Jane the Actuary Retirement

Forbes Post, “Six Things Every American Should Know About Social Security And Retirement”

Originally published at Forbes.com on July 26, 2018.

 

Earlier this week, Marketwatch featured a retirement quiz, “Are you as clueless as the rest of America when it comes to your retirement?” with six questions and the shock claim that only 2% of Americans passed the quiz (that is, got at least four of six correct).  I looked at the quiz and wasn’t much impressed with it (more comments on it at the end of this article), and thought to myself, “self, you could do better.”  So here, with a focus on Social Security, are six key things to understand.

Social Security’s average benefit is just that, an average.

How much can you count on from Social Security?  It’s common to read that Social Security will replace about 40% of your pay, on average (e.g., here, in a February Forbes article) but it’s important to understand that, due to Social Security’s progressive benefit formula, the more you earn, the lower the percent that Social Security benefit checks cover.

According to the OECD’s Pensions at a Glance calculations, an individual earning half the average wage will see a net-of-tax replacement percentage of 60%; the average earner, 49%, and twice the average, 37%.  (The figures not adjusting for tax are 48%, 38%, and 27%.)  These are substantial differences and should be taken into account in retirement planning.

Your benefit level if you wait until age 70 to start, is 75% greater than if you begin at age 62.

Yes, we’re accustomed to thinking in terms of “full retirement age” and that’s the basis on which those OECD values are calculated.  But it’s much better, in terms of understanding the system, to simply think of Social Security as offering the maximum benefit level at age 70, and a substantially reduced benefit level at age 62.  This is true for everyone, regardless of their official “full retirement age.”  And because Social Security offers a guaranteed income, with an annual COLA adjustment, this is a really great deal, and retirees should consider spending down at least a part of their savings, to delay the age at which they claim Social Security, rather than trying to spend their savings evenly throughout their retirement.  (See my April article on the topic.)

Yes, the increase in retirement age really is a benefit cut.  Suck it up.

See my prior point:  the age at which one can begin to take Social Security didn’t change.  The age at which additional benefits for delaying claiming cease, is also unchanged.  What’s changed is that, at any given benefit commencement age, the benefit formula is lower for us young ‘uns (I know, I hardly ought to claim that label these days) than our parents. Which means it’s a benefit cut.

But what are you going to do about it?  Nothing much, really.  It was an unavoidable benefit cut, and we’ll likely see more such cuts in the future.

You can plan on working until 70, 75, or even later, but your body, family circumstances, and the job market may not cooperate.

It is true that the average retirement age is increasing.  But recent research has concluded that it is the better-educated who are retiring later than in the past, in part because less educated workers tend to be in poorer health and to work at physically demanding jobs.  In fact, a recent study by Prudential showed that half of retirees retired earlier than they had previously planned to do so, and for three-fourths of them, this was involuntary, due to job loss, ill health, or other reasons.  So it’s great to plan to work until late in life, and evidence is growing that it actually may help individuals stay in good health, physically and mentally, but you’ll need a Plan B.  And, likewise, it’s great, as a matter of public policy, to want Americans to stay in the labor force longer, but for the working class especially, policymakers will also need a Plan B.

The Trust Fund?  It doesn’t matter.

Yes, I’m going to get back on my soapbox about this.

At some point in the future, the Social Security Trust Fund will likely be exhausted.  According to current law, benefits will have to be cut by about 25%.  Not good.  But the cynic in me says that there’s a good chance that Congress will just pass legislation allowing general revenues to pay Social Security benefits that can’t be paid for from the FICA taxes.

No harm, no foul?  Eh, not so much.  Quite apart from the Trust Fund exhaustion is the question of how our economy can handle the need to spend ever-more money on the needs of the elderly, through Social Security, Medicare, Medicaid long-term care, and so on.  And that’s much more difficult to solve than simply passing new funding legislation.

We are not locked into our 80-some-year-old benefit formula.

