Jane the Actuary Retirement

Forbes post, “Keep On Squeezin’, Squeezy The Pension Python”

Originally published at Forbes.com on March 20, 2018.

 

Illinois voters may remember Squeezy the Pension Python, the main character in a video meant to gain public support for pension reform legislation in 2012.

 

The bill passed in 2013.  As described by CNN at the time,

The plan will reduce annual cost-of-living increases for retirees, raise the retirement age for workers 45 and under, and impose a limit on pensions for the highest-paid workers.

Employees will contribute 1% less out of their paychecks under the reform, while some will be given the option to contribute to a 401(k)-style plan.

Legislative leaders of both parties crafted the deal, which they say will save $160 billion over the next three decades — savings desperately needed to help fill the state’s $100 billion pension shortfall.

Alas, it was found unconstitutional in 2015, and no action has been taken by the legislature with respect to public pensions in the meantime.  Illinois’ funded ratio now stands at 40%, a slight improvement over its 2016 funded ratio of 39%, which placed it fourth most underfunded in the nation.  In dollars, its pension underfunding stands at $130 billion.

And today Illinois will be choosing its nominees for governor, among them a man who was among those spearheading that 2013 pension law, Democratic State Senator Daniel Biss.  In any ordinary set of circumstances, “I tried to reform the Illinois pension system” would be a resume-booster.  Instead, he’s apologizing for it.  According to the suburban Chicago Daily Herald,

“The state’s got awful budget problems, and state pension debt is an awful part of it,” said Biss, a co-sponsor of the 2013 legislation. “I do think there was kind of an obsessive hysteria about it a few years ago that led a lot of people in the legislature, myself included, to act irresponsibly. That bill was unconstitutional.”

His opponent, billionaire front-runner J.B. Pritzker, has been running ads attacking Biss for his vote.  The Chicago Tribune provides the text:

“Dan Biss says he’s a proven progressive,” a narrator says. “Ok. Let’s check his record. Biss wrote the law that slashed pension benefits owed to teachers, nurses and state workers. The court ruled it unconstitutional. Dan Biss. Take a look for yourself.”

The ad then directs voters to the Pritzker-created website danbiss.net, where one is told,

In 2013, Biss helped write the bill that unconstitutionally stripped hundreds of thousands of teachers, nurses, and state workers of benefits promised to them. Biss admitted on the Senate floor that his pension cut efforts were unfair and broke a promise to workers. He led the charge for them anyway.

Solving the pension funding issues in Illinois will not be an easy task, after so many years of underfunded and overpromised benefits, of pension spiking and other boosts, and missed contributions to direct state funds elsewhere.  But using an honest attempt to solve the problem as a basis for attacks will surely set the state back even further, by constraining legislators even further in terms of the range of options they’re willing to consider if they wish to preserve their future political careers.

To be sure, there’s a lot more going on in today’s primary than simply Biss’s support for pension reform.  Polls suggest that it would be quite an upset for Pritzker to lose the Democratic nomination, and, either way, there will be no way of saying that it’s because of or despite this issue, or whether it really mattered to voters at all.  But it’s one more indicator that Illinois has a long way to go on the path towards financial health and good governance, if indeed it chooses to take that path.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “No, Andrew McCabe isn’t ‘losing his pension'”

Originally published at Forbes.com on March 17, 2018, and, honestly, it’s of little relevance 7 years later – but it was my first “viral” article so I’m duplicating it here out of pure sentimentality.

 

Note: See updates at the bottom of this column.

In the news this weekend, Attorney General Jeff Sessions announced that FBI Deputy Director Andrew McCabe had been fired.  And I’m not going to debate whether this was right or wrong, especially not in this forum.  But I wanted to address this as far as retirement issues are concerned.

