During most of our adult lives the value of the stock market and other traditional assets (including owner-occupied houses) followed a roughly upward trend. This instilled in most people an assumption that greatly influenced thinking about employer-sponsored pension plans. But in recent years, this formula has come unwound. With no sign that conditions will return to the former status quo, it may be time to take a radically different approach.
Middle-class American employees traditionally saved a portion of their income during their working lives to build a personal retirement fund. They would leverage the savings by investing them in low-risk assets whose value would increase over time.
They could do roughly the same thing by selling their homes for a nice profit, then using a portion of the profits to buy smaller, cheaper houses in a low-cost retirement community.
Together with Social Security, these “lifetime annuities” from personal savings and employer-provided defined benefit pensions would enable middle-class retirees to enjoy something close to the same living standard they enjoyed during the later stages of their working careers.
But employers started to control their pension costs by piggy backing on the assumption that employees would save for retirement by squirreling away a portion of their salary and investing it in the growing value of assets like their homes.
This allowed employers to replace their defined benefit pensions with defined contribution pensions, under which they would contribute fixed sums to employees’ 401(k) plans.
And in recent years, several things have wreaked havoc with the traditional arrangement. Since 2008, the credibility of investing has been shattered for most middle-class employees. The stock market’s long-term upward trend has been replaced by chaos punctuated by periodic scandals. Now “safe” investments like treasury bonds, government guaranteed bank savings accounts and CDs, and money market funds pay such low interest as to be virtually meaningless as a means of leveraging personal savmgs.
So the basic mind-set of middle-class employees has returned to what it was in the 1940s and ’50s, when memories of the 1929 crash were still vivid enough to leave them with no confidence in pure financial assets. This helped fuel demand for employer-provided defined benefit pensions.
The collapse of house prices coupled with high vacancy and abandonment rates has wiped out the assumption that home ownership is a safe investment vehicle.
Over a somewhat longer period, purchasing power has stagnated, even as the prices of goods have risen. There is no longer any realistic chance that middle-class employees can offset the absence of personal savings leverage with investments or home ownership. More than likely, they will save even less in an effort to maintain their living standards.
With respect to retirement, middle-class employees face two disagreeable options: Work until you drop or accept forced retirement (from layoff or illness) and be prepared to survive on the lower living standards that employer pensions and Social Security provide.
Surely it’s only a matter of time before the AARP or another organization marshals senior citizens who vote at a high rate to tell members of Congress they must increase Social Security and Medicare benefits. If huge tides of senior citizens are directed to vote for challengers who promise to do right by seniors, is there any doubt about the electoral outcome?
Maybe it is time to create a national pension system that replaces all existing retirement plans and provides everyone with a defined benefit pension, which should be indexed to inflation. It should be fully funded by an initial debt issue and sufficient payments from working taxpayers.
This giant pool of money could then be invested in public and private projects that offer respectable returns and help rebuild America.
Many would view this as another step away from personal responsibility and toward socialism. But this Basic Income Concept was first proposed by no less of a wild-eyed socialist radical than economist Milton Friedman.
Separating employee pensions from the bottom-line pressures employers face by creating a national pension system can restore the fading promise of a comfortable retirement to millions of Americans. At the same time, money paid into the system can be invested to rebuild our country for future generations.
originally published: September 1, 2012