This is my final pet peeve, and in fact was the topic of my first published article on retirement.  Many, many other countries have tweaked their formula or even wholly re-written it, and there’s no reason we can’t do the same.  The United Kingdom, Sweden, Norway and Italy have wholly redesigned their systems.  Switzerland, South Korea, Australia, Hong Kong, and others have instituted “Second Pillar” systems.  Other countries have raised the retirement age, or even instituted a formula in which the retirement age automatically increases as life expectancy does.  And in the meantime, the experts insist that the only changes we can make are tweaks around the edges.

Finally, here’s the original quiz:

  • What is the full retirement age for young workers?  (Answer:  67)
  • What does IRA stand for?  (Answer:  Individual Retirement Account, but knowing the name isn’t especially relevant.)
  • If your full retirement age is 66 and you draw SS benefits early at age 62, by how much is your benefit reduced?  (The answer is 25%.  The choices were in increments of 3 percentage points to make it harder, but the principle is more important to know than the exact number.)
  • These states can tax SS benefits: Colorado, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah and…  (This is the sort of list that seems designed just to elicit dramatic “failure” rates for the quiz.)
  • A Roth IRA allows tax-free withdrawals in retirement.  (true/false)  (Yes, it’s important to know how the two types of IRAs work — but if your employer offers a 401(k) you’re better off with that anyway.  And, incidentally, the “Roth” in “Roth IRA” doesn’t abbreviate anything but was the name of the senator who sponsored it.)
  • Which of the following is NOT covered by Medicare?  (Answer, dental & hearing aids.  More importantly, nursing homes aren’t covered except for short-term rehab stays; perhaps that wasn’t included in the quiz because people generally know that after all.)

 

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, “Yes, Let’s Expand Social Security – To Public Sector Employees”

Originally published at Forbes.com on July 23, 2018.

 

In a prior article, I referenced offhandedly the generous nature of the benefits for teachers and other state and local government employees.  Here in Illinois, a teacher hired before 2011, who worked continuously after graduating college, is eligible for retirement, at a 75% pay replacement increasing at a compounded rate of 3% per year, at the age of 56.  This is a benefit level that, even in the days of generous private-sector traditional defined benefit pensions, would have been exceedingly generous.

As it happens, these high pensions, and the inclusion of a generous COLA, are frequently justified by the fact that these participants don’t participate in Social Security, at least in the 15 states in which this is the case (a list which, as far as teachers are concerned, includes two of the most notoriously underfunded plans, Illinois and California; with respect to other public-sector unions, Social Security opt-outs are rarer, or, as in the case of Illinois, some groups do and others don’t participate).

And those retirement plans which stay out of Social Security portray it as the best choice for both plan members and the state.  The Illinois Teachers’ Retirement System says this:

Currently, teachers pay 9 percent of their salary and school districts pay 0.58 percent of its teachers’ salaries to TRS. The federal Social Security tax is 12.4 percent, split evenly between the employee and the employer. For school districts, placing teachers in Social Security would result in a 137 percent increase in total taxes and contributions devoted to retirement. TRS members would see their total retirement contribution rise to 15.2 percent of pay, a 68 percent increase.

Teachers’ Retirement System retirement benefits were significantly better than those offered under Social Security. . . .

Along with the increased cost to local governments for Social Security, adding teachers to the system would not wipe out the $122.9 billion that TRS currently owes all active and retired TRS members for the next 30 years. These are retirement benefits that already have been earned. . . .

A 1999 study by the General Accounting Office found that adding teachers and other public employers from around the country who are not currently in Social Security would create, at best, a temporary surge in revenue for Social Security. Over the long term, adding teachers to Social Security would only increase the System’s total obligations and deepen the program’s long-term funding problem.

But that’s misleading in a number of ways.

In the first place, touting the higher costs to teachers and school districts omits the high cost to the state of funding that portion of teachers’ benefits which is not covered by the small teacher/district contribution.

In the second place, benefits are indeed generous — for full career teachers or state employees.  But, as an explainer video at TeacherPensions.org points out, nearly half of all teachers won’t continue teaching for long enough to vest in a pension, and another third will vest, but with poor levels of benefit accruals.  With respect to other public employees, an analysis showed that about half of plans required five years of service to vest, and another 20% required 10 years; only 16% required less than 5 years.  A teacher who moves from one state to another, or who leaves teaching for another career field, may be as good as starting over, as far as retirement benefits are concerned.

