The defined benefit is dying. Barack Obama is struggling to keep it alive, but it’s apparent that it’s something that even as bounteously rich a society as ours can’t afford.
Yes, I know that “defined benefit” is not a common household phrase. But most people know what a defined-benefit pension is. It’s when your employer promises to pay you a certain amount of money, pegged to your salary or according to some other formula, when you retire.
Some 30 years ago, most big employers had defined-benefit pension plans. Some private-sector employees still have them, and many government employees do.
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But a little-known provision of the 1978 tax law, section 401(k), authorized companies to offer defined-contribution pensions. Instead of promising to pay workers specific amounts years later when they retired, companies would put certain amounts in the employees’ 401(k) accounts.
The employees would own the money and choose among investment options. The money wouldn’t be taxed until it was removed from the 401(k) accounts years later.
It’s easy to understand why employers prefer defined-contribution plans. Once they’ve paid the employees, they don’t have any further obligation.
Many employees like them, too. They have actual money, not a claim on some fund someone else is managing. They can move from one job to another rather than stay with one employer for many years until their defined-benefit pension is fully vested.
Pensions are not the only defined-benefit system in our society. Social Security is a defined-benefit system; you pay money in, and you get retirement benefits when you reach a certain age. Medicare is a defined-benefit system, as well, though when you become eligible, you may be surprised to find it doesn’t cover everything; that’s why elderly people buy Medigap insurance policies.
Many on the political left decry the disappearance of defined-benefit pension plans from the private sector and strive mightily to maintain them for public-sector employees. They argue that people with defined-contribution plans often don’t save enough for a comfortable retirement, or that they make bad investment choices.
They argue that defined-benefit plans and defined-benefit public policies provide you with absolute 100 percent security and eliminate all risk. Unfortunately, it’s becoming clear they don’t.
The people who put defined-benefit plans and policies in place assumed there always would be someone able to pay for them.
There always would be enough new workers to pay for retirees’ Social Security and Medicare. Benefits were raised on the assumption that the baby-boom generation would produce a baby boom of its own. Oops. Birth rates near replacement levels, which we have now, are not enough. The ratio of workers to retirees is in inexorable decline.
General Motors always would be a big enough company to pay for the pensions and health benefits promised to hundreds of thousands of retirees. Turned out it wasn’t.
Congress recognized the fact that both employers and employees have incentives to underfund defined benefit pensions (it’s more fun to spend the money now) and passed the Employee Retirement Income Security Act (ERISA) in 1974. But when companies fail, ERISA’s Pension Benefit Guaranty Corp. doesn’t pay the full amount of many private pensions.
Defined-benefit policies assume a static society. But we live in a dynamic society, and defined-benefit policies cannot keep up with constant change.
Social Security and defined-benefit pensions assumed that people wouldn’t live very long after turning 65. Now we do. Medicare didn’t provide a prescription-drug benefit, because prescription drugs weren’t a big deal in 1965. It took 38 years before a prescription-drug benefit was added.
Defined-benefit pensions are now mostly a thing of the past, replaced by defined-contribution pensions, which place some risk directly on individuals rather than promise them full protection, which turns out to be highly risky when big entities out of their control fail.
We need to adjust defined-benefit public policies to shift some short-term risk to individuals while reducing toward zero the huge systemic risk that exists now.
Barack Obama seems to believe we can shore up these policies by taxing high earners more. But there’s not enough money there to keep things going as they are, and a big tax increase on high and middle earners would increase the risk that our current sluggish economy becomes the norm. That’s not a risk worth taking.
Defined benefits were always an economically bad idea; one doesn't have to be conservative to know that. As with many such bad ideas, the problem doesn't emerge until long after those who created it are gone. This has been frequently noted here at NRO.
However, there can be problems with defined contribution plans, as well, and as noted in the article. Here's one that is not often mentioned: I suggest that the costs of retirement expand to absorb all available retirement funds, whether such funds come from defined-benefit plans, entitlement programs, insurance, savings, or anything else.
It's like a motel room on the beach for Fourth of July, or for tickets at a World Series game: Price rises in accordance with available money. No amount of saving for your holiday will suffice, if others have just as much money to spend on it. An even better analogy is the cost of higher education: Same (or worse) product, higher costs, less return on investment. Why? Availability of funds, whether from loans or second mortgages.
If my suggestion is correct, and I certainly believe it is, then it will not much matter whether retirement funds come from private savings, or not, except in terms of administration costs. Entitlement programs pay government workers as administrators; private funds would pay private administrators. Admittedly there is more choice in the latter, but few of us would be able to make knowledgeable choices no mater how much information is available, due to the futures nature. Instead, we will merely be deluged with ads from the numerous private administrators.
