Monday, October 31, 2005


Lots of good articles today regarding pension and aging. Jane Galt has an excellent post regarding a recent NYTimes magazine article on the end of private pensions. The upshot is that private pensions are diminishing as companies decide they can no longer afford to make committments that rely on their financial health 40-50 years in the future, and individuals change careers more often and don't see the value in taking less pay now for a pension tied to seniority.

I thought the article contained some howlers, but also some good points. First, the howlers:
To understand why pensions are still important, you have to understand the awkward beast that benefits professionals refer to as the U.S. retirement system. It is not really one "system" but three, which complement each other in the crudest of fashions. The lowest tier is Social Security, which provides most Americans with a bare-bones living (the average payment is about $12,000 a year). The highest tier, available to the rich, is private savings. In between, for people who do not have a hedge-fund account and yet want to retire on more than mere subsistence, there are pensions and 401(k)'s.
. This crude complementarity, of course, is that they all give money to you once you are retired. I'm not sure what more there is to retirement savings than that, but clearly there is some sort of sophisticated nuance that I am missing. It probably has to do with social contracts, animism, and the special glow that money from some sources has but money from other sources lacks. I would also add that the last I checked, private savings is available to both the rich and the poor (although their savings rate may be very different) and that social security was only available to those who worked -- so an individual who never worked, and never married, would not be eligible for social security and would probably also be quite poor. As corporate pensions start to look shaky, and social security looks shaky, private personal pensions are the only sane way to save for retirement.
From the beneficiary's standpoint, pensions mean unique security. The worker gets a guaranteed income, determined by the number of years of service and by his or her salary at retirement. And pensions don't run dry; workers (or their spouses) get them as long as they live.... A 401(k), on the other hand, promises nothing. It's merely a license to defer taxes - an individual savings plan.
Of course, this article is all about how companies are unable to live up to their pension promises, and how this harms neither company nor pensioner since it all just gets passed to the government anyway. A private savings plan, last I checked, would still have money in it and does not require anyone to keep their word -- especially politicians. Morover, I am amused at any article that can have these two paras in it:
Social safety nets have their price - in this case, a little moral hazard - and that is really what the debate is about.... According to Barclay's Global Investors, if you use realistic assumptions, the total underfunding in all public plans is on the order of $460 billion. If this figure is even close to true, future taxpayers will be hopelessly in hock to the police, firefighters and teachers of the past.
If almost half a trillion dollars is a little moral hazard, I'd hate to see what a lot of moral hazard looks like (although maybe Fannie Mae will show me).

If defined benefits are on their last legs, then it would make sense to try to incorporate their best features into 401(k)'s. The drawback to 401(k)'s, remember, is that people are imperfect savers. They don't save enough, they don't invest wisely what they do save and they don't know what to do with their money once they are free to withdraw it. Quite often, they spend it.

Here there is much the government could do. For instance, it could require that a portion of 401(k) accounts be set aside in a lifelong annuity, with all the security of a pension. Behavioral economists like Richard Thaler have demonstrated that you can change people's behavior even without mandatory rules. For instance, by making a high contribution rate the "default option" for employees, they would tend to deduct (and save) more from their paychecks. If you make an annuity a prominent choice, more people will convert their accounts into annuities.
The article poses the question of how one makes ones savings last a lifetime as this tricky conundrum, but it's really very simple -- you buy an annuity and live off that. Mandatory savings, mandatory annuities, and good default investment options would make 401(k)s a much better savings vehicle for everyone, not just the financially savvy.

Other good articles: a guy who tells people to live more frugally (wacky, I know, that's why it was written about in a newspaper) and how old folks are partying it up while the collect their pensions.


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