Big Problems, Big Solutions: Retirement
Scenario 1: I know a civil service retiree with two pensions. Between what they saved in their 401k and what they had in their pension from their first job they could have lived comfortably. This person wanted a little bit more than just living at the same quality of life in retirement as he wanted two homes. He wanted one near the family’s traditional home town and one on a lake in another state. The retiree also wanted the security of the second income after their first retirement because of some later in life children he had still hadn’t left the nest yet. The two careers dovetailed nicely to provide support for the longer than usual child-rearing years as well as the desire for a more affluent retirement.
Scenario 2: I also know several people with disjointed careers. One in particular worked hard their entire life but it was in artistic and service endeavors with limited retirement options. They never worked a corporate job and had minimal periods of time with the availability of contributing to a 401k. Now they are in their mid-to-late 60s with a tiny Social Security payment that does not allow for independence from working. Their current retail gig was getting too difficult for them and so I met them when they were looking for a job that would be less stressful from a physical and emotional perspective.
In both instances you had truly hard-working individuals. One was fortunate enough to fall into a career that included not one but two older style long term jobs with pension plans. The other also contributed to society throughout their entire life and wound up having to literally work until they are incapable of working anymore because they had nothing saved for retirement.
One of these two models works pretty well but doesn’t really exist anymore, especially not in the private sector. The other model is great for the needed flexibility of the modern world during the working years but offers zero security for the weaning years. It also massively stifles the potential creativity that would be available if the artist was free to do something other than retail jobs and scrounging for a living as they progressed through their end stage working years. Retirement is clearly a problem, it’s not just a big problem, it’s considered a crisis today, at least when framed against the options we had in decades past. This is why I have chosen it as the subject for a big problems big solutions article.
Like all of the Big Problems, Big Solutions articles, we ask two questions. The first question is how did we get into the situation? The second question is how can we fix it?
First a very quick primer. The current retirement picture in America includes two types of programs, well two types if you don’t include social security, which is in a class by itself. Looking at only employer based retirement, we have defined benefit (pension plans) and defined contribution plans (401K, IRA, Roth IRA, et.al.). Pensions literally are designed around the idea of determining what you get after a predefined period of time and contribution. They start with the end in mind and are built around shared resources for a pool of employees. So if you want your employees to retire with 70% of their income for the rest of their lives, then you work backwards. How much do they have to contribute and how much does the employer have to contribute to get them there after a life of service? When they and their beneficiaries die, then the money stops. The ones who live longer get the benefit of the contributions made by the ones who don’t live as long. The math isn’t too complicated to figure out. Contributions are fixed and the employer contribution is usually high. The employer is on the hook to make sure the retirement goal is met because, remember, you start with the goal as the foundation of the plan and work backwards. The 401K came of age in the early 1980’s. It started with congressional legislation allowing for deferred compensation to extend to regular wages. This new legislation in conjunction with broad IRS regulations facilitated the 401K for average employees. The 401K is built around individual defined contribution. There is no end goal with a 401K, you work from the beginning and what you put in is what you get at the end. Employers can decide how much they want to contribute, if anything at all.
What have we done in the past?
Pensions were the rule of retirement until the end of the 1970’s Without going into a deep history, the pension plan started in the golden age that included the modern industrial age and the age of American ascendence i.e. the first half of the 20th century. Industry needed a large workforce to stay on the job for long periods of their life. When employees got too old to work, there needed a way to politely scoot them out the door. The pension was the perfect tool for this. Put in your 30 years, and thank you very much. I have to imagine that the guys still working the shop floor didn’t mind the compulsory requirement to take part in the company’s pension plan knowing that the retirement was a form of entitlement. They knew they were helping the previous retirees so when their time came to retire there would be others behind them.
Pensions were dropped en masse like a hot potato when the 401K came along. There were many reasons for this. The biggest of which was that pensions are very expensive to fund and manage. They also go on in perpetuity so once an employee is vested the employer is required to maintain a relationship through the retirement plan for the rest of the employee’s life. There is a benefit to the 401K in that it’s transportable, if you leave the company the 401K is converted to an IRA. This became hugely important as we entered into the information age where more and more employment was designed around a just-in-time model. Businesses no longer wanted a large staff of employees that they maintain for 30 or 40 years, they wanted just enough people at just the right time. The 401K is ideal for this from the employer’s perspective. The problem with a 401k is that it’s self-directed and completely voluntary on the part of the employee because it’s an individual plan. Not only can employees choose not to take part, they can also liquidate their assets at any time.
