That’s the claim, anyway. She’s been flogging her “Guaranteed Retirement Account” concept for longer than I’ve been flogging my Jane Plan, since her first book, When I’m Sixty-Four, published in 2008, so, in my pre-blogging days, so I can’t reference a “from the library”-style blog post about it. (Though I can point you to How to Retire with Enough Money and How to Know What Enough Is, a Clear Answer in 116 Pages, but that was a rather throwaway sort of book.) Now she’s got a new book, Rescuing Retirement, co-authored with Tony James, which I’m reading in ebook form as borrowed from my library but the basics of which are in an interview she gave promoting the book, titled “Fixing Retirement Without Tax Hikes or Benefit Cuts.”
So because it is an ebook, which I find to be a pain in the rear to read, but since Ghilarducci’s out there promoting her book and I want to be able to respond without waiting for it to be available in the library, I’m going to start with a lengthy, Jane the Actuaryish summary before getting into an evaluation of the whole idea, which is a variation on a mandatory account system, similar to the Jane Plan but with differences that (spoiler alert!) I think make the Jane Plan better. Note that since it’s an e-book, I won’t be providing page numbers for the quotes and since this is Ghilarducci’s pet proposal, I’ll refer to it as hers rather than referring everywhere to the two co-authors.
Chapter 1: Society’s Retirement Crisis
Everyone’s worried about retirement, and with good reason. “Since 1980, the number of Americans making it into their nineties has tripled.” And the 401(k) and IRA “experiment . . . has failed miserably to deliver on its promises” due to “predatory fees, low returns, leakages, lump-sum payouts.” “More than half of working people nearing retirement today won’t have enough to maintain their standard of living.” And for the next generation, the situation is even worse due to income stagnation and other Bad Things. As a result, “Based on current trends, we will soon be facing rates of elder poverty unseen since the Great Depression” (though Ghilarducci cites projections for “poverty or near-poverty“).
This wave of older poor Americans will strain our social safety net programs, from the Supplemental Nutrition Assistance Program (SNAP) to Medicaid. It will devastate federal, state, and local budgets. Left unaddressed, poverty among the elderly could drive up federal income tax rates by ten percentage points.
(This seems overblown. Wouldn’t formerly middle-class workers, even without any other retirement benefits than Social Security, still exceed the threshold for qualifying for food stamps? Isn’t it those who were poor during their working lifetimes, and thus have very small Social Security benefits, who qualify for these benefits?)
And we can’t blame people for not saving enough, or claim that we should simply improve our system of educating people on personal finance.
Hence, the Ghilarducci proposal, the GRA:
A portable retirement savings account, with a 3% contribution, split between the employer and the employee, but with a $600 tax credit covering the contribution for the first $40,000 in income.
Individuals select fund managers and can change annually; at retirement, the account is annuitized. Those who die before retirement will pass the account on to their heirs.
Both pre- and post-retirement, the funds are guaranteed by the government.
Other components:
Pre-retirement leakage is banned. Providers are anticipated to be large enough funds that fees are accordingly “rock bottom.”
Chapter 2, How We Got Here
Yeah, let’s skip this, shall we, since we’ve read this story before. Ghilarducci paints 401(k)s as monstrously destructive and marshals a large number of statistics which are nothing new, really.
Chapter 3, Six Key Problems
It’s a list, which makes summarizing easier!
Problem 1: too few workers save enough, even if there’s a DC plan.
Problem 2: even if they do save, they spend before retirement too often, either with hardship withdrawals or when changing jobs. (There are arguments in favor of retaining early withdrawals: if people know there is at least some way of accessing the money if needed, they’re more likely to be willing to put it into a retirement account.)
Problem 3: returns are too low, due to high fees, and due to the need to provide liquid investments (that is, in comparison to pension funds’ investing in hedge funds or whatever). In one comparison, DC plans earned 6.45% vs. 7.51% average returns from 1995 – 2008.
Problem 4: “The overall economy misses the full benefit of people’s savings because 401(k)s and IRAs fail to build long-term capital formation.” That is, DC accounts aren’t invested in such assets as infrastructure, or real estate, or venture capital.
Problem 5: because subsidies from the government come in the form of tax-deferral, and require personal decisions to save, to benefit from them, the wealthy benefit disproportionately.
Problem 6: the current system “offers no cost-effective means to convert retirement savings into lifelong income” because annuities are expensive, and that due to the longer life expectancies of annuity purchasers.
Chapter 4, Rescuing Retirement
Here Ghilarducci reiterates her chapter 1 description of the GRA, with more details.
Workers will select pension managers, which may include state pension funds, traditional money manages, or a federal entity such as the Thrift Savings Plan. Everyone with a Social Security number who does not already have a workplace retirement plan will be automatically enrolled. Workers can contribute additional amounts voluntarily which will not be required to be annuitized.