And while vesting requirements are perfectly normal in the private sector — though by law the requirements are less demanding, typically 3 years for a 401(k) employer contribution or 5 years for a traditional defined benefit plan — and it is perfectly ordinary to move employers often enough to accrue low or no benefits in any given employer, Social Security always serves to provide a basic level of benefit, regardless of whatever other pension one might have.  Social Security is always portable, always vests immediately, and, crucially, indexes wages to adjust for inflation when calculating benefits at retirement, unlike frozen benefit accruals when one leaves an employer.

And finally, while the TRS correctly observed that existing liabilities could not be erased with participation in Social Security, it would provide greater financial stability for a state to do so going forward.  To the extent that such a benefit change were to produce a benefit formula integrated with Social Security rather than simply making public sector pensions even more generous, it would shift at least some of the future pension accruals’ cost into predictable contributions and take away the temptation, at least for that portion of the benefit, to defer contributions to future taxpayers.

Having said this, yes, it’s also the case that the federal government cannot force states to participate in Social Security — at least not directly.  But I will remind readers of my longtime pet Social Security reform proposal, in which Social Security as we know it today would be replaced by a flat benefit paired with some sort of mandatory participation in pooled retirement accounts.  And I will further remind readers that this is, in broad outline, the system which has been implemented in the U.K. in recent years.  In such a case, if, in the case of the flat benefit, benefits were funded out of income taxes/general tax revenue rather than a dedicated payroll tax, there would be no way in which states could opt out of the system because there would be no employer role.

And, to be sure, this is only one small piece of a much larger issue, but it is a relevant item to take into consideration.

 

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, “Should Poor People Save For Retirement?”

Originally published at Forbes.com on July 21, 2018.

 

Andrew Biggs, American Enterprise Institute scholar (and fellow Forbes contributor) has a new article at the Washington Post, “State-run retirement plans are the wrong way to protect the poor,” in which he addresses the new auto-enrollment state-managed IRA plans.

Five states are launching plans to automatically enroll employees, predominantly lower-income workers, in state-administered individual retirement accounts. More than 20 other states are considering “auto-IRA” programs like those of California, Connecticut, Illinois, Maryland and Oregon. Auto-IRAs seem like an obviously benign effort: Only about 20 percent of low-income workers participate in 401(k) plans, and many low earners depend heavily on Social Security when they retire.

But bureaucratic good intentions sometimes address problems that aren’t problems or end up doing more harm than good. In the case of auto-IRAs for low-income workers, states are likely doing both: These workers are in better shape for retirement than misleading news coverage suggests, and auto-IRAs could saddle them with higher debt while disqualifying them from means-tested government health and welfare programs — thus saving the states a fortune.

The problem, Biggs writes, is that low-income workers have little to no need to save for retirement because Social Security (and, as needed, the relevant means-tested benefits) will provide a sufficient degree of pay replacement, at the standard of living they’re accustomed to.  However, many of these folk are living at the margin to such a degree that even a small loss in income due to (semi-)obligatory savings could increase their debt levels (you’d think they could adjust their savings over time, but Biggs cites a study demonstrating this effect), and the asset tests for many benefits for the poor would mean that they wouldn’t be able to benefit from much of their savings anyway.  Biggs notes as a partial answer that “A good model is Britain’s national saving plan policy of automatically enrolling only workers with salaries above £10,000 pounds (about $13,000).”

