
Let’s recognize and embrace this cultural change and design
an affordable program that provides benefits in a time of crisis,
whether for short periods of work cessation during one's career or
during the periods of later-age work slowdown and final cessation.
We further suggest that providing work/life balance income during
advanced education and training, or approved philanthropic
ventures (that could be valuable to both the employer and the
employee) or periods when there is a need to take care of sick
or elderly family members, be accepted as a form of temporary
retirement and be an important part of our proposed retirement
program of the future.
A New Retirement Perspective
Just as we do for health, life, and disability, tomorrow's retirement
programs should treat longevity as an insurable event. What does
Insurance, in its most basic form, is a pool of money that pays
benefits only to the premium payers who suffer the fundamental
risk (e.g., sickness, death, disability). Generally, people choose to
insure only life contingent risks that would throw their lifestyles
into financial crisis. Those losses that can be predicted and/or
easily replaced by current financial income and savings don't need
to be insured. Ideally, one should have enough savings to cover
all predictable expenses. It's the unpredictable, catastrophic expenses
that need to be insured.
Ironically, in this case, living a longer, healthier life is the catastrophic
event that needs benefits protection.
Purchasing individual insurance policies is generally more expensive
and less efficient than buying policies as a group. Employer-
sponsored benefit programs have worked well as vehicles to
offer this pooled insurance coverage for our working population
by providing group health, life, and disability insurance. Indeed, a
worker's true level of compensation is usually considered to be a
combination of wages, contributions to retirement and other savings
programs, and other employer-paid benefit expenses (such
While workers expect that they'll receive each dollar of an employer's
contributions to benefit programs such as 401(k) plans
through deposits into their accounts, workers accept that dollars
spent on insurance programs are returned only to the people who
have the applicable benefit claim. For example, even though the
employer may pay $10,000 in health insurance premiums for an
employee, if that employee has only $2,000 of medical expenses,
that's all he'll receive; the remaining $8,000 stays in the insurance
pool to pay the insured benefits of others. The average worker knows not to expect a dollar-for-dollar credit for employer-paid
insurance premiums in contrast to wages and savings programs.
Protecting the risk of outliving income resources in old age is
emerging in everyone's awareness as equal in importance to covering
other traditional catastrophic life-contingent risks such as
medical care and death. This urgent need for catastrophic financial
protection can't be met by an employer-sponsored program
under today's tax laws. A new kind of benefits program needs to
be created to insure against the risk of people outliving their other
This program would work essentially like an annuity and pay
a stream of gradually increasing life contingent benefits. In addition,
the program may optionally cover permitted breaks from
the workforce before retirement.
Our concept is similar to the growing trend in health care.
Health savings accounts (HSAs) for day-to-day and predictable
medical costs, used in connection with high-deductible health
plans for the unpredictable catastrophic medical costs, can work
for individuals who understand and accept the concept. Retirement
programs should follow this lead by using 401(k) or other
account-balance-accumulation-type plans as the savings accounts
for expected or desired retirement expenses, while a new kind
of employer-sponsored retirement program protects against the
unpredictable events, such as living too long.
Retirement Program of the Future
Based on what we've learned from our industry's retirement plan
experiences, and keeping in mind the actual emerging income
needs of our nation's retirees, we suggest that where possible,
employers sponsor a multi-plan retirement program to meet the
retirement income needs of their employees.
No one type of program will do the job. At a minimum, all employers
should be strongly encouraged to sponsor a new kind of plan,
the retirement income security plan (RISP), in addition to whatever
401(k) and/or defined benefit plans fit their business goals.
The RISP, essentially a monthly-benefit-type program, is intended
to provide reasonable, affordable, and essential needs-only
retirement income protection that's missing today. Without such
plans, expect a future social crisis.
Savings plans should be the next most important component
of the twofold program of tomorrow. Employers need to sponsor
401(k) programs. These plans provide employees with a vehicle
to take responsibility for their retirement, by encouraging them
to save personally. In addition, employers have another plan that
allows them to add to employees’ retirement savings through
Where possible, employers should be encouraged to adopt
and sponsor traditional and hybrid defined benefit pension programs.
Employers should continue to benefit from these types
of plans because they can grow with their business and suit their
unique business objectives, while providing employees with additional
What Do RISPs Look Like?
RISPs are not intended to replace current qualified retirement
plans. Rather they're to be companion, catastrophic-coverage-only
plans. Some features we suggest include:
- A benefit formula of .5 percent, 1 percent, 1.5 percent, or 2
percent of final average compensation times years of service would
- Years of service can include up to five years of past service from
- Final average compensation is at least an average over five consecutive
years but may be any number of years including career
- Compensation used must be gross compensation as defined for
maximum benefit purposes under IRC Section 415.
- The form of benefit should be an annuity payable for life of
the participant, with 50 percent of the benefit continuing to the
surviving spouse, if married.