The reports that are flying across the news, Twitter, and Facebook are that McCabe was just two days short of retirement and that this move by Sessions will, as, for instance, Vox, reports, “cost him his federal pension.” On Twitter, Andrea Mitchell writes:

One suggestion from a McCabe supporter: if a friendly member of Congress hired him for a week he could possibly qualify for pension benefits by extending his service the extra days

and Massachusetts Congressman Seth Moulton tweeted in reply,

Would be happy to consider this. The Sixth District of MA would benefit from the wisdom and talent of such an experienced public servant.

Which all gives the impression of a veteran, elderly federal official being cheated out of his pension accruals due to a vindictive Trump administration.  But this didn’t pass the sniff test.  Pensions — public as well as private — are required to meet certain vesting requirements, and, in fact, the FERS (Federal Employees Retirement System) benefits vest at five years, meaning that benefit accruals cannot be taken away.

In fact, McCabe is all of 49 years old, likely 50 by the time readers see this, and what he lost out on was, as CNN much more calmly recounts, the ability to take his benefits at age 50, rather than somewhere between age 57 and age 62, and he lost his eligibility to a special top-up in benefit formula.  These are, admittedly, tangible financial losses, but it is grossly misleading that various news outlets are giving the general public the impression that he has lost his pension entirely.

But the existence of these special perks, benefits that we in the private sector can barely comprehend in the year 2018, points to a fundamental disconnect between the private and public sector.  Why shouldn’t someone whose benefits consist of 401(k) account accruals believe that government pensions work so differently as to punish someone arbitrarily by removing their benefits?  Add to this the fact that retirement at age 50 is well-nigh incomprehensible for the average working American, except perhaps in the case of high-risk, health-sapping occupations, which surely likewise added to the impression that actual pensions, rather than generous ancillary provisions, were being lost.

Yes, the rationale for these generous pension benefits is that these civil servants accept significantly lower salaries than they would be able to earn in the private sector.  But this exchange of “low salaries now, rich retirement benefits later” is a matter of “robbing Peter to pay Paul” that isn’t wise in the long term, either.

UPDATE:  On Saturday evening, the Washington Post reported:

Rep. Mark Pocan (D-Wis.) announced Saturday afternoon that he has offered McCabe a job to work on election security in his office, “so that he can reach the needed length of service” to retire.

According to the Post’s experts, McCabe “would need to just go to work with the federal government for another day or so in any job he pleases,” although “it would probably look more ethical if McCabe worked for at least a pay period rather than just one day.”  And, due to the nature of federal pensions and their portability from one position to another, this sounds credible — though at the same time, well, I’m from Illinois, a state with a long list of examples of pension spiking, ghost employees, and other ways that public officials have manipulated public pensions, so it doesn’t sit right with me.

In addition, according to a helpful Twitter exchange, the particular nature of McCabe’s pension benefits condition age-50 retirement eligibility on primary law enforcement employment, not just general federal government employment, at age 50; what’s more, being terminated “for cause” wholly eliminates eligibility for special age-50 retirement, according to 5 U.S.C. § 8412.

(Note that this column is based on the information available to me; if any part of it proves incorrect, I will update as needed.  If you wish to comment, please visit janetheactuary.com)

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “(How) Should We Make Social Security Fairer For Moms?”

Originally published at Forbes.com on March 16, 2018.

 

Let me tell you about my mom.

Back in the days when one could earn the R.N. certification via apprenticeship-like training, she did exactly that, because her old-world father was willing to sign off on only a small number of occupations for his daughters.  She worked up until shortly after my older sister was born, then quit her job and became a stay-at-home mom when she tired of the long commute to drop off my sister at my grandmother’s before starting her shift.  Money was tight, to be sure — we kids wore hand-me-downs — and she went back to work when my younger brother started school, but never again returned to hospital nursing, instead working at an orthodontist’s office, a market research company, and various other jobs, mostly part-time and with various spells of nonworking, ending up with a long stretch at a department store before she finally retired.

