Every time I write about Social Security, I get an email box full of letters from readers who just plain don't like the philosophy behind the government-run retirement insurance program.
They don't like the idea that the government takes their money and, after "investing" it for them, decides how big a check they'll receive every month after they've reached some bureaucratically determined retirement age. It's paternalistic because it assumes the government invests our money better than we would. And it's coercive because the government doesn't give most of us a choice about whether we're going to participate in the system.
All of which is true. The program is bureaucratic, often arbitrary, definitely paternalistic and certainly coercive.
But a recent study from Hewitt Associates, the global human-resources management and consulting company, argues that paternalism and coercion are exactly what most Americans need, at least when it comes to saving for retirement. It also says that the average 401(k) retirement savings plan could use a bit less freedom and a tad more paternalism and coercion.
I know that goes against the philosophical and political grain for many of us. But frankly, the Hewitt Associates study says that many of us aren't exactly in need of more financial freedom and that we aren't ready to take on more financial responsibility.
Put that in your pipe and smoke it when the discussion turns to how to reform Social Security.
The Sad Results
Here's what Hewitt Associates found in a study of nearly 200,000 workers who participate in 401(k) retirement plans:
45% of workers take a cash distribution from their 401(k) plans when they leave or change jobs. In other words, they take money out of their 401(k) retirement plan and spend it.
66% of workers aged 20 to 29 take a cash distribution. In other words, the very workers who have the most to gain from compounding over time take money out of their retirement plan and spend it.
42% of workers aged 40 to 49 take a cash distribution. In other words, workers in their prime retirement-savings years take money out of their 401(k) and spend it.
73% of workers with balances under $10,000 take a cash distribution. In other words, workers with very little put aside for retirement, either because they've just started to contribute to a 401(k) or because they don't make much money, are saying, "To heck with a $10,000 nest egg and a lifetime of saving," and just spend their balance.
Now, granted, the data I've seen from the Hewitt study don't distinguish between the worker who takes everything out of his or her 401(k) and spends every last dollar and the worker who spends just 10% before reinvesting it. But the picture still isn't very comforting.
Failure to Help Ourselves
When it comes to figuring out how a rapidly aging society can avoid a retirement crisis, I keep hearing the words of Walt Kelly's Pogo: "We have met the enemy, and he is us."
I'm surprised that the numbers in the Hewitt study are so depressingly high. But I'm not surprised at the trend. I know I'm generalizing radically, but my own email indicates that when it comes to investing for retirement or anything else, we're not especially patient, and we don't use the investor's most reliable tool -- the power of compounding over time -- especially well.
I regularly get emails that run like this: "I'm 25 and I've saved $10,000. Can you give me the names of three $5 stocks that'll double in the next year or two?"
In the eight-plus years that I've been writing Jubak's Journal, I've never once received an email anything like this: "I'm 35 and I have a portfolio of $50,000, but it's mostly in risky, highly volatile stocks. Can you give me the names of three stocks that I can use to reduce the risk in my portfolio, even if it means I'll get a lower average annual return?"
The Hewitt study puts the returns scored by Social Security in a different light. Sure, many investors could beat the 6.25% yield the Social Security Trust Fund is getting on the funds that it has invested in Treasury securities. And I'm sure that many of my wealthier readers, who are paying the highest Social Security taxes but getting a relatively smaller future payout on taxes paid, could certainly get a better return on their Social Security tax dollars if they managed the money themselves. But the evidence remains that almost half of us, 45% to be exact, would spend our 401(k) money if given the chance, rather than roll it over to another retirement plan or keep it where it is. (The Hewitt study found that 45% of workers took the cash, 23% rolled it into another qualified retirement plan and 32% left it in their employer's 401(k) plan.)
Nobody beats even the most meager of investment returns if they spend, rather than invest, their savings.
The results of the Hewitt study also explain why the hottest trend in 401(k) plans today is removing choice, a move in exactly the opposite direction from that advocated by proponents of adding a private-account option to Social Security.
This year in its every-other-year survey of 450 large companies, Hewitt found that 19% of the companies automatically enroll employees in their 401(k) plans, up from 14% in 2003; 26% of those companies provide automatic account rebalancing, up from 11% in 2003. And 63% offer premixed life-cycle funds that automatically change their balance of assets as the plan participant ages, up from 55% in 2003.
Further evidence of a move away from choice comes from the survey's finding that the average number of investment options per 401(k) plan is stuck at 14, making 2005 the first year since the survey began that the number