I feel like the author is mixing together some important differences between 401ks and pensions.
------ Pensions:
- "Your" money and everyone else's money is lumped into a single pool. If previous retirees were given too much money because of poor planning, "your" money will evaporate
- Your future benefits are fixed, regardless of market conditions. Unless the pension can't afford to do so because of a market crash, and declares bankruptcy. In which case, anyone left holding the bag will be screwed
- Zero financial literacy/discipline required. Your contributions are pre-determined, and the pension managers will take care of all investment decisions
------ 401ks:
- Your 401k is 100% yours. There is no risk of your 401k account "going bankrupt" because too much of it was given to others.
- Your future benefits are dependent on market conditions - unless you choose to buy an annuity.
- Financial literacy and discipline is required. If you don't contribute enough, or make bad investment choices, you're screwed
-----------------
The article completely ignores the 1st and 2nd differences, which is why many people like myself are uneasy with pensions. The 3rd point is what the article mostly focuses on, and that's a valid point. I'd love to see "full-service" 401k plans, where employees are forced to contribute at least X% of their income, and all of it is managed by the equivalent of a pension-fund-manager (ideally, invested into low-cost diversified index funds)
Too many people lack the financial discipline to make sufficient contributions, and the financial literacy to make good investment decisions. So full-service 401ks as described above, could be a net positive for society, without all the baggage that come with pension funds.
> - "Your" money and everyone else's money is lumped into a single pool. If previous retirees were given too much money because of poor planning, "your" money will evaporate
There are more benefits to this than you might think. In particular, its easier to spread death statistics across larger populations than against individuals.
We can reasonably expect 50% of men to die before they're 78.74 (life expectancy in the USA). A Pension Fund (since it is pooled across many individuals) can plan for this very well. True, life-expectancy changes from year to year, but this slow-moving change can be corrected over time.
An individual 401k however, has no real way of planning for the event. Realistically, individuals need to have a plan for death at age 60 and death at age 100. On the one hand, you may die before you have a chance to even crack your retirement fund, but on the other, you may die in extreme poverty, with all your money wasted away years before you die.
Planning for your age of death is damn near impossible on an individual basis. A 401k would be innately less efficient than a pension fund as we all have to plan far more conservatively. IE: A Pension Fund can plan for an age-of-death at ~80 years old (for males), while an individual male may need to plan for 85 or maybe 90 years old.
Or pension plans. Which essentially combine an Annuity with a Retirement Fund.
Life Insurance is weirder. Its more about leaving money left over for your family, especially if you die earlier than expected and your family will need a source of money to sustain themselves after losing you.
The 401k being 100% yours is a somewhat significant downside, too. It means that the funds get transferred to your heirs on death, diverting funds from supporting retirement in general. This can be counteracted by purchasing an annuity, but that usually isn't the route taken by retirees. Overall, it means that saving for retirement is more expensive than it needs to be, since you're also effectively saving for an inheritance too.
The pension, on the other hand, effectively collects mortality credits as beneficiaries die and distributes them to survivors.
The ideal retirement system would be effectively some sort of actuarially adjusted tontine. Nothing gets left behind when you die - instead, it gets split among surviving retirement savers in an actuarially fair manner.
Except for the fact that psychologically, those who think, expect, or worry that their money might outlive them may take significant comfort in that money being passed to their heirs. This may make them more likely to save for retirement, even at the risk of over-saving, because the benefit of that money is not fully "lost" on death.
You don't want to (IMO) design a retirement system where the well-to-do have every incentive to opt-out.
Erm, what? Yeah, you want to structure a retirement system where the well-to-do want to opt out. Otherwise, we're giving tax advantages for "retirement saving" that really goes to heirs. How it's currently structured in the US, we do so through contribution limits.
If all the retirement system change is make rich people opt out and have poor people who die early pay for the retirement of poor people who die late, it's a smashing success.
I see your point, but in any private system where only the poor participate, only the poor pay the fees that allow the system to exist, so you either further disproportionately disadvantage them financially and/or you provide them with notably worse service and support than the well-to-do enjoy for their investments.
Old-style tontines are not actuarially fair - they are significantly more valuable for you if you have a higher life expectancy. It transferred wealth from older individuals with a higher chance of dying to younger individuals with a lower chance, with the obvious failure mode of a tontine being something you sign your children or grandchildren up for.
Actuarially fair tontines would yield mortality credits based off age and amount invested. So if you had a 10% risk of dying in a year based off actuarial tables, and you had a balance of $10k, you'd have 1000 mortality credit units. 1% chance of dying means only 100 mortality credits. So there's no advantage to signing up younger folks - the lower risk of dying proportionally lowers the mortality credits earned.
I agree that it's worth acknowledging the effects of 401ks as having some downsides for retirement in general. That said, I don't think it's fair to consider it a "significant" downside at face value when the upside of the transaction is that you can leave it to your heirs. For someone who values individual agency and family values that's going to be an upside, for someone who values optimizing around what benefits society at large it's obviously a negative. I might also be wildly misunderstanding you though so please correct me if I've gone off track.
I'm optimizing both for "what system is best for society to implement" as well as "what system is best for individuals within it". There's a pretty significant individual upside - people who were unable to save enough for retirement can now retire due to their tax-advantaged plan earning mortality credits.
Being able to leave assets to heirs comes at a price. Just look at the pricing of the different single premium immediate annuity options - anything that also preserves assets to heirs in certain conditions also costs significantly more for the same income stream. The goal of retirement programs in general should be to ensure that as many people as possible aren't destitute in old age as cheaply as possible, IMO.
If you plan for a 20 year retirement, but live an extra 10-20 years and run out of money, that is a pretty significant downside.
Another advantage of retirement policies that can take advantage of actuarial risk, is that they can also adjust their market risk to match the actuarial distribution. The common advice is to have most of your 401k in bonds and other safe assets by the time you retire to protect against market volatility. But if you live another 40 years, you will have missed out on a lot of potential investment return if you were all in on bonds. Pooled retirement solutions can balance those risks better.