So here are a few thoughts to build on this:

What the United Kingdom has done is not simply a matter of a creating an income threshold below which workers do not participate in the autoenrollment plan.  Not only is participation for workers with less than £10,000 in income on an opt-in rather than opt-out basis, but income below £5,876 is not included in the calculation at all.  A typical retirement plan in the Netherlands works similarly, with pensionable salary for employer pension purposes excluding between approximately the first €13,000 – €15,000 of pay, depending on plan type.  Likewise, Switzerland’s Second Pillar plan starts at income of about CHF 25,000.  And in my “MyPlate” retirement savings proposal I had suggested “a rule of thumb such as, ‘save 15% of your annual income above $20,000.'”  (As a reminder, I’d also prefer a Social Security system in which the benefit was a flat benefit for everyone to ensure that every American is protected from poverty, but even absent this, there are multiple layers of supplemental benefits, such as SSI and food stamps, for the elderly whose benefit accrual was low during their working years.)

In our American Social Security system, we don’t have a floor but we do have a ceiling, and that is applied on an annual basis; at whatever point in the year, one reaches that year’s ceiling, Social Security taxes stop.  But this wouldn’t make sense for a floor, and for savings for the poor, which should be regular and predictable.  What would make sense, though, is to apply a floor on an hourly-wage basis.  For example, for simplicity’s sake, a plan could make automatic contributions on income that exceeds, when adjusted to an hourly basis, $10 per hour (though the nice rounding would be lost if the threshold is indexed for inflation) or on income that exceeds the minimum wage.

In addition, there is an income level, for any given family circumstance, at which short-term savings is more important than a retirement fund, and where providing better vehicles for this short-term savings is more valuable than automating retirement savings, especially if those retirement funds end up being withdrawn to cover living expenses between jobs, or even just an unexpected car or home repair bill or a security deposit on a new apartment.

Happily, retirement policy experts and politicians are attempting to address this issue through the concept of a “sidecar” account, so called because it sits alongside a retirement account.  The exact method varies depending on the proposal, though one version exists in recently-introduced bipartisan legislation (more on which later),as detailed recently at Plan Advisor:

Designed either within the retirement plan, as a sidecar next to the retirement plan or completely separate from a retirement plan, the employer establishes an after-tax contribution source, in which the employee contributes up to a certain threshold, such as $1,000 or $1,500, through payroll deductions. Once the employee’s account reaches the specific threshold, future contributions shift to the participant’s formal retirement plan. . . .

David Mitchell, associate director for policy and market solutions at the Financial Security Program of the Aspen Institute, explains, “To ensure a constant savings buffer, the short-term account is automatically replenished as necessary. The hope is that by formalizing the dual role the retirement system currently plays, savers would be in a better position to distinguish between what is available now and what is locked away for retirement. This would allow them to meet both short- and long-term financial goals more easily.”

(Mitchell and the Aspen Institute have published an Issue Brief which provides more detail on the proposal.)

At present, there are various regulatory barriers which prevent employers from offering these, and the proposed legislation aims to remove these barriers; in addition, none of the state-managed programs (to the best of my knowledge) yet include such a short-term savings program.

That being said, I should also admit that I remain, in general, uncertain about whether these state-managed programs are the right path forward in what is very much a transitional period for our retirement system — but it may be quite some time before we really know how they shake out.

 

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, “Public Pension Funding Crisis: Who Was Jeremy Gold And Why Should You Care?”

Originally published at Forbes.com on July 17, 2018.

 

The bottom line:  public pension plans’ poor funding levels would be even worse if they were accounted for the way that private pension plans are, the fact that their accounting methods differ has contributed to the funding crisis, and Jeremy Gold was either a prophetic or foolish in attempting to call attention to this fact.

Let’s start with more actuary-splaining:

Actuarial valuations . . . in the corporate world

In the corporate pension world, there are two types of actuarial valuations:  accounting valuations and funding valuations.  The former determine what liabilities and expense are recorded on the company’s books, and the latter determine what contributions the employer will make to the pension fund, or define a range of choices.

The interest rate — or, in actuarial terminology, the discount rate (since you’re discounting to the present, the present value of a future benefit) — for accounting valuations is pretty nearly the corporate bond rate; once upon a time, it was just a generic bond rate; then more attention was paid to ensuring that the duration of the bond rate is equivalent to the duration of the plan liabilities (that is, simply defined, that the weighted average of the future payouts of the bond index match the future payouts of the pension plan); now most companies use a yield curve to determine the discount rate.