Now, due to Dad’s income during their working lifetime, and his pension and their joint savings now (Dad:  “yes, I know, all your friends are going to Disney, but we save our money instead”), their finances are healthy now in retirement.  But her Social Security benefit is still, not surprisingly, considerably smaller than dad’s, bolstered as it was by his full career of full-time middle-management employment.

Is it “fair” that her benefit is small?  Heck, is it “fair” that she, like many women, stayed at home with children, and has lower lifetime earnings as a result?   For reference, in 2015, the average annual Social Security retirement benefit for women was $14,184, compared to $18,000 for men.

What elements of the Social Security benefit formula, if any, should make the situation more “fair”?  In my last column, I wrote that the top-up to 50% of the primary earner’s benefit was a crude way of approximating a benefit for women who, as caregivers, had an insufficient earnings history of their own.  But implicit in my characterization is the idea that it’s not the best approach, though it does start to grow on you if you consider a woman’s husband’s income as a proxy for what she might have earned had she not left the workforce.  Here are some alternatives.

Option 1:  Remove the benefit top-up entirely.  After all, one can presume that in the case of a married couple making the decision that one of them would stay at home to care for children, they made this decision because they had a healthy standard of living even with one income, and, in that case, why should they need a top-up now?  And strictly speaking, it’s a subsidy from the rest of us to women who chose to stay at home or work part-time.  If, as a result of the “grey divorce” phenomenon, these women have trouble making ends meet, then the Social Security benefits their husbands have earned can be considered in the overall divorce agreement alongside workplace pensions, IRAs, and other assets and income.

Option 2:  Replace the top-up with income-splitting.  Instead of giving women with poor earnings history a top-up based on their husband’s benefit, just total up the earnings of a married couple, in any given year, and allocate half to each spouse’s earnings history.  This means that, assuming both were earning similar amounts prior to marriage, they’ll end up with similar Social Security benefits at retirement, and eliminates the reduced benefits that women have, to the extent that they’re the result of staying at home with children while their husbands work.  This eliminates any unfair cross-subsidy because no one’s getting any benefits they didn’t earn.

As it happens, back in 2009, the Social Security Administration put out a report modelling variations of this alternative.  They found that

  • 13% of individuals would see no impact on their benefit,
  • 29% of individuals would see an increase, of, on average, 8%, and
  • 58% of individuals would see a decrease of, on average, 11%,

for a net impact of a 4% overall reduction in average benefits, which, depending on one’s perspective, is either a win for solvency and fairness for the childless, or a penalty and a take-away.  Which is probably why despite prior discussion of this possible change, according to the report, this proposal never saw public airing.

Option 3:  Provide child-rearing credits.  This is the approach that many European systems take, though the exact implementation varies. For example, in Germany:

For births since 1992, a parent providing care to a child aged 0 to 3 receives 1 earnings point each year. For parents with at least 25 years of paid or credited contributions who continue to work part time while providing care to a child aged 0 to 10, the value of contributions paid is increased to 1.5 times the value, up to the value of contributions for average earnings of all insured persons; nonworking parents providing care to at least two children aged 10 or younger receive 0.33 earnings points a year.

In Austria:

As from 01/01/2005 mothers may acquire contributory years under their pension insurance for times spent raising children, too, not only for times of gainful employment. Fathers will have such years credited as contributory years if they are able to substantiate that they primarily took care of the child/ren, e.g. as a lone parent or male homemaker living with a working mother. The maximum credit per child is four contributory years from the pension insurance (five years in case of a multiple birth). Pension contributions for periods spent raising children are calculated on the basis of a monthly assessment basis of 1.649,84 € for the year 2014.

In Switzerland, provision for stay-at-home moms comes in the form of

Bonuses for raising children or providing care: an increase in income taken into consideration to calculate the pension for parents with children aged less than 16 years and for those looking after close relatives needing care.

Variations in benefit design tend to center around whether one must be out of the workforce to get these benefits, or simply be credited due to having a child.

