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There is a widespread perception that most Americans are inadequately prepared for retirement. The story pushed by pundits and policy makers is that the shift over the past 30 years from defined-benefit pensions to defined-contribution savings plans such as 401(k)s has dramatically reduced retirement income to supplement the benefits provided by Social Security.
Sen. Tom Harkin (D., Iowa) has introduced legislation to increase Social Security benefits and build a government-run supplemental saving plan. Sen. Elizabeth Warren (D., Mass.) has so captivated progressives with her demands to raise Social Security payments that she is touted as a potential presidential candidate in 2016.
Nevertheless, the story about the declining income prospects of retirees is not true. The story is largely based upon data from the Current Population Survey, conducted annually by the U.S. Census Bureau. Data from the Current Population Survey, or CPS, form the basis of the Social Security Administration’s Income of the Aged publication series—which is widely cited as showing that Americans’ inadequate retirement incomes force them to increasingly rely on Social Security benefits. But the CPS fails to count most of the income Americans derive from 401(k) and IRA plans, as well as significantly understating the percentage of current American workers who are saving for retirement.
The CPS measures the sources and amounts of income received by American households, including income from retirement plans. The Census Bureau’s definition of income, however, includes only payments made on a regular, periodic basis. So monthly benefits paid from a defined benefit pension or an annuity are counted as income, while as-needed withdrawals from 401(k)s or IRAs are not.
This definition of income obviously understates the resources available to retirees. And this understatement will only grow as more and more Americans save for their retirement through defined-contribution plans and not from defined-benefit plans.
The misperception about retirement income becomes clearer when other data are taken into account. For 2008, the CPS reported $5.6 billion in individual IRA income. Retirees themselves reported $111 billion in IRA income to the Internal Revenue Service. The CPS suggests that in 2008 households receiving Social Security benefits collected $222 billion in pensions or annuity income. But federal tax filings for 2008 show that these same households received $457 billion of pension or annuity income.
In combined terms, the Current Population Survey that ostensibly documents how poorly pensions and individual retirement plans provide retirement income ignores at least 60% of the income being delivered to retirees. Even that is not the whole story—because tax filings do not include distributions from Roth plans, since those distributions are not taxable.
Tax figures omit pension and IRA distributions to low-income retirees who do not file annual tax forms. Across most income levels, the tax data show that 50% more households report pension or IRA income than the census data. The tax data also show that those households collecting pension income receive about 50% more than the Current Population Survey suggests.
The CPS also understates the share of working-age individuals participating in retirement plans, reinforcing the view that Americans are inadequately preparing for retirement. According to the CPS, only around half of American workers are offered a retirement plan by their employer, prompting calls both for increased Social Security benefits and new government-run retirement plans.
But the Current Population Survey relies on responses from individuals, who often make errors. A 2011 analysis, “Assessment of Retirement Plan Coverage by Firm Size, Using W-2 Tax Records,” by the Social Security Administration’s Office of Retirement and Disability Policy, found that 72% of all workers in private business in 2006 were offered retirement plans, rising to 84% at firms of 100 or more employees.
The Social Security Administration has used the Census survey for the last 40 years to report the income status of the elderly. The agency has known for nearly 20 years that CPS data ignored much of the retirement income paid out by pensions and IRAs, and that the underreporting of this income was a growing problem. The agency’s own policy analysts have been increasingly forthright in pointing out the shortcomings of the CPS in measuring retirement income. For example, “Shifting Income Sources of the Aged,” a 2012 study by the Office of Retirement and Disability Policy, concluded that the CPS “greatly underreports distributions from DC plans and IRAs, posing an increasing problem for measuring retirement income in the future.”
Nevertheless, Social Security Administration summary reports developed from CPS data continue to be published. They are widely cited as justification for expanding Social Security and shifting away from the 401(k) and IRA saving system that today produces more income for retirees than does Social Security. Based on this faulty data, activists propose enlarging Social Security, which itself is dramatically underfunded, currently operating in deficit, and facing depletion of its trust fund in fewer than 20 years.
Without doubt, we need pension reform, but we need to have a full, accurate and honest understanding about how all the elements of the current retirement income security system are working if we hope to have any chance of making the right adjustments to current policies.
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