Expand Social Security, get rid of 401Ks
People, can we face some hard truths about how Americans save for retirement?
It Isn’t Happening
Here’s a fact: most people aren’t seriously saving for retirement. Ever since we chucked widespread employer based pension systems for 401K’s and personal responsibility, people just haven’t done very well saving. They take money out for college for their kids, or an unforeseen medical expense, or they just never put money in in the first place. Very few people are saving adequately.
In Fact, It Shouldn’t Happen
Next: it’s actually, mathematically speaking, extremely dumb to have 401K’s instead of a larger pool of retirement money like pensions or Social Security.
Why do I say that? Simple. Imagine everyone was doing a great job saving for retirement. This would mean that everyone “had enough” for the best-case scenario, which is to say living to 105 and dying an expensive, long-winded death. That’s a shit ton of money they’d need to be saving.
But most people, statistically speaking, won’t live until 105, and their end-of-life care costs might not always be extremely high. So for everyone to prepare for the worst is total overkill. Extremely inefficient to the point of hoarding, in fact.
Pooled Retirement Systems Are Key
Instead, we should think about how much more efficient it is to pool retirement savings. Then lots of people die young and are relatively “cheap” for the pool, and some people live really long but since it’s all pooled, things even out. It’s a better and more efficient system.
Most pension plans work like this, but they’ve fallen out of favor politically. And although some people complain that it’s hard to reasonably fund pension funds, most of that is actually poorly understood. Even so, I don’t see employer-based pension plans making a comeback.
Social Security is actually the best system we have, and given how few people have planned and saved for retirement, we should invest heavily in it, since it’s not sufficient to keep elderly people above the poverty line. And, contrary to popular opinion, Social Security isn’t going broke, could easily be made whole and then some, and is the right thing to do – both morally and mathematically – for our nation.
mathbabe 
There are actuarial products that fix this problem without socializing retirement (further). Annuities for example. Did you have some reason for not discussing these?
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Well I don’t know much about annuities but it seems like they only work for people with money to set aside, which doesn’t solve the problem we have already whereby people don’t have money to set aside. Or am I missing something?
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Except many annuities today are generally designed to confuse and baffle the consumer so the insurer can make a nice big profit.
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Compulsory superannuation was introduced here in oz a few decades ago. I believe it was thought that the social security system would come under pressure when the baby boomers started to retire and that some enforced saving would alleviate this. Defined benefit schemes are popular with workers as they provide certainty but are being replaced with market linked products. These of course suffered during the gfc. I think the same has happened in USA. I agree with your arguments in support of maintaining an adequate social security system. Do you think compulsory superannuation is a useful adjunct to a government provided retirement income?
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Yes, the Australian system is pretty good – compulsory employer contributions, means-tested safety net (Age Pension), govt subsidized health care/aged care. Not perfect, but ranks highly in most international comparisons. (Nataxis and Mercer each do a global retirement index – highest ranking are generally northern Europe, then oz.) In the latest Nataxis index, Australia ranked 6th, US ranked 14th.
Defined Benefit Plans did suffer during GFC, but for those with time until retirement, values have come back up.
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Yes we are quite fortunate to have a fantastic government funded health system that is available to all and a social security safety net provided by the government as well as a legislated minimum wage of around $18 per hour at the moment. It’s definately not perfect and our indigenous population is suffering but it is more than a step in the right direction. It was a struggle for working people to get these conditions and requires constant vigilance to maintain and improve them.
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annuities are a solution to problem #2 (over saving for retirement due to survival risk) — not problem #1 (people aren’t saving). My point was that these are separate issues and their solutions shouldn’t be conflated.
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which wasn’t clear in my first reply, sorry!
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But over saving for retirement isn’t really a problem if you can afford it (unless the money is being saved under a mattress, because then it isn’t doing anything economically productive), because it means that you can pass on more to your children. Annuities only help if a bunch of people have saved up enough to live to 80 but not to 105, and so an annuity seller can charge up front the cost of living to 80 but provide for the life of the recipient, however long that might be. Since underwriting annuities only really makes sense if you have enough people to enjoy the advantages of pooled risk, annuities are essentially just pension plans for upper middle class people, except they are run by third parties and you pay in with one lump sum instead over a lifetime of work. They only help the people who can ride out the average case scenario, but not the worst case.
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“But over saving for retirement isn’t really a problem if you can afford it ”
Very few people can “afford” it without significantly reducing their quality of life. Essentially it is a problem only for those who have more money to spend than they could ever need. You can see this with people being encouraged to forego purchases at 25 to save for their retirement 40 years later. The idea seems to be that a comfortable retirement is the goal in life.
