An Online Simulator for Testing Reform Options
Our Social Security Simulator: An objective, neutral, bipartisan tool
for understanding Social Security issues quickly and accurately.
Select Your Preferred Economic Assumptions
Expected Long-Run GDP Real Growth Rate
Stock Market Scenario Preferred
Key Stock Market Assumptions
Expected Dividend/GDP Ratio
Expected Index Fund Lag Factor
Expected Real ROI, Stocks
Expected Real ROI, Bonds
Likely PRA Management Fees, Pre-Retirement
Likely Annuity Management Fees, After Retirement
Likely Trust Fund Asset Management Fees
Turn On Inheritance Leakage Assumptions
Percent of Inheritance Dollars That Leave the Retirement System
Percent of Inheritance Dollars Transferred to Spouse's PRA
Percent of Inheritance Dollars Transferred to Children's PRA's
Percent of Inheritance Dollars Transferred to Grandkids' PRA's
Policy Leakage: PRA Savings/Year Lost to Non-Retirement Uses
Select Your Preferred Economic Assumptions
This Simulator provides two sets of input tools - prediction tools and decision tools. The Assumptions Page supplies a menu of prediction tools, while other pages offer a broad set of decision tools.
Economic prediction is a vital factor in the Social Security debate, though its role is not always as objective as it could be. Conservatives like to give an optimistic gloss to predicted stock market returns, liberals a pessimistic gloss. On the issue of Social Security's future solvency, liberals tend to minimize, conservatives to exaggerate. And so it goes.
Most variables listed on the Assumptions Page are those over which no one has any real control. At the same time, every reform strategy is to some extent at the mercy of these same variables. If you are searching for a realistic solution, it makes sense to pick choices that are as realistic as possible.
Expected Long-Run GDP Real Growth Rate. Social Security's Office of the Actuary prepares the annual Trustees' Report, which regularly updates Social Security's rolling 75-year forecast. The forecast covers both OASI and DI, Social Security's Old Age and Survivors Insurance program (OASI), and its Disability Insurance program (DI). Of course, the forecast also blends its separate OASI and DI forecasts into a combined OASDI forecast. We use the combined OASDI forecast as the foundation of the Simulator's analysis.
In making its OASDI forecast, the Office of the Actuary tries to determine, as best it can, the likely growth rate in the nation's Gross Domestic Product (GDP). Two primary factors drive GDP growth - growing productivity and a growing work force. Inflation-adjusted GDP growth has historically averaged about 3.3% a year. Of that 3.3% growth, productivity growth has in recent decades accounted for roughly 1.8% of the total, while workforce growth has added another 1.5%.
Now, they say, our nation is in the midst of a profound change. America's population and workforce growth rates are expected to shrink dramatically, almost to zero, as the 21st Century unfolds. Future GDP growth will, therefore, be almost entirely at the mercy of future gains in productivity. What should we expect? Will the productivity growth rate rise, shrink, or stay the same?
The productivity growth rate is not an easy number to forecast, partly because annual productivity gains fluctuate somewhat, falling now to 1%, rising now to 3%. Social Security's intermediate case forecast assumes long-run real productivity growth of 1.5% a year and long-run real GDP growth of 1.6%.
If productivity grows at 1.5% a year, how fast will real wages grow? According to Social Security, real wages are likely to grow 0.5% more slowly than productivity. A real productivity growth rate of 1.5% implies, we are told, a real wage growth rate of 1.0%.
Sounds simple, but it's not. The "real" gap between productivity growth and wage growth is only 0.3%. The remaining 0.2% is a "measurement gap," rooted in the quirky techniques that economists use for constructing "GDP Deflators" and "CPI Deflators." If this piques your curiosity, stay with us. We'll try to explain.
Nominal Growth Rates. Social Security forecasts a long-run nominal growth rate for productivity of 4.6% a year, a long-run nominal growth rate for wages of 4.3% a year.