Canada probably provides the best model for what a such a system could look like in the United States.  Since Social Security is based on the 35 years with the highest wage-increase-indexed wages, the most straightforward way to provide a benefit top-up to people with low average earnings due to childrearing would be to reduce the number of years in the averaging period, so that these years which would otherwise be zeros or very low due to part-time wages, wouldn’t be a part of the average calculation.  To be sure, this wouldn’t make mothers whole, in taking into account lost earnings growth due to lost promotional increases, but it’s probably about as good as can be managed.

For further reading, the Social Security Administration produced a report in 2011 with extensive detail on potential caregiver credit designs and international comparisons.

Option 4:  Yes, you guessed it, my own retirement system proposal, which really deserves a better name than the “purpose-based plan,” as well as similar plans in existence elsewhere in the world, which provide benefits purely based on having lived up until retirement age, regardless of how much or how little one has worked, or for what reasons, with or without means-testing for higher-earners.  Yes, we’d have a host of other arguments then, including the question of whether the government has an obligation to do anything, as a matter of policy, about lower lifetime earnings feeding into a lower “second-tier” benefit, but at least the baseline benefit would be the same for everyone.

What’s fair?  What’s unfair?  It depends on whether one’s objective is to even out benefits between spouses or ex-spouses, or whether one’s initial premise is that the state should in some way reward, or offset the costs of, parenting.  After all, however appealing caregiver credits might be, as a “nice thing” for the government to do, the end result is still the provision of benefits not just to the needy but to perfectly middle-class families, in the same way as various parental leave proposals would do.

And this is all connected up as well with concerns about women’s retirement assets and income, which is a subject for another day.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes blog post, “Social Security Isn’t Fair – And That’s Actually The Point”

Originally published at Forbes.com on March 13, 2018.

 

“Why does [name of sibling] get to [do or have desired activity or thing] and I don’t?  It’s not fair.”

“Oh, yeah.  Well, life’s not fair.”

How many times have you been on one end or another of this parent/child conversation?  I still can picture in my mind the time that my one-year-older-than-me sister was allowed to stay up late to play Monopoly with my parents and I couldn’t.

As it happens, a writer at the Washington Post made this discovery about Social Security:  it’s full of benefits that benefit the wrong people and shortchange others, a litany of items that call to mind my first-grade self standing there in my nightgown saying, “it’s not fair.”  (Did I really do this?  I have no idea.)

The article in question, “How late-in-life dads — like Trump — are eligible for a Social Security bonus,” by Allan Sloan and C. Eugene Steuerle, starts with a complaint about what it calls the “Late-in-Life-Baby Bonus” which gives supplemental benefits to parents of minor children.  As Sloan and Steuerle see it, it is particularly unfair because, on the one hand, parents who have not yet reached retirement age aren’t eligible to collect these benefits (unless, though the authors don’t mention it, because they’re widowed/widowered or disabled), and, at the same time, retirees who have children for shameful reasons (e.g., President Trump being a parent late in life because he took up with a younger trophy wife) and who don’t need the money (again, Trump) are eligible.

But it is in the nature of Social Security that there is no means test, and there is no judgment of whether those late-in-life children are due to skeezy May-December relationships or because of unexpected near-menopausal pregnancies or because retirement-age individuals have adopted children, sometimes even grandchildren when their parents are unable to care for them.  It’s just taken as a given that household financial needs are greater with a child present so additional benefits are provided.

Also subject to criticism is the so-called “Single Parent Shortchange,” which is another way of observing that the somwhat crude mechanism by which Social Security provides benefits to stay-at-home/low-earning moms, constructed in an era in which those moms were expected to be married to the fathers of their children, is a benefit that isn’t earned by those women and accordingly comes from everyone else’s FICA taxes.  They write,

Single parents are among the lowest-income payers of Social Security taxes. Why should they subsidize other folks’ never-working spouses in a way that gives the biggest benefits to the best-off people?

