August 17, 2013
IT CERTAINLY ISN’T VERY GOOD AT SAVING FOR ITSELF, WHAT WITH ALL THE DEFICITS AND EVERYTHING: Megan McArdle: Don’t Count On Government To Do Your Saving For You.
California is considering implementing a version of the Ghilarducci Plan, in which automatic payroll deductions are used to create a defined-benefit fund run by the government, guaranteeing a modest minimum return, which is then rolled into an annuity at the age of 65. The Guardian’s Helaine Olen likes the idea, which has been put forward by Kevin de Leon, a California state legislator. . . .
Of course, even $210 or $375 is better than nothing! But, also of course, that money is not free. To pay for it, they need to give up 3 percent of their salary right now, every year until they retire. While Olen likes the guarantee, my take is that the guarantee is not doing most of the work here; almost all of the benefit comes simply from the quasi-mandatory saving. In fact, the majority of people would be better off if you took that 3 percent and stuck it in an S&P 500 index fund. Your real return, after taxes and fees and inflation, from 1982 to 2012 would have been about 5.8 percent.
Which demonstrates two things. The first is that for all the nostalgia about defined-benefit pensions, guaranteeing a benefit is really, really expensive. There’s a reason that DB pensions were really popular up until 1974, when congress passed ERISA, the law that forces companies to fully fund these commitments in advance. Starting in the 1980s, the popularity of these plans began rapidly declining, precisely because they were extremely expensive, and worse, tended to demand top-up contributions during recessions, right when you were least able to make them.
And the second point is that you need to save a whole lot of money for retirement if you want to have a decent shot at living comfortably in your golden years. Three percent isn’t going to cut it. And my calculations used 3 percent every year for 40 years, which is not what the majority of people do. The majority of people have employment gaps, lean times when they slow or stop their contributions and so forth. If you want to make sure you have enough income in retirement, a government guarantee will in no way make up for those vicissitudes. What you need is to put away lots and lots of cash.
At this point, I think of myself as saving for retirement, rather than investing for it. With likely rates of return over the next couple of decades, that only seems prudent. I’d be happy to be wrong, of course.