The Real Gap. The 0.3% gap between 4.6% nominal productivity growth and 4.3% nominal wage growth is real. Part of the gap, 0.2%, arises from a steady increase in fringe benefits. (Fringe benefits aren't included in calculating nominal or real wages - they belong to a broader category, "Compensation," which embraces both wages and fringe benefits.)
The remainder of the gap, 0.1%, arises from a gradual long-term decline in weekly hours of work. (The wage number measures growth in weekly wages. Since employees respond to rising hourly wages by gradually reducing weekly hours worked, weekly wage growth lags hourly wage growth by 0.1%.)
Adding the Measurement Gap. Now watch what happens when these two nominal growth rates are converted to real growth rates. The gap widens. Economists typically use the GDP Deflator to deflate nominal productivity growth. When Social Security economists apply a 3.1% GDP Deflator to a 4.6% nominal productivity growth rate, they end up with a 'real' productivity growth rate of 1.5%.
On the other hand, economists routinely use the CPI Deflator to convert nominal wages into real wages. When Social Security economists apply a 3.3% CPI Deflator to a 4.3% nominal wage growth rate, they end up with a 'real' wage growth rate of 1.0%.
Note the discrepancy. A starting gap of 0.3% widens to 0.5% as nominal rates are converted to inflation-adjusted rates. Seeing this, a normal person logically asks: "Which is more 'real'? If the 3.1% GDP deflator is more real, shouldn't productivity growth be set at 1.5% and wage growth at 1.2%? Or, if the 3.3% CPI deflator is more realistic, shouldn't real productivity growth be forecast at 1.3% and real wage growth at 1.0%? Hey, guys, how about some consistency here?"
Perfectly good questions, but, alas. Social Security's economists are apparently locked into these procedures by the arcane rules of their discipline. So what if the GDP and CPI deflators are different by 0.2%? So what if they do produce an extraneous "measurement gap" of 0.2%? That's the way economists do things. Get over it.
And so we do. With apologies to our users, we take the same path.
The Scenario offers four options for future GDP growth - 1.6% (the Trustees' choice), 2.1%, 2.6%, and 3.1%. These options imply real productivity growth rates of 1.5%, 2.0%, 2.5%, and 3.0% respectively. They also imply real wage growth rates of 1.0%, 1.5%, 2.0%, and 2.5%. Benefit obligations are adjusted accordingly, and the Simulator incorporates year-by-year output from special sensitivity runs prepared for us by Social Security's Office of the Actuary.
From our perspective, the Trustees' 1.6% GDP growth forecast seems low, while our 2.6% option may be a trifle high, and our 3.1% option almost certainly unattainable. We recommend a growth forecast of 2.1% as our 'most likely.' But it's your call.
As you test the higher growth rate options, you will notice some improvement in Social Security's financial prospects. And you may wonder: Why the improvement? Why does a faster GDP growth rate make any difference at all?
Social Security calculates its retirement benefits by using each retiree's career "average wage." The faster the economy grows, the smaller the overall career "average wage," relative to the retiree's final pre-retirement wage. As a result, calculated benefits for each new retiree are slightly cheaper than they would have been in a slow growth economy. Extrapolate this pattern across all retirees in the system, and you can see why - in a faster growth economy - Social Security's total benefit obligations won't be quite so large.
Noting this pattern, a few economists contend that the solvency problem is really a phony crisis, that the nation wouldn't even be discussing this issue if Social Security were forecasting future growth rates more realistically. As the phony crisis claim has received rather wide circulation, you may well be interested in putting it to the test. The Simulator's four GDP growth rate options allow you to do exactly that.
Stock Market Scenario Preferred. Our Solvency Simulator contains a built-in stock market simulator. In the convenient world of budget forecasting, it's nice to pretend that annual real returns on stocks will behave just like savings account interest rates. It makes long-run forecasting so much easier. If you like that sort of convenience, pick the first choice, "Market Capitalization to GDP Ratio Steady."
