Retirement is a modern concept; people historically worked until they couldn’t work anymore, at least in some capacity. Regardless, like most people, I would like to retire. The question is: How do you get the money?
A Pension is a defined benefit; it pays a fixed amount per year until you die no matter what. You receive/accrue your pension based on years worked (private sector pensions); you can also accrue based on amount paid in (like Social Security), or simply buy a financial instrument (annuity).
The alternative to a pension (defined benefit plan) for retirement is usually a defined contribution plan (401K), in which you don’t accrue a fixed payment, you contribute and draw against the balance in retirement.
The advantage of a pension is its simplicity:
A fixed stream of payments until you die is very predictable. It is the best, simplest solution for the retiree.
The retiree knows how much they are accruing each year of service along the way; that is something you can plan around. They will not run out of money if they happen to live a long time. This is the kind of security and simplicity everyone would like in retirement. Life is complicated; retirement shouldn’t be, no?
This is why I like pensions.
If pensions are so great, then why are they so unpopular?
The biggest reason is that companies (and even governments to a certain extent, though they can print money, which is helpful) cannot manage the risk appropriately.
Pensions (like social security) can be unfunded. There is no social security fund. The people that pay in (working age) are really giving money directly to retirees. I could accomplish the same effect by simply mailing my money directly to them. The government is facilitating a direct transfer payment. Some risk issues here could be the value of the US Dollar, the life expectancy of retirees, and/or the total population paying into the system. These risks are hard to manage and predict over short and long term time spans. The advantage the government has is that its pension is always solvent so long as the government can issue its own currency.
Pensions that are funded (like CalPERs and other large corporate plans) receive payments from employees (or simply lower their salary paystub, which is an indirect payment) and then manage the pool of money from which to payout the annuity revenue stream promised to retirees.
These plans have to manage even more variables than the government with a smaller population size (leading to more volatility); and they can’t print money. They must predict how much people should contribute now, then predict a rate of return in the stock market, then make sure they don’t run a negative…and their business/industry must be healthy enough to continue to continue to exist when these people retire (avg life expectancy of a public company is less than 10 years). That is hard to do. The main issue for corporate pensions is that they have assumed a rate of return (historically 7%) for the stock market that hasn’t materialized.
So here is the crux, and why I still like pensions (preferably a government pension which can’t go bankrupt):
All the risk factors mentioned above that large companies and governments find difficult to correctly assess…..also apply to us.
We don’t know how long we will live. We don’t know what payout amount is adequate. We can’t predict the stock market. We don’t know whether we will stay healthy enough to continue working. We don’t know what the value of the dollar will be. We are woefully unqualified to bear and assess these risks.
By switching from pensions to 401ks companies are shifting these risks from them to us. If they have been unable to assess these risks correctly, how would we be able to?
Tags: economics, retirement
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