Railroad retirement and survivor benefits are financed by the following sources
of income:
- Payroll taxes on railroad earnings paid by covered employees and
employers.
- Investments. Funds not needed immediately for benefit payments or
administrative expenses are transferred to the National Railroad Retirement
Investment Trust for investment (see "Investments").
- Income from a financial interchange with the social security trust funds.
- Borrowing from general revenues related to certain features of the
financial interchange mentioned in (3).
- Revenues from Federal income taxes on railroad retirement benefits.
- Appropriations from general revenues.
Each of these income sources is described briefly below.
Payroll Taxes
Payroll taxes levied on covered employers
and their employees are the primary source of income to the railroad retirement
system.
The tax rate equivalent to that which would be paid under social security is
commonly called the tier I tax. The tier I tax rate of 7.65 percent is divided
into 6.20 percent for railroad retirement and 1.45 percent for Medicare hospital
insurance. Payroll taxes in excess of the tier I rate are called tier II taxes.
In 2006, tier II taxes are 12.60 percent on employers and employee
representatives and 4.40 percent on employees.
The Railroad Retirement and Survivors’ Improvement Act of 2001 significantly
revised the financing of the railroad retirement system through provisions for
the investment of railroad retirement funds in nongovernmental assets,
adjustments in the payroll tax rates paid by employers and employees, and the
repeal of a supplemental annuity work-hour tax. Supplemental annuities continue
to be payable and are funded by the National Railroad Retirement Investment
Trust.
Tier II taxes on both employers and employees are based on an “average account
benefits ratio.” Depending on the average account benefits ratio, the tier II
tax rate for employers will range between 8.20 percent and 22.10 percent, while
the tier II tax rate for employees ranges between 0 percent and 4.90 percent.
The “account benefits ratio” is, with respect to any fiscal year, the amount
determined by the Railroad Retirement Board by dividing the fair market value of
the assets in the Railroad Retirement Account and the National Railroad
Retirement Investment Trust (and for years before 2002, the Social Security
Equivalent Benefit Account) as of the close of such fiscal year by the total
benefits and administrative expenses paid from the Railroad Retirement Account
and the National Railroad Retirement Investment Trust during such fiscal year.
If the ratio is not an exact multiple of 0.1, it is raised to the next highest
multiple of 0.1.
Likewise, the term “average account benefits ratio” means, with respect to any
calendar year, the average determined by the Secretary of the Treasury of the
account benefits ratios for the 10 most recent fiscal years ending before such
calendar year.
Tier I taxes are ultimately transferred to the social security and hospital
insurance trust funds through the financial interchange. The tier II tax is used
to finance tier II benefits, supplemental annuity benefits, and also the portion
of tier I benefits not reimbursed through the financial interchange.
Earnings Base
The taxable amounts of an employee’s earnings are subject to tier I and tier
II maximums, which are both indexed to annual increases in national wage levels.
The tier I maximum is the same as the social security wage base and is higher
than the tier II base as a result of 1977 social security amendments, which
provided for a series of yearly increases in the social security tax base that
effected corresponding increases in the railroad retirement tier I tax base.
Investments
The National Railroad Retirement Investment Trust was established by the
Railroad Retirement and Survivors’ Improvement Act of 2001. The Trust, a
tax-exempt entity independent from the Federal Government, became effective
February 1, 2002.
The sole purpose of the Trust is to manage and invest railroad retirement
assets. The Railroad Retirement and Survivors’ Improvement Act authorizes the
Trust to invest the assets of the Railroad Retirement Account in a diversified
investment portfolio in the same manner as those of private sector retirement
plans. Prior to the Act, investment of Railroad Retirement Account assets was
limited to U.S. Government securities. For the fiscal year ended September 30,
2005, the investment portfolio managed by the National Railroad Retirement
Investment Trust achieved a 14 percent rate of return.
The Board of Trustees is comprised of seven individuals, three selected by
railroad labor unions and three by railroad companies. The seventh is an
independent Trustee selected by the other six Trustees. The terms are for 3
years and are staggered.
The Trustees are required to discharge their duties solely in the interest of
the Railroad Retirement Board, and through it, the participants and
beneficiaries of the programs funded under the Railroad Retirement Act. The
Trustees are subject to fiduciary rules similar to those required by the
Employee Retirement Income Security Act (ERISA).