Here in Australia, Superannuation (essentially 401k) is compulsory and the process to get the money out before you retire is quite arduous. It is contributed by your employer and often isn't included in the advertised income. The compulsory contribution is about 9% of your income (exact value eludes me).
Social Security is only a little bit of money however. It taxes 12.4%, half of which is employer contribution, and the other half is an individual tax. Most people only see 6.2% individually. (Self-employed get taxed at the full 12.4%)
No one actually expects to live on Social Security alone in the USA. Supplemental savings (such as Pension Plans or 401k plans) are needed for a real retirement.
No. We have the 'Age Pension' [0], which is the equivalent of your Social Security. It kicks in once you're 65 and not working (much), and pays up to $23k a year (which IMHO is enough to live on as long as you own your own home). The funds for it come out of general income tax.
"Superannuation" was the 401k-alike system started in 1992 which has the 9.5% minimum. You can choose your investment allocation, and there's a bunch of tax incentives if you choose to contribute extra.
To be more precise. Among elderly Social Security beneficiaries, 23% of married couples and about 43% of unmarried persons rely on Social Security for 90% or more of their income [1].
> Your future benefits are fixed, regardless of market conditions. Unless the pension can't afford to do so because of a market crash, and declares bankruptcy. In which case, anyone left holding the bag will be screwed.
AFAIK, "defined benefits" are pretty much unavailable to new entrants. The vast majority of national and employer pension schemes are "defined contribution" only.
> I'd love to see "full-service" 401k plans, where employees are forced to contribute at least X% of their income, and all of it is managed by the equivalent of a pension-fund-manager (ideally, invested into low-cost diversified index funds)
My employer does something like this. They put money (3% of my salary) into a 401k for me regardless of my own contribution, so I have no option of not saving at least that much (although I still save additional money, because 3% is not really enough). This defaults into a low-cost index fund. However, I still have the option of transferring the 401k to another fund; but I suspect that most people would stick with the default instead of trying to change the investment.
> I'd love to see ... where employees are forced to ...
I'd prefer to live in a country free from people who think they are smarter than the rest of us, and that that entitles them to force their ideas on us.
>Your 401k is 100% yours. There is no risk of your 401k account "going bankrupt" because too much of it was given to others.
Systemic risk is present either way. You're just playing category theory sleight of hand and drawing distinctions between forced savings plans that aren't meaningful.
I don't see how actually having control over where you invest your money in a 401k vs having none whatsoever in a pension is "category theory sleight of hand" or a distinction lacking in meaning.
The risk is systemic either way. Those in this thread feel good about themselves for contributing more than others, but long run they're in the same boat as those 'others'.
You never escape systemic risk. The reality is that guaranteed pensions have a track record of getting people to save for retirement. Those programs are gone now and people don't save. The clever reductionists in this thread blame the workers, but placing blame is an exercise that bears only schadenfreude. Personally, I'm interested in lessening systemic risk - and that doesn't mean buying more bonds with shit yield.
The author just kind of brushes by this, but my main problem with pensions in general is their tendency to be underfunded. It's just one more way for current voters to externalize the costs of their benefits onto future generations.
401(k)s by design can't extract funding as future liabilities. Are there proposals for ways to do this for pensions? I know there are pushes to "fully-fund" them, but the temptation to use overly optimistic projections seems like it will never really go away.
Some states, like New York mandate public pension funding and do pretty well. There are issues with pension spiking for public safety positions, and some municipalities have had to bond to make payments, but as a whole the system works.
The formula is simple, don’t allow skipping out on liabilities and have an independent entity administer the plan. In New York, the state comptroller controls the pension funds as well as 529 plans. This avoids the issues in many states and the private sector where executives raid the funds.
The other issue with the anti-pension crowd is that people need to live. So no matter what you do, the public ends up paying for things like subsidized housing, healthcare and other entitlements that impoverished elderly people end up needing without adequate income. I think will start to appreciate this phenomenon when the wave of 50-somethings purged by the Fortune 1000 start qualifing for Medicaid.
Indeed nothing was written about city/state pensions that do not make projected returns year after year and require significant funding which most cities can't afford.
I think that to some extent it's a case of 'who takes the risk' or 'what happens if things don't work out'.
Anyway, consider that this is all quite new to us. A highly financialized pension setup is not something multiple generations have done and the pension demographics have never really been what they are now, or will be soon.
I'm not sure the macroeconomics of that many pensioners, living for 30-40 years on savings... it goes beyond just financial math, or even political-financial math.
The article isn't promoting the absolute return of pensions. They're arguing that whatever system ends up replacing it should have some collective shareholders voice for dealing with the financial industry.
> We let ourselves be charged high fees that we do not understand, we accept poor returns quarter after quarter, we never sue to enforce our rights, we never vote as shareholders and we never tell our investment managers how we think they ought to vote.
Is this satire? How is a pension better than a 401k in any of these dimensions? If my retirement is invested in overpriced, underperforming funds it's 100% my own fault. If my pension is chronically mismanaged (as they tend to be) there is literally nothing I can do about it.
Although I agree with you that many pension funds have been mismanaged, it's not 100% your fault if your 401k plan only offers poorly-performing, high fee funds as many do. I'm not sure either model is a good solution going forward.
> it's not 100% your fault if your 401k plan only offers poorly-performing, high fee funds as many do.
Well, IRAs and Roth IRAs are the competitor in that realm. I don't trust most people to handle their own funds in an "automatic" 401k plan however. How many "normal" people do you know who has a Roth IRA for example?
Not a lot. A ton of people I know even pull money from their 401k early for luxurious reasons. (It makes sense to do so in an emergency. But not for like... a Euro-trip or Cruise Vacation like some people in my circle...)
Honestly, each time I hear about stupid personal finance stories like that, I wish that those people were on a pension instead. There's a lot of stupid out there.
That's exactly the problem. We've moved to a system where the individual bears all the risks and is supposed to know what he's doing. But what if the individual doesn't? Are we going to just accept an explosion of old-age destitution? Are we going to pay to mitigate it some other way?
Are there plans that actually only offer actively managed funds? Even the bare bones bottom tier Fidelity plan I had years ago from a notoriously tight pursed startup gave me a few index tracking funds.
