The Public Price of Growing Old

North Carolina’s population is aging. In 2011, the number of individuals age 65 and older who call the state home began to grow at an estimated rate of 153 persons each day, 56,000 persons each year. If this projected rate of growth continues, approximately 20 of every 100 North Carolinians—some 2.3 million individuals in all—will be age 65 or older by 2030.¹

Population aging is a dynamic hardly unique to North Carolina; rather, the entire country is traveling down the same demographic road due to the aging of the “Baby Boomers,” the 76-million person cohort born between 1946 and 1964.² Thanks to advancements in medicine, public health, and socioeconomic conditions, Baby Boomers are poised to enter the last third of their lives enjoying degrees of health and independence far surpassing those experienced by prior generations.³

Viewed in one light, this is a stunning social achievement. A century ago, few Americans—and even fewer North Carolinians—lived to 65 years of age, and those who did were apt to live only for a few more years. In 1900, the typical American man reaching age 65 was likely to survive for another 11.5 years, the typical woman 12.2 years. By 2008, the average 65-year-old man would live another 17.3 years, a woman 20 years.⁴ Moreover, the average American who reached age 65 in 1900 was likely to be financially insecure, evidenced by the fact that 65 percent of older men were in the labor force; jump ahead to 2010, and just 22.1 percent of older men held jobs or were seeking work.⁵ Altogether, the rise in life expectancies over the last century and the increasing financial security of older adults led American society to re-conceptualize old age as a distinct phase of life known as “retirement.”

Conventional wisdom holds that retired Americans draw their incomes from a three- legged stool of pensions, personal assets, and Social Security. This assumption likely will not hold for Baby Boomers, as many possess few guaranteed retirement income streams apart from Social Security.

Today, lengthening lifespans and the retirement ideal are presenting individual American households and society as a whole with unprecedented challenges. Never before has the country had a population structure like the one now taking shape.⁶

How will large numbers of older Americans finance their later years?

Can the health care system handle the costs associated with serving a sizable older population, most crucially the provision of expensive long-term care?

Will enough workers be available or be productive enough to replace the labor provided by Baby Boomers?

These are the kinds of policy questions with which citizens, organizations, and civic leaders will grapple over the next two decades.

This article examines a specific issue indivisibly linked to the aging population and the implications for our state: North Carolina’s pension system. Even in states that have paid attention to aging issues, states that include North Carolina, uncertainty about potential aging-related costs abounds. Conceptually, population aging should present state and local governments with two types of costs: those incurred by governments as employers (e.g., employee pensions) and those incurred by governments as providers of public services (e.g., health and human services). Some of these costs are within state and local control, but others are not. State governments determine the pension benefits offered to their employees, for instance, but the federal government sets the Social Security payments upon which most older adults depend for the bulk of their incomes.

Retirement Security

Financial insecurity long has troubled older Americans. Early in the 20th century, all but the richest older adults worked, and those who could not work became impoverished or “were generally forced to rely on the generosity of their children to maintain them in old age.”⁷ Growth in the older population thus created popular political pressures for government action.

In response, a few dozen states experimented with establishing old-age pensions, followed by the federal government, which established Social Security in 1935 and then the Medicare and Medicaid health insurance programs in 1965. The federal government further used tax preferences to foster private pensions, and consequently, the share of the private, nonagricultural labor force covered by a pension plan rose from 14 percent in 1929 to some 50 percent by the mid-1970s.⁸  Additionally, all levels of government established pension plans for their employees. Such policy actions collectively reduced older poverty by insuring a basic level of financial security. Explains economist Edward Wolff of New York University:

The poverty rate among elderly persons (aged 65 and older) has declined dramatically, from 35.2 percent in 1959 to 12.2 percent in 1993 and then to 10.1 percent in 2005. In 1959, the incidence of poverty among the elderly was greater than that among children and more than twice that among nonelderly adults . . . By 2005 it was still slightly lower than the adult poverty rate and 57 percent of the child poverty rate. This reduction in elderly poverty was tied to increased social security benefits and was therefore accomplished without requiring the elderly to work more.⁹

When combined with secularly rising incomes, public policies fostered the idea of retirement as a distinct, leisurely phase of life earned as a reward for a lifetime of productivity—the very kind of retirement enjoyed by many of the parents of today’s Baby Boomers, expected by many Boomers, and marketed to those Boomers.