The more aggressive investment strategy, compared to 401(k) options, will produce a 6 – 7% annual nominal investment return, compared to a cited 2 – 4% return for 401(k)s or IRAs.
The net result is $127,000 in lifetime savings after 40 years of $600/year contributions — “free” to median earners due to tax credits.
Is this enough? Ghilarducci says that, because this assumes contributions from the first day of employment, and much higher returns than a 401(k), this will provide 70% income replacement for workers earning less than $100,000. She gives a sample of a worker starting at $30,000 salary at age 22, with 3% annual salary increases, reaching the U.S. median salary of $46,600 at age 40. They assume a nominal return of 6.5%, a retirement age of 67, and a conversion into an annuity based on a government bond rate of 3.5%. And this produces a 38% replacement ratio, which produces a comfortable income when combined with Social Security.
Now, I should at this point state that I could not match her math. All her assumptions are clearly stated except for the mortality table, and it’s possible that the mortality tables that we use in our daily work are simply so far removed from that which would be appropriate for the population as a whole, because of all of the sickly Americans that are not in the labor force, that she gets a more generous result than I do, by obliging the sickly Americans to be in the same annuitization pool as everyone else. It’s possible that my math is bad. But I get 27% instead of 38%, and that based on a single life annuity rather than the joint and survivor annuity she seems to assume.
Some more mechanics on the contribution:
the system provides a $600 tax credit for everyone regardless of income, and provides for tax-deductibility for this 1.5% contribution for everyone earning over this $40,000 threshold, which suggests that additional contributions would no longer be tax-deferred, but she later says that they would continue to retain this tax-defer-ability. She says specifically that “the income on super-sized IRAs (more than $5 million) would no longer be tax deferred” and that the government would see savings from not needing to pay out as much in food stamps or SSI in the future. I’m not entirely certain whether she envisions 401(k)s continuing to have their existing tax deferral benefits, though, and I certainly recall it being the case in prior iterations that the money for the tax credits came from eliminating tax deferral here. (** In chapter 7, she more specifically says that 401(k)s and IRAs would lose their tax breaks.)
Ghilarducci also says that the GRA would be a win for employers because it’ll save them from the administration costs and fiduciary liability of a 401(k). (Employees could lose out, though, if they see the 1.5% mandatory contribution as a default and drop their currently higher contribution; in her proposal employers converting to a GRA would be prohibited from reducing contribution levels for 2 years but it’s hard to see how this would be enforced if employers drop the contribution before converting, or if, regardless of GRA participation, they view the existence of the GRA as setting a new, lower norm.) For employers currently offering no retirement benefit at all, she concedes that the GRA would be a new cost, but hopes that employees with retirement benefits would be more productive and, in any case, inflation is low and corporate profits are high so there’s no real damage done if inflation increases or profits drop temporarily. In any case, only the first $250,000 of compensation would be covered in the GRA.
Also, employer administration would be simplified because, although workers would choose fund managers, employers would forward contributions on to a single clearinghouse.
Ghilarducci then expounds on the ways in which GRA participants would see greater return than those in 401(k)s: The funds would see dramatically lower administrative fees, a drop as high as 65 basis points per year. They would have “top-tier portfolio managers” and they would have long-term investment horizons, which would permit alternative investments like hedge funds and private equity, which would seek higher return and would be negatively correlated with “core public market investments.” She compares these funds’ possible returns to those of public pensions and university endowments.
(Side comment: Ghilarducci says that because these funds are pooled at such a large scale — though she doesn’t quantify how large she expects them to be, or how many different funds she envisions — and without the ability to withdraw the money pre-retirement, they will have long-term investment horizons. But will each fund offer a single investment category, without today’s investment offerings with different risk levels related to closeness to retirement? And, given that participants will be able to switch from one provider to another, could these funds really have the same long-term horizon as a university endowment?)
It also is at this point that she explains the “G” in GRA — the federal government would guarantee the principal and make up the different between the sum of the amounts originally contributed and the account balance at retirement. This is a significantly smaller guarantee than prior proposals had, which promised a return of, say, 2% or 3% either nominal or real. Because this guarantee is so small it is “essentially costless,” because no rolling forty-year period since 1945, even the the 2007 – 2010 crash. And, unlike prior proposals, she actually suggests that the CBO score the cost of the guarantee and establish a small fee to build a reserve fund. So this is a positive element of her revisions, since prior iterations of the proposal actually had the government bear the cost.