The fact that Social Security accommodates divorce by providing spousal benefits to divorced ex-spouses, in the same manner as if the couple was still married, is subject to criticism as the “Serial Spouse Bonus,” that is, because any given worker, if he had been married multiple times, each for over 10 years, would have multiple ex-wives able to claim spousal benefits if they exceeded benefits under their own earnings records.

And, finally, they take issue with the “Equal Earner Penalty,” which they characterize as

a couple with two people each earning $40,000 gets about $100,000 less in lifetime benefits than a couple with one spouse earning $80,000 and the other earning nothing. This happens even though both couples and their employers pay identical Social Security taxes.

This is, of course, not a surprise — again, spouses’ benefits are a clunky form of social welfare spending built into Social Security.  And even comparing two unmarried individuals, the progressive nature of Social Security benefits means that, in a more real-world example than a zero-lifetime-income individual, a person with a low lifetime income gets an “unfair” amount of “extra” benefits due to the 90% first-bendpoint percentage — irrespective of whether that low income was due to having been poor, or having been a stay-at-home mom in a middle-class family.

I’ll remind readers that my preferred benefit is a flat benefit, and all of these are non-issues in such a system, especially if the issue of benefits for mothers is solved by giving accrual credits to individuals who were out of the workforce caring for children, rather than adjusting benefits at retirement, or, alternatively, by not caring at all about employment history in handing out benefits.

But such a system would generate its own cries of unfairness:  why should Bill Gates get a benefit if he doesn’t need one?  Why should that fat slob who never worked get one?

Ultimately, all these cries of unfairness really highlight the ways that Social Security does dual duty as a social welfare program for the elderly and as a mainstream income-replacement retirement program.  People want it both ways — they want to feel they’re “earned” their benefits but at the same time, they want benefits to be progressive, with the needy getting more and the wealthy paying more.  And when it comes to proposed updates to the system, we see even more of these two impulses, as pundits and ordinary Joes and Janes alike simultaneously insist that workers have earned every penny of their future benefits by dint of their own hard work and FICA taxpaying, and yet, in order to repair the solvency of the system, that the millionaires and billionaires had better be called upon to pay in their “fair share,” that is, subsidize the system.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes blog post, “It’s Another Retirement Reform Proposal!”

Originally published at Forbes.com on March 11, 2018.

 

It will surely not surprise readers that, like seemingly everyone else these days, I’ve got a plan for a reform of our retirement system.  (Eyeroll.)  It’s got a clunky title—the “purpose-based retirement plan”—and it’s either far more visionary or far more delusional than everyone else’s plans.  But hear me out.

Here’s the background: As it happens, my first foray into the world of public discussions around retirement policy was round about eight years ago, in the form of a paper my husband and I submitted for the “Retirement 20/20″ project sponsored by the Society of Actuaries, titled “A Purpose-Based Retirement Plan.”  Since then, I’ve tinkered with it at my first blog, but, as you can tell by the fact that (but for the most loyal of readers) you’ve never heard of it, it didn’t get much traction; in fact, in general, public discussions around retirement reform seemed to have died down.  But these discussions are emerging again.

Our basic idea was this: we re-imagined Social Security and the retirement system in general as a three-tranche/three-tier system, with three different types of benefits for three different purposes; hence the label “purpose-based.”  The first tier is a flat, pay-as-you-go, general-revenue-funded poverty-level benefit to keep seniors out of poverty.  The second is a pre-funded account-based benefit, based on a mid-level income tranche, to replace lost income.  And third is a supplemental voluntary savings option similar to our existing 401(k) system.

What’s the point of making such changes, and what do I mean by “different purposes”?

Fundamentally, Social Security tries to do two things, but does neither of them well:  it wants to be an anti-poverty program for the poor, and it wants to be an income-replacement program for the middle-class.  To meet the first objective, it provides 90% pay replacement up to the first “bend point,” $10,740 in annual income.  And that’s great — but 9.3% of seniors (over 65s) still have income (counting Social Security as “income”) below the poverty line, because of low wages over their working lifetime, and use a patchwork of programs such as SSI and SNAP to supplement their Social Security benefits.  Doesn’t it make more sense to simply provide a flat benefit to all recipients?  And it makes more sense to fund such a benefit out of general revenues than to tax the poor, with FICA, from the first dollar of income earned, then effectively refund that income, to some extent, through the Earned Income Tax Credit.