What do we need to do?
Yes, i’m thought of as a socialist in some quarters, but don’t forget, i’m a stealth pro-business capitalist who’s really just journaling the collision points between work and life. In this instance my first thought goes to the needs of business. No I don’t think business needs to provide pensions to every employee and get penalized for using contract labor. Everyone generally does better when business structures are tremendously flexible. Yet there needs to be a truly strong retirement plan for the workforce. If working under the current models I have espoused the use of all three types of retirement that are available to us including defined-benefit, defined contribution, and Social Security working in concert for the perfect foundation. Unfortunately not everyone has access to all three types and as cited earler, many only have the fallback of social security. We really need a single type as the foundation. What does the perfect retirement plan look like? The interesting thing about the 401K, and the pension plan, and even Social Security is that they all have different elements of the perfect plan. So the secret to success is just to combine the best pieces into a single retirement offering.
The first thing is that it needs to have a shared element, i.e. a pool. We know the laws of averages. We know some people live longer than others. The ones who live should benefit from the ones who didn’t make it that far. This makes the plan less expensive for everyone contributing to it. The pools need to be large, ie huge populations so risk is really diluted for the individual members. This shared plan mentality is directly from traditional pension plans.
It needs to be mandatory and universal. The only solution we have for retirement that is mandatory and universal is actually social security which is more of a social insurance program than it is a retirement program. You need the universal element to make sure that everyone has a good retirement. You also need it to be mandatory without flexibility to keep people from withdrawing to address a short-term need when the long-term problem is still out there. This is the biggest flaw of the 401K plan and the biggest benefit of social security. As I stated earlier, 401K’s and IRA’s are voluntary and with a small penalty you can liquidate at any time. Life is always happening and there is always a financial need. Using your retirement by either not contributing or withdrawing marginalizes the benefit of the 401Ks reliance on compound interest. Sociality Security offers the best solution here. You have to pay the money and it’s gone. You don’t see any cash until it’s time to receive benefits. When you do receive benefits they can’t be garnished, they can’t be loaned against or transferred. They exist as long as you and one beneficiary are alive.
There needs to be competition. Competition always breeds higher quality products and services. Being honest I have always had much better service out of my retirement plans from my employer then the social security system. This is simply because the retirement plans have to compete against each other to become the plan of choice at any employer. The best service I have received has been through organizations that are very customer or member focused.
It needs to be flexible like the 401K. The modern career includes working long and steady periods, not working, working again in different ways and at different incomes, working part time, and contract work. All of these types of employment need to be able to take part in this. Technically this is possible with self-directed retirement accounts like the IRA but from a practical standpoint it’s unrealistic to expect a huge population to be efficient at managing contributions into such a retirement account as they deal with the undulations of life. As an employer it shouldn’t matter what kind of staff you have, if they are driving productivity then they need part of the profit from that productivity to go into long term investments, i.e. their retirement.
It needs to be portable, wherever you go there it should be seamlessly. The biggest benefit of the 401K is its transportability. It’s one of the things employers love about it. They only have to deal with your retirement account when you’re working with them. It goes without saying that in a world of a just in time and contract workforce a retirement program needs to be portable from employer to employer and retirement program manager to retirement program manager.
It needs to offer benefits commensurate with productivity to allow highly effective members of the workforce to retire early should that be what they desire to do. This is the one area the 401K far exceeds the pension programs. Generally speaking if you are willing to take on risk, then you can maximize tax deferred contributions the tune of 18,000 a year, and you can sock a ton of cash away. Pension plans and social security generally have caps that keep people from benefiting or retiring early should that be their goal.