The financial statements of the Trust are required to be audited annually by an
independent public accountant. In addition, the Trust must submit an annual
report to Congress on its operations, including a statement of financial
position, a statement of cash flows, a statement on internal accounting and
administrative control systems, the independent auditor’s report, and any other
information necessary to inform Congress about the operations and financial
condition of the Trust. All National Railroad Retirement Investment Trust annual
management reports and quarterly updates are available
here.
Financial Interchange
Purpose and History of Financial
Interchange
The financial interchange between the railroad retirement and social security
systems is intended to put the Social Security Old-Age, Survivors, and
Disability Insurance (OASDI) and Hospital Insurance (HI) trust funds in the same
position they would have been had railroad employment been covered under the
Social Security and Federal Insurance Contributions Acts. It follows that all
computations under the financial interchange are performed according to social
security law. The amount of benefits payable under the Railroad Retirement Act
has no effect on the results.
The financial interchange provision was introduced by the 1951 amendments to the
Railroad Retirement Act and was made retroactive to January 1, 1937. The initial
determination covered the period from January 1937 through June 1952 and
indicated a balance of $488.2 million in favor of the social security system.
Only interest was paid on that amount until the debt was liquidated by
subsequent offsets in favor of the railroad retirement system. Since the
liquidation of the original balance, annual transfers reflecting the experience
of the preceding fiscal year have always favored railroad retirement.
The experience under the financial interchange proved to be more favorable to
the railroad retirement system than was originally anticipated. There were two
primary causes for this. The first was a series of successive amendments to the
Social Security Act which raised benefits immediately while tax increases were
deferred. The second factor was the decline in railroad employment, which
reduced the taxes payable to social security but had little immediate effect on
the benefit reimbursements.
Financial Interchange Determinations
Placing the social security trust funds in the same position they would have
been had railroad employment been covered under social security since its
inception involves computing the amount of social security payroll and income
taxes relating to railroad employment and computing the amount of additional
benefits which social security would have paid to railroad retirement
beneficiaries during the same fiscal year. In the computation of the latter
amount, credit is given for any social security benefits actually paid to
railroad retirement beneficiaries. When benefit reimbursements exceed payroll
and income taxes, the difference, with an allowance for interest and
administrative expenses, is transferred from the social security trust funds to
the railroad retirement trust funds. If taxes exceed benefit reimbursements
(this has not happened since 1951), a transfer would be made in favor of the
social security trust funds.
Borrowing From General Revenues Related to the Financial Interchange
Financial interchange transfers are made in a lump sum for a whole fiscal
year in the June following the close of a fiscal year.
At any time, therefore, there are between 9 and 21 months’ worth of financial
interchange transfers which, in a sense, are owed the Board. The Board receives
interest on this money, so this practice does no long-term harm to the financial
condition of the railroad retirement trust funds. The lag in the transfers,
however, periodically caused short-term cash-flow problems in past years.
In order to avoid any further cash-flow problems from this lag, the 1983
Solvency Act provided for monthly loans from U.S. Treasury general funds. Each
loan is equal to an estimate of the transfer the Board would have received in
the preceding month if the financial interchange with social security were on an
up-to-date basis, with interest adjustments. The Board must repay these loans
when it receives the transfer from social security against which the money was
advanced.
Income Taxes on Railroad Retirement Benefits
Social security amendments in 1983 subjected railroad retirement tier I benefits
to Federal income taxes on the same basis as social security benefits, and
subsequent railroad retirement legislation subjected benefits over and above
social security levels to Federal income tax on the same basis as private and
public service pensions, beginning with taxable year 1984. Revenues from income
taxes on tier I, tier II and vested dual benefits are used for benefit payments.
Appropriations From General Revenues
Prior to the Railroad Retirement Act of 1974, concurrent social security
benefits (dual benefits) payable to railroad retirement annuitants had a
significant effect on the amount of the financial interchange. Consider the
example of two hypothetical employees shown in Table 5 below.
.
The size of the benefits is appropriate to the early 1970’s. The employees are
assumed to have identical dates of birth, dates of retirement, and histories of
railroad earnings. One employee, however, is assumed to have had just enough
covered employment under social security to qualify for a social security
benefit. (The difference in railroad retirement benefits arises from minor
reductions in the 1937 Act formula for receipt of a social security benefit.)
