Social security: defined benefit, or defined contribution?
One of Bush's major themes for Social Security is to 'create an ownership society'. To do that, social security funds would be invested directly into the market. This money would then be protected (i.e. no early withdrawal) until the worker reaches the appropriate status in life to receive their benefit.
This does recast social security to the currently misconcieved notion that money deducted from your paycheck now is what will pay your retirement (or disability, or...) later. Currently, that money is spent to pay current benefit receivers. It is the nature of the current system that creates the benefit gap in the future, as more and more money will be needed to support the boomers as they retire and the working-age population diminishes as a percentage of the total population.
The Bush plan is attempting to change the 'pay it forward' system we have now, into a 'pay myself later' system. On the surface of it, it sounds like a really nice idea. This way spikes (or dips) in birth-rate won't skewer the fund.
The big problem comes in converting the system. As retires and near-retires have noticed in the past 15 years, pension funds have been undergoing a revolution. Out are the defined-benefit plans of old, and in are the defined contribution plans such as the much vaunted 401(k). The defined-benefit plans of old took a drubbing in the recession of the early 1990's as the stock market and current contributions weren't enough to keep up with benefits being paid out. Then the stock market took off like a rocket in the mid '90s and some new savings instruments were created, such as the 401(k), 403(b), and the Roth IRA. Plans were converted, often without much warning, and the wailing and gnashing of teeth of those within a few years of retirement were heard.
Much can be learned from their pain. The big problem with defined-contribution plans is that in order to get a good benefit out of them, you have to participate in the plan for a couple of decades. The defined-benefit plans our parents and grandparents enjoyed paid out with as 'little' as 10 years of employment. The ways of handling this are varied, but came in two flavors. First, a line was drawn in which anyone hired after a certain date is in the new defined-contribution plan and people hired before that date still contribute to the old defined-benefit plan. Second, if the pension fund was solvent enough to handle it, the pension fund itself was restructured so that past contributions were allocated to the employee in a protected state until their retirement.
Social Security lacks something the old defined-benefit plans had, and that's the ability to invest towards the future. By law right now that investment is limited to US treasury notes, which while safe, underperform the stock market by a wide margin. Pension funds do not have that limitation, which has led to fund failures and bailouts in the past, as well as greatly improved solvency. This additional solvency means that current participants don't have to pay as much in order to match paid-out benefit. Since Social Security lacks this, restructuring it will be devilishly hard. If a line in the sand is drawn in which new contributors are shunted into a defined-contribution version of Social Security, it will be the continuously shrinking working-pool that has to 'feed' the continuously increasing retired-pool of workers. The fund is patently not solvent enough for a restructuring. And factor into all of this that AARP is a very powerful lobby in Washington, and you have a Prime grade mess.
So how the heck is this fund going to get converted? A bit at a time, and with some painful public funds kicked in to keep it running, that's how. In the beginning, the contribution to the defined-contribution portion will be a pittance as compared to the rest of it; at my salary I'll probably sock away a few hundred a year even with the employer-match. As time moves on and retires kick this mortal coil, the percentage of payroll deduction going into the savings fund will increase. This increase will, due to actuarial needs, be devilishly slow and measurable in multiples of decades.
So is this a good idea? Hard to say. The defined-benefit plans had a weakness in that if they were badly managed, the entire plan fails and everyone is out in the soup-line. The defined-contribution plans are weak in that if a worker doesn't work long enough, or picks funds poorly, they are individually out in the soup-line but the plan survives. Social Security as it sits now is facing the first problem since the ratio of retired-to-workers will be undergoing sea-change in the not too distant future, and that will force either greatly increased social security deductions (i.e. new 'taxes'), or greatly reduced benefits (i.e. AARP gets pissed). Rock, meet hard place. Clearly, Something has to be done.
Social Security was created in the shadow of the Great Depression. Because of this, trust in the stock market to be a reliable vehicle for long term savings was at a relative low. This caused, in my opinion, the rule that Social Security funds shall not be invested in anything as risky as stocks. Social Security was devised as a guarantee of an income in your later years. A very risk-adverse guarantee at that. As anyone who has had need to know the difference between 'Income', 'Value,' and 'Growth' classes of securities can tell you, 'income' offers highest short-term stability but at a lower long-term return, and 'growth' offers high long-term return but with greatly increase short-term volatility. Funds that Social Security can invest in now are on the very conservative end of the 'income' bracket. Which is as it should be, as it provides that guarantee.
The Bush plan introduces more individual risk into the plan as a hedge against avoiding a hideously expensive bailout in the future. But more risk is something that AARP and the Unions won't take well. The camel's nose under the tent-flap is the only way to get this plan off the ground without royally screwing current and soon-to-be-receiving recipients. Even with control of both halves of congress and the whitehouse, this will not be an easy sell.