All our solution-finding Scenarios use the 'steady' choice. There's no other realistic way to determine the direction in which the Funds-to-Benefits Ratio is heading in the 2070 to 2075 time period, no other good way to determine whether the solvency problem has been "solved" or not. In fact, if you select Scenario D, E, F, or G, you won't even see the "cyclic" option displayed.
In the real world, of course, the Market Capitalization-to-GDP Ratio never stays put. Even during stock market "Troughs" and "Plateaus", which are, relatively speaking, periods of calm, the Market Cap-to-GDP Ratio fluctuates vigorously. (The Market Cap-to-GDP Ratio fluctuated between 35% and 50% during the market's 1943-52 and 1974-84 Trough periods. It fluctuated between 80% and 105% during the market's 1962-72 Plateau period.)
As we look at the empirical evidence from 1925 onward, we believe we see a broad, four-phase cycle of Crash-Trough-Growth-Plateau repeating itself at thirty-year-plus intervals. We have, therefore, constructed a hypothetical model based on this rhythm, with two full stock market cycles playing themselves out between 2002 and 2075. The Simulator uses both these long cycles and an ongoing series of minor fluctuations to derive its year-by-year real ROI estimates. (Real ROI = Real Return On Investment). Our 'ROI Display' page shows you how this works.
If you select an investment-based strategy for strengthening Social Security and incorporate stocks into that strategy, the market scenario you choose ('steady' or 'cyclic') will affect the results displayed by Chart 1A, the "assets as a percent of GDP" chart, and the Chart 5B results, "the stock assets as a percent of market capitalization" chart. Pick the "steady" option, and Charts 1A and 5B will look rather smooth. Pick the "cycles likely" option, and the same graphs will be somewhat bumpier. After experimenting with both approaches, you may decide that the 'cyclic' option creates a more realistic picture of Social Security's potential presence in the stock market.
Key Stock Market Assumptions. Year-by-year stock market ROI (Return On Investment) is, in our Simulator, a short-hand term for the real returns that PRA's and the Social Security Trust Fund would earn by investing in market-wide or 5000-stock index funds. Any such fund is analogous to a mutual fund based on the Standard & Poor's 500 stock index.
Total ROI consists of two elements - capital appreciation and reinvested dividends.
Over the long run, capital appreciation in an index fund is linked to the GDP growth rate, minus an "Index Fund Lag Factor." In the short run, capital appreciation is also affected by transitory fluctuations in the Market Capitalization-to-GDP Ratio.
Dividend yields in an index fund are linked to two important factors: the Dividend/GDP Ratio, on the one hand, and Total Market Capitalization, on the other. Dividend yields rise when the Dividend/GDP ratio rises; they also rise when Total Market Capitalization falls. The reinvested dividend rate is quite important, as reinvested dividends have historically accounted for two-thirds of the Standard &Poor's 500 long-run real return rate.
There are two sets of choices available to you in this section - the Dividend/GDP Ratio and the Index Fund Lag Factor. As you'll see, each GDP Growth Rate choice has its own pair of choices. By modifying the Dividend/GDP Ratio and the Index Fund Lag Factor, you can fine-tune the Simulator's long-run economic predictions about stock market behavior and potential index fund returns.
Expected Dividend/GDP Ratio. If you click each of the four GDP growth rate options (1.6%, 2.1%, 2.6%, and 3.1%), you will see four separate pairs of boxes appear, one pair for each growth rate choice. Boxes in the top row contain estimates for the Dividend/GDP ratio. We have arbitrarily picked some starting values for these boxes, but we freely admit to eyeballing these estimates, as no one really knows what the future Dividend/GDP ratio is likely to be. We do have a hunch. If the economy grows rather slowly, we'd expect lower corporate profits and a lower volume of dividend payments. If the economy grows more rapidly, we'll expect correspondingly higher profits and a higher Dividend/GDP Ratio. As you will see, our preliminary Dividend/GDP settings are based on this hunch.
