Wednesday, November 28, 2012

Moving to a National Retirement Plan

The nation seems to be lumbering into a retirement crisis. Social Security is intended to provide a significant fraction of preretirement earnings for only the lowest income seniors. Others require additional funds if they are to maintain anything like their preretirement standard of living. The 401(k) fund was intended to provide a mechanism by which a wage earner could manage a savings plan to provide for retirement. The 401(k) (403(b) for nonprofit organizations) was used to replace defined-benefit pension plans. It is referred to as a defined-contribution plan on the assumption that employees and employers would both contribute to it. In reality, many companies have not chosen to institute such a plan, and those that have contribute very little. The burden falls on the employee, assuming he/she has access to one, to manage it wisely and maintain a high level of contributions over the working career. A combination of unwise investment decisions, a dreadful economic environment, and stagnant or falling wages have made it difficult for saving to occur at an appropriate level. We have large numbers of young workers struggling to gain entry into the work force, while we have large numbers of senior citizens who can’t afford to retire and leave the work force.

A New York Times article by Steven Greenhouse provides an excellent summary of the situation and describes a number of proposed corrective measures in Should the 401(k) Be Reformed or Replaced?.

"But many investment experts and economists give the 401(k) system low marks. They note that fewer than half of the nation’s private sector workers are in 401(k) plans and that nearly a quarter of businesses with more than 100 employees do not offer 401(k)’s. Moreover, many Americans put only 3 percent of their earnings into 401(k)’s when investment experts often recommend saving 10 or even 12 percent."

"The typical worker age 55 to 64 had just $54,000 in a 401(k) in 2010, according to a new report by the Center for Retirement Research at Boston College, and households with workers in that age group had $120,000 in retirement savings on average, if the money rolled into I.R.A.’s was included. That $120,000 is less than one-fourth the savings recommended by many retirement experts. Moreover, the center calculated, that $120,000 would provide an annuity of a paltry $7,000 a year."

The current system has many defects that seem fixable. An improved approach would make a plan available to all, remove the need for individuals to make investment decisions, encourage people to invest more, and provide some sort of guarantee that there will be a return on their investment and that income will be maintained until end of life.

One of the financial experts queried about ways to improve the 401(k) system was John C. Bogle. He provides a lengthy discussion of his suggested approach in his book The Clash of the Cultures: Investment vs. Speculation. His proposed plan addresses most of these issues in a compellingly straightforward manner.

Bogle would keep Social Security as is except for modest changes to increase revenue. His idea is to replace the 401(k) and all other retirement savings options encouraged by the tax code with a single, national plan managed by a federal commission. This commission would delegate management of the assets to a non-profit entity to avoid the exorbitant fees that financial firms now charge when they control investors’ funds. Bogle would set up two indexed funds in which to invest. One would be a broad market stock fund and one would be a broad market bond fund. The use of indexed funds that follow the entire market simplifies management and guarantees that investors will do as well as the markets do. An investor’s funds would be invested mainly in equities when young and gradually emphasize bonds more as he/she ages. This would all be automatic based on an algorithm. Bogle addresses the issue of longevity by suggesting prospective retirees switch at least a portion of their accrued savings to an annuity.

Bogle’s idea provides a healthy core for a viable national plan, but there are modifications that would make it more effective.

Teresa Ghilarducci has been promoting what she refers to as a "Guaranteed Retirement Account." Her notion would add a federally provided guarantee that funds would earn at least 3% above inflation, a number chosen to correspond to the anticipated growth in GDP over the years. She would offset this potential fiscal burden on the government by eliminating the various tax breaks that shelter retirement savings now. She indicates that would provide almost $200 billion in new revenue. Ghilarducci also recommends converting funds to an annuity on retirement, perhaps through integrating with Social Security.

The addition of a guarantee that there will be a return on their investment might be critical in encouraging people to save more for their retirement.  Ghilarducci's 3% above inflation seems excessive, but guaranteeing a return equivalent to the return on investments in treasury bills could be a reasonable approach.

The most contentious issues would be the degree to which the program is voluntary for the employee and for the employer. Bogle would make all contributions voluntary; Ghilarducci prefers a plan where both employer and employee contribute 2.5% of income automatically. A 5% contribution is minimal in terms of covering preretirement earnings so, presumably, employees could contribute more and employers would match the first 2.5%. A limit on how much could be contributed would also limit the potential fiscal burden of the earnings guarantee.

Asking employers to contribute a few percent of income to a retirement plan does not seem an unreasonable burden. Many that are now offering 401(k) plans are already making similar contributions plus suffering the administrative burden of carrying the plan. The simplicity of the proposed retirement system should be attractive to those with current plans and not unduly burdensome on those who do not.

Combining Bogle’s investment ideas with Ghilarducci’s concept of a guaranteed return would provide the core of an effective retirement plan. There are many details that would have to be worked out. For example, since it is a savings plan, should people be allowed to extract funds? And under what circumstances?

There do not seem to be any issues that can’t be resolved, other than dealing with the inertia built into out legislative system. The only way to overcome inertia is to start pushing. The time to begin is now.

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