The second objective of Social Security is (partial) middle-class pay replacement.  But the pay replacement above the first bend point is only 35%, up to $64,764, and 15% thereafter to the maximum pay level, hardly a princely sum.  What’s more, the progressive nature of the formula, however well-intentioned it is in providing a disproportionately generous benefit level to lower-income recipients, makes it more difficult for middle-class recipients to really understand how Social Security fits into their retirement future, or identify how much they really need to save.  Back in the heyday of Defined Benefit pension plans, this was not an issue because the plan formulas typically had a “Social Security offset” or had two different accrual levels, but Social Security is much harder to integrate into Defined Contribution plans.  And don’t get me started on the lack of meaningful pre-funding for the system!

Our proposal tried to remedy these issues.  The first tier is straightforward, though we didn’t prescribe any specifics about what the benefit level or retirement age should be, except that the latter should be set at the age at which the average American can no longer reasonably be expected to work, with a wholly-separate (hopefully-)reformed disability benefit, as well as perhaps unemployment insurance more generous in duration for near-retirees, replacing reduced early retirement benefits.  The benefit is funded from general revenues, which can mean anything from an across-the-board income tax hike to the usual sort of tinkering with marginal tax rates at various income levels.

As to the second tier, the idea is this:  all American workers would be required to participate in retirement accounts, with contributions of 10% of pay.  I’m indifferent on whether this is all employer-paid, employee-paid, or a split, since, in principle, it doesn’t matter.  The key, though, is that the contributions would only apply after a certain income threshold coordinated with the flat-dollar benefit, and would cut off at some higher income level.  Funds would accumulate over one’s working lifetime like a 401(k) account but would be converted into a cost-of-living-adjusted annuity, which we estimated, back in the day, would produce a cost-of-living-adjusted pay replacement of 50% on that tranche of income, which produces a weighted-average pay replacement greater than 50% when the “100% of pay” the first-tranche benefit is taken into account.  Originally we envisioned that employers would administer the benefit, similar to a cash balance plan, and I suppose it’s indicative of how much has changed in the pension world that we even considered this.  At this point, what makes more sense is some sort of pooled solution, in which there might be some sort of return smoothing mechanism and some protection from the risk of outliving assets.  And it goes without saying that, because the funds would be privately managed, this would be a true funded system.

Would these accounts be “owned” by individuals in the same way as other funds we own in bank accounts?  Would they simply be government benefits like any other?  It seems to me that we’d have to really conceptualize this as something in-between, to avoid battles over whether it’s “fair” for the government to limit investment choices or require annuitization, or whether the government can require participation in the first place.  It also makes sense to transition to the new system by providing the old Social Security benefit as a minimum while participants’ accounts build up, and one of the benefits of a complete redo of the whole system is that it reduces the risk of getting trapped in arguments about winners and losers.

Finally, our plan included a continued voluntary tax-favored supplemental savings component, not only to provide a lump-sum pot of money for other needs and wants in retirement, but, to some degree, to serve dual-duty as a rainy-day fund, since we are increasingly aware that many Americans lack the basic savings for emergencies that would keep them afloat in the case of medical expenses, home or car repairs, or the like.  We know that tax deferral or Roth-style untaxed earnings systems have come in for criticism because the benefits disproportionately accrue to higher earners, since they’ve got higher tax rates and are more likely to save in the first place, but it is in the nature of the tax code to deem some income as not subject to taxation, and the label “tax deduction” is a motivator of behavior even if the net impact on one’s finances is small.

