Friday, January 6, 2017

The 401(k) Problem We Refuse to Solve

There’s a perpetual pundit debate over the best way to provide for retirement: defined benefit plans (pensions), defined contribution plans (401(k)s, IRAs and the like) or pay-as-you-go social insurance schemes (Social Security). Most retirement experts I’ve talked to prefer a mix of these, a “three-legged stool.” But as I’ve written before, this is a bit like arguing whether the Titanic would have survived the iceberg if only its hull had been painted green. All three types of retirement savings have different costs and benefits. But these costs and benefits are not the primary reason that people in Western countries have to worry about an impoverished old age.

The funny thing is that, for all the people arguing that some dire problem in one of these three retirement systems urgently requires that we switch to another kind at once, the major problem with all three is exactly the same. It’s even a problem that’s easy to state and easy to fix -- no need for extensive blue-ribbon commissions or elaborate white papers. Here’s the solution: Pick whichever system you prefer; it really doesn’t matter. Now slap a 10 to 15 percent surcharge on a worker's wage income, and divert that money into the system for the worker’s future use. Problem basically solved, because in all three cases, the only flaw that actually matters is that they’re badly underfunded.

If you expect to spend 40 years of your life working, and then another 20 or 30 years living off the money you made during that time, then you need to save a large portion of your salary. Imagine yourself storing up food for the last 30 years of your life from the harvests made during the first 40. You might hope that when you're older, and no longer toiling in the fields, you won’t need to eat so much. Nonetheless, you’d understand that you would need to put aside a considerable portion of your harvest -- something close to what you're eating each day -- to ensure that you don’t starve to death in your old age.

Somehow, we imagine that modern society can make the math different for all the other stuff we consume, from cars to televisions to little paper umbrellas to stick in the cocktails at our retirement parties. And to be fair, to some extent, it has. If productivity is growing quickly, then it is easier to maintain our pre-retirement lifestyles with a smaller pool of savings, because that savings will buy more.

Alternatively, we can have a lot of kids. No matter how you manage your retirement system, you are ultimately expecting to depend on the labor of people younger than you. Whether that labor comes to you in the form of a dividend check or a government benefit or a saintly daughter-in-law building you a new annex in the backyard, you are still expecting someone else younger than you to make stuff, then give it to you without expecting more than gratitude in return. The more workers there are relative to retirees, the smaller the fraction of their income each worker has to give up to support each retiree, and the easier it will be to get them to do so.

Unfortunately, productivity isn’t growing rapidly, and we didn’t have a lot of kids. That leaves plowing a great deal of money into savings and investment, in the hopes that productivity will start to grow again. There is no substitute, no neat transformation we can enact to make that fundamental problem go away.

by Megan McArdle, Bloomberg | Read more:
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