Nonetheless, such forecasting is anything but exact. Corporations are as subject to fads, in their own way, as the nation's teenagers. If the nation's finance professors preach a gospel of "no dividends, reinvest for growth," and if this notion is widely adopted by corporate executives, dividend payments to shareholders would suffer. On the other hand, Congress might at some point terminate the double taxation of dividends. Should this occur, the Dividend/GDP Ratio could rise to a surprising level.
So it's your guess. High Dividend/GDP numbers are capable of producing higher dividend yields, provided that the Market Cap-to-GDP Ratio stays reasonably level. Or, from another angle, one might expect higher Dividend/GDP Ratios to trigger higher Market Capitalization-to-GDP Ratios. For additional insight into these matters, spend a few minutes analyzing the formulas on the Simulator's ROI Display.
Expected Index Fund Lag Factor. You may not be familiar with this concept. If so, that's quite unfortunate. There is a lag factor, it's real, and for indexes based on small groups of stocks, it's quite substantial.
We first learned about the Lag Factor when we asked Jeremy Siegel, the Wharton guru, why his research showed long-run capital appreciation in the S&P 500 trailing the long-run GDP growth rate. Because, Siegel explained, not all the factors that drive GDP growth can be captured in an index fund portfolio. New companies enter the stock market. Companies not listed in the S&P 500 have faster growth rates than companies which are listed in the S&P 500 index. And so on.
So we went about analyzing this for ourselves. How best to measure the capital growth rate of an index fund? We had already graphed the Market Capitalization-to-GDP Ratio, and been intrigued to find stock market capitalization sometimes dropping as low as 35% of GDP, sometimes rising as high as 105% of GDP, and rising, by the late 1990's, as high as 180% of GDP.
In thinking this over, we realized that Siegel's capital appreciation calculations suffered from an important flaw. He'd chosen as his starting point a year with a low Market Capitalization-to-GDP Ratio. For his ending point, he'd picked a year with a much higher Market Capitalization-to-GDP Ratio, introducing an upward bias that doesn't reflect the true long-run average capital appreciation rate in the Standard & Poor's 500 Index.
If the S&P 500's long-run capital appreciation rate is to be measured accurately, we concluded, it must be measured on a Comparable Year basis. It's important for the starting and ending years to have similar Market Capitalization-to-GDP Ratios.
For our own analysis, we picked two pairs of years that offered comparable Market Cap-to-GDP Ratios, a peak-to-peak pair (1965 - 1995) and a trough-to-trough pair (1954 - 1990). We eliminated inflation. And we measured the "CAGR", the Compound Annual Growth Rate, of the S&P 500 index and the GDP over both those time periods. For comparison, we also measured the inflation-adjusted growth rate of the Dow Jones index. The S&P 500 Lag Factor turned out to be quite substantial, trailing the GDP growth rate by about 1.5%. The Lag Factor for the Dow Jones index, a 30 stock index, was substantially worse. For more details, see Are Seven Percent Returns Realistic? elsewhere on this website.
The Lag Factors we have tentatively selected for the Simulator are not as high as those we found in analyzing the S&P 500 and the Dow. Two reasons for our optimism are based on logic; the third is wholly intuitive. In a slower growing 21st Century economy, we shouldn't expect the Lag Factor to be as great as it was in the 20th Century's faster growth economy. Furthermore, we shouldn't expect the Lag Factor to be as large in a 5000-stock index fund as in a 500-stock index, as the market-breadth index has a better chance of capturing total GDP growth. And, intuitively, we also think that pessimistic estimates of the Lag Factor entail unrealistically low Market Cap-to-GDP Ratios.
Now it's up to you. We recommend lower Lag Factors for slower GDP growth rates, and higher Lag Factors for faster GDP growth rates. It's your choice.