The consequence of this is that liabilities can increase substantially in periods when corporate bond rates are low in a given country.   Incidental fun facts:  internationally this can be a bit tricky.  What do you do about countries where there are very few long-dated corporate bonds?  Sometimes you use government bonds instead, and sometimes you can add a bit of an adjustment to represent what you think the discount rate would look like if there were enough corporate bonds.  What about a country where there are no long-dated government bonds? To be honest, my colleagues and I never really had a good answer, but just made some reasonable estimates and tried to persuade the client that they weren’t material.

But I always preferred to go back to the original text of FAS 87, the first FASB statement on pension accounting, which says that

that is, the rate at which an employer could purchase an annuity from an insurance company for the benefit.  And that’s always felt right to me.  If you have to assign a value to a piece of property, you base it on how much you could sell it for in the market.  If you have to value a liability, it makes sense to assess its value in the market, by how much it would cost to “exchange” that debt, in this case, by purchasing annuities.  Conveniently, group annuity rates are more or less the same as corporate bond rates, so that the corporate bond rate has become the norm.

Pension funding?  That’s a bit different. In the United States, there used to be a fair bit of flexibility in funding, with a defined minimum and maximum funding level, the former to ensure adequacy and the latter to ensure that employers didn’t take advantage of the ability to avoid taxes by making (tax-deductible) contributions to their pension funds.  In this idealized world employers would fund their plans more generously in good years, less so in lean years.  And because the expectation was that employers were setting their annual contributions with the full understanding that, as a business, they were taking risks, and that they’d have to make up any shortfall in the future, they were allowed to use an interest rate that matched their expected return on assets.  But that’s in the past — the Pension Protection Act of 2006 prescribes specific rates that must be used in funding valuations, based on government bond rates, so the “choose your interest rate” is really more of an idealized approach, or what a church plan (exempt from funding requirements) might do.

. . . and in states and municipalities

But the rules are different for government pension plans.

There are, of course, no federal government rules for how much states and cities must fund their pensions — states might instead define some funding target (“100% funding target . . . in 50 years”) and pledge to contribute the required amount each year; and those states may or may not actually do what they say they’re going to do, and the method of calculating the contributions needed to get to that funding target may be more or less fanciful depending on who’s deciding the assumptions.

But even government financial accounting rules are different, as defined in GASB 67.  A plan that’s unfunded, and that never has any intention of being funded, is valued based on

A yield or index rate for 20-year, tax-exempt general obligation municipal bonds with an average rating of AA/Aa or higher

that is, not much different than a corporate pension plan.

But a plan that is funded, and whose actuaries determine that the combination of funds already in the plan, as well as contributions scheduled to be made by the state or local government in the future (whether or not they’re actually made is another story), are enough to pay out benefits in the future, has different rules, using

the long-term expected rate of return on pension plan investments that are expected to be used to finance the payment of benefits.

And if a plan is partially funded, they use a weighted average of the two rates.

Which leads to some peculiar outcomes, such as that reported at Wirepoints, in which the pension plan for the city of Chicago almost-magically is in a better financial position this year than last, not because of an increase in contributions or a decrease in benefits owed, but because the city council’s most recent budget includes a new schedule of contributions which intends, by means of increases each year in the future — which may or may not actually happen — to arrive at a funding level sufficient to shed the lower discount rate requirement.

Does this sort of manipulation sound any more reasonable to you than it does to me?

The more you think about it, the more bizarre it becomes, that the valuation of a future debt should depend on how aggressive you are in your plan to save up to pay for that debt.

Understated liabilities have consequences.

In the corporate world, asset return-based funding discount rates had been allowed with the expectation that companies could catch up out of future profits, if necessary, and that they didn’t have any particular obligation one way or the other, as long as their accounting is correct and disclosed to shareholders, regulators, and the financial community, to have greater or lesser levels of debt.  But when a corporation goes out of business, it can no longer make up the difference between its pension fund and the cost of annuity purchases, and the federal government is left holding the hat.