 

Consider changes in labor force participation rates among older white men. In 1954, some 40 percent of older white men were in the labor force, but by 2005, just 20 percent were.¹⁰  Yet economic security is not the same as affluence. In 2010, half of all North Carolina households led by an older adult had annual incomes of less than $31,694.¹¹  That same year, 94 percent of older Tar Heels drew Social Security benefits averaging $13,818 annually.¹² Between 2010 and 2012, some 29.9 percent of older North Carolinians derived at least 90 percent of their household incomes from Social Security, while 58.5 percent relied upon Social Security payments for at least half of their incomes.¹³  Absent Social Security, many older North Carolinians—particularly those who are racial minorities, rural residents, or quite elderly— would have little household income.

Aging and the Problem of Financial Security

Conventional wisdom holds that retired Americans draw their incomes from a three- legged stool of pensions, personal assets, and Social Security. This assumption likely will not hold for Baby Boomers, as many possess few guaranteed retirement income streams apart from Social Security.

Baby Boomers generally began their careers during the 1970s, a time when the expansion of private pension plans was ending. Since then, the share of private sector workers ages 25 to 64 with access to an employer-sponsored plan has fallen from 57.8 percent in 1979 to 52 percent in 2011; put differently, nearly half of all Americans employed in the private sector work for organizations that do not offer any kind of retirement plan.¹⁴ Moreover, the nature of the available plans has shifted from defined-benefit (DB) plans to defined-contribution (DC) plans.

Under DB plans, employees earn a guaranteed benefit based on wages and years of service. Contributions are tax-advantaged for employees and employers, and by pooling resources from all participants in a firm, DB plans spread risks across a large population. On the flip side, such plans are complex, tightly regulated, legal commitments tied to specific firms. In contrast, the DC plans (e.g., 401(k) plans) that have replaced DB plans are portable ones that allow employees and employers to make tax-advantaged contributions to individual accounts.¹⁵  DC plans are cheaper and simpler for employers, but they expose “workers to a host of risks that they are ill-equipped to bear as individuals: inadequate contributions, poor investment choices, financial market volatility, and outliving their retirement savings.”¹⁶

Today, DC plans (including hybrid DC-DB ones) are the private sector norm. A survey by the U.S. Bureau of Labor Statistics found that 47 percent of private establishments in the South Atlantic sponsored retirement plans in 2013, but just 7 percent of those establishments offered DB plans.¹⁷ Available evidence suggests that the spread of DC plans has not benefited workers. Apart from shifting all risks to participants, DC plans are expensive and offer ordinary workers many more chances to make expensive investment mistakes.

A related problem is that such plans are costly to the taxpayers despite providing coverage that is less than universal. The staff of the U.S. Congress Joint Committee on Taxation estimated that preferential tax treatment of employer-sponsored retirement benefits will cost the federal treasury an estimated $101.2 billion in foregone revenue in federal fiscal year 2013.¹⁸  (These tax expenditures “flow” through to the state income tax code, resulting in an estimated loss of $786.5 million to North Carolina during state fiscal year 2014–2015.)¹⁹ Despite the sizable cost, only 41.8 percent of private sector workers in North Carolina had access to a plan between 2008 and 2012.²⁰ And low-income workers—arguably those in greatest need of help in saving for retirement—are much less likely to have access to an employer-sponsored retirement plan than other workers. In 2009, only 38 percent of private sector workers in the lowest wage quartile had access to an employer retirement plan compared to 85 percent of those in the top wage quartile.²¹ Other research has found that 72 percent of the lowest-income American households reach retirement age without ever having had access to an employer-sponsored retirement plan.²²

Perhaps the greatest flaw of DC plans is that households with them have not amassed enough savings. According to the Federal Reserve System’s triennial Survey of Consumer Finances, 61.2 percent of American families headed by someone near retirement age (ages 55–64) in 2010 had a retirement account, and of those families, half possessed less than $104,800 in savings.²³ That is far below conservative minimum recommendations of the amount of savings needed for retirement. By one estimate, 95.4 percent of all American households approaching retirement age in 2010 simply had saved too little for retirement and likely would rely on Social Security payments for the bulk of their retirement incomes.²⁴

Inadequate retirement savings is a problem for people all along the income spectrum.