Two conclusions are apparent. First, the employee with benefits under both
systems received an advantage over the career railroad worker, which many
considered unfair. In the example, the employee who is eligible for social
security collects $80 more than the employee who is not eligible (the difference
in line C); while, under a completely integrated system, the social security
earnings would have added only $20 (the difference in line D). Second, because
social security subtracted the social security benefit in calculating the
financial interchange transfer, railroad retirement paid most of the cost of
these benefits. In the example, this is represented by the $60
difference in line F.
Table 5. Example of Effects of Dual
Benefits
on Financial Interchange
(A) |
Railroad retirement benefit |
$380 |
$400 |
(B) |
Social security benefit |
100 |
- |
(C) |
Total benefit,
A + B |
480 |
400 |
(D) |
Social security benefit on
combined earnings (gross tier I) |
240 |
220 |
(E) |
Financial interchange transfer
from social security to railroad
retirement,
D - B |
140 |
220 |
(F) |
Amount to be financed by excess of railroad retirement taxes
over social security taxes,
A - E |
240 |
180 |
This situation was a major cause of the poor financial condition of the
railroad retirement system in the early 1970’s. In order to improve the system’s
financial condition, the Railroad Retirement Act of 1974 provided that the tier
I component of the railroad retirement annuity be reduced by any social security
benefit. This essentially integrated the two systems and eliminated the
advantage of qualifying for benefits under both systems.
However, it was generally considered unfair to eliminate this advantage entirely
for those already retired or close to retirement when the 1974 Act became
effective. The 1974 Act, therefore, provided for a restoration of social
security benefits which were considered vested at the end of 1974. The restored
amount is known as the “vested dual benefit.” This benefit was initially
available to qualifying spouses and survivors as well as to qualifying
employees. The vested dual benefit was explained in the previous chapter on
benefit provisions. Eventually, after a period of several decades, the vested
dual benefit will be entirely phased out.
Under the 1974 Act, appropriations had been authorized from general revenues for
the phase-out costs of vested dual benefits. The amounts were to be sufficient
to fund (on a level payment basis over the years 1976-2000) the vested dual
benefit for new accruals and for beneficiaries on the rolls. The yearly amount
was to be reviewed every three years at the time of each actuarial valuation.
The costs of these vested dual benefit payments, which were intended to be
funded solely from general revenues, were substantially more than the amount
estimated at the time the 1974 Act was passed, and substantially more than the
funds that were appropriated between 1974 and 1981. To stop the resulting drain
on the Railroad Retirement Account, the 1981 amendments established a Dual
Benefits Payments Account. This account is credited with the general revenue
appropriations, and it is charged with vested dual benefit payments. The Board
is required to adjust vested dual benefit payments from this account so that the
amounts paid to annuitants do not exceed the amounts appropriated.
Financial Position of the Railroad Retirement System
The financial condition of the railroad retirement system is closely related
to the size of the railroad work force. This is because, as mentioned
previously, the payroll taxes on covered employers and their employees are the
primary source of income to the system. Clearly, a large labor force will
generate more revenue for the system than a small labor force. Railroad
employment has declined steeply over the years and the drop in employment
necessitated the strong corrective action taken in the 1981 and 1983 amendments.
In the absence of these amendments, substantial reductions in payments would
have been required.
The omnibus budget legislation enacted December 22, 1987, increased railroad
retirement payroll tax rates in January 1988 by a total of 2 percent, and it
provided for revenues from Federal income taxes on certain railroad retirement
benefits to be transferred to the railroad retirement system for an additional
year, fiscal year 1989. Subsequent legislation extended these income tax
transfers on a permanent basis.
Legislation in 2001 provided for the investment of railroad retirement funds in
non-governmental assets, adjustments in the payroll tax rates paid by employers
and employees, and the repeal of a supplemental annuity work-hour tax.
The Board’s 2005 railroad retirement financial report to Congress, which
addressed the 25-year period 2005-2029, contained generally favorable
information concerning railroad retirement financing. It concluded that, barring
a sudden, unanticipated, large decrease in railroad employment or substantial
investment losses, the railroad retirement system will experience no cash-flow
problems during the next 25 years. However, the 2005 report also indicated that
the long-term stability of the system is still questionable. Under its current
financing structure, actual levels of railroad employment and investment return
over the coming years will largely determine whether corrective action is
necessary. No railroad retirement financing changes were recommended by the
Board.
As of September 30, 2005, total railroad retirement system assets, comprising
assets managed by the National Railroad Retirement Investment Trust and the
railroad retirement system accounts at the Treasury, equaled approximately $29
billion.
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