Have a look at the total fees for your account/index funds. My experience is that they are not always competitive with the lowest fees in the free financial markets. (3 basis points for Schwab S&P 500 index).
If your company is small or your benefits person clueless, you may have worse funds available to you than in the taxable brokerage world.
I think there are better things to worry about than a couple basis points. If I'm charged 1% for a basic index fund, sure that's a problem. But given the minute fees for most, the inefficiencies from trading strategies could dwarf the explicit fees - if you really care about every penny, you need to look at the actual tracking error. You may be surprised to find it's substantially larger than the fees.[1]
My attitude in practice is that if I'm getting an employer match, then why complain about fees? It's their problem to minimize them - I'm still doing better than I would on my own. The efficiency is their problem, and because they have an incentive to minimize their costs, there shouldn't be a systemic problem.
Yes, it's happily becoming less common, but it was and is common for all options in a 401k plan to have high fees, and be set up to benefit the company
But the beautiful thing is if you don't like the plan you can opt out (or only invest up to the match) and invest in an IRA instead. Can't do that with a pension.
I agree, even with the often quoted "the inventor of 401(k)'s doesn't even like them anymore" it always fails to identify the primary concern as being one of personal mismanagement and not the vehicle itself.
There are some decent arguments that need to be made about investment education and regulatory simplification but this article doesn't make them.
> If my retirement is invested in overpriced, underperforming funds it's 100% my own fault
Its my understanding that there are a lot of 401(k) plans out there that charge a significant management fee on top of any fees charged by underlying funds. A lot of plans also don't offer much choice in terms of underlying funds.
That isn't much of an issue unless you have the same employer for decades, which typically means your probably at a large organization with good 401k fund options.'
On the other hand, I feel like we should remove the strange limits on IRAs and just merge them together with 401k plans so employers don't have to set up a '401k plan' each.
Well, it seems pretty obvious. The pension has people who spend their work days thinking about it and has the resources to read all the documents, understand what's going on, and even sue. Individuals do not.
When a state puts matching funds in workers 401(k) plans each year, that is an easily quantified expense. A state that makes pension promises can minimize the stated expense by using unrealistic investment assumptions. Government workers' unions and politicians have collaborated to make promises that are ruinous in the long run. If politicians had been more honest and unions less greedy, I would be ok with public pensions. But both groups have shown that they are not to be trusted.
Pension funds are some the biggest investors in underperforming asset classes like VC, and have been epically fleeced in recent years by professional asset managers (pension bond debacles). Pension funds are desperate and easily manipulated because many of the big ones, especially public ones, are basically insolvent. Governments overpromised and under saved and now pension funds are counting on 8% returns that they’re not going to get.
With respect to the activism/pushing for improved corporate governance near the end of the article, I like to think it is happening on the 401K and individual side and that the reason it is behind the curve is because 401Ks are a more recent invention than pensions.
Here's an example of it happening on the 401K front.
“Today we have more choices and more opportunity to make our voices heard than ever before,” says Audrey Choi, head of Morgan Stanley’s Institute for Sustainable Investing. And collectively, we have the power to change the way companies and other institutions approach environmental, social and governance (ESG) issues. Finance, she says, “can be one of the most powerful forces for positive social change at our disposal – if we ask it to be. We have the power to make sustainable investing the new normal,” says Choi.
Choi calls out the fable that many of us carry in our heads that if you care about environmental or social issues when you invest, you probably aren’t going to make as much money. To bust those myths, she cites studies showing that investing in companies with strong sustainability strategies can result in the same if not better returns than investing in those that don’t.
As we enter 2018, BlackRock is eager to participate in discussions about long-term value creation and work to build a better framework for serving all your stakeholders. Today, our clients – who are your company’s owners – are asking you to demonstrate the leadership and clarity that will drive not only their own investment returns, but also the prosperity and security of their fellow citizens.
I feel like private annuities should be more popular than they currently are. Like a pension, an annuity pays a defined benefit until the day you die. They can also afford to pay out a slightly higher annual benefit than you could safely take from your own 401(k), because it's a statistical certainty that X% of the risk pool will die early, whereas with your own savings you can never be sure how long you'll have to make it last.
Unlike a pension, an annuity isn't tied to a specific employer, so it doesn't have career-immobilizing vesting requirements or weird payout rules tied to how much money you make in the last N years of your career. And you can select an annuity provider based on its fees and how solid its financials are, factors that aren't necessarily high on the list while selecting an employer.
So, why aren't annuities more popular as a retirement savings vehicle?
It's too easy to write an annuity as a scam, and there's huge counterparty risk of insolvency over 10-40 years. So we only see annuities where's there's no meaningful choice whether to opt in (Social Security and pensions)
So maybe we just need to invent the Vanguard of annuities? An annuity provider with a governance model designed to work in the interest of its customers that can build trust as a reliable player?
EDIT: it appears that Vanguard itself offers annuities, but they're not particularly transparent so I'm unsure if they're "good enough" for general-purpose retirement savings.
Social security is an annuity, and a damn good one--it's guaranteed by the US Government. What we need is for supplemental annuities (above SS amounts) to be offered by the federal government at cost, or to guarantee annuities sold by insurance companies (a la FDIC).
Social security is fine, but there's no way to over-contribute to intentionally up your benefit. In fact it's sort of the opposite -- the more you contribute, the lower your marginal returns. If the US government allowed voluntary SS contributions that paid out on a fiscally responsible schedule that might be a good solution. But I'm not sure it would be a better one than just letting private companies implement them.
It is much easier to create a mandatory annuity than an optional one because you don't have to worry about people who have a lower than average expected payout opting out. If the annuity is optional you need to have a much more sophisticated way of determining how much people should pay.
> What we need is for supplemental annuities (above SS amounts) to be offered by the federal government at cost
The U.S. government already sells 30-year Treasuries and savings bonds [1]. Spinning up a new government program is complicated. Just authorize the issuance of 50, 70 and 90-year Treasuries.
