Social Security's Unsafe Harbor

Chad Aldeman
Publication Date: 
March 8, 2016
For the majority of retirees today, Social Security makes up the largest portion of their retirement income. Yet despite Social Security’s importance, and its prominence as a political issue, most Americans aren’t aware that not all workers enjoy the benefits of Social Security. In fact, 6.5 million state and local government workers, including 1.2 million public school teachers, lack the protection of Social Security. 
The IRS has a formula for testing whether state and local government retirement plans provide sufficient retirement benefits to their workers. If a retirement plan fails the IRS test, the state or local government must offer its workers Social Security instead. In theory, this “safe harbor” provision sets a base floor for the retirement plans offered by state and local governments. Even in the worst economic times, state and local policymakers know that they can’t cut benefits by too much, or they risk being forced into Social Security and into paying the taxes that come with participation. 
In practice, however, this safe harbor provision fails to protect the majority of workers who aren’t covered by Social Security. This brief analyzes the safe harbor provision and comes to four main conclusions: 
  1. The Social Security safe harbor provision governing defined benefit plans ignores key variables that affect the actual retirement benefits workers receive.
  2. The defined benefit safe harbor rule, like pension plans generally, is backloaded, leaving many workers with very low benefits for many of their working years.
  3. The IRS applies different safe harbor rules for defined benefit and defined contribution plans. As implemented, those rules subtly bias employers toward traditional pension plans.
  4. Both safe harbor provisions are set too low. As a concrete example, the brief looks at the case of Illinois public school teachers. Illinois does not participate in Social Security, meaning its teachers neither pay into nor receive benefits. However, the vast majority of Illinois teachers would be better off participating in Social Security, even after subtracting employee and employer contributions. 

By allowing states to avoid offering Social Security coverage, the safe harbor provision provides a false sense of protection and leaves millions of workers without sufficient retirement savings.