But when a government body uses the GASB-defined asset return rates, it creates all manner of potential for misgovernment, using the device of assuming higher asset returns (either simply by declaring it so, or by investing in riskier assets) to create artificial reductions in liability and as a means of justifying inappropriately low contributions.  It makes pensions seem cheap compared to actually giving employees wage increases in the here-and-now, and (see my earlier actuary-splainer) enables lawmakers to effectively borrow money to pay wages, asking the next generation to pay for the wages of this year’s teachers and toll-takers and other state workers.  And it means that when, as in the case of Detroit, the municipality is no longer, in corporate-speak, a “going concern,” the money’s not there.

What would Illinois’ 40% funding rate look like if the state were obliged to use the same accounting regulations as corporations?  It wouldn’t be pretty – but it would be honest.

And Jeremy Gold?

That’s where, finally, Jeremy Gold comes in.  New reports that he passed away on July 6th may not have made their way much outside the actuarial world, but Gold was an actuary who watched the pension fund raids of the 1980s and then embarked on a mission, iconclastically warning for more than 25 years about the risks of pension underfunding caused by too-lax funding and accounting methods.  In a Forbes article in 2015, “Where Are The Screaming Actuaries?“, he took actuaries, or specifically, the actuarial profession to task for not ensuring that professional standards required actuaries to provide more appropriate values:

The actuarial profession acknowledges, but does not fulfill, its duty to the public. . . .

The public will get the best estimates only when the Actuarial Standards Board requires the actuaries, who do have the data, to produce economically pertinent and decision useful numbers.

a refrain he elaborates on in an article at ConcernedActuaries.com. Yes, actuaries follow accounting standards and the requested scope of work by the governments engaging them, but Gold’s message is that actuaries have a professional duty, and a duty to the public, to disclose “true” liabilities whether or not the accounting standards or the legislature calls for it. If you’re even more interested, Mary Pat Campbell has even more information on the man and his life’s work at her blog.

So what will Gold’s legacy be?

 

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, “Retirement Savings And Pension Funding 101 (Some Actuary-Splaining)”

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

 

How do employers fund and account for pensions?  How should workers save for retirement?  It occurs to me that going back 20 years to my first days, and first training sessions, as a trainee actuary, and revisiting the basics of pension funding methods, might provide a different way of thinking about these issues.

Back in the day, we learned that there were two general methods by which an employer could calculate their annual contribution, and their accrued liability, for a pension plan:  level-cost methods and unit credit methods.

In the level cost method, or more specifically the Entry Age Normal or EAN method, the actuary calculates an employee’s projected future benefit at retirement, then calculates the amount needed to fund this benefit on a level basis throughout the employee’s career.  If the benefit at retirement would be a flat dollar amount, then you’d calculate this as a level dollar amount throughout the employee’s career, kind of like paying off a mortgage.  If (as in a traditional pension plan) this was based on the employee’s pay at retirement, you’d project the payout to retirement, and calculate the amount needed to fund the benefit as a level percent of pay throughout the employee’s career.  For example, a worker starting at age 25, with a retirement age of 65, and a benefit accrual of 1.5% of pay per year would have accrued 40 x 1.5% = 60% of pay at retirement, so the actuary uses actuarial mathematics to determine a funding percent of pay for the employee’s working lifetime.

Sound familiar?  This is the same sort of calculation, in general principles, as a retirement savings calculator would perform when you enter in your variables, such as “I want to retire at age 65 with enough savings to cover 70% of my future salary,” and ask for the recommended savings amount as a percent of pay — except that the actuary also has to reflect the likelihood that you’ll terminate before retirement (with or without a vested benefit), and your probabilities of dying before and after retirement.

In the Unit Credit method, the actuary’s calculation is different.  To calculate the employer’s liability for any given employee, the actuary calculates the amount of benefit accrued up to the present point in time, then determines its value as a lump sum based on actuarial mathematics, considering the time-value of money as well as probabilities of termination and death.  For a pay-based plan, this is called Projected Unit Credit (PUC) and, just as in the EAN method, pay is projected to retirement to determine the benefit accrual; in the above example, if the worker was age 45 at the time of the valuation, the liability would be based on 20 x 1.5% = 30% of projected pay, and the baseline amount for one year’s funding would be 1.5% of pay.

