When a Retirement Plan isn’t a Savings Plan

What’s the difference between saving for retirement, on the one hand, and plain old saving, on the other? Teresa Ghilarducci, an economist at the New School, has a provocative book out, entitled "When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them," which forces us to ask that question very seriously.

Ghilarducci starts by noting that many defined-benefit pension plans have worked very well, be they in the public sector (CalPERS), the private (GE), or through a union (Teamsters). Yes, there are defined-benefit pension plans which have failed, often because they were plundered and/or underfunded by management. But overall, if you look at pension plans where a fixed amount of money is invested per employee per month, they tend to have been successful.

Ghilarducci also notes the big weakness with 401(k) plans – if you put individuals in charge of retirement and investing decisions, they have a tendency to make big mistakes. They save too little, they think they can beat the market, they get greedy, they are badly advised, they don’t have a good handle on their own risk profile, etc etc. And while the freedom to make one’s own mistakes is often a very good thing, it can be disastrous when it means penniless retirees throwing themselves on the mercy of the state because they haven’t been able to save enough money themselves.

And so Ghilarducci starts thinking big. What’s been proven to work? Low-cost, large-scale, not-for-profit investment schemes handling individual pensions. So, extend such a scheme to every working American, and seed it with $600 per worker per year, provided by the federal government. And to sweeten the deal even further, the government will guarantee a real rate of return of 3% per annum. Workers save 5% of their income each year into this Guaranteed Retirement Account, or GRA; upon retirement, 10% of the money in the account goes to them directly, while the rest gets invested in an annuity which they can draw on for the rest of their lives.

The money to fund this scheme comes from two places. The first is that 5% mandatory savings, which behaves in much the same manner as a tax: it’s money you’re forced to give up out of your take-home pay, and which is going towards your retirement security: not your savings as the concept of savings is currently generally understood. The money in your GRA can’t be liquidated; if you die, there are some survivor benefits for your spouse, but generally the money in that account disappears if you’re not there to either pay into it or draw an income from it.

The other main source of funding is the $100 billion in tax subsidies that the federal government presently gives not to retirement savings per se but rather to savings in general – subsidies which go overwhelmingly to the rich. Says Ghilarducci, in an email to me:

Why should tax dollars subsidize a bequest? Dreaming of leaving something to your loved ones? That dream motivates people to save; to pay off their house; to buy and cherish fancy watches and jewelry.

Providing bequests is NOT the job of retirement security; a joint survivor annuity is.

So Ghilarducci would remove tax-free status from all retirement accounts and other tax-privileged savings vehicles. Saving is good, go ahead and do it, but don’t expect to do it without paying taxes. On the other hand, if what you want is retirement security, that’s a cause that the federal government can get behind, and it will give you $600 a year plus a 3% guaranteed real annual yield in order to make that happen.

In round numbers, the $100 billion per year that’s currently spent on savings subsidies is equivalent roughly to a 2% payroll tax. Ghilarducci is in effect taking that 2% payroll tax, adding another 5% payroll tax, and layering it all on top of the existing social security system (which she wouldn’t meaningfully touch). All of that money would go to retirement security, either through the GRA system or through the social security system.

I’m not a huge fan of this proposal, because it feels to me like a very substantial income-tax hike. The GRA isn’t really savings: in the worst-case scenario, if I die a bachelor the day I retire, my heirs and I get nothing out the system at all, but I have paid 5% of my life’s income into it. And it’s not an opt-in system, either: Ghilarducci wants it to be mandatory.

On the other hand, I think that Ghilarducci makes a very good point when she says that 50% of savings subsidies go to the to 10% of taxpayers. That simply isn’t an efficient use of government funds, and it would make sense to move to a system which benefits everybody equally, and which targets retirement security over savings-for-the-sake-of-savings. I just don’t think that the problem is big enough to justify a solution which requires, essentially, an extra 5 points of income tax.

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