Expected Real ROI, Stocks. In forecasting Social Security's future, it's comforting to be able to select a specific Return On Investment (ROI) rate for stocks. Right or wrong, at least we know what we're dealing with. The Simulator supports that desire. Pick the real ROI that you think most likely, and the Simulator will generate a long-run real ROI for stocks that matches the rate you've chosen here.
If you've already chosen an investment strategy for Social Security, involving the Trust Fund, PRA's, or both, the Real ROI rate you select will certainly affect your strategy's overall prospects. Specify a high ROI, and you'll see greater success in protecting long-run solvency; specify a low ROI and you'll see somewhat less success. Bear in mind, though, that long-run Real ROI is not your decision to make or anyone else's. All you're asked to do is predict the likely rate of return for stocks held in a 5000-stock index fund. Once you've made your forecast, the Simulator takes it from there.
Your ROI selection also affects the level of the Market Capitalization-to-GDP curve displayed in Chart 4. You'll see an inverse relationship between the overall level of this curve and the overall Return On Investment. The lower the Real ROI rate you forecast, the higher the overall curve in Chart 4. And the higher your ROI forecast, the lower the curve in Chart 4.
The inverse relationship between Real ROI and the Market Capitalization-to-GDP Ratio has already been shown historically. The low "Trough" years of 1943-52 and 1974-84 produced above average returns to the Standard &Poor's 500 Index, while the high "Plateau" years of 1962-72 produced lower than average returns. Why? Dividend yields. The lower the market's total value, the higher the dividend yield, the higher the Real ROI.
As you become more familiar with the Simulator, you'll eventually conclude that the real world cause-and-effect sequence has been inverted. In the Simulator, your stock ROI pick affects the level of the Market Cap-to-GDP curve. In real life, it's the level of the Market Cap-to-GDP curve that affects long-run ROI. The relationship is right, the correlations are right, but the Simulator's cause-and-effect sequence has been flipped.
There's a reason for this. We designed the Simulator to let you pick the Real ROI you wanted. We could have done the opposite. The Simulator could have been set up to obtain your Market Cap-to-GDP forecast, then used your prediction to derive the likely ROI for stocks. Such an approach would have matched the real world linkages more accurately, but wouldn't have satisfied the widespread desire to pick an ROI number and see where it takes us.
Not to worry. On this point, at least, you can have your cake and eat it too. If you like, you can forecast real ROI's for stocks without worrying about the Market Cap-to-GDP Ratio implied by your forecast. At the same time, you're perfectly free to tinker at some length with Real ROI until you see the Market Capitalization-to-GDP Ratio in Chart 4 stabilize at the level you most expect. Real returns to stock index funds are, in life, correlated with overall Market Capitalization; the Simulator allows you to spend as much or as little time on that correlation as you choose.
Expected Real ROI, Bonds. The Simulator treats bonds as relatively stable securities, given the Federal Reserve's demonstrated success at curtailing inflation and its institutional commitment to low inflation growth. Bonds, if bought at issue and held to maturity, are predictable sources of income. Any investment program as massive as Social Security's will inevitably possess a portfolio with properly staggered bond maturity dates. The Simulator, therefore, does not give you a wide range of choices.
If you disagree with this, let us know. If you'd like to make the case for offering a greater variety of possible Real ROI's for bonds, we'll be happy to consider it. And, if it makes sense, happy also to adjust the range of real ROI options presented here. It's an easy programming adjustment.
Likely PRA Management Fees, Pre-Retirement. Mentioning PRA's to a roomful of Social Security specialists is like administering a Rorschach ink-blot test. No two experts will see PRA's in the same way.
The disputes have been especially heated on the topic of PRA management fees.
Conservatives fan the dispute by sending mixed messages. In their enthusiastic "mutual fund" mode, they pitch PRA's as a new generation of mutual funds, loosely tied to Social Security, with PRA owners free to get on the phone with their PRA stockbrokers as often as they like.
