Justin Fox: Why Retirement Risks Are Best Shared: Noted for August 10, 2013
Justin Fox: Why Retirement Risks Are Best Shared:
It's been a tough few years for the Dutch pension system, long praised as the best in the world…. Yet from outside the country's borders, the Dutch system still looks pretty spectacular. Its average ratio of assets to liabilities is 104%, more than 90% of the workforce belongs to a pension plan, benefits are generous by global standards, and costs are low…. Here in the U.S., which came in ninth of the 18 countries ranked in the Melbourne Mercer survey, things look a bit different. State and city pensions are in deep trouble--with Detroit's currently tied up in bankruptcy court and The New York Times reporting this week that Chicago's much-bigger system might be next in line for a funding crisis. Corporate pensions, once a major pillar of the retirement system, are disappearing, and their replacement, the 401(k), is turning out to be a woefully inadequate source of retirement income for most workers. Social Security… [is] the strongest pillar in the system. And remember, the U.S. is in the middle of the global pension pack. Most of the countries that scored lower than it on the Melbourne Mercer Index (France, Germany, and Japan among them) did so because they've set aside far too little to cover the big pension promises they've made.
So what distinguishes good pension systems from bad ones?… I can suss out two basic principles behind the pension systems that work:
Pension risk ultimately has to be borne by pension recipients. Attempts to transfer that risk to others--shareholders in the case of corporate pensions, taxpayers for all the rest--are generally destined to end in tears.
That risk should be shared across a lot of pension recipients. Having every worker shoulder the risk individually is not just, well, risky--it's really expensive, too.
This first principal is now widely understood, although it remains political dynamite….
The 401(k) shares the characteristic that poor investment returns don't result in funding crises or taxpayer bailouts. That's a good thing. But beyond that, it's been a pretty disastrous failure…. Most workers haven't put aside nearly enough money… myopia… wages have been stagnant… employers stingy… higher fees and worse investment performance…. And finally, it takes much less money per person to guarantee an adequate retirement income when that guarantee is spread across a bunch of people.
This last one deserves extra emphasis. If you're 65, and don't know if you'll live to 75 or 105, you need a huge stash of money to ensure that you won't run out. Guaranteeing retirement income for 10,000 65-year-olds costs a lot less per person, because you can be sure that most of them won't make it to 105. Traditional pensions work on the latter principal; 401(k)s the former….
The Dutch pension alternative is markedly more free-market-oriented than the French one, which consists mostly of (underfunded) government-run plans. It is also markedly less free-market-oriented (or, to put it another way, more collectivist) than the American 401(k) system. And it is markedly better than both.