The question is, can government do anything to drive down the real costs of retirement? I doubt it. Rationing is one possibility, widely derided; but let us not forget that many (all?) private plans merely provide rationing by different methods.
One method of having a lower paid government workforce in Florida is/was to promise the defined benefit method of retirement. In this manner the Legislature and Executive were able to pay the professional state employees of the 4th largest state in the union a scale of wages which ranked in the bottom three of all 50 states for the last twenty-five years. Will an increase in wages accompany the drive to defined contribution? As Bill Cosby's Noah said to God - "Righhhhht!"
"bounteously rich a society as ours can't afford."
I take issue with this egregious over statement that is far from the truth. 46% of our GDP is simply government spending at one level or another, leaving 54% to the private sector. Of the 54% the vast majority is in the hands of the super-rich, as the middle class has shrunk to such a degree that the 50% of Americans pay no Federal Income Tax as a result of not earning enough to do so. The top 1% pay 38% of all taxes at the Federal level as they are the bounteously rich. The government itself is a cesspool of debt to the tune of $118 trillion in total when you combine Municipal, State, Federal and Entitlements. The total assets of the entire nation is only $70 trillion by comparison. This sir concludes that there is no net wealth in this once great nation, as we are currently $48 trillion in liabilities above and beyond every asset of every citizen, business, and government in the entire country. On paper we are already insolvent if not for the printing of dollars, which leads to further problems as it simply delays the inevitable.
Of course public employees and unions always expect a free lunch regardless of all realities, but they demagogue any attempt to shore up entitlements and retirement by shifting to a defined-contribution system. Defined benefits is a lousy model as it remains static while the entire demographics and economy are in constant flux and thus make the concept unsustainable, but we have known that since the 1970's. This is not a revelation, it is 40 years of failure to address the obvious.
I have defined benefits and defined contribution benefits that look like this:
7% Gross income is fully funded by employer and deposited into a 401(a). I elect this to be deposited into a fund that is merely CPI (Consumer Price Index) +3%. This means 7% of my gross is contributed on my behalf by my employer with no tax obligation by me until I take it out. There is no risk as it is tied to the CPI +3%, period. It goes up and doesn't come down. Since 1999 the returns have been as follows.
Now the return may not be stellar, but there is no risk of loss to capital or gains, so each consecutive year the balance is compounded by another 7% contribution of new funds, appreciation of interest on the total balance cumulative annually, which when combined shows that my worst year was 2009 with a 9.6% gain. My best year was 2008 with a 13.8% gain. How were your stocks doing in those years?
In addition to this I also fully fund a 403(b) pre-tax with my own money, of which I contribute 7% of Gross Income as well. This has averaged a return of 18% annually for me since 1999. I will have to explain to you how this is possible, as I do something myself, that most people are either ignorant of or simply have no clue, which is the same thing.
I invest it in a midcap stock fund geared to moderate to aggressive growth with about 10% in Income or dividend stocks.
I have the ability to change funds and reallocate balances of this account whenever I decide. I use historical long term trends to move my funds between the Aggressive Growth and a Capital Preservation fund. When the market is on the rise, I ride it up in Aggressive Growth, when it is in decline I shift 100% to Capital Preservation. I ride the up's and skip the down's, and average 18% the past 11 years.
That shows the long term trend of the market. In every down trend I am in Capital Preservation and not losing account balance, yet making small gains in the Bond Market. As soon as the down trend stops and reverses I jump back to Aggressive Growth, always a bit late as I want confirmation. Likewise I always jump to Capital Preservation a bit early, as stocks can fall fast once they do, "Bear goes up the stairs, Bull goes out the window." Meaning long slow uptrends, fast sharp downtrends. Get our early, get in late, no worries 18% average because you are not riding the ups and downs, you are only riding the ups and avoiding the downs. So as most investors that ride through the entire cycle have to wait to break even, I ride the same uptrend twice, or three times.
99-02 Capital Preservation. Got back in a $7,700.
03-07 Aggressive Growth. Jumped out at $12,800.
08-09 Capital Preservation. Back in 09 $7,800.
10-11 Aggressive Growth. Any sign of trouble at $13,900 I'll be back out.
As you can see, I almost fully rode all of the ups, and avoided the downs. Active management of your own retirement account is not hard to do, but costly if you don't do it because your broker fully rode the ups and downs, and as such no broker can out perform what one can do themselves with a little bit of knowledge and discipline.
This is why public employees are against defined contributions, people just let their money ride the ups and downs and you spin your wheels. Those that retire when it is down tend to use up capital and can't recover. Had they shifted to capital preservation the would not have lost a penny. You can make more in retirement than you ever did working if you also did this yourselves.