These hardly seem like two different methods, but there’s a very important difference:  in the PUC method, as each year the employee ages and gets one year closer to retirement, the cost of that benefit increases, because the discounting for the interest rate (and the likelihood of terminating in the meantime) decreases.  If the EAN method is similar to the idealized retirement-calculator method of saving for retirement, the PUC method more closely resembles the clunky way that Americans tend to save in practice, with the amount increasing from one year to the next as retirement grows nearer — except that in the latter case this is due to worry setting in and in the former case this is a consequence of the funding method.

What’s more, in my first paragraph, I referenced learning these funding methods as a trainee actuary.  In practice, new pension funding regulations prescribe the PUC method, and pension accounting has always required this method — which makes sense, because, from an accounting point of view, the PUC method does reflect the true cost to the employer.

Incidentally, here’s another interesting tidbit:  the method of providing Defined Contribution/401(k) benefits at the same level for everyone?  There are two European countries which follow an entirely separate approach.  In The Netherlands, because DC benefits were supposed to provide benefits equivalent at any given age to the traditional pension/Defined Benefit (DB) plans they replaced, employers’ contributions to their employees’ accounts also increase by age:

A typical individual DC scheme uses an age-related table in which contributions increase with age. Since the Dutch tax authorities have set up a maximum DC premium per age bracket (of five years), most companies use a system that corresponds to this.

KWPS provides two sample tables, based on the standard target equivalent defined benefit accrual and two different interest rates (their data, my reformatted table).

 

from KWPS; https://kwps.nl/usr-uploads/files/brochures/Pension%20in%20the%20Netherlands.pdf

own table

And in Switzerland, where employers are required to provide a retirement plan, vaguely similar to a Defined Contribution system in the U.S., with employees contributing about 1/3 of the total contributions, contributions are also based on age, with a minimum total contribution of:

Age 25- 34, 7%

Age 35-44, 10%

Age 45-54, 15%

Age 55-65, 18%

So step back and imagine your employer contributing more to your 401(k) account the older you are.  Hard to imagine, isn’t it?  — Although in some of the earliest American cash balance/hybrid plans, the employer’s contribution schedule did that as well.

So far this all seems very abstract and not of much relevance to American retirement savings or retirement policy.  But consider an article in yesterday’s Wall Street Journal, “Behind on Retirement Savings? It’s Not Too Late to Catch Up.”  It’s paywalled, but much of its content is based off of a blog post by Michael Kitces, “Why The Empty Nest Transition Is Crucial For Retirement Success,” which proposes that, as an alternative to the goal of saving a level percent of your income throughout your working lifetime, you actively plan to cut your spending upon becoming an empty-nester, to the degree necessary to, in fact, fund your retirement, bearing in mind that this requires active efforts to keep your standard of living the same when kids have left the house, rather than boosting your spending to enjoy travel you’ve deferred or otherwise make up for an empty house with more (costly) activities.

Kitces writes:

for those who allow their total family consumption to fall (now that Mom and Dad are only supporting Mom and Dad, and not the kids), a significant uptick in savings can almost entirely make up the lack of savings during the child-rearing phase. In other words, if all the money that used to be spent to raise a family and send kids to college is now redirected into saving for retirement, a couple might find themselves suddenly leap from saving less than 5% of income to being able to save 25% or more.

Is this realistic?  The WSJ article mentions research by the Center for Retirement Research that, on average, empty nesters don’t actually significantly increase their retirement savings when the kids leave home — whether because they’re still supporting those kids (college tuition, weddings, helping out in other ways) or for other reasons, and Kitces himself acknowledges that for who started their families late in life, there’s not much time to save after the kids are grown and before hitting retirement age — which means that, rather than providing a solution to the question of retirement savings, it really just provides a different perspective to take into consideration.

 

 

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.