Here’s how annuitization would work in her proposal: the GRA could be annuitized at any time after becoming eligible for any form of Social Security, so as young as disability eligibility, or else any time from 62 to 70. Participants could also take 25% of the balance as a lump sum, as long as the remaining GRA balance plus Social Security, is above the poverty line. Mandatory annuitization would only apply to the mandatory contributions; all else would be voluntary. Annuity conversion factors would be based on projected longevity and would be purchased from the federal government. Ghilarducci says that the government would bear “the risk of increasing longevity” but that the government would also use “the most current actuarial projections to take this risk into account.” Given that actuaries build expected improvement in life expectancy into their generational mortality tables, I’m not sure if she just means that rates of improvement above what’s forecast are for the government to bear, or something else. She also specifies that, in order to reduce this risk of annuitizing at a time when rates are particularly low, the system would use a five year average of a long-term Treasury bond rate. How would this conversion factor compare to what you can get in the private sector? It seems odd that she builds in an assumption of aggressive investing pre-retirement, but then obliges everyone to basically invest in government bonds post-retirement, which certainly reduces one’s income considerably, even though she seems to assume that the government would cover all administration costs, and she puts the sickly and the healthy into the same risk pool to reduce annuitization costs for the healthy. Also, it’s not clear whether she envisions incorporating a cost-of-living adjustment into the annuity; her earlier example with the higher-than-I-can-replicate replacement ratio would suggest the answer is “no,” but in a later graphic she says that an example retiree is protected “despite increases in medical and living expenses.”
She also plots out a transition process: in the first year, the Treasury Department and the Social Security Administration set up their processing systems, and pension managers apply for approval. In the second year, employees are educated on the plans, accounts are set up, and workers are invited to roll over existing 401(k)s. In year 3, contributions begin for all but tiny (<5 employees) businesses. In year 4, annuity payments begin. And in year 5, micro-sized employers begin to participate.
Chapter 5, Case Studies
Here, Ghilarducci provides examples from other countries.
Australia has a mandatory pension system in the form of the Superannuation Guarantee, in which employers are required to contribute 9.5% of pay into a DC-type account. Ghilarducci notes that there is no annuitization requirement, but points to the apparent lack of harm the mandate has posed to the growth of the economy. (I looked into this at some point, and it seemed to me it was a mix of a slow phase-in, and the happy coincidence that this occured at a time of pre-existing economic growth, in particular due to demand for the country’s natural resources, that prevented this from any negative impacts.) Australia’s plans are also managed by employers, so they are not suitable examples for her notion that gigantic fund managers will provide better returns.
She also cites various state moving toward a “GRA-style model,” though none of these have actually been implemented.
It’s actually very weird that her examples are so limited, as there are many countries which have developed similar models, from Switzerland’s plan in which employers are required to provide benefits with guaranteed returns, to the many Asian countries with provident funds, to the Scandinavian plans, both state pensions and national collectively-bargained plans, with features similar to the GRA. (See the top hit at this google search, not accessible as a direct link, for an article with details on some of these plans.) Perhaps she chooses not to highlight these because none of these promise the extraordinarily high returns of her proposed GRAs. Many systems rely heavily on insurance companies and insurance products that bear more than a passing resemblance to the vilified deferred annuity. Perhaps it was just late at night and she still had laundry to put away. I don’t know.
Chapter 6, Why not just expand Social Security?
First, because the GRA model is based on private accounts, and Social Security is tax-funded benefits; thus, you can require contributions while claiming the system requires “no new taxes.” But more significantly, because there is no political will for changing Social Security, but, because the GRA system is an add-on, she believes that consensus can be reached. What’s more, the only countries that had entirely state-run Social Security-type systems that aimed at providing generous income replacement for the middle-class, have failed — here she cites Greece. Instead, systems which have a significant private-funded program, such as the Netherlands, Australia, and Denmark, are more sustainable.
Chapter 7, Growing support from the American people and a mandate for Congress
Why Ghilarducci believes her plan is politically viable:
First, it doesn’t change Social Security, and keeps 401(k)s and IRAs in place, albeit without tax breaks.
Second, there will be a major retirement crisis if nothing is done.
Third, “the American people are clamoring for a national retirement solution.” (Actually, I’m skeptical here; there are certainly plenty of polls showing Americans being worried, but whether they’re worried enough to take political action, like writing their Congressmen, or supporting a political action group, is another question.)
Chapter 8, The employer’s stake in retirement reform
Or, is this book over yet? The problem with reading an e-book and having no sense of how far from the finish line I am.
Employers want to do right by their employees, and it would be easier to administer a GRA. They respond favorably to the idea of mandating savings.
Chapter 9, Conclusion
Hooray! I’m at the conclusion. Not surprisingly, she says that we should implement GRAs.
So that’s that. Tomorrow I’ll write up a tightened summary of her proposal, and its pros and cons relative to the Jane Plan. Tonight I’ll take the laundry out of the dryer.
Image: http://www.navair.navy.mil/index.cfm?fuseaction=home.NAVAIRNewsStory&id=4801
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