- No optional benefits, even if actuarially equivalent, should be
offered. Allowing smooth benefit payments or lump sums would
undermine the purpose of these plans and interfere with new proposed
funding rules that apply to RISPs.
- All benefit payments will commence at age 65, regardless of the
participant’s employment status.
- Benefits will be payable in gradually increasing increments: 25
percent of the full benefit formula from ages 65 through 67, 50
percent from ages 68 through 71, 75 percent from ages 72 through
74, and 100 percent starting at age 75.
- RISP annuity benefits are calculated as of the earlier of termination of employment or age 65, with no increases to the benefit
level after 65 due to additional service or compensation. Benefits
would, however, be increased at each benefit tier (e.g., when the
benefit level increases from 25 percent to 50 percent). Increases
would be tied to some economic index, such as the average wage
base that Social Security uses. If the individual is still employed,
employer contributions and accruals, if any, would continue after
benefits from the 401(k) commence.
- Pre-retirement death benefit is the minimum qualified pre-retirement
survivor annuity (as per existing qualified pre-retirement
survivor annuity rules).
- No early retirement subsidies or options are available.
- No subsidized disability benefits are provided.
- The plan sponsor may reduce, increase, or freeze future benefit
accruals, depending upon business needs.
- Plan eligibility rules should follow existing minimum statutory
- Controlled groups may sponsor a single RISP.
Mid-career benefit payouts:
- These payouts would be available for a limited period of time.
- These payouts might occur for approved work-related academic
or training sabbatical, a pressing family care need, or an approved
- These mid-career payouts might be permitted once every x
number of years or perhaps only a certain number of times the
retirement benefit begins. The participant would need to be unemployed
during these mid-career payout periods.
- Interest rate assumptions must equal the yield curve rate or
other prescribed rate (i.e., as ultimately adopted for ERISA required
- All other actuarial valuation assumptions (e.g., pre-retirement
turnover, disability, mortality, cost of living, mid-career benefit, marital
status probabilities) are to be chosen at the discretion of the plan's
enrolled actuary, based upon the best estimate of future experience.
- Funding method must be “level percent of pay” or “level dollar”
entry age normal, with entry age calculated as of the date of the
first year of service credit (which can be no more than five years
prior to plan adoption).
- Each tier of annuity benefit will be funded separately, that is:
25 percent of the full annuity benefit due to commence at age 65
will be funded from entry age to age 65; an additional 25 percent
of the full annuity benefit (with assumed cost-of-living increase),
which commences at age 68, will be funded from entry age to age
68; the same will occur for the 25 percent benefit increases (with
assumed cost-of-living increases) at ages 72 and 75.
- All amortization bases, including past service bases, may be
funded immediately or over no more than five years, at the annual
election of the plan sponsor.
- Mid-career benefits would be funded actuarially, as would any
other ancillary benefit, and it would be considered as part of the
entry age normal accrued liability during the first retirement benefit
age tier (age 65) funding period.
- Current liability is equal to the entry age normal accrued liability.
- Contributions must be adjusted by the required funding interest
rate assumption from date of valuation to dates of deposit.
(Note: FASB disclosures are based upon entry age normal accrued
liabilities, and FASB net periodic pension costs equal actual contribution
obligations. That is, the enrolled actuary's funding actuarial
valuation matches the FASB disclosures and amounts.)
The Final Question
Why would an employer sponsor such an insurance-type benefits
program with companion 401(k) plan or similar savings program?
If the U.S. population is to enter its later years of life with financial
security and peace of mind, employers must take on the responsibility
of adding this type of guaranteed longevity income benefit
to their benefits program.
The three R's of wage and benefit programs never change:
recruit, retain, and reward. Our proposed type of program helps
to support this. As employees begin to understand that survival
beyond one's means is a distinct probability, they'll be attracted
to employers that offer this type of benefits program. Retention
and appreciation would improve. The RISP, with new smoother
funding and FASB rules, would be much more affordable and
much less volatile than today's qualified defined benefit pension
programs, which are quickly becoming extinct.
It's time to redefine retirement. Let our industry lead in this area,
and let us build a better, but more secure, U.S. retirement system.
Scott D. Miller is a principal and consulting actuary with
the Actuarial Consulting Group, Inc. in Quogue, N. Y.
Carol R. Sears is a principal and consulting actuary with the same firm
in Morton, Ill.
Contingencies (ISSN 1048-9851) is published by the American Academy of Actuaries, 1100 17th St. NW, 7th floor, Washington, DC 20036. The basic annual subscription rate is included in Academy dues. The nonmember rate is $24. Periodicals postage paid at Washington, DC, and at additional mailing offices. BPA circulation audited.
This article may not be reproduced in whole or in part without written permission of the publisher. Opinions expressed in signed articles are those of the author and do not necessarily reflect official policy of the American Academy of Actuaries.
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