Calculations from the Center for Retirement Research at Boston College indicate that 53 percent of all households in 2010 stood “at risk” of reaching age 65 unable to maintain their living standards. While 61 percent of low-income households were at risk of saving too little, 54 percent of middle-income households and 44 percent of high-income house- holds were in the same situation. And the share of households at risk of saving too little for retirement has increased for every income group since 2007 as a result of the destruction of wealth that occurred during the “Great Recession.”[25 Alicia Munnell, Anthony Webb, and Francesca Golub-Sass, The National Retirement Risk Index: An Update (Boston: Center for Retirement Research at Boston College, 2012), 3, http://crr.bc.edu/wp-content/uploads/2012/11/ IB_12–20–508.pdf.] The loss of housing wealth was particularly problematic for Baby Boomers, as illustrated by a 2009 study by the Center for Economic and Policy Research in Washington, D.C. that found that the typical household headed by an Early Boomer experienced a 50 percent decline in its net worth between 2004 and 2009, while the typical household headed by a Late Boomer experienced a 45 percent decline.²⁵

Although state-level data on retirement savings are not generally available, patterns in North Carolina likely mirror national ones. A 2014 study by the National Institute of Retirement Security in Washington, D.C. found that 41.6 percent of private sector workers between the ages of 21 and 64 in North Carolina participated in an employer-sponsored retirement plan in 2012, with the average participant possessing an account worth $38,330.²⁶ Compared to other states, North Carolina ranked worse than average in terms of the overall level of financial security facing future retirees measured in relation to potential retirement income, major retirement expenses, and labor market conditions for older workers.²⁷

Such facts contradict the popular view of Baby Boomers as being a relatively affluent cohort. Even before the recession, few Boomer households were on track to reach retirement age with significant sources of income apart from Social Security benefits, and even then, the value of those benefits was eroding due to the rise of the full-retirement age to 67.²⁸

Many Baby Boomers therefore may look to the state for services designed to help them meet their needs. Such demands could take forms ranging from tax credits for long-term care to direct spending on services like home energy assistance to laws mandating flexible leave policies so younger workers can provide eldercare. Younger people, meanwhile, might look to state leaders to address some of the increasingly visible problems related to retirement savings, such as by offering incentives to help low-in- come households save or by—as a number of states are considering and California and Massachusetts are doing—establishing publicly sponsored savings vehicles for private sector employees who lack access to employer-sponsored retirement plans.²⁹  In that respect, states could reprise their historic role in modeling forward-looking retirement policies for the nation as a whole.

Public-Sector Retirement Systems

The specific costs that North Carolina may face owing to Baby Boomers’ insufficient retirement incomes are difficult to gauge because they hinge upon federal policies and personal circumstances. Costs related to the pension plans offered to public-sector employees, in contrast, are firmly within the state’s control, and thanks to a tradition of prudent fiscal management, North Carolina’s public-sector pension systems are in overall sound condition.

The very concept of pensions originated in the public sector. The national government has offered military pensions since the Revolutionary War, and during the 19th century, large municipalities began to offer benefits to police officers, firefighters, and teachers. In 1911, Massachusetts established the first plan for state employees, and in 1920, the federal government created a system for its civilian employees.³⁰ Such plans quickly spread and became the template for private industry.

Public-sector plans typically are DB plans, not DC ones. The U.S. Bureau of Labor Statistics estimates that 89 percent of all state and local employees had access to a retirement plan in 2013 and that 83 percent of all state and local government employees could access a DB plan. While 32 percent of public employees also had access to a DC plan, those plans were, more often than not, supplemental in nature. Unlike in the private sector, state and local employees generally must contribute to their core retirement plans. Some 86 percent of all state and local DB plans in 2013 required employee contributions, typically a percentage of annual earnings, and in 2013, the average employee contribution totaled 6.4 percent of earnings.³¹
North Carolina has offered public-sector pensions since the Second World War. A framework for local government pensions took form in 1939, one in 1941 for state employees; both pension plans became DB ones that coordinated with the larger Social Security system in 1963.³²

The strong funding position of TSERS has insulated the state from problems facing other states.