Is a complete revamp of Social Security impossible?  Are we stuck tweaking the margins?  I hope not.  However promising our specific plan may or may not be, it simply doesn’t make sense to be so fatalistic as to believe that Social Security’s benefit formula is fixed in perpetuity.

***

Follow-up/bonus article:  “News Flash: The U.K. Adopts My Social Security Reform Proposal.”  Also published March 11, 2018.

Well, sort of.  And it’s a bit “old news” by now, but still important to know about.

I wrote in my prior column that it’s a mistake to view our Social Security system as forever unalterable, and I wrote that a flat-dollar benefit, paired with a system of real, funded individual accounts, would solve many of the difficulties of our present system.

Well, the United Kingdom, whose pension system, prior to 2016, was fairly similar to that of the U.S., implemented a variation of the “purpose-based retirement plan.”  No, I don’t claim that their parliament reads obscure American blogs for reform ideas, but rather that this demonstrates that change is, in fact possible.

Here’s what they’ve done:

The U.K. system consists of two components.  As with the “purpose-based plan,” there is a flat-dollar, or, rather, of course, flat-pound State Pension benefit, of, at present, about GBP 8,000 annually.  The system phases in gradually, and once it is fully in place, to get the full benefit requires 35 years of participation in the system, either with qualifying employment during the year or credits due to parenting, providing unpaid care for a disabled person, or unemployment with documented job-seeking.  Prorated benefits are available after at least 10 years of participation, and it’s possible to pay voluntary contributions if needed due to gaps in one’s earnings record.

Now, to be sure, GBP 8,000 isn’t a lot of money, but it replaced a prior system which combined a lower flat benefit level and a supplemental pay-related benefit, the latter of which was tied into employer-provided benefits via a system of “contracting out,” where employers were able to substitute their own pensions for the supplemental state pensions.  But, just as in the United States, employers in the United Kingdom are closing their pension plans to new entrants, so that this prior system no longer worked.

And similar to, though not identical to my proposal, there is a mandate that all employers who don’t otherwise offer an equivalent benefit themselves, must facilitate the participation in retirement savings accounts, called NEST, or National Employment Savings Trust, through autoenrollment and must contribute to the plans, with minimum employer contributions growing from 2% to 8% of pay by 2019, paid partly by employers and partly by employees, on the tranche of income from £5,876 to £45,000, with those earning less than GBP 10,000 able to request participation.  Unlike the Jane Plan, workers can opt out, in which case they forgo their employer’s contribution but are likewise not obliged to contribute themselves, and, also unlike the Jane Plan, they are not obliged to annuitize their benefit at retirement age.

How is the plan working out?  At this point, the contribution requirements are small, with only a 1% employer and 1% employee contribution required, and about 9% of eligible participants have opted out of the plan.  The first of the increases in contribution levels begins in April of this year, to 2% employer, 3% employee, and opt-outs may increase at that time, although each time an employee opts-out, they are required to re-opt-out or be again automatically enrolled in three years’ time.

The current options for taking your money out of NEST focus on making the most of relatively small pots. That’s because NEST is only a few years old, so our members haven’t been saving with us for very long. We’re now developing new options for how people with larger pots will be able to take their money out in the future.

So hooray for the U.K. And if they can update their state pension system to reflect new realities, why can’t we?

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

 

 

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Elegy for the pension plan”

Originally published at Forbes.com on March 11, 2018.

 

Once upon a time, when I first started in the field as a new actuarial student, the older actuaries would regale us with stories of punchcards and mainframe time and filling in the personnel count grids by hand.  There were still vestiges of the past, with reference documents copied from the old mainframe e-mail to the “new” Lotus Notes, and input fields in some of the mainframe computer programs were still called “parameter cards” because they replaced literal cards.

Now, twenty-some-odd years later, I could regale new actuaries with stories of my olden days when the large majority of large private employers offered traditional Defined Benefit pension plans.  In fact, I had a unique vantage point, working on a project which included collecting benefits information from large American companies, and using a defined methodology to assess how the benefit value differed from one company to another.  You might say I had a front-row seat due to my day-to-day work.