In their cautious "index fund" mode, conservatives communicate quite a different message. PRA's will be tied very closely to Social Security, their stock assets invested in stock index funds, with stock churning prohibited and daily calls to the broker completely unnecessary.
Anti-PRA liberals are quick to pick up on the "mutual fund" view of PRA's. The typical mutual fund account holder pays an annual management fee equal to 1% or even 1.5% of assets, they argue, an asset transfer that will enrich the brokers just as it drains wealth away from PRA's.
On the other hand, liberals almost never acknowledge the cautious, "index fund" side of the conservative case. Management fees collected by index funds, the cautious conservatives argue, are quite modest, only 0.2% of assets, and therefore much more affordable.
Up to a point, the Simulator allows you to test both strategies. Select management fees of 1.00% or 1.50% if you'd like to test the "mutual fund" strategy. Select fees of 0.10% or 0.20% if you'd like to test the "index fund" strategy.
In modeling likely PRA returns, though, the Simulator assumes the same rate of return for all PRA's. No attempt has been made to model situations in which some PRA's earn extraordinarily high returns while others earn low or even negative returns.
Some liberal critics of PRA's have gone to great lengths to argue that any PRA program will be crushingly expensive, with administrative expenses running as high as $300 per year per account. Such criticism may be sincerely intended, but the math is other-worldly. 150 million PRA's times $300 a year equals $45 billion a year, more than half the likely $80 billion cash flow from a 2% PRA tax rate. Our website is capable of modeling any option that's sensible, but there's little reason to model pure fantasy.
Likely Annuity Management Fees, After Retirement. We've seen no discussion on this point. We start with the assumption that a post-retirement fee structure will be much the same as the pre-retirement fee structure, and we accordingly provide a similar range of choices. If you anticipate that sending monthly checks to retirees will be more expensive than the passive cost of maintaining an index fund account, you may want to test a higher management fee for the retirement years. If you expect Social Security to negotiate contracts with Fund Managers in which post-retirement fees won't be any higher than pre-retirement fees, you may want to use the same amount in this box as in the preceding box.
Likely Trust Fund Asset Management Fees. (This option not implemented yet.) This option will be activated whenever you check the box approving the use of the Trust Fund as a permanent investment vehicle (Funding Page).
Should the Congress decide to convert the Trust Fund into a permanent investment vehicle, at least one important change would be made, probably two. Management responsibility for Trust Fund assets would almost certainly be turned over to hired Fund Managers, with those managers given voting control over all stocks in the Social Security portfolio. And, second, the Trust Fund itself might be rechartered and placed under the supervision of a politically neutral, professionally experienced Board of Trustees, modeled along the same lines as the Federal Reserve Board of Governors.
With that picture in mind, it's quite reasonable to expect Social Security to have to pay a management fee of some kind to the Fund Managers responsible for handling the Trust Fund's assets. This option allows you to estimate the likely fee.
Turn On Inheritance Leakage Assumptions.
This section is relevant only if you've checked those options that authorize the creation of PRA's. When you do, the Simulator establishes accounts for every cohort (a cohort is an age group defined by birth year rather than current age) and credits the appropriate funds to that cohort's PRA's. As the cohort ages, its mortality rate slowly rises, and the Simulator will, if asked, transfer the funds from the deceased to the PRA's of the likely heirs - modeled here as spouses, children, and grandkids - but certainly including other heirs as well.
It's important to think through what will actually happen to those funds when they're transferred to the heirs. Are they put in the bank? Spent as current income? Or deposited in the heirs' own Personal Retirement Accounts? If they're not deposited in the heirs' PRA's, they constitute a "leak" out of the retirement system.
The "Turn on Inheritance" box should normally be checked. From time to time, though, you may want to run a "pure" PRA scenario, in which no assets whatever are allowed to leak away from PRA's into non-PRA uses. Then, step by step, you can turn each leak back on, in order to quantify the cost of each individual leak. If you're interested in running such a test, turn off the checkmark. The Simulator will then pretend that no money leaks out of the PRA system, and you'll be ready to run the "no leaks" test.