Bonds work differently from annuities, and are vastly more expensive per desired dollar amount of fixed income (provided you don't care about your children's inheritance).
In many different aspects of life, it takes generations to build up trust, and once it is really ironclad, some smart-alec always comes along and uses that trust to scam people.
Social security is an annuity, and one of the most popular retirement vehicles. I mentioned this in a comment below, but I believe private annuities aren't more popular because a) the industry is rife with high fees, perverse incentives, trickery and b) they're not guaranteed. The insurance companies offering them can fail. If we had something akin to FDIC insurance for annuities, I'm positive they would become far more popular than they are.
>it's a statistical certainty that X% of the risk pool will die early, whereas with your own savings you can never be sure how long you'll have to make it last
This is rather similar to a tontine, which have been considered highly unsavoury for a long time and are illegal to boot.
> This is rather similar to a tontine, which have been considered highly unsavoury for a long time and are illegal to boot.
Sure, they are similar in that a tontine is considered to be a type of annuity, but a typical annuity does not have the unsavory aspect that other members get more money if I die.
If I murder a fellow member of a tontine, I get more money. In a normal annuity, I would get no benefit.
I've never quite understood how pensions are supposed to work when one changes jobs every 1-5 years. With 401(k) I can roll my account into a Vanguard IRA and keep all the control. I'd hate for my retirement to be beholden to 5-10 different sets of pension fund managers.
Stream-of-consciousness - The Investor Class hates pensions? Really? I know a lot of investors. None of them hate pensions. Quite the opposite, actually. And since when did they become a class of people?
I have some friends who are politically-involved in California and quite concerned about public sector unions and the fiscal sustainability of the pension promises that were made. This couldn't be about that, could it? On HN?
"...his relentless, well-funded attack has taken every form of political advocacy available. It ranges from campaign contributions to ballot initiatives to model legislation to lobbying to lawsuits to financing academic and judicial conferences...The justification is that these pensions are in crisis. The familiar claim is that states and municipalities face unsustainable pension obligations that will crowd out other government spending and lead to higher taxes. Therefore, traditional pensions, which guarantee retirement payments to workers — leaving states and cities on the hook — must be replaced by 401(k)s, which offer no such guarantee...Though the mainstream media has mostly taken the crisis claim at face value, economists and actuaries debate its extent and even its existence..."
Well fuck me. There it is. This isn't an analysis of pension funding. It's not a survey of financial managers. It's political cover-your-ass. Some folks think pension funds are in trouble. We're going to attack and say their claims are politically-motivated.
Everything is politics now, including, it seems, figuring out whether you have enough to retire on or not. I know plenty of people who are serious investors who are concerned about public pensions, but it's got jack squat to do with politics. All of the folks I know are huge union supporters. It has to do with the numbers not adding up.
We gotta stop this thing we do where we form up into teams and throw crap at one another. It's certainly possible that these two things are unrelated. It's also certainly possible, highly-likely even, that this essay is a desire to politicize something for the purpose of obfuscating the real issues involved. That's a shame, especially for both the citizens and workers who are not expecting a crisis.
> economists and actuaries debate its extent and even its existence
I mean... I'd ask for a citation right here. Maybe it's due to my "bubble" but I've never once heard an actuary state that most public pensions are perfectly fine. The opposite is almost universally true with a few notable exceptions. Heck, a high schooler with a napkin and basic math skills can figure out how utterly unsustainable so many of these plans are - and how they've only sustained so far by being what amounts to a pyramid scheme.
Illinois in no way is even a sustainable state long-term at this point, almost solely due to insane unfunded pension debt coming due. You can be pro-pension or anti-pension, but either way the math is pretty clear.
I think a much more productive discussion is over the models and standards used to judge the worthiness of pensions, a discussion that has roots going back a long time before the current stuff. None of this has to be political. This is common stuff people have been doing for decades. I am quite curious who these people are and how they defend the statements they make.
When friends of your cause tell you that you have a problem and your response is creating villains and presupposing the dangers of various unacceptable solutions that may or may never actually come to pass, you've got two really bad problems instead of just one: the original problem and denial.
This type of essay is identifying bad guys and pre-planting rhetorical defenses to be used if anybody gets close to the problem. Attack the messenger! It's much easier to just discredit people than engage with them on the merits. And it's simple enough that anybody can do it.
Hell, I'd be interested in a discussion of the various pension models and just the history of how each has fared over the years. You could take all the political fearmongering stuff out and just go with that. I think it'd be fascinating. There are several fact-based, dispassionate essays that could be written on this topic that would be both interesting and informative.
This doesn't seem to even try to explain by what measure 401(k)'s have failed (if the problem is low contributions, that is not the fault of the 401(k)), or back up the suggestion that pensions are not bankrupting municipalities.
It seems to mostly invoke the Koch brothers and paint a target on The Investor Class, and hope that is proof enough.
If the Koch brothers favor pension reform, then by definition pensions are not failing!
You assert "if the problem is low contributions, that is not the fault of the 401(k)", but that conjunction doesn't hold.
To wit: is it possible that the requirements for participation in a 401(k) are such that fewer and fewer people can actually contribute to one for a significant period of time? In that case, low contributions would be a result of the 401(k)'s structure, and your conjunction's consequent would be false.
This op-ed is a dog's breakfast of Big Labor talking points, and pretty much what one would expect from a law professor flogging his latest book, entitled, "The Rise of the Working-Class Shareholder: Labor’s Last Best Weapon" (see author bio at bottom of piece).
TLDR: The Kochs are trying to kill pensions because they don't like Calpers' political activism. The author doesn't get into specifics, preferring to make sweeping accusations such as, "This relentless, well-funded attack has taken every form of political advocacy available. It ranges from campaign contributions to ballot initiatives to model legislation to lobbying to lawsuits to financing academic and judicial conferences."
Sounds pretty scary. And as a former investment banker I can confirm that, in fact, F500 CEOs and boards are afraid of Calpers and Ontario Teachers and a few others who have gone the activist route. So maybe there is something to the thesis that all these fat cats want to stymie the ability of the working class to effect meaningful change through its collective ability to influence corporate governance.
