Pensions, Careers, And Retirement

Pensions and careers have changed.  Ramesh Ponnuru thinks the retirement changes are for the better and we heartily agree.  We will give an example and explain why it matters.  Ramesh thinks Americans should stop mourning the loss of traditional (defined benefit) pensions concludes:

These are changes that would build on, rather than attempt to reverse, the last few decades of developments in the American retirement system. Those developments, especially the rise of the 401(k), have largely been for the better.

Sidebar One: Pensions can be divided into defined benefit and defined contribution.  In a defined benefit plan you typically get a pension equal to then number of years worked * highest salary over three years * a percentage.  So if you work 30 years and your percentage is 1.8 then you get 54 percent of your highest salary.  A 401 (k) is an example of a defined contribution plan where a defined amount is invested and you get the result at retirement.  We often think that the worker takes the risk in a defined contribution plan and the company takes the risk in a defined benefit plan.  That is only true if the worker retires from that employer.  We will show details later.  End Sidebar One.

Sidebar Two: Risk is both upside and downside.  If a worker spends his entire career with one employer then a defined contribution plan is more risky because he might get much more or much less than a defined benefit plan.  End Sidebar Two.

The big reason for changing pensions is that the nature of careers have changed.  Years ago it was bad to have a resume that indicated you were a job hopper.  Now career advice is:

If you are changing jobs less than every three years, you are in the minority.
You may need to have a well-prepared explanation when you front up to your next job interview.

It also true that employers come and go.  Both of these are reasons why we should cheer at the increasing number of defined contribution plans.

MWG has a defined benefit pension plan.  It worked very well for us although it limited our opportunities, as it was intended to do, in the time close to retirement.  It worked very well for us because we spent nearly 40 years with one employer.  Thus, our paltry year salaries in the seventies and eighties were irrelevant and only the years mattered in the computation of benefits.  If we had of switched employers it would have been bad for us because our salary was so low. Another benefit was sick days.  In our case sick days accumulate and can be used to pay for medical insurance after retirement.  The sick day benefit is based on your highest salary but you must retire in order to get it.  Thus, because of both sick days and defined benefit, as retirement approached it was financial suicide for us to leave before retiring.  When we became eligible for retirement, the sick days became a powerful incentive towards retirement because workers had to pay for part of the cost of health insurance but retirees, like us, with lots of sick days did not.

For us and our employer, the defined benefit plan worked.  We got a nice retirement and they got us to work for less than market prices late in our career.  We are not sure if the intent of the pension was to get us to retire.  It was effective at that too.  We retired because the tax on working was over 100 percent.  That is, we had more disposable income in the first year of retirement then we would have had if we worked that year.

Defined contribution was a fair deal for us in another era.  Even then we were a minority in staying with one organization so long.  Now we would be a micro-minority.  Defined contribution is the way to go in the new environment.  We need to find incentives to increase them.  We have three suggestions:

First make health insurance benefits taxable to the recipient.
Second, increase social security benefits for the needy by means testing benefits for high income individuals.
Third, increase the tax benefits of Roth IRAs.  Make the contribution tax deductible and keep the returns not taxable.

The first would help by producing a bit of government revenue and focusing both employer and employee on the retirement issue.  The second would provide a safety net to the really needy.  The third would reduce complexity at retirement because everyone would go Roth and there wouldn’t be any taxes having an impact on decision making.

As Ramesh says, let us build on the success of 401 (k) plans.  Folks are looking for freedom.  The right incentives will help them make good choices.

 

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Accounting Versus Arithmetic

At NRO George Will reminds us of the fiscal problems that we face by starting with pensions for states and municipalities:

Some American disasters come as bolts from the blue — the stock-market crash of October 1929, Pearl Harbor, the designated hitter, 9/11. Others are predictable because they arise from arithmetic that is neither hidden nor arcane. Now comes the tsunami of pension problems that will wash over many cities and states.

The WSJ reports on Illinois where the state has a $130 billion in unfunded pension liabilities.  The Democrats are trying to tax their way out.  Illinois is one of the few states with a decreasing population of less than 13 million.  We’d avoid it too.

Then George concludes with the entitlement crisis:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

We agree with George on the severity of the problem but we’d like to add a bit of explanation.  Pensions can be accounted for and the extent of the problem is an accounting result.  Pensions are very long term so they are very responsive to compound interest.  George notes that when Illinois went from an expected return of 7.5 percent to 7.0 percent it added $400 to $500 million to the annual bill.  George thinks 7.0 percent is still imprudent but gives no evidence to suggest why.

Entitlements like Social Security and Medicare are not pensions.  Pensions have assets that will grow and, hopefully, meet the obligations.  MWG’s pension from the state of Wisconsin is nicely funded and gives us great comfort.  Entitlements are paid on a cash basis.  MWG Social Security payment comes from the younger readers.  Thanks!  The probability of the coming disaster for Social Security is approaches 1.0 because only a plague among retirees can stop it unless Congress acts.  The extent of the Medicare disaster depends greatly on the rate of increase in medical costs.  Pensions could be fixed but Illinois shows us why it doesn’t happen in many states.

The clock is ticking.  Social Security needs to be means tested yesterday.  Start now with a small changes and get it right by the end of the decade.

The only current good news is that the GOP is trying to fix Medicare while eliminating the ironically named Affordable Care Act.  Let’s hope they get their sums right.