(Technically, the Simulator assumes that all PRA funds, at death, are inherited by spouses who are exactly the same age as the deceased, thus recycling all inheritances back into the system right at the same point where they originated.)
Percent of Inheritance Dollars That Leave the Retirement System. You can choose any number you like from 0% to 100%. As cohorts age, the Simulator uses Social Security's mortality tables to thin the ranks of each cohort and reduce cohort-owned PRA assets correspondingly. If you believe all such assets will be transferred from the PRA's of the deceased into PRA's owned by their heirs, you should enter 0%. If you believe a third of these assets will end up in bank accounts rather than Personal Retirement Accounts, you should enter 33%. And so on.
The number you enter is partly a guess about how families will deal with the retirement inheritances they receive from PRA owners, partly a guess about the likelihood that Congress will require all such inheritances to be transferred into the heirs' PRA's, and partly a guess about whether some who inherit might not even own PRA's. Those state and local government employees who are outside the Social Security system might not own PRA's. What happens if they inherit funds from relatives who did own PRA's? And PRA funds owned by recent immigrants might well be remitted to relatives who live outside the U.S. Such inheritances represent "leaks."
Percent of Inheritance Dollars Transferred to Spouses' PRA's. Again, you are free to enter any number from 0% up through 100%, subject only to the rule that all four entries in this section (leak, spouse, kid, grandkid) must sum to 100%.
When a person dies before retirement, the Simulator assumes that a portion of that person's PRA assets will be transferred into his or her spouse's PRA, according to the percentage you specify here.
When a person retires, begins to receive an annuity, and then dies, the Simulator handles the matter differently. It assumes that all assets involved in funding the annuity remain with the company from whom the annuity was purchased. In a post-retirement scenario, therefore, the assets associated with the deceased are not transferred to anyone else. Instead, the heirs of the deceased now begin to receive the monthly annuity payments which the deceased had been receiving. Will those annuity payments be deposited in the heirs' PRA's? Or allowed to "leak" out of the retirement system altogether?
If you selected "Ten Year Annuities" on the Funding Page, the heirs will receive annuity payments until the ten years has expired. If you chose Fifteen or Twenty Year Annuities, the heirs will receive annuity payments over those time periods. If you chose "Lifetime," the Simulator assumes a Lifetime Annuity with a Twenty-Year Certain payout.
In other words, if Grandpa Elwood dies 15 years after his retirement, his heirs will receive his annuity payments for another 5 years. If Grandpa Elwood dies 25 years after his retirement, his annuity payments will end. His PRA will effectively be zeroed out, with no funds remaining for his heirs.
In the real world, the possible scenarios are almost infinite. The Simulator, though, makes a logical set of simplifying assumptions. It assumes that all spouses are the same age as the deceased, that all children are 27 years younger, and that all grandchildren are 54 years younger.
What follows is still a highly detailed system of asset transfers. For every year from 2002 through 2075, the Simulator calculates the mortality rates for each living cohort, and then transfers the appropriate shares of that cohort's PRA funds to the cohorts of the spouses, the children, and the grandchildren.
If you believe all pre-retirement inheritance will transfer to spousal PRA's, if you believe all post-retirement annuity inheritances will also pass to spouses and become part of their Social Security related survivors benefits, you should enter 100% in the spouse inheritance box. If you think 100% is too high, you should pick a more realistic number. (Our rule of thumb is leaks, 10%, spouses 65%, kids 20%, and grandkids 5%.)
Percent of Inheritance Dollars Transferred to Childrens' PRA's. Again, you're free to enter any number from 0% through 100%, so long as all four percentages in this section add to 100%.
For simplicity's sake, the Simulator assumes that the average child is 27 years younger than the parent who has died and bequeathed a portion of his or her PRA assets to the child's PRA. In the real world, children may be 16 years younger than their parents, or 45 years younger, or anything in between. The 27 year gap has been picked as a sensible approximation of the average gap.
