Friday, July 29, 2011

Pensions and Promises

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Earlier this month I met an Army sergeant major who, after 20 years of service, is retiring from the military. He and his spouse (also Army) had spent many years apart over a variety of duty stations, and they were looking forward to time together and starting a business. Then he mentioned that his pension wasn’t going to be all that was promised. I didn’t get the chance to dig deeper into specifics, so I accepted it at face value and asked some friends who are still in the military.

After 20 years, the sergeant major can expect to receive a pension that amounts to 50 percent of the average of the last three years of service. It appears that some medical benefits have been pared, but the basic retirement pay package hasn’t changed from that formula in recent years.

But there is unease within the ranks about the future – an unease that is shared by Social Security beneficiaries and other pensioners, whether in public service or private industry. Will the benefits that were promised be there when expected?

I’d like to turn that question on its head: Do legislators and employers want to make promises that they may not be able to keep? The cynic in me says that legislators don’t care what future obligations they make; they can make promises and pass laws that future legislators and generations have to pay for. As chief operating officer for a small business, that tactic would put my company’s finances – and my future as a manager – at risk. And it’s that risk of future obligations that has moved many companies from defined benefits schemes like that of the military to defined contribution schemes such as 401(k) plans that pay the pension bill now for the future benefit of retirees.

Some people have painted 401(k) plans as merely a ruse that allows companies to escape obligations to employees. However the portability of 401(k) plans is a boon to labor mobility between industries and regions, helping to increase overall employment in the economy. Defined contribution plans still impose employment costs on employers: all plans require an administrator to establish and maintain the plan and invest employee and employer contributions.

As the employer sponsor of my company’s 401(k) plan and an employee participant, I’d rather see higher ceilings on Individual Retirement Accounts (IRAs) to provide the flexibility I crave as an employee and – as an employer – minimize the cost to the business, sharing those savings with employees in the form of higher salaries. But with its $5,000 limit on annual contributions for workers under 50 years of age and $6,000 cap for those over 50, that amounts to only $215,000 over a 40-year career.

So let me propose that all tax-deferred plans and accounts be merged into a single annual IRA contribution of $25,000 per worker with the ability to catch up later in life should any annual contribution fall short; that’s $1 million over a 40-year career and more likely to sustain a comfortable retirement than the current limit. And it means that workers without access to a 401(k) plan can save at a higher rate than law currently allows. With the focus on “individual” retirement rather than company or government provision, retirement accountability is put back on the individual. While I know that not all workers will be able to save $1 million, Social Security and other systems can be redefined to aid only those who fall short.

There are many examples of pensions coming up short; California state employees and domestic auto workers come immediately to mind. These failures came about because the retirement benefits were too generous and the risks – expected rate of investment return and rate of employee contribution growth – were too great. While the risk of expected rate of investment return remains with IRAs, the risk to public and private finance is ameliorated by employees taking control of their individual retirement needs now – not relegating the obligation to the future.

Will any of these changes ease the sergeant major’s mind or improve public finances in the short run? No. Now is not the time to change the compact made with today’s retirees. Now is the time to modernize civilian and military retirement plans and entitlements for future retirees. Pay the bill – now.