But as someone currently involved in the government of a small town, I can also tell you that pensions are, legitimately, a major problem. Especially when they pertain to unionized public employees whose unions are allowed to force every member of that group of public servants (cops, teachers, garbage collectors, etc) to pay union dues regardless of whether they want to be part of the union.
The tenacity of union leaders, coupled with the universally bad optics of management not giving labor the future financial security that labor wants, often results in management making pension promises that they won't be able to deliver in a decade's time -- especially if the discussions happen during a good market run when modeling a perennial 7% YoY return on the pension portfolio seems reasonable.
This is ultimately much more of a public sector problem than a private sector one. Unfunded pension liabilities can kill companies, giving union leadership a strong incentive to compromise in cases where the pension is going to bankrupt the company.
On the public sector side, what you see instead is hiring freezes that benefit tenured union members, tax hikes that prompt wealthy residents to move to Florida, and cutbacks in other areas (e.g., paving roads).
It's not a pretty picture, and this op-ed is a good example of the rhetoric that can be deployed against people trying to make sources of funds equal uses of funds. Please DO NOT take that as an implicit defense of anything the Kochs are doing, btw.
> especially if the discussions happen during a good market run when modeling a perennial 7% YoY return on the pension portfolio seems reasonable.
That's a pretty reasonable, even conservative, assumption for the long-run nominal total return of the stock market.
I wish I could find the version that had figures in it (rather than simply 3% wide buckets, but all of the 25 and 30-year long periods in the heatmap have real returns in excess of 6% (meaning the nominal would be over 7%) https://portfoliocharts.com/portfolio/total-stock-market/
I think 7% nominal over a long period (such as a pension fund could expect) is quite reasonable and would expect a pension so funded to be quite stable.
> I think 7% nominal over a long period (such as a pension fund could expect) is quite reasonable and would expect a pension so funded to be quite stable.
Pension funds aren't retirement accounts; you don't care about a total 30-year return, you care about ongoing cash flow, and if you have fixed obligations in a bad year then you eat into principal. This obviously creates problems down the road, especially when you have decreased contributions over time due to a shrinking population in the municipality in question -- or a shrinking tax base (e.g., the downward spiral of rich people leaving because they don't like tax hikes, which results in tax hikes to cover the revenue shortfall....repeat).
Also, they're usually diverse portfolios with a fair amount of lower-risk/lower-return assets (mostly T-bills and investment grade F500 debt), so 7% is actually pretty ambitious.
As a permanent pension fund (rather than an individual retirement account), the fund has the advantage of a timeline of "forever" with a greater portion of assets than a 401K could. This allows them to hold a smaller percentage of cash/cash equivalents.
To your excellent point about shrinking base making things fall apart, this is only a problem for underfunded pensions and Ponzi schemes. I leave it to the reader to determine whether those are two different things or not.
Right -- the problem is underfunding, but the driver of the underfunding of public pensions isn't just that nobody can predict the future; it's that politicians and union leaders both have morally hazardous incentives to agree to something that both parties know might not hold up in the future, because they (the individual politician and the union leader, specifically) will have moved on from their current roles by the time the wheels fall off in a couple decades.
I'm not sure I understand your point about cash and cash equivalents....securities are fungible to cash....the issue is that there's a defined payout every year in $USD, and if the contributions to the fund from which it were paid were modeled in an overly optimistic way, then the fund runs out of money.
Individuals need to hold a certain amount of their 401K/IRA in cash to pay expenses, to prevent having to sell a lot of stock in a bear market. Individuals will not have the time to recover from a sharp bear market just as they begin retirement. This causes them to miss out on the higher upside in normal and bull markets. (see "sequence risk")
Permanent funds, adequately funded, could leave a greater percentage of their money in equities, which has (historically had) higher overall returns despite larger short-term drawdowns.
> Permanent funds, adequately funded, could leave a greater percentage of their money in equities, which has (historically had) higher overall returns despite larger short-term drawdowns.
Agree, but they don't. Every pension portfolio I've seen has a lot of fixed income in it.
How many of those pension funds are adequately funded? (defined as "could pay out the already earned benefits for all current benefit holders without any future cash infusion")
I think you see them holding fixed income and cash equivalents because they need current cash and future cash deposits. (They're pretty damn close to Ponzi schemes in a lot of cases.)
The GDP growth rate is quite steady and nowhere near 7%, so I do not see how the stock market can produce higher returns indefinitely - otherwise P/Es would go to infinity and labor's share of income would go to zero. It seems like a perpetual motion machine.
It has held for the last 100+ years (that chart is only the last 50 or so, but other calculators go back to the late 19th century).
Not all the growth is domestic. Many "US" stocks make a substantial portion of their revenue and profit from international operations [sales and/or manufacturing], not all of which is reflected in US GDP growth. As an example, when Apple makes an iPhone in China and sells it Europe, that doesn't contribute to US GDP, yet it contributes to the total return of Apple shareholders.
Real world GDP growth over the last 55 years has averaged less than 3.5% [1]. Not that matters, but I didn't even specify US GDP growth in my previous comment.
Ah, but when you add the average inflation rate to the real return of the S&P500 since 1928 or so, you get about 10% rather than about 7%.[1] So the discrepancy remains, whether you add inflation in or not, if you are consistent.
There could be some simple and comforting explanation for the discrepancy between the markets and the economy, but I find it both interesting and perhaps portentous that bringing it up generally elicits glib responses (not just from you here and now) that really don't explain anything. It tends to reinforce my gut feelings about things reverting to the mean and a very long period of market underperformance being necessary to do so.
In my original comment, I was being consistent when I claimed "I think 7% nominal over a long period (such as a pension fund could expect) is quite reasonable and would expect a pension so funded to be quite stable."
I don't think 7+% real returns are long-run sustainable and don't plan my retirement around those optimistic figures, even though we've crushed those figures for the last 15 years. It's possible after all this back and forth that we discover that we more or less agree.
Some pension funds, like one of the largest (https://en.wikipedia.org/wiki/Government_Pension_Fund_of_Nor...) with over US$1 trillion in assets, you can offered indeed to put some pressure on the companies you invested in. When they can divest ~$700M from British American Tobacco all at once, it can be a serious leverage.
