Pensions and Pension Plans: The Guaranteed Retirement Account

 Experts claim that if a retiree can maintain an income that is 70% of the preretirement income, then the individual will be able to maintain the preretirement lifestyle.  People who survive but struggle will continue in the same mode, those who were living the good life should be able to continue living the good life.  Sources of retirement income include Social Security payments.  This system was never intended to be a full retirement program; it was intended to keep the elderly out of abject poverty.  Benefits are focused on providing the greatest assistance to low-wage workers.  As income increases, the benefits from the program become a smaller fraction of that desired 70%.  Those with moderate to high incomes now need either an employer provided defined benefit plan, an employer provided defined contribution plan, a healthy personal savings accumulation, or some combination of the three.

A defined benefit pension plan was once common for employees of large companies.  With the ascendency of neoliberal concepts and the acceptance of the dubious claim that a company’s only responsibility was to provide the greatest profit for the benefit of shareholders, defined benefit plans began to disappear and be replaced by defined contribution plans such as 401(k)s.  This was a massive transfer of risk from companies to their employees.  As points out Max Reyes in a Bloomberg Businessweek article, Companies Decide the Time Is Right to Offload Pensions to Insurers, a perverse outcome of the pandemic was that the suffering was born by mostly low-income individuals, while investors were able to dramatically increase their wealth.  Pension plans are major investors and they have performed quite well.

“The hundred largest corporate pensions were funded at 97.1% in August [2021], according to the consultant Milliman Inc., and they could creep as high as 102% by the end of the year under optimistic projections.  A year ago, pensions were less than 87% funded.”

Being underfunded means the plans did not have the projected resources to meet their projected obligations.  The companies would be at risk of having to default in some manner in the future or extract large sums of money from their businesses.  Now that they are at or near full funding, they have a convenient mechanism for terminating their defined benefit plans entirely and eliminating the potential for risk to return in the future—without having to contribute any of their profits.  The path forward is called a pension risk transfer or PRT.

“…By buying a financial product called an annuity, a company can essentially place the assets of a plan and the responsibility for paying for it into the hands of a life insurance company. The insurer makes money if it can earn more from investing the assets than it has to pay out. (Another risk-transfer option is to offer to pay benefits in a lump sum; in that case, the risk of ensuring the money lasts is taken on by the pensioner rather than another company.) These deals with insurers aren’t new, but record high markets are making them especially attractive to employers.”

Major companies have recently opted to take this path and many more are expected to follow.

“A recent study commissioned by MetLife found that 93% of 250 plan sponsors surveyed intend to divest all of their obligations, up from 76% in 2019. Companies can choose to fully divest the plans or reduce the scope of pensions on their balance sheets without removing them entirely. But plenty of businesses are looking to get out for good, according to Yanela Frias, president of Prudential’s group insurance business. ‘The reality is that an insurance company is much better positioned to manage this liability than a car manufacturer or a telephone company,’ Frias says. ‘We do this for a living’.”

This trend protects the pension rights of employees and is revenue neutral for retirees and nearly so for those close to retirement.  However, for younger employees and new hires they will be pretty much on their own in saving for retirement, managing their savings, and making sure they don’t outlast their savings in retirement. 

This trend of divesting pensions will hopefully generate serious consideration of what is really needed: a national retirement that is not dependent on the whims of employers with mandatory participation by both employers and employees.  Teresa Ghilarducci has for years been promoting a Guaranteed Retirement Account (GRA).  She and Tony James provided a detailed account of their proposed GRA in Rescuing Retirement: A Plan to Guarantee Retirement Security for All Americans.  If implemented throughout employees’ working lifetimes and earning returns consistent with those of existing public employee pension plans, the cost to individuals and companies is surprisingly small. 

The authors begin with some perspective on why their plan is necessary.

“As recently as 1979, half of all private sector workers with retirement plans had traditional, employer-administered pensions.”

“Today, however, only 15 percent of the U.S. workforce (mostly government workers and public school teachers) has access to a traditional pension.  Beginning in the 1980s, most private employers shifted to ‘defined contribution plans such as 401(k)s, which cost companies less and shift funding risk rom companies to employees.  Roughly half of private sector workers (53% in 2016) either lack access to any plan or do not participate in one.”

Most employers offer only modest contributions to 401(k)s, usually matching workers’ contributions up to a few percent of wages.  Most workers have endured nearly stagnant wages over the last several decades, leaving little opportunity to lock up precious earnings in a long-term effort to prepare for retirement.  As a result, most workers, particularly those with low wages, will have little other than Social Security available when they hit retirement age.

“The World Economic Forum (WEF) estimates that the United States had a $28 trillion retirement savings gap in 2015—the largest in the world.  By 2050, they project this will grow to $137 trillion.  This is almost a $3 trillion annual increase—five times the annual defense budget.”

The goal of the GRA is to fill the gap between what Social Security provides and the desired 70% of preretirement income.  The intention is to provide that amount for workers earning less than $100,000 per year.  Those with higher incomes will still benefit but should be able to provide some additional savings for retirement.  The basic plan is simplicity itself.  Every worker, from the time of first employment to the full Social Security retirement age of 67 is assumed to contribute 1.5% of their income to a retirement account.  Employers are required to match that amount.  There is also a $600 annual tax credit for individuals making the participation of lowest wage workers nearly free.  This 3% annual contribution invested in a long-term investment plan is to be converted to an annuity at retirement that will provide a constant source of income for the remainder of their lives.  

At the historical rates of return for these types of pension funds, the GRA is expected to produce about 38% of preretirement income for all participants.  This will augment the amount provided by Social Security (SS).  The authors provide these quantities: for an income of $22,021, SS provides 53% + 38% = 91%; for an income of $48,937, SS 40% +38% = 78%; for $78,295 SS 33% + 38 = 71%; for $127,500, SS 26% +38% = 64%.

The authors assume the money invested will earn 6-7% over a lifetime.  This is consistent with past performance for defined benefit plans, of which public employee plans seem to perform the best.  Historically, defined contribution plans have poorer performance in terms of return on investment.  Whether the economy in 40 years will be anything like the economy over the last 40 years is an open question.  However, being able to accomplish so much with such a small level of investment, this type of GRA provides a platform for modifications in the future as needs arise.  

The plan is designed to work for young people who will contribute all their working careers.  Those who are approaching retirement with little in savings will at least have the opportunity to invest more in the GRA than the 3% to hasten the buildup of benefits, but the main recourse seems to be to work longer to buy more time and to boost Social Security benefits.

The universality of the approach frees the individual from a dependence on the employer for retirement benefits.  Just as a good healthcare plan provided by a company can induce individuals to make unwise economic decisions based on the fear of losing that level of coverage by choosing another job, a good company pension can provide a similar constraint.  The GRA continues wherever the worker goes.  This should make life simpler for both employees and employers.

You can learn a little about a lot of things or you can learn a lot about a very few things. Guess which is the most fun.