The following is in response to Joe Tomlinson’s article, We Need a Bold Solution to Fix the Retirement System, which appeared on October 9:
Dear Editor,
Your article missed a key point that would allow a government or private system that had a mandatory enrollment provision and used inflation-adjusted annuities for payout to be successful at a much lower cost/risk. Specifically, if I save for myself, I must assume that I will live to my maximum potential life expectancy in order to ensure that I do not run out of funds. On the other hand if I am saving within the context of a group with mandatory participation requirements, I need to save only for my life expectancy. If I live longer, my needs will be met by funds from those who die earlier. This issue means that on average our do-it-yourself 401(k) system requires over-savings.
I am amazed that I have never seen this critical issue discussed when analyzing or reviewing alternative retirement programs.
All the best,
Barry Korb, CFP®
Lighthouse Financial Planning, LLC
Potomac, MD
Joe Tomlinson replies:
Hi Barry,
I too am a fan of inflation-adjusted annuities. I like your idea, but there is still the issue of how to save during the pre-retirement accumulation period, before one purchases the annuity. If one saves in low-risk assets such as bonds, then there is still a need to save at 15% or so of income (see the chart in my article). The ways to get around this are to either invest in equities or provide a guarantee at higher than a bond yield. The problem with investing in equities is that you still need to save at the 15% level of be safe. Professor Ghilarducci, in her book, argues for inflation-adjusted annuities at retirement, with funds earning at least a 3% real guarantee prior to retirement. The Center for Retirement Research paper I cited discusses arguments for and against such a guarantee.
Another approach would be to offer delayed payout inflation-adjusted annuities where funds saved during the working years went into inflation-adjusted annuities that started paying out at retirement. (My understanding is that the Harkin proposal I mentioned may advocate something like this.) The problem I see with this is that, to make it work financially, those who die during the working years would have to give up their retirement savings – and those are likely to be families in very difficult financial circumstances, having lost the breadwinner.
So, while I agree with you about inflation-adjusted annuities, the problem is still how to accumulate safe and sufficient retirement savings during the working years. Guarantees are needed – with the cost perhaps split between employers and the government –but that's not the way the tide is running at the moment.