Today, the N.C. Department of State Treasurer administers four major retirement systems—the Teachers’ and State Employees’ Retirement System (TSERS), the Local Governmental Employees’ Retirement System (LGERS), the Consolidated Judicial Retirement System (CJRS), and the Legislative Retirement System (LRS). Additionally, the Department administers several smaller pension plans, including the Register of Deeds’ Supplemental Pension Fund, (RDSPF), the North Carolina National Guard Pension Fund (NGPF), and the Firefighters’ and Rescue Squad Workers’ Pension Fund (FRSWPF), along with a number of supplemental retirement savings, death, disability, and other benefit plans and programs (see table 1).³³

The N.C. General Statutes authorize the major retirement systems and entrust their governance to various boards of trustees. Governance of TSERS, the Consolidated Judicial Retirement System, and the Legislative Retirement System rests with a 13-member board that the State Treasurer chairs and that has members drawn from active and retired State teachers, employees, and members of the public.

Nine members are appointed by the Governor, two members are appointed by the General Assembly, and two members serve ex-officio (the State Treasurer and the Superintendent of Public Instruction). The LGERS board contains five of the same individuals who serve on the TSERS board, along with seven members with various ties to local governments and one active or retired member of the Firefighters’ and Rescue Squad Workers’ Pension Fund (FRSWPF). Note that LGERS and FRSWPF differ from the other systems in that participation is not mandatory. All agencies eligible for participation, with the notable exception of charter schools, must participate in TSERS, whereas local units of government or fire and rescue agencies may opt into LGERS or FRSWPF, respectively. A separate Board of Trustees governs the three supplemental retirement income plans.³⁴

TSERS is what most people have in mind when they think of the state pension system. The largest system in terms of members and assets, TSERS covers “all full-time teachers and State employees in all public school systems, universities, departments, institutions, and agencies of the state.”³⁵  As of December 31, 2013, TSERS had 310,370 active members, 125,513 inactive ones, and 187,448 beneficiaries.³⁶ Some 64.2 percent of active members work in education (of whom 76.4 percent are classroom teachers).³⁷ Women account for 68.9 percent of active plan participants, and 66.9 percent of all active members are age 40 or older; additionally, the average annual compensation of active TSERS members is $41,351.³⁸
TSERS members earn benefits based on a formula linked to average final compensation and years of service.

The current annual benefit is equal to 1.82 percent of average final compensation (average of four-highest paid years) for each year of service completed.³⁹ So, a retiring employee with 30 years of service and an average final compensation of $50,000 would receive a lifetime annuity worth $27,300 per year, subject to possible future cost-of-living adjustments. That benefit would replace 54.6 percent of the employee’s average annual final compensation. Employees may qualify for unreduced benefits in three situations: 1) upon reaching age 60 and having completed 25 years of creditable service; 2) upon reaching age 65 and having completed five years of creditable service; and 3) upon completing 30 years of creditable service at any age.⁴⁰

TSERS members can retire with a reduced benefit if they meet certain combinations of age and service length criteria, such as reaching age 50 and having completed 20 years of creditable service or reaching age 60 with five years of creditable service.⁴¹  The calculation for determining reduced benefits is the same one used to determine full benefits with the difference that the benefit amount is reduced by an age- and service-adjusted factor to account for the fact that the early retiree will receive payments over a longer period of time than someone who retires at the normal time. For example, an employee who retires at age 60 with 20 years of service and an average final compensation of $50,000 would receive a lifetime annuity worth $15,470 per year (subject to possible future cost- of-living adjustments). This amount is 15 percent less than the unreduced benefit amount of $18,200.⁴²

By the end of that period [2030], approximately one of every five North Carolinians will be age 65 or older. Such an older population structure is unprecedented, and as a result, citizens, civic organizations, and public officials will confront important policy questions. Those challenges, while serious, are not unmanageable, but addressing them will require state leaders to pay heightened attention to issues of aging and to champion wise public policies focused on improving the well-being of all North Carolinians, young and old.