There are a few problems with pensions -- all basically forms of underfunding:
1) Underfunding due to shrinking business or region -- it's a lot easier to make your pension numbers work if people who retired 20 years ago are a tiny fraction of your current workforce.
2) Underfunding due to overly-generous plans (the retirement pay a lot of public sector employees get is disproportionately generous vs. their pay while working. Especially when contracts do "highest 3 years" or "last 3 years" and employees collude to give lots of overtime or other special pay to let people about to retire juice the pension
3) Underfunding due to bad math -- really easy to just make the "expected investment return" the dependent variable
> the retirement pay a lot of public sector employees get is disproportionately generous vs. their pay while working
Perhaps the other way to look at it is "these government workers sacrificed current income throughout their career in exchange for a secure retirement via their pension agreement".
Yet another way to look at it is lower expectations for work performance along with more security of employment along with lower pay and guaranteed pensions.
Seriously, many public pension schemes are absolutely ridiculous. People shouldn't retire after 20-25 years of work and be defacto millionaires with lifetime pensions on the backs of tax payers. The system really can't support that scheme as is becoming painfully clear.
The beauty is when you pull their pensions out from under them after they've worked for 30 years. Then they took the pay cut and have nothing to retire on. That'll teach the next generation of kids to work for the government (and compete with the benefits I provide my employees at my oil company).
> turning retirement savers into passive investors
I.e. stealing money from pension accounts so you can satisfy your urge to gamble with money you don't have for money you'll inevitably lose in the next bubble or blow on unnecessarily expensive shit noone needs?
Cool, so when I rob someone on the street, I could tell the judge I just turned the victim into a passive investor for that new phone I want to buy...
Many comments blame 'politicians'. I agree that some particular politicians exacerbate the problem of underfunded pensions.
But it's easy to blame someone else. The problem is the people posting here, including me, and the people posting on every other forum on the Internet and people who don't use the Internet. People don't vote, they don't hold politicians accountable, they create perverse incentives for politicians to kick the can down the road by voting against those who are fiscally responsible, and people oppose paying their share to fund the pensions.
I know it's more complicated than blaming the voter, but on the other hand, it's also much more complicated than blaming the politician. There's also a systemic problem, but that's also on the voter IMHO.
Trivia question: Name your local elected representatives (e.g., state legislators, or the equivalent wherever you live. Can you? Those are the people dealing with the pension issue to a large extent.
This is an underappreciated point when people see voting as just a way to keep the evil enemy party out of power and forget to use it for what it's really powerful at - getting the government to do what you want.
I think it would be a great idea if when people on the internet complain about the government, they also identify who they voted for. Then they're forced to face responsibility for whatever that guy does when the next blame-the-politicians new story comes up.
> We 401(k) holders are the world’s ideal source of capital. ... alone and devoid of leverage to negotiate.
It's really best if leverage goes all the way through from me to the end, though.
With a 401(k), if a fund is being managed poorly, I can "fire" the manager by selling it and buying another fund in the plan. (And at next job change, I can roll over to a new 401(k) plan or an IRA.)
If my pension is being managed poorly, as far as I know, I'm just out of luck. I have a pension from an old job, and to my knowledge, I cannot touch it until I'm 65. Of course there is no choice of pension "funds" to switch between within the plan like mutual funds in a 401(k). Even though I've changed jobs, I can't roll it over to anything.
So as far as I can tell, the pension trustees (managers) may have leverage over whatever they invest in, but I have no useful leverage over the pension trustees.
And it's not like pensions are never mismanaged. For example, in recent years there has been a scandal where the Dallas Police and Fire Pension System (DPFP) had a high guaranteed payout that their investment returns couldn't match, and instead of trying to fix it properly (whatever that means), they just kept it a secret and went wild with risky investments. See https://interactives.dallasnews.com/2017/dallas-police-fire-... . Thankfully my own pension is better managed. At least, I assume so, but it's hard to research since it's a private fund thing.
It's disgusting to me that something like this could even be published in the NYT. Pensions are absurd financial instruments. Paying someone a percentage of their salary in perpetuity is financial nonsense, and creates all kinds of perverse incentives for the recipients. The only reason these things ever got popular in the first place is because they were a way of borrowing from the future to pay the present. Creating a massive latent risk that allows you to get cheap labor in the short term and exposes you to catastrophic failure on the backend. Corporations realized this decades ago and stopped using them.
If the problem is that 401k fees are too high, let's make 401k's more mobile. Let's create a liquid market in 401k managers so that fees get pushed towards zero - as they should be.
Why? Pensions exist to serve retirees, not those retirees' former corporate masters. One of the only truly kind things an organization can do for an individual that serves them over a lifetime, and you would shit on it?
401(k) is a poor solution that requires individual initiative to deploy successfully. Those who don't contribute eventually burden those who do (even if that burden can potentially be paid for in advance, if you have the account type that taxes on deposit), and that's only if they withstood the lifetime of temptations that press people into early withdrawal.
You're absolutely right! Pensions exist to serve retirees, not their former overlords. Looking after the needs of the retired is the kind, decent, humane thing to do.
It's not about whose interests they serve so much as it is how sustainable and practical they actually are. Is it kind to make a commitment to someone around which they will organize their life at the cost of crippling the lives of their successors? What if that organization isn't a company, but a government, and the resulting costs cripple its ability to perform other functions? Is it kind to cripple a city's services or a school's ability to teach in order to meet pension obligations that were poorly planned for decades? Who will pay a company's pension bill if the pensions push it into insolvency?
These aren't trivial questions with easy, pre-baked answers. They also are real, pressing questions that face us today. Your heart is unquestionably in the right place - it's not about the investor class! It's about the retirees who have given their lives! But there might be some room for subtlety.
