Thursday, July 26, 2012

Another Viewpoint on Retirement -- Has the 401(k) System Failed?

Our Ridiculous Approach to Retirement -

Last Sunday, Theresa Ghilarducci, a career retirement policy person and now Professor of Economics at the New School for Social Research wrote this interesting piece for the New York Times. In it, Ms. Ghilarducci's penultimate paragraph reads as follows:
It is now more than 30 years since the 401(k)/Individual Retirement Account model appeared on the scene. This do-it-yourself pension system has failed. It has failed because it expects individuals without expertise to reap the same results as professional investors and money managers. What results would you expect if you were to pull your own teeth or do your own electrical wiring?
In the article, she makes some very interesting points. Most people underestimate what they need to live well in retirement. One of her observations, however, is exceedingly important and rarely raised; that is, the probability that your last dollar will run out on the day you die is essentially zero, and if we take it to the moment you die, that probability, for the math geeks out there, is approximately epsilon (for you non-math geeks, that means it's not going to happen).

Put differently, this implies that you need to have more money in savings than you will need. But, all this is based on life expectancy. That's a median. Fully half the population will outlive that median. So, they need more. Do you know if you are part of that half? By how much will you outlive that life expectancy? Don't know that either, do you?

Clearly, the solution lies in lifetime income options, preferably with inflation protection. Where can you find that? It's tough. You can take your assets and find an annuity salesperson who will sell you such a product, although there aren't many such products around. And, given that there aren't many products, they are not priced fairly to the consumer. Then, there is the in-plan lifetime income option. But, I spoke to representative from a large 401(k) provider the other day who said that their research suggests that neither plan sponsors nor their employers currently want them.

So, how do you get lifetime income options? Defined benefit plans? You remember them, they used to be popular. Has anyone considered a low-risk (for the employer) defined benefit solution that might help to solve this problem? Sadly, the law has made this very difficult. But, consider this hypothetical design:

  • Cash balance style
  • There is a non-elective employer "pay credit" and a matching employer pay credit on employee contributions (this is not currently allowed)
  • Inflation-protected annuities as a distribution option
What do you think? I'd love your comments, pro or con, serious or even with a little humor.

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