While Baby Boomers constituted 38 percent of active TSERS members at the end of 2013, North Carolina is not facing a retirement wave.⁴³ Because state employees can draw an unreduced benefit immediately upon completing 30 years of creditable service, Baby Boomers have been retiring steadily from the workforce since 1994, while others must continue to work before qualifying for an unreduced benefit. Employees between the ages of 55 and 64 who were eligible for a reduced or unreduced benefit accounted for 11.2 percent of the active TSERS membership.⁴⁴ Given that the average age of a TSERS member in 2013 was 45 and the average period of service was 10.6 years, the overwhelming majority of TSERS participants will not be eligible for any type of benefit for years.⁴⁵ And the retirement of Baby Boomers, in and of itself, will not impose any additional costs on TSERS since the plan’s actuarial models already have accounted for the associated obligations.⁴⁶

North Carolina operates TSERS on a pre-funded basis, meaning that the system receives regular contributions for each covered employee over the course of the employee’s career. The advantage of pre-funding is that it allows for investment earnings to finance the bulk of the benefits rather than employee and employer (taxpayer) contributions. TSERS derives its funding from three sources: employee contributions (6 percent of annual salary), employer contributions related to the plan’s actuarial value (the actual annual funding decision rests with the General Assembly), and investment earnings.

In recent years, many states have shifted from pre-funding their pension plans to “pay-as-you-go” approaches that use current contributions to pay current benefits. Some states also stopped making annual employer contributions to their pension funds. Such policy choices have caused many plans to become underfunded, which occurs when the actuarial value of a plan’s liabilities exceeds that of its assets. Underfunding does not mean that a plan is in danger of collapsing, but it creates fiscal pressures for plan sponsors. North Carolina fortunately has avoided these temptations, and TSERS is one of the nation’s best-funded plans; in fact, it was in overfunded status for most of the last decade (see Figure 1). The severe investment losses that occurred during the recession hurt the plan, but even with those struggles, TSERS ended 2013 with a funding ratio of 94.8 percent, a ratio that is especially strong compared to those of most public pension plans in the United States.⁴⁷

The strong funding position of TSERS has insulated the state from problems facing other states. That said, the greatest threat to the plan’s health would be for the state to stop making its annual required contributions—a significant temptation during tough budget times that merely raises future costs. Prior to fiscal year 2010–2011, the General Assembly never had failed to make the full actuarially recommended contribution to TSERS; that year, however, North Carolina contributed only 73 percent of the required amount. In fiscal year 2011–2012, the state again fully contributed the required amount, followed by a contribution in 2012–2013 that was larger than required.⁴⁸

Provided the state continues to make employer contributions, the comparatively strong health of TSERS provides the state with an opportunity to better the system, particularly since the basic design of the plan, including the benefit structure, has not changed since 1963. For guidance, interested state leaders could look to the recommendations and analysis contained in the 2010 report of the Future of Retirement Study Commission, a 13-member advisory commission named by the boards of TSERS and LGERS. That commission undertook a comprehensive review of issues pertaining to benefit adequacy, risk management, workforce management, participant decision making, and administration, and offered numerous recommendations aimed at strengthening the two retirement systems’ accountability to the public and their abilities to manage responsibly the assets held in trust on behalf of public employees.⁴⁹

Conclusion

In 2011, the oldest members of North Carolina’s Baby Boom generation celebrated their 65th birthdays, in the process inaugurating an era of rapid growth in the size of the older population. If current demographic projections hold, North Carolina will gain older residents at a rate of 153 persons per day, or 56,000 persons per year, each year from 2011 until 2029, which is when the youngest Baby Boomers will turn age 65. By the end of that period, approximately one of every five North Carolinians will be age 65 or older. Such an older population structure is unprecedented, and as a result, citizens, civic organizations, and public officials will confront important policy questions. Those challenges, while serious, are not unmanageable, but addressing them will require state leaders to pay heightened attention to issues of aging and to champion wise public policies focused on improving the well-being of all North Carolinians, young and old.

 

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John Quinterno is a frequent contributor to North Carolina Insight. He is a principal with South by North Strategies, Ltd., a public policy consulting firm in Chapel Hill, N.C., and the author of Running the Numbers: A Practical Guide to Regional Economic and Social Analysis (New York: Routledge, 2014). 

Figure and Graph Design by Carol Majors, Publications Unlimited.

Aging