I agree with you that increased lifespans throw a wrench in the works, but that is not enough of a problem to justify throwing out the baby with the bathwater. Pensions represent a HUGE portion of market actors' institutional conservatism and that is a necessary counterweight to the sort of irrational exuberance that is endemic to tech and other forward-thinking sectors
You want to talk about skyrocketing costs? Why not focus that energy on sorting out the mountains of institutional waste found elsewhere in the economy? Like, why the fuck does infrastructure here cost 10x other industrialized countries? Lots more money to be freed up that way
In the US, public sector pensions have been mismanaged so frequently that no conflation is required.
EDIT:
Further, there's a basic accountability problem. It was - is - easy to gain politically in the short term by making promises about pensions. Promise bigger pensions, smaller contributions, and so on. The gains can be realized almost immediately. The price is paid much later, often decades later, and the people who made those unwise promises cannot be held to account so long after the fact.
For many states and cities, pensions act as a counterweight to the ability to do anything other than pay pension costs.
As before, you are absolutely right that there are mountains of waste to be investigated and addressed. You're completely right that there's a lot of money to be freed up there. Those issues are real, and they are pressing. Yet it is perhaps no more real or more pressing than the burden imposed by decades of financial mismanagement around pensions.
Out of curiosity I checked my admittedly-boring hometown's financials for 2017, and found their pension spend to be less than 10% of overall budget for the year (though they note a pending crisis and potential doubling of pension expenses over the next few years).
Not knowing what other entities' books look like, and also knowing that one town is hardly representative, pension spend looks large (large enough that I'd guess many different types would like to optimize out of the equation) but not that large. How big of a crisis are we looking at -- 50% of total budgets? 30%? 20%?
You're right- mismanagement needs to be addressed. And I have no idea how to bring these firms to heel -- I just think that a market-based solution ("let them have 401(k)s!") is not the right answer here.
In general, underfunded pensions and large increases in expenses are a looming threat to many state and local governments. In California, many cities are expecting their pension costs to increase by 50% or more. Few have much in the way of spare cash to begin with.
It's not just the mismanagement of professional pension management funds, though you are of course right that that is a major concern. Broadly, the crisis is the result of applying unreasonable discount rates (8% or more) and making unrealistic promises about contributions and payouts. This is very, very easy to do when you're negotiating a union contract, as a state generally has little choice but to pay up when the time comes. It's also easy to do when you can bump up the assumed discount rate a bit and use the cash this frees up for goodies for your voters.
These weren't just poor management decisions made by self-interested private companies. Indeed, private pensions often assumed much less rosy discount rates and fared much better. These poor financial management decisions were quite often made by union leadership and local officials, some of them elected.
Sad to say, shifting from a defined-benefit system to a defined-contribution system seems to be the only way to guarantee that this particular form of politically expedient mismanagement will not recur. This doesn't have to be 401(k)s, 403(b)s, or other market-oriented system. But whatever the eventual system is, it clearly cannot look anything like the pensions of yesteryear. That system has failed, and the kindness and compassion and pure intentions at its heart has gone to waste.
The way I see it, there are three pension scenarios:
1. You are promised a pension and the company delivers.
2. You are promised a pension and the company does some creative accounting to screw you.
3. You are not promised a pension and plan for your own retirement accordingly.
4. You are not promised a pension and fail to plan for your retirement.
I don't believe #1 is reliable enough. Unless (and maybe even if) you are working for a government, your pension isn't rock solid. If you (more likely) run into #2 you end up betrayed, and have to scramble to make things work in your retirement.
I am 100% in camp #3. Plan for your own retirement-- No expectations; no disappointment.
Option #4? Well... there are consequences to your actions.
I generally 100% agree with you. The problem with your stance (and mine) on #4 is that there aren't consequences to their actions.
Those consequences will inevitably be put on group #3 since they will be vilified as a group and it will be very easy to politically take their money to give to group #4.
I've not really figured out away around that problem. The numbers are simply too great too ignore - unless you truly feel something like 60% of retirees who have saved literally nothing other than their (meager) social security benefits will simply quietly die in the street.
Unfortunately this fact is one of the larger reasons why I feel this social division in the country is just starting, not coming to a head as most I talk to seem to think.
> Why? Pensions exist to serve retirees, not those retirees' former corporate masters. One of the only truly kind things an organization can do for an individual that serves them over a lifetime, and you would shit on it?
Morality left the building a long time ago in American capitalism--few consider there to be any real moral duty that a company owes its workers. If it's not in the contract, you're a sucker.
It's not a good way to run a polity as far as I can tell, but that's the program.
> 401(k) is a poor solution that requires individual initiative to deploy successfully
That's why 401k's are good. I have control, and if my retirement is underfunded it's my own fault. Compare this to pensions (both public and private) which are chronically underfunded:
Except most don't. Many don't even have the opportunity, or realize that they have it. In a world where everyone takes advantages of all the opportunities presented to them I would agree with you, but for most (at least around me) 401(k) seems like afterthought or fantasy
If I don't have steady work the last thing on my mind is retirement...
I can count the number of 401k holders in my social group with one or two hands. Many more than that set are employed, mostly semi-regularly, and their jobs offer them nothing retirement-wise
Pensions may not be the answer, but neither are retirement accounts.
I would recommend googling for "airline bankruptcy pensions" to see how this plays out in a lot of cases.
If pension liabilities get large enough, companies will tend to "go bankrupt" (not really!) or restructure in such a way as to shed the liability.
An interesting midpoint, I think is super in australia or kiwisaver in nz - mandated retiredment savings which can be invested in a choice of compliant funds (or self managed if you really want). Variable % contribution but a legal minimum. From a regulatory POV you can set these up with mandatory "employer" contributions and/or add government sweeteners. Of course, it's all part of your compensation, just like a pension promise but more direct and payable immediately.
I think these schemes also work more cleanly with modern reality: few people work for the same company for 30 years anymore.
I don't think there's too much of a difference between the sentiment of how you two want retirees to be treated. I think the main difference is that he respects people enough to believe they can plan for themselves, but you think they need to be coddled. But you both want them to have a prosperous and comfortable retirement.
Pensions aren't done out of kindness. Their original purpose is to allow a company to underpay its employees until the employees retire in a few decades. By that time, the original investors have long since cashed out. It's essentially a free loan to them.