This does recast social security to the currently misconcieved notion that money deducted from your paycheck now is what will pay your retirement (or disability, or...) later. Currently, that money is spent to pay current benefit receivers. It is the nature of the current system that creates the benefit gap in the future, as more and more money will be needed to support the boomers as they retire and the working-age population diminishes as a percentage of the total population.
The Bush plan is attempting to change the 'pay it forward' system we have now, into a 'pay myself later' system. On the surface of it, it sounds like a really nice idea. This way spikes (or dips) in birth-rate won't skewer the fund.
The big problem comes in converting the system. As retires and near-retires have noticed in the past 15 years, pension funds have been undergoing a revolution. Out are the defined-benefit plans of old, and in are the defined contribution plans such as the much vaunted 401(k). The defined-benefit plans of old took a drubbing in the recession of the early 1990's as the stock market and current contributions weren't enough to keep up with benefits being paid out. Then the stock market took off like a rocket in the mid '90s and some new savings instruments were created, such as the 401(k), 403(b), and the Roth IRA. Plans were converted, often without much warning, and the wailing and gnashing of teeth of those within a few years of retirement were heard.
Much can be learned from their pain. The big problem with defined-contribution plans is that in order to get a good benefit out of them, you have to participate in the plan for a couple of decades. The defined-benefit plans our parents and grandparents enjoyed paid out with as 'little' as 10 years of employment. The ways of handling this are varied, but came in two flavors. First, a line was drawn in which anyone hired after a certain date is in the new defined-contribution plan and people hired before that date still contribute to the old defined-benefit plan. Second, if the pension fund was solvent enough to handle it, the pension fund itself was restructured so that past contributions were allocated to the employee in a protected state until their retirement.
Social Security lacks something the old defined-benefit plans had, and that's the ability to invest towards the future. By law right now that investment is limited to US treasury notes, which while safe, underperform the stock market by a wide margin. Pension funds do not have that limitation, which has led to fund failures and bailouts in the past, as well as greatly improved solvency. This additional solvency means that current participants don't have to pay as much in order to match paid-out benefit. Since Social Security lacks this, restructuring it will be devilishly hard. If a line in the sand is drawn in which new contributors are shunted into a defined-contribution version of Social Security, it will be the continuously shrinking working-pool that has to 'feed' the continuously increasing retired-pool of workers. The fund is patently not solvent enough for a restructuring. And factor into all of this that AARP is a very powerful lobby in Washington, and you have a Prime grade mess.
So how the heck is this fund going to get converted? A bit at a time, and with some painful public funds kicked in to keep it running, that's how. In the beginning, the contribution to the defined-contribution portion will be a pittance as compared to the rest of it; at my salary I'll probably sock away a few hundred a year even with the employer-match. As time moves on and retires kick this mortal coil, the percentage of payroll deduction going into the savings fund will increase. This increase will, due to actuarial needs, be devilishly slow and measurable in multiples of decades.
So is this a good idea? Hard to say. The defined-benefit plans had a weakness in that if they were badly managed, the entire plan fails and everyone is out in the soup-line. The defined-contribution plans are weak in that if a worker doesn't work long enough, or picks funds poorly, they are individually out in the soup-line but the plan survives. Social Security as it sits now is facing the first problem since the ratio of retired-to-workers will be undergoing sea-change in the not too distant future, and that will force either greatly increased social security deductions (i.e. new 'taxes'), or greatly reduced benefits (i.e. AARP gets pissed). Rock, meet hard place. Clearly, Something has to be done.
Social Security was created in the shadow of the Great Depression. Because of this, trust in the stock market to be a reliable vehicle for long term savings was at a relative low. This caused, in my opinion, the rule that Social Security funds shall not be invested in anything as risky as stocks. Social Security was devised as a guarantee of an income in your later years. A very risk-adverse guarantee at that. As anyone who has had need to know the difference between 'Income', 'Value,' and 'Growth' classes of securities can tell you, 'income' offers highest short-term stability but at a lower long-term return, and 'growth' offers high long-term return but with greatly increase short-term volatility. Funds that Social Security can invest in now are on the very conservative end of the 'income' bracket. Which is as it should be, as it provides that guarantee.
The Bush plan introduces more individual risk into the plan as a hedge against avoiding a hideously expensive bailout in the future. But more risk is something that AARP and the Unions won't take well. The camel's nose under the tent-flap is the only way to get this plan off the ground without royally screwing current and soon-to-be-receiving recipients. Even with control of both halves of congress and the whitehouse, this will not be an easy sell.
posted by Corwin at 2:22 PM
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