Between then and now, I’ve watched the move to cash balance plans, and the closing or freezing of pension plans, and, now, the move to offering “term vesteds” (former employees with vested pension rights) and retirees lump sums in exchange for their pension benefits, and, beginning in 2012, the trend of large employers (GM, Ford, Verizon) purchasing annuities for their retirees to settle their pension liability. Yes, some private sector employers still offer traditional pension plans, and some of these employers have weighed the pros and cons and continue to believe that’s still the right decision for them, but their numbers are small and shrinking.

There are all manner of reasons why these trends have emerged.  Pension funding regulations are stricter, mortality tables predict higher life expectancy, employers are more risk-averse, especially when it comes to taking risks outside their core business.  Accounting rules have placed more of an emphasis on the “real time” liabilities, making cost increases due to bond rate drops more visible.  Plus, 401(k) or cash balance plans provided even steady accrual rather than being backloaded, so they didn’t require employees to stay until retirement to get the full benefit as with a traditional final pay-based formula, and they offered more value than a traditional pension for short-tenure employees.  What’s more, employers came to believe that employees didn’t even properly appreciate the value of the pension they provided in the first place, but preferred the immediate visibility of a cash balance or, later, 401(k) account balance, so that the plans were failing in one of their key purposes, employee loyalty and appreciation.

On top of all this, back in what you might call the Golden Age of pensions, large American companies were viewed as forever so, and forever financially healthy.  While pensions have been subject to funding rules ever since 1974, they could nonetheless be viewed to some degree as a future expense paid out of future income.  But recall that the running joke about General Motors became that it had so many retirees in its pension funds relative to its active employees that it was effectively “a pension plan that makes cars,” which was hardly sustainable; even now, despite its settlement of some pension liabilities with annuity contract purchases, its total pension liability is still almost 90% greater than its market cap.*  Yes, there are opposing voices that say that employers eliminated pensions out of their worst, Scroogian impulses, but there are real reasons for this trend.

But at the same time, I know that traditional pensions were a tremendous benefit to those who received them, and there is a real loss to the next generation of retirees.  After all, my own father was a full career automotive engineer at one of the Big 3.  He started as a foreman after he got out of the army (K-town, Germany, not Vietnam, where he was a second lieutenant travelling the country on the weekends) and retired thirty-some years later with a plaque that hangs in their study, and it gives us great peace of mind that, no matter what happens to their IRAs — whether the market crashes or whether they make poor financial decisions or simply live a long life — Mom and Dad will still be getting that monthly check.  My sister works somewhere in the IT department of another automaker, but she’s employed via a contract house rather than directly, and not only does she have a 401(k) instead of a pension plan, but it’s a small one at that.

The bottom line is this: with few exceptions, traditional pensions at private employers are gone, but the very fact that employers acted as annuity-providers in the first place was something out of a different time and place.  It’s common for pension advocates to say, “the 401(k) experiment has failed,” but, from another entirely reasonable point of view, the widespread, near-universal (among large companies) employer-provided pension plan — generous in benefit level, fixed, guaranteed, lifelong — was itself an experiment, however long-running, that failed in the face of stronger funding demands, low interest rates and risk tolerances, increased life expectancy, and changes in American business in general.  We can mourn its demise, but we can’t go back.

And what happens next — whether the 401(k) is the long-term path going forward or an interim step, and who’s right and who’s wrong in the regular reports on retirement readiness, and what the right fixes are in any case — remains to be seen.

Do I have the answer?  No, not really; I don’t even think there is one single policy change that constitutes The Answer.  I have some ideas that I tinker with; there are other proposals that merit discussion.  But the answer isn’t to look back to the past, but to look forward.

And, yes, I know, an elegy ought to be in the form of a poem.  Sorry ’bout that.

* Pension liabilities per the 2016 annual report:  $99 billion.  Market capitalization as of March 9, 2018, $53 billion.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.