Now imagine if Social Security was not handed to the government to spend and place an IOU in its place, but that money was also given to the employee directly. I already invest 14% towards long term retirement, with minimal exposure to losses.
Social Security would have been another 12.4% Prior to 2011, or 10.4% in 2011. That brings total retirement contributions to 24.4% of Gross annual earnings in 2011, or 26.4% in years prior.
I really could care less about Social Security as they have raided the coffers and I do not expect to see a penny as my retirement is a few decades away still. However, I don't need it anyways, as I knew I was never going to get it. I would have however loved to have kept and used my contribution and better yet employers as well. If Americans implemented this type of retirement philosophy we would all be fully funded and there would be no need for government involvement to begin with.
As a side note, I can contribute more to my 403(b) if I so choose, but I don't due to the problems with the dollar, as it might not even be around when I am eligible to retire as well, so I also invest in Commodities as a hedge, and as you know, they are doing wonderful as well.
The Rich are getting richer, as they do these and other types of investments, the middle class is dying because they are losing the job base itself, and lack the basic skills to manage their money as they learn all about FICO which is a debt trap for the middle class. Debt is not what wealth and freedom are made of. You do not go into 30 year mortgage debt as a means to become wealthy, that is the slowest form of death there is. You GROSSLY over pay for something you never own until you make the final payment.
The sooner defined benefits are eliminated, the better. They become unnecessary if people learn the basic of managing defined contributions.
@Jim B: The problem with defined benefits is that behavior now is manipulated by promises to be kept in the future.
It's rather like some religions, actually. Be nice now, get reward later. If the reward doesn't happen, you won't be able to do anything about it.
But there are also numerous secular examples, such as: Study now, get big pay later; work as intern now, get big pay later; start at low union scale now, get big union scale later. I note that the last of these is quite common among public employees, and is negotiated by the unions supposedly on behalf of the workers.
Indeed, unions love to negotiate pie in the sky later, for less now, because more now is not available. That's why so many retirement and health plans are under-funded. If the unions (and politicians) negotiated present pay and benefits based on present ability to pay, then they would be unpopular among the union members, without (until nowadays) losing any popularity among others. Back in the days when large corporations were either unionized or had similar defined benefit plans, who would question them? But now, few are left, and they are mostly in the public sector.
If Florida changes its method of retirement benefits for workers who have already "paid in" by (supposedly) accepting low wages, then that's cheating. But we must ask, how many of those workers would actually have migrated to another state to take public employment at higher wages there? Few, because they would have had to compete against the locals for those jobs. How many public employees would have taken a private sector job? Few, because at whatever wages, the private sector has not offered the kind of job protections historically available to public employees.
If a union (public or private) has ever negotiated a two-tier contract wherein new workers (not already there, thus can't vote on it) get less than those already in, then its members shouldn't complain.
Public employees love to tell us how much better they would be paid somewhere else. So, go there.
@Never_Outraged
I have provided you with the basics, which include everything but the specifics to your unique situation, but you should be able to devise from what I posted exactly how to implement your own finances much better than leaving it up to a broker.
Likewise, if you buy a small plot of land, say 5 acres and pay for it, build your own house on it, your retirement cost is minimal beyond medical. Yes this means some would have to move to do accordingly, but those able to should. City living is going to degrade more and more as infrastructure and structural debts plague cities and states as it is and the federal government will have to cut back as well to a massive degree.
The economy and country of pre-2000 is gone and not coming back at all. The future of America and its citizens need to wake up and prepare for a new reality that will take place under the next President, no matter who it is, as that will be the last President where we are the world leader. More and more citizens are returning to a life somewhat like 1880's but with modern transportation and communications of course, but the values are being returned, the simplicity versus the excesses of the past 40 years.
America was sold out when it began shipping jobs overseas and spreading the labor force globally to improve profits for the rich, while laying waste to the jobs of the working middle class. Unless the next President is very aggressive in bringing back jobs, it's over. Obama is interested in increasing the wealth for the rich and taxing it so government can support socialist society, where the once working class are all on welfare and food stamps paid for by the super rich, but it won't work as they will simply move off shore themselves.
We either are going to be allowed to drill our own oil, use our own resources, fire up our factories, produce the goods we consume and ship some abroad or we go belly up by 2017, as at that point the interest on debt crowds out too much of our comfortable programs and we begin cutting those first to massive degrees and replacing them with nothing, as there simply is no magic money machine less job creation to get out from under the debt spiral.