It's a ponzi-like system. When the population pyramid inverts it becomes insolvent. This is happening everywhere. Then the taxpayers have to foot the bill.
I don't agree. Retirees do need money as long as they live, which is what pensions (including Social Security) provide. Pensions needed to be properly funded, as the income annuities offered by insurance companies are.
Life insurance companies commonly sell various kinds of annuities as well, since they are experienced with pricing life expectancy. Google "immediate annuity" or "income annuity" to get quotes.
> It's disgusting to me that something like this could even be published in the NYT.
Just because the take is left-of-center and questions neoliberal doctrine, it shouldn't be publishable?
We were sold that privatization would lead to more efficiently run societal safety nets, that it would provide a net-benefit to the worker and to society. The article argues that not only did transition to 401k enrich money management middlemen, it's done worse: it's disenfranchised us. It's destroyed our ability to collectively act via our retirement funds.
In New Zealand, we have Government Super, which is set to 65% of the net average wage (1).
Of course, this is expensive, which is why we have the Government putting aside money into a sovereign wealth fund to help pay for it (2).
We also know that we should personally contribute if we want a better retirement, so we have personal retirement accounts, where the minimum contribution is 3% of salary, matched with 3% from your employer, plus ~$500 NZD from the Government (3).
That is a valid point. Pensions probably made a lot more sense when life expectancy was lower. Today? Not so much. Probably the reason why so many pensions went bankrupt.
401(k)'s do seem like a much better option. However not all employers provide that. I'm not sure what the solution is.
Life expectancy at 65 has barely budged in the past 100 years (we gained about four years.) On top of that, for the past two years (2015 and 2016), it's decreased.
It seems like the "investor class" should love pensions. I'm not expert on accounting or law, but pensions sound a lot like a free loan and a borderline scam:
A young company wants to hire 100 people, but from the market rate of salaries, they can only afford to pay hire 80 people. They also don't want to dilute their stock holdings so they opt for pensions instead. The extra 20 employees increase company profits and stock prices explode. The company's balance sheet looks good because they don't have to pay any pensions yet. The original investors can sell their stock long before pensions get paid out, and don't suffer any negative consequences.
>The company's balance sheet looks good because they don't have to pay any pensions yet.
Companies under GAAP accounting actually do have to carry their pension liabilities/assets on their balance sheet and have to report on the status of their pension fund. So investors can see if the pension is underfunded.
Edit: for example, check GM’s last 10-K, note 16. [0]
Suppose someone effectively pools together investors' money and makes outsize returns due to actively managing away the complacency the author purports. Well, then, any 401k holder is free to share in those superior returns by purchasing the security while the pensioner cannot.
Caveat emptor, because ain't nobody looking out for you but you.
these failing pensions are largely due to mismanagement, properly managed these retirement vehicles work as intended. unfortunately in the current climate a large company or even a state government can't resist the temptation to use a massive pension fund for something other than it's intended purpose. One lean quarter and they start eyeing up the 7 billion sitting in the pension fund. I read a book a couple years back that changed my thinking on pensions, before I was of the mind that they never worked, were a massive Ponzi scheme, stealing from young workers, etc... no, pensions work provided they are left alone. http://www.retirementheist.com/
One of the reasons I'm not a big fan of pensions is precisely that it's not "in the current climate", but a persistent problem over the span of decades. Many of the bills that are now compounding to an unignorable size are trainwrecks decades in the making. It isn't just that they were mismanaged today; they were mismanaged in the 200xs, and the 1990s (much harder to see because the stock market was doing really well up until it wasn't), and the 1980s... it's not hard to think that maybe the fact they worked at all was simply another historical accident of the bizarre just-after-WW2 period, rather than any sort of good idea. We seem to lack angels virtuous enough to be honest about the numbers and to resist dipping into the Honkin' Big Pile o' Money.
I'm convinced it's the changes in the tax laws at the root cause of this. When income over $400k/yr (5 mil in todays money) was taxed at 90% there wasn't the incentive to screw over retirees. The "bizarre just-after-WW2 period" wasn't some fluke it was the result of purposely crafted policies.
Do you mean would "saving for your retirement" be needed? Or were you specifically asking about pensions?
In any case I don't think any basic income plan works if you imagine that everyone stops saving their earnings and relies on the basic income for their working years and retirement. It is called universal basic income after all and not universal "luxurious" income.
Some type of retirement system would be needed (whether pension, 401K, IRA, or simply "money you saved and invested"). I did some back of envelope calculations that suggest to me that UBI for Americans would be no more than $650/mo - 0 Realistically, it might be $600/adult and $200/minor 5-18 or something like that. Basic indeed.
In that type of a world, people who chose to work during what we today call "working years" would likely feel the need to put some money aside for their "post-working years" so they didn't slip back to the $1200/mo as a couple standard of living.
------ Pensions:
- "Your" money and everyone else's money is lumped into a single pool. If previous retirees were given too much money because of poor planning, "your" money will evaporate
- Your future benefits are fixed, regardless of market conditions. Unless the pension can't afford to do so because of a market crash, and declares bankruptcy. In which case, anyone left holding the bag will be screwed
- Zero financial literacy/discipline required. Your contributions are pre-determined, and the pension managers will take care of all investment decisions
------ 401ks:
- Your 401k is 100% yours. There is no risk of your 401k account "going bankrupt" because too much of it was given to others.
- Your future benefits are dependent on market conditions - unless you choose to buy an annuity.
- Financial literacy and discipline is required. If you don't contribute enough, or make bad investment choices, you're screwed
-----------------
The article completely ignores the 1st and 2nd differences, which is why many people like myself are uneasy with pensions. The 3rd point is what the article mostly focuses on, and that's a valid point. I'd love to see "full-service" 401k plans, where employees are forced to contribute at least X% of their income, and all of it is managed by the equivalent of a pension-fund-manager (ideally, invested into low-cost diversified index funds)
Too many people lack the financial discipline to make sufficient contributions, and the financial literacy to make good investment decisions. So full-service 401ks as described above, could be a net positive for society, without all the baggage that come with pension funds.