So how do we do all this? What’s the best solution? I posit that the best option would be a new retirement base program that could potentially displace, but not eliminate, all of the different retirement solutions currently in use. In this scenario, the social security system would shrink dramatically because the only purpose of that program would be to assist those who are not part of the workforce. 401K’s exist, but only after basic retirement is achieved, ditto for what remains of pension plans. The plans would have to be managed by a special new type of organization that is authorized by the federal government. These new organizations would be highly regulated. They would be required to accept anyone. The base program would include state mandated minimum employer contribution levels and non-profit status for the retirement management institutions.
I envision a series of member owned non-profits, retirement Co-Op’s if you will, that are private organizations but which are underwritten by the federal government. Members of the workforce would all have an account number like a social security number. They would go to their employer and the employer would take the number and know what co-op the employee was a member of. The employer takes some of the employee’s income, adds the employer contribution for a target of about 10% between the two and it all gets sent to the co-op of the employee’s choice. It doesn’t matter if the employee is paid for a single job, paid on an annual salary, or paid for just a few hours a week. All labor based compensation would be subject to the 10% total target minimum. After the minimum is met employees can contribute more into this system or into the older 401K style individual programs if they want to grow individual wealth through a deferred income plan. The co-op deposits can be automated through the employer’s bank assuming there are only a few dozen retirement co-ops. Co-Op’s would be required to accept any member of the workforce but in theory would compete for the business in services available to it’s members. The co-op would manage the funds in a highly conservative way similar to how pensions currently manage them. I know some pensions target 6–7% growth and this seems about right when you consider the stock market has a 100 year history of growth at about 11%.
Benefits would start to get paid after a set period of time, say 30 years, and the amount would be based upon contributions. Early withdrawal would only happen if the annuity account grows to the point where the payout would equal the average household income plus medical, until medicare kicks in, plus cost of living adjustments, and taking into account average life expectancy. This would mean high income earners could start retirement much earlier than lower income earners thus rewarding productivity in the workforce. I ran some spreadsheets and the numbers follow: If a business executive makes 200K a year (we’ll keep this number static for their entire career for demonstration purposes), and the average wage in America is 42K. Under this system, assuming 10% mandatory contribution and 6% growth, it would take that high level wage earner 16 years to hit $43,540.61 a year in benefits. If they wanted a benefit that was comparable to their high income it would take 36 years to start seeing an income of $202,028.99 annually. That means someone who started work at 20 could retire at 56 with full income and assuming they were a very high wage earner from day one or they could retire at 36 years old with the average household income or anywhere in between and have that income until they die. Talk about empowering the individual with retirement flexibility! Think of what society would be like if we freed up the workforce earlier? If you have that guaranteed income, imagine what business you would start on your own? What civic organizations would people engage with? What art you could create!
Clearly the numbers would have to be massaged but the key ingredients are universality, simplicity, non-profit, shared risk and basic reward, yet higher reward for those with higher productivity. This program would be a win-win for both the employee and the employer. The employer doesn’t have to worry about rules like how many hours, vesting, or choosing a retirement plan management company. In the same way they submit the income tax receipts, they submit the retirement contributions to their bank or accountant who simply sends them along to the plan managers. For the employee they can bounce from big employer to little employer. They can go from part time to full time and contract work and then back again. No matter what they do, they are always contributing to retirement and they start receiving money as soon as they are able. The 401K and IRA goes from a flawed retirement program to a tool that benefits the super savers in the country. These mega-savers may want a truly high quality nest egg for their waning years or to retire very early. Maybe they just want to leave a massive financial legacy and the best way to do that is to save in individual retirement accounts in addition to the basic retirement co-op account.
I’m sure there are many people who can come up with dozens of reasons why this idea of mandatory participation in retirement coops is improbable or impossible. The point of the big problems big Solutions articles is not to discuss feasibility. The central thesis of these articles are about coming up with something that is potentially much better than what we currently use. I have to say making everyone in the modern Workforce maintain access to a universal shared risk retirement system that’s based on investments, not redistribution, that rewards hard work yet sets a baseline for all workers, and that let’s employers focus more on their business and less on the benefits they have to manage would be a true advancement over the systems we currently have. It’s not just one big solution either, with the freedom in retirement that a larger percentage of our population would enjoy, I’m positive many retirees would use their time figuring out ways to fix other problems in our world. Like a perpetual retirement annuity with regular cost of living adjustments, this big solution would only get bigger and better over time.
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