The Best Solution to the Retirement Debate


Government programs connected with retirement are controversial. But rather than having endless arguments from both ends of an irreconcilable spectrum, the best alternative is one that lets both sides have their choices -- as long as they accept the full consequences of their decisions.

Election-year nonsense
For pragmatic folks who prefer to see things actually get done, election years are pure torture. On one hand, you inevitably see grandiose proposals from the extremes of both parties, most of which would have absolutely no chance of becoming law even under ordinary circumstances. Yet on the other hand, even for cynics who believe that gridlock is generally the order of the day for government, Washington becomes particularly immobilized when elections are right around the corner, as no one wants to take a stand on anything important that could get them in trouble with segments of their constituencies.

Focusing on retirement issues, you can see this phenomenon in action:

  • In the past, the idea of privatizing Social Security by replacing traditional monthly benefits with privately managed investment accounts has come to the forefront on numerous occasions. Yet even though those proposals mostly went nowhere, the idea is making the rounds again this year, thanks to vice presidential candidate Paul Ryan's sponsorship of a 2004 bill that relied in part on private accounts.

  • On the other side of the political spectrum, some analysts have argued that employer-sponsored, worker-managed 401(k) retirement plan accounts have been an abject failure, given mediocre average account balances and relatively poor investment performance. Just a couple of weeks ago, Sen. Tom Harkin revived an idea related to one previously championed by Professor Teresa Ghilarducci that would replace 401(k) plans with what would amount to a pension-like substitute, providing lifetime monthly benefits akin to what private employers used to give the majority of their workers.

With current systems firmly entrenched, proposals like these rarely go anywhere, mostly because they tend to be extreme. If you tone down the rhetoric, though, and set up an environment where people have the choice to participate in novel ideas, then you can create a living experiment that can help drive public policy for generations to come.

Let people invest!
On the 401(k) front, it's easy to criticize the entire concept as being flawed, and it's tempting to blame workers' basic lack of investing know-how for the shortcomings of 401(k)s. But when you look at whether private employers are doing well in covering their pension obligations, the record isn't all that much better. A recent report from S&P Dow Jones Indices found that General Electric (NYS: GE) , Boeing (NYS: BA) , and Ford (NYS: F) all had funding shortfalls of $15 billion or more. A big part of that stems from poor investment performance, given the market's meltdown in 2008, despite companies being sophisticated investors. Putting the onus to invest well on the government could easily lead to no more than another unfunded mandate.

On the flip side, full Social Security privatization misunderstands the insurance element of the program. For one thing, disability and survivors' benefits aren't typically self-insurable; given how early in a career problems can strike, you need a large group to offset joint mortality and accident risk. And while private products can address some of those risks, reasonable people will always disagree about whether the profit that Prudential (NYS: PRU) , Genworth Financial (NYS: GNW) , and a host of other insurance companies would earn from a private insurance program would outweigh the inefficiencies of a government-run program.

Take a risk
Middle grounds exist in both of these debates. Letting some people have supplemental pensions in place of 401(k) accounts could be a valuable experiment in seeing whether steps to control longevity risk work better than relying on insurance companies to provide immediate annuity coverage in private markets. Similarly, letting people partially privatize their Social Security would provide data on whether it actually works in real life.

The key, though, is to force people to live with the consequences of their actions. If people rely on bailouts if they get into too much trouble -- and, unfortunately, the moral hazard of the financial crisis is still at the forefront of people's minds -- then they'll make bad decisions. Only if they embrace risk do they deserve its rewards.

Taking risk has always been the keystone of ingenuity. Too much risk is dangerous, but by giving people more choices with at least some limited financial freedom to control their retirement destiny, we can gain useful information about potential policy changes down the road. That beats election-year hype any day of the week.

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