"Now the return may not be stellar, but there is no risk of loss to capital or gains, so each consecutive year the balance is compounded by another 7% contribution of new funds, appreciation of interest on the total balance cumulative annually, which when combined shows that my worst year was 2009 with a 9.6% gain. My best year was 2008 with a 13.8% gain. How were your stocks doing in those years?"
The interest returns are provided above by year, I meant those interest returns plus an additional free 7% of Gross Income, not 7% interest on total investment. I lost track of my point and combined the 7% and annual interest, which of course is incorrect.
I should proof-read I suppose, na.. I'm not paid to write.
Outraged - came here because of the lack of income tax (came from heavily taxed Md. in 1980). Worked in private industry then came to the state to use my training. Accepted the deal - as you say a leap of faith (as is all of life since nothing except Mr. Franklin's duo is assured) stayed, raised the family and now am sliding into retirement just ahead of the Rape of Tallahassee by the new Vandals in the (long time laughing stock) Legislature and their sometime "leader" Scott the Bald. The exuberant rush of speculators created the atmosphere for the state to experience the economic downturn leading to the hole in revenue which is cited in the effort to stop gap the hole with pension/health benefit reductions, tuition increases and per capita student spending reductions. My time in the trenches is coming to a close but I do advice every youngster I can to get the hell out before it’s too late and Florida returns to the swamp land hustle it was prior to the widespread use of air conditioning.
You can roll your own defined benefit pension plan and as an added benefit you can withdraw your money out tax free on the back end. Check out External Link
401K plans have the disadvantage of being heavily taxed at a time in life when you have few if any tax deductions. When you consider the impact of income taxes on 401K plans you can easily outlive your wealth.
@MarathonMan
I can also take out a loan to myself and pay back with interest to myself, with no penalties paying back early etc.
For example a car is not a huge expense compared to the size of a retirement account. Rather than finance a vehicle if you can't afford to pay cash, take out a loan to yourself and pay cash for the vehicle, and rather than make car payments you pay yourself back with interest to your retirement and can always pay the loan off early.
You reach a point where you can become your own bank, so long as you don't take out more than you can afford or should for the wrong reasons. I would rather contribute much more into this type of plan and utilize effectively than contribute less due to paying interest to a bank for life's expensive necessary items such as a vehicle.
Granted, my vehicles are all paid for and I do not have a loan active against my account, but I could if I wanted or needed to.
The loan to self is tax free, your only taxed with distributions.
It's not right to say that a major shift to defined-contribution policies would reduce huge systemic risks toward zero. If the events of 2007 have taught us anything, it's that no saved money is safe.
I don't think you put enough emphasis on the immorality of the public sector offering defined benefit plans. Elected officials are taking on open ended obligations for future taxpayers. Taxpayers should pay for the current benefits out of current receipts. We have municipalities whose main current expense is paying for police and fire protection given decades ago.
First of all, a tip of the hat to Captcha, which precedes this comment with "a load of codswallop". Seriously. You have been warned.
I'm a child of the grey flannel suit era. My father worked for one of the Big 3 U.S. auto companies (not GM, so keep guessing). He and my mother retired on a defined benefit retirement plan that they had conservatively augmented with their savings. Twenty years after my dad's retirement, they are still alive and financially secure. The financial and corporate world that helped them to reach that point is gone. Kaput. So Mr. Barone is right - but he neglects to acknowledge that the era of large corporations and the defined benefits plans many of them offered was an era that provided incalculable benefit to American society. In the post war era the laboring class moved into the middle class. Home ownership, educational aspirations (and their realization) and retirement security were all assisted by the availability of benefits from large corporate employers. Nothing quite like it has followed. We all have our 401k's, and we ride the cycles of the investment markets, which more and more have come to resemble a big casino. But the comparison with the 50's cannot be avoided Then, people were being moved into the middle class. Now, the underpinnings of the middle class are being progressively eroded. One of the pieties of the conservative movement is that we can all be successful investors, and that we can all be successful entrepreneurs. Kevin Williamson wrote trenchantly in a recent issue of NR that, well, no we can't. The post war era offered a period of opportunity and assurance to a broad cross-section of the populace - a rising tide that lifted more boats than have been lifted since. Defined benefits were a part of that social contract. They're gone, and time has moved on. But please forgive me and others if we perceive that the future looks bleaker than the past.
@Reality Check: I'm not surprised that you mentioned the buy land, build a house thing. I actually looked into that. Could do it, decided against it. Not my lifestyle.
Consider the opposite: the large quantity of mobile (manufactured) housing on which the land is rented. A lot of that goes to retirees, not just in the sunbelt, but elsewhere. In this case, when the retirees die or are sent to the nursing home, the valueless home is rented out (if lucky), towed away, or abandoned.