The bequeathed assets from each cohort old enough to be a "parent" cohort pass to a "child" cohort that's 27 years younger. In 2020, therefore, the children's share of PRA assets from the cohort of 1950 will pass to the cohort of 1977, the children's share from the cohort of 1951 will pass to the cohort of 1978, and so on. And the same process repeats again, in 2021, and each year thereafter through 2075.
If members of the parent cohort are too young to retire, the inheritance consists of the PRA assets of those in the parent cohort who died. If the members of the parent cohort are already retired and drawing annuities, the Simulator assumes that the annuity payments from the parent cohort are deposited in the Personal Retirement Accounts of the child cohort, and become part of the PRA savings pool belonging to the child cohort.
If you don't believe Congress will require the PRA asset and annuity inheritances from parents to be deposited in the PRA accounts of children, an entry somewhere between 0% and 5% would probably be appropriate. If you believe that such a deposit will be required by Congress, then an entry somewhere in the 20% range may be the most appropriate.
Percent of Inheritance Dollars Transferred to Grandkids' PRA's. As before, you're free to enter any number from 0% through 100%, as long as all four percentages in this section add to 100%. As a practical matter, though, any entry that's much above 5% is probably an unrealistic guess.
As mentioned, grandkid cohorts inherit from grandparent cohorts that are 54 years older than the grandkids. If the grandparent cohort hasn't reached retirement age, the grandkid cohort inherits PRA assets. If the grandparent cohort has retired and is still young enough to be receiving fixed-term annuities, the grandkid cohort inherits the fixed term annuities, which are then deposited in the PRA's owned by the grandkid cohort. If the grandparent cohort has outlived its fixed term annuity, or the twenty-year certain portion of its lifetime annuity, then there's nothing left from the grandparent PRA's for the grandchild cohort to inherit.
POLICY LEAKAGE: PRA Savings Lost to Non-Retirement Uses.
One of the selling points in the conservative campaign to create Personal Retirement Accounts is the argument that the money would be "yours." The government wouldn't control the money. You would.
Now, imagine you have a terrible family emergency. Your daughter is stricken with a rare disease. Heavy medical expenses are accumulating. You're between jobs and your medical insurance isn't nearly enough. But you and your wife/husband do have thousands of dollars built up in your Personal Retirement Accounts. And you're keenly aware of the promise made when PRA's were created. The money is "yours," and you're the person who controls it, not the Government.
What do you do? You petition Congress. What does Congress do? Congress allows you to pull the money out of your PRA to cover your daughter's medical emergency.
If you don't think such a scenario will ever happen, if you believe ALL the funds deposited in PRA's will remain there until retirement, you should select 0% as your choice for this option. If you think that one-tenth of one percent of all PRA funds are likely to be drained out of PRA's each year for extreme emergencies like the one described above, you should pick 0.1%. If you think the annual loss rate is likely to be higher than that, pick a higher number.
As you do, pay careful attention to the line atop our first Charts Page that reports the cumulative annuity payout from PRA's. The higher the "policy leakage" rate, the lower the annuity payout total.
There is a cure for the "policy leakage" problem, by the way, although it's certainly not free. To protect PRA's, Congress could create a Family Disaster Insurance Program as part of any overall PRA system. If your daughter falls sick, you'll be covered by the Family Disaster Insurance Program for the full value of all the assets you have in your PRA. You won't be allowed to drain your PRA, but you will qualify for an insurance payment equal to your PRA funds.
The numbers in this box are deceptively small. Even a modest amount of "policy leakage" can weaken the ultimate value of a PRA program substantially and put everyone's retirement benefits at greater risk.
The Simulator exists to help citizens roll up their sleeves, dig into the numbers, test different ideas, and get a tangible feel for the solvency challenge. If you have any suggestions for us, we'd be delighted to hear from you.
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