15 Aug 2010

The End of Retirement

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Megan McArdle argues that the era of unionized public sector pension benefits keeping retirees living on full salary for decades is over. Demographics giveth and demographics taketh away.

It was nice that a combination of rising life expectancy and broader pension coverage allowed a large segment of American workers to take what amounted to a multi-decade vacation. (Though this was never quite as widespread as people now “remember”). But this was never going to be sustainable. Retirement experts typically say that retirees should shoot for 75-90% of their working income in retirement (the theory being that some expenses fall, but other expenses rise, and you don’t need to save for retirement when you’re already retired).

That’s fine when the ratio of workers to retirees is 1:12, as it was within the Social Security system in the early years. But by the time you get to 5:1, it starts to pinch–assuming everyone has the same income, each worker has to toss at least 15% of their own income into the pot to support the retirees. Once you get to 2:1–which is where we’re rapidly headed–33% of your income is going to support someone in retirement. Woe betide you if you also have kids.

It’s important to note that this is true no matter how retirement is funded. Whether you collect a dividend check, get a corporate pension, or live off your social security, your retirement is funded by real claims on the output of people in the workforce. Private pensions have a couple of advantages: the investments that fund them actually help make the economy more productive, unlike transfer payments; and they aren’t necessarily indexed to inflation, so over time, as incomes grow, it becomes easier to support the older retirees. But they don’t eliminate the problem; they merely mitigate it.

Mathematically, society simply cannot have a high and growing dependency ratio–at least, not if the retirees expect to be supported in the style to which they have become accustomed. (I take it that this is what is meant by “a decent living and a stable retirement”). We can warehouse people in spartan old folks homes (or treat them like kids and move them into the spare bedroom), in which case they can enjoy a lengthy retirement. Or they can retire for less time, and live more lavishly. But there is no conceivable system that is going to allow the vast majority of the population to spend a full third of their adult life in retirement, at anything like the same standard of living they had when they were working.

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SDD

If Social Security had been set up as a defined contribution plan rather than a defined benefit planned (an unfunded one at that), the biggest problem it would face today is what to do with the enormous level of investment it owned.

Think about it. The average individual earns close to $40,000 annually. At the 15% payroll tax rate, that’s $6000 per year in “contributions”. At a moderate 5% rate of return, the average worker would have a million dollars to spend in retirement after 40 years of working.

But, no, Congress set up Social Security as a gigantic demographic Ponzi scheme in order to buy the votes of the millions of people who retired in the 1940s-60s who contributed very little to the fund.

There IS a system that would allow the majority of the population to spend a full third of their adult life in retirement. It’s called “investment”. Unfortunately, government squandered that investment and left behind a mountain of debt that will make it difficult for future generations to actual pursue real investment. Amidst that mountain of debt are obligations to tax the population to pay for the defined benefits plans they have generously provided those currently working in government.



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