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.

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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.