The terminal dispersion of wealth is the technical term that describes the variability of the future value of investment portfolios. This inevitable variability means that no one knows what your investment portfolio will be worth when you reach retirement age or at any time during your retirement. And the uncertainty of the life expectancy of individuals aggravates this problem.
Covering against the risks associated with these two factors places an onerous burden on individuals. Although this hedge could result in a very comfortable retirement, if one can afford the hedge and the timing is right, the potential downside risk is so great that many people may find it unacceptable. So one has to ask, “Would people really rather forgo a secure but modest retirement income and play with their retirement savings in the hope of doing great in retirement?”
With individual accounts, people lose the benefit of risk pooling. The two risks that force people to save excessively are investment risk and the risk of living beyond the average life expectancy. In both cases, the results, the terminal richness and the duration of life, are highly variable. When risks are pooled for large numbers of people over many overlapping lifetimes, the average results are highly predictable, which is why traditional pension plans work so well.
Traditional pension plans exist, for all intents and purposes, in perpetuity. This being the case, they can accumulate reserves during good times in the financial markets and weather the bad times, allowing them to make consistent payments to retirees, regardless of when they retire. Unfortunately, people cannot choose their holding periods or the years of their retirement and must take what comes, and what comes can be good or bad. Therefore, individuals should set savings goals that are high enough to protect against the risk that the average return on an investment portfolio over its holding period will be much lower than would be expected in the very long term.
The relatively short length of individuals’ holding periods makes them highly susceptible to the effects of market cycles, which are notoriously unpredictable in amplitude and frequency. Being broadly diversified mitigates this risk but does not eliminate it, as a global bear market is quite possible during the holding period. Then, at the end of the holding period for wealth accumulation, a second holding period begins, which will be the term of retirement, and this second holding period carries the same risks as the first, but at a time in life where which there is no source. of income to compensate for the poor performance of the portfolio.
The other component of risk that people need to hedge is the risk represented by life-span uncertainty, which means that people need to aim even higher when setting their savings goals. Administrators of large pension plans may depend on retirees living on average only the average life expectancy of employees reaching retirement age. The average life expectancy for someone reaching the age of 66 is currently 82, and 66 is currently the age that workers are eligible for full Social Security benefits, making it a baseline. reasonable. Based on these assumptions, the average retirement term would be 18 years and pension plans should only be funded to the extent necessary to cover the cost of this average retirement term.
However, people do not know how long they will live, so they must save excessively to ensure that they do not run out of money before time runs out. This need to oversave is independent of the first need, so the need to oversave is compounded, that is, an individual needs to save enough to cover the cost of living well beyond the average life expectancy and the amount of savings. The target retirement age must be large enough to ensure with a reasonably high level of certainty that the actual amount available at retirement is at least the minimum necessary for survival.
A popular estimate of the retirement length that people should plan for is 30 years. Saving enough to cover the cost of a 30-year retirement is a far greater burden than saving for an 18-year retirement, but planning for a shorter retirement exposes people to tremendous risk. It also exposes taxpayers to tremendous risk, as people who outlive their savings will no doubt require some form of public assistance to make ends meet and are likely to become wards of the state when they become physically unable to care for of themselves.
A person who bases their retirement savings on living to age 96, but only lives to age 82, will have given up many of life’s pleasures, such as travel, good food, and better vehicles, that they might otherwise have enjoyed. But many people simply do not have the level of income required to support the savings rate needed to accumulate the wealth required to protect themselves against the handicap of terminal wealth dispersal and the possibility of living well beyond the average life expectancy. For them it is not a question of wasted consumption, it is a question of going through life with the knowledge that they are likely to spend their golden years living in abject poverty and that this will be their reward for 40 or 50 years of hard work. . And it gets worse!
Some economists now believe that within about 15 years, given the current rate of health care inflation, 100% of Social Security benefits will be spent on medical expenses: Medicare Parts B and D premiums, copays, expenses not covered and medigap insurance premiums. If that becomes the case, anyone without substantial savings or a defined benefit pension will seek public assistance the day after retirement. Although this is probably the worst case scenario, there is a general consensus that people retiring today will need to set aside approximately $180,000 for medical expenses not covered by basic Medicare.
With the situation already in this state, adding private Social Security accounts to the mix would be like adding gasoline to the fire, since individual Social Security accounts carry the same risks as other individual retirement accounts. Those who have tried to do away with Social Security since its inception find private accounts very attractive. But not coincidentally, most of them seem to be in the enviable position of not needing Social Security to support their retirement. More recently, younger workers have also come to oppose Social Security, but not for the same reason as traditional opponents. Young workers may find themselves crushed by the growing burden of Social Security and may never receive any benefits from the system. Those who oppose Social Security simply because it is a social program should devote their efforts to reforming it rather than ending it.
If Social Security had been run like a pension plan instead of the illogical system that it is, with today’s workers paying for yesterday’s workers’ retirement, your current situation wouldn’t be so dire. In fact, it could very well be a fully funded working system. CalPERS and other large public employee retirement plans have operated successfully for decades, success being defined as being able to meet its obligations, not having an adverse effect on financial markets, not having scandalous events attributable to the misconduct of plan sponsors and be free of influence from elected officials. There’s no reason Social Security can’t be run that way. It would literally take an act of Congress to do this, but the hardest part for Congress would be letting the system work without them interfering with its operation.
Shifting the burden of retirement to individuals was a big problem for corporations, but it’s a very poor deal for most people, and extending individual accounts to include the Social Security system would only make things worse. not a bad deal for all individuals because there will be some who can afford to save a substantial part of their income and whose holding periods will coincide with bull markets, thus putting their wealth in the upper range of their terminal wealth spread, and who will also live long and healthy lives. They will be the ones to benefit from excessive saving and living beyond the average life expectancy, but they may end up losing a portion of their wealth in the form of taxes to support the less fortunate. I don’t think that’s what the public expects of a well-conceived system.