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Wednesday, November 5, 2008

Towards Guaranteed Retirement Security

Teresa Ghilarducci
Bernard L. and Irene Schwartz Chair of Economic Policy Analysis
The New School for Social Research

American workers lack pension security, beyond Social Security, because individual commercial retirement accounts are tied to the volatility of finance markets, are inadequately funded, have poor net-of-fees returns, and do not pay a guaranteed rate of return for the rest of a retiree’s life. Also, employers have conflict of interests between their needs and their workers' needs when choosing 401(k) investment vehicles. Pension coverage is stuck at half of the workforce

I propose a short term and long term solution to inadequate pensions. Short term, workers should be able to swap out their 401(k) assets – if they choose -- (valued mid August) for special issue government bonds paying a guaranteed 3% plus inflation rate of return. Long term, everyone should be able to be in a national “cash-balance” fund where the contributions are a steady percent of pay – at least 5% -- and the returns are guaranteed (3% plus inflation.). Workers’ contributions should be subsidized by a government tax credit of $600 (adjusted for inflation). The short term swap would be voluntary and the participation in the Guaranteed Retirement Accounts would be mandatory if there was no other pension plan available. One way to pay for the $600 subsidy is to turn the tax deduction for 401(k)s into a tax credit.

Posted on November 5, 2008  |  Add your comment
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Well, somebody had to be first, so here goes... There's one thing I like here but several I'm troubled about. 1. The part I like is restructuring incentives to participate in retirement plans. Currently, individuals with the highest propensity to save get the largest subsidy, while low earners who don't save as much get little or nothing. This doesn't make much sense, so some type of reform is a good idea. If you're interested in support on the center/right, though I might look at ways to improve marginal incentives without changing the overall progressivity of the tax code. Simply redistributing current tax subsidies down the scale makes the whole thing much more progressive, and I'm not sure I see the case for that.2. Guaranteeing a 3 percent real return with a risky underlying portfolio is very expensive. Essentially, the government is providing a put option guaranteeing a 3% return, but using Black-Scholes and some reasonable assumptions re riskless returns, volatility, etc., this implicit guarantee could easily cost 25% of total contributions. If contributors were instead simply given the government bond rate this issue would go away. 3. From a financial perspective, it's not clear most people would benefit from having most or all of their retirement savings in de facto government bonds. For the typical worker, Social Security acts much like a government bond (low risk, low return). Having invested 10% of wages in Social Security, I wonder whether an additional 5% of wages in another quasi-government bond makes financial sense. There are real advantages to diversification. Unless someone were very, very risk averse I doubt a standard portfolio analysis would point in this direction. Andrew Biggs
Teresa Ghilarducci focuses on a short term fix to help Americans whose retirement security has been impacted by the financial crisis. I am concerned about the cost and effectiveness of this fix because:It would lead to selling large blocks of stock at just the time when markets are down leading to further downward pressure on the market.It is offered to all 401(k) participants without focus on whether they are also in a defined benefit plan, without focus on age and time to retirement, and without focus on need.Unlike some proposals that give institutions or individuals more time to make payments or catch-up, this proposal just gives funds to individuals. It gives the most money to those with the largest 401(k) balances and the most to those who had the largest investments in equities.It appears that it would not prevent the people who took the funds from later switching back into equities, so that there losses are made up and they then take advantage of the potential for future returns.If there is a short term fix to help people badly hurt in their retirement planning, it seems that the fix should be focused on helping those near or at retirement and most in need. Temporary added Social Security or SSI payments for those meeting certain criteria seem to be to a better idea.Another way to provide help to people who are near or at retirement and hurt by the market drops impacting their retirement savings would be help create better job options for older Americans. In this regard, there are some relatively easy steps that may help and that are not costly. For example, employers who might rehire retirees are often reluctant to do so because of ERISA and legal concerns. For example, a safe harbor is needed to define termination of employment. I discussed these issues in testimony to the ERISA Advisory Council this year and would be happy to send anyone who wishes a copy of that testimony.My posting in the blog also pointed out another important short term issue – the need to provide Pension Protection Act temporary relief for defined benefit plans. Anna Rappaport, F.S.A., M.A.A.A.President, Anna Rappaport Consulting

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