It is also extremely expensive with the finance industry taking 2% annually on average from people’s retirement savings for management costs. Its pretty clear the most cost-effective retirement program we have in the United States is social security. Of course, if you are in the private retirement industry “cost-effective” is not a positive attribute
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401(k)s are a blight. They are false promise distractions from far larger issues. But they are wonderful sources of profit for a few select and powerful industries. So there’s that.
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I agree! While we are at it, can we also create Medicare for all so that our healthcare does not depend on our employers, too? Both of these things end up reducing labor mobility and requiring that individuals take on too much risk themselves.
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Here’s a blog post I wrote two years ago on the easy fix for social security:
Because few people hit the upper limit they don’t even know this phenomenon exists… and because many are innumerate they don’t appreciate how much $$$ this would generate…
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Yes, I get one of those “November payraises” every year, although they seem to get earlier each year, indicating that I’m one of the few who’s doing better than inflation. I agree we should remove the cap on contributions. If I understand correctly, that gets us most of the way to solving long term funding problems at the current payout level, but probably not enough to raise benefits.
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I generally agree; I do have a question, though. When Social Security started, only about half the people reached sufficient age to obtain benefits. That is one of the ways in which it remained solvent. Currently, there are a couple of things that need to be done: raising the cap on the taxes (so that those earning more than $250,000 still contribute), and potentially raising the retirement age. I’m not sure if it should be raised to a point where about half the people reach it, but presumably this is a discussion that needs to be had.
What are your feelings on raising the retirement age?
(On top of that, of course, it’s important to launch a big education drive to inform people that social security is *not* a savings account: they aren’t putting in money so that they can later benefit personally, but rather to benefit society. So it’s *not* a pyramid scheme, and the cap does *not* make sense [it is justified on the grounds that those earning more money will not benefit from those contributions])
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I agree that the retirement age should be adjusted as the population changes and as cultural norms change. At the moment I don’t think our life expectancy is growing, what with all the diabetes and such.
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life expectancy has increased only for the rich – raising the retirement age is cruel.
“Men in the top half of the earnings distribution have increased their life expectancy at age 65 by five years since 1982.
Lower-income men have seen a gain of only 1.1 years, and lower income women have seen life expectancy decline.”
Click to access 08242010_social%20security%20fact%20sheet.pdf
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Thank you for the information; though I will note that I was comparing life expectancy when Social Security started with life expectancy today, not today’s with that of 1987. This period includes the pre-Reagan supply-side revolution, which had broad gains across all income levels (and a much smaller portion of the gains going to the top 1%).
The main thing to do is indeed eliminating the cap; the second most important thing is to counter the claim that social security is a savings account or a pyramid scheme: it needs to be understood as a societal investment, much like roads and schools. And then we can start addressing the issue of falling benefits and the appropriate actuarial tables. But I do bristle at the idea that the retirement age is sacrosanct, when the realities on the ground have changed. I’m not saying “raise it”, but certainly I think it needs to be on the table.
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Nobel Prize winning economist Kenneth Arrow wrote pretty much this in Uncertainty and the Welfare Economics of Medical Care (1963) https://assets.aeaweb.org/assets/production/journals/aer/top20/53.5.941-973.pdf. And it was the last thing he ever wrote on healthcare. The idea of pooling risk is so offensive to American Economists and Americans in general that his argument about the limitations of individualised markets in the face of uncertainty and his argument for pooling risk somehow got twisted and turned into an argument for a healthcare market and for Health Economics as a discipline.
But here is what he actually wrote:
“I propose here the view that, when the market fails to achievean optimal state, society will, to some extent at least, recognize the gap, and non market social institutions will arise attempting to bridge it”(p 947)
You are describing the impact of uncertainty on planning for old age he was describing the impact of uncertainty on planning for an ill future young or old and in both cases the solution is risk pooling–how you make that argument to the American People because Socialism is the prize question.
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as Teresa Ghilarducci observes, here’s what has to go right for 401ks to work:
“First, figure out when you and your spouse will be laid off or be too sick to work. Second, figure out when you will die. Third, understand that you need to save 7 percent of every dollar you earn. (Didn’t start doing that when you were 25 and you are 55 now? Just save 30 percent of every dollar.) Fourth, earn at least 3 percent above inflation on your investments, every year. (Easy. Just find the best funds for the lowest price and have them optimally allocated.) Fifth, do not withdraw any funds when you lose your job, have a health problem, get divorced, buy a house or send a kid to college. Sixth, time your retirement account withdrawals so the last cent is spent the day you die.”
It is essentially impossible.
For the last 25 years I have been putting 20% of my salary into a 401k. That has not yet recovered from 2008 and sequelae, so I can’t afford to retire in any reasonably conceivable future.
“The independent individual is always a fictive creation of those men sufficiently privileged to shift the concern for dependence onto others.” – E.F. Kattay
401ks as a supplement to an actual retirement income might be a good idea, but that is not what they are. Right now they are just a convenient tax shelter for the better-off few.
Infogram
As for annuities, as BradSF says, those don’t solve the problem of not saving. The other set of problems is that as currently sold most annuities are rip-offs with high commissions and fees, operated by companies which may not be financially secure and certainly are less secure than the US government.
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Meanwhile, the Balanced Budget Amendment task force http://bba4usa.org/
has gotten 28 states to call for an Constitutional Convention to pass a Balanced Budget Amendment. If they get to 34 states, there will presumably be a constitutional convention for that purpose. They have gotten about 5 states to sign on in the past year or so, so they could reach 34 relatively soon. Would be quite interesting.
This would certainly put Medicare and Medicaid in jeopardy — also Soc. Sec. though that could be fixed by raising cap as others have noted. Or, we could cut military spending by 60%.
Brought to us by our friends at ALEC and the Heartland Institute.
http://bba4usa.org/partnering-organizations/
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… and a Constitutional Convention cannot be limited to any particular issue. If you call a convention, *everything* is on the table. Sigh….
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Reblogged this on Managementpublic.
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Work until you die, if you’re lucky enough to keep your job.
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Reblogged this on zanesworld1.
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The problem with pooled retirement systems is that they have usually ended out being underfunded, often to extreme degrees, even if they supposedly planned them well. Inevitably the people who design them decide they will need far less money than they end out needing, and then crises happen (with a few exceptions).
I agree 401k’s aren’t really working. Most people can’t manage their money well enough to work them properly. I think this is a bigger issue than the leftover money when people die, which is just inefficient but doesn’t really lead to big problems.
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This about it from this standpoint: You spend the first 20 or so years of your life being a drag on the system in the form of parents taking care of you and public school and some college educating you. You then work until 65. The you retire and are on Social Security for 20 years. So, out of 85 years you contributed to society only 45 of them. The rest society had to contribute to you. Tie in to that how unproductive some people are and there you go.
JamesNT
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“out of 85 years you contributed to society only 45 of them. The rest society had to contribute to you. ”
Which means society nets 5 years of productivity. Why is that a problem?
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Because it can be a real net loss. Society as a whole can’t pay out forever and ever on everyone in that society. For any given system, there has to be at least as much going in as being taken out. I’m not saying everyone has to be as productive as Bill Gates, but enough people must be productive nonetheless. With our high prison population, high retired population, high welfare population, and young generation with unreasonable expectations we currently don’t have the level of productivity needed.
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” Society as a whole can’t pay out forever and ever on everyone in that society.”
Of course it can. It has throughout human history. While they are working, people pay for the people who are not yet working or no longer working. Just like the people who are no longer working paid for them when they worked. And the people not yet working will pay for them when they stop working.
Its obviously silly to expect babies and the elderly to produce enough to support themselves. They more than pay it back when they do work if they are working 45 years and not working only 40.
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“…if they are working 45 years and not working only 40.”
And that’s the problem. Too many fail that conditional statement you yourself put in your own comment.
JamesNT
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That 45-40 split was your postulate, not mine. Of course most people fail that measure. Most people don’t live to 85. Nor do they get their first job at 20. The typical person is unproductive more like 30 years, rather than 40. The actual number of people working for each one collecting social security is about 2.4, rather than your postulate of slightly more than one.
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Let’s go with your numbers. I say that easily because it doesn’t matter which numbers we use, their isn’t a big enough difference between them to matter. Question: How are situations where there are more unproductive people than can be absorbed handled? For example: a large number of retiring people and not enough young people to take their place which is similar to what we have now? Sooner or later, any given system is going to have these issues. And these issues may last for decades. Going to your remark about the number of people working per person collecting social security being 2.4, back in the 1940’s it was closer to 40 people working for every one retired. 40 down to 2.4 is a BIG drop.
JamesNT
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“40 down to 2.4 is a BIG drop. ”
Almost all of that “big drop” happened a long, long time ago. What does a comparison to the situation 70 years ago during World War II shortly after the social security system was created have to do with anything?
“How are situations where there are more unproductive people than can be absorbed handled?”
I am not even sure what that means. It seems to postulate a conclusion. The obvious answer to having a higher proportion of retired people is to increase the productivity of people who are working. Of course, increasing production is a benefit regardless of whether the proportion is increasing or decreasing.
As I said earlier, this is the nature of human society. When people are young and the elderly they are not productive and rely on the rest of us to provide for them. What exactly are you proposing be done to change that?
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So I work hard and try to save as much as I can for myself and my family, but you want to take it easy and vote to confiscate my money via “pooled fund”, so I get less money and you get more money. Did I understand your proposal correctly?
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Nobody’s taking away you money. Except through taxes.
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Taxes is another way of taking money away. Just because it is called “tax” it does not make it any less detrimental to my finances.
In fact, let me compare your proposal to the practice of “sharing” insurance costs by Airbnb and Uber, and by “sharing” I mean that it is other drivers and home owners who will be ultimately paying higher rates to subsidize increase in risk of Uber drivers or Airbnb owners. Similarly, you want hardworking and financially responsible Americans to subsidize those who are less hardworking and not as financially responsible.
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But some things simply make sense to socialize in this manner. I mean, what you describe is true of all insurance, not just AirBnB and Uber. We socialize health insurance costs in old age. In Canada it’s not called Social Security but Social Insurance, to emphasize the insurance aspect of retirement. In addition pretty much every defined benefit private pension plan (as rare as they are) involves confiscating money from people who die young to support people who live longer.
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Nothing is called “Social Insurance” in Canada. There are two pensions run by the Federal government, namely the “Old Age Pension” and the “Canada Pension Plan”. The first is simply a benefit supposedly paid out of “Taxes” and for the very low income it is supplemented again out of “Taxes”. The CPP is “funded” from premiums generally paid equally by employer and employee.
Actually taxes paid to the Federal government in both Canada and the USA do not fund anything. Why would a government that has the authority to create all the money it wants to out of nothing any time it wants need taxes to “fund” it’s expenditure?
But this is a taboo subject and we are not supposed to talk about it.
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” you want hardworking and financially responsible Americans to subsidize those who are less hardworking and not as financially responsible.”
That actually misses the point since this has nothing to do with how financially responsible or hard working someone is. Instead the question is how long one lives and a the inability to predict that. If one lives a long time, you will need to save more money for retirement. If you die before you retire, you didn’t need to save anything. Far from being “detrimental” to your finances, social security is a financial benefit that provides you with an assured income in your retirement regardless of how long you live and at a very low cost. And that is without considering the disability and survivor benefits.
As an aside, I always find it amusing that people who sit behind a desk and whose “work” includes lunches with clients think that low-paid loggers, mineworkers and farm workers don’t work as hard as they do. The difference has nothing to do with how hard people work, the difference is how much people get paid for that work. In general, that is determined by negotiating power.
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Dear OV, as the other commentators have suggested, the whole point of insurance is pooling risk and it simply makes sense. But I am concerned about your condescending attitude towards others. I agree with you that it is likely true that others are lazy, and I have no doubt you have your life together, things are great for you because you worked hard and had if not good luck, an absence of truly bad luck, and I sense your feeling of injustice that your hard earned money is being taken away. But keep in mind that your good fortune can all change in an instant … a car crash, cancer diagnosis, natural disaster, job loss, victim of a crime, dementia, … the list is endless. The vicissitudes of life. One of the most haunting sentence i once read is that apart from those who die unexpectedly in youth, we are all destined to become become a dying, decrepit animal. In that time, you will need the support of others – emotionally, physically, financially. I urge you to develop compassion for all fellow human beings, flawed as they are. Visit or volunteer at an elderly living facility. Not too long ago, I had a similar attitude to yours, and have been humbled by an illness that has left me in a terrible state at times. I would say I have worked hard all my life, am a good person, and so on, but as the other commentators have said, that isn’t really the point. Best wishes. Stay humble.
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Right on the money. The reason we moved to retirement savings is that it is an extremely lucrative business. The finance industry depended on taking its 2% of peoples retirement savings every year to make itself our largest industry.
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Greetings from Germany, where people are beginning to realize that introducing a (voluntary) system of supplementary private retirement savings was one of the worst ideas we ever had. The insurance companies were quite happy for some years, but now we’re trying to figure out how to reintegrate it with the general public retirement system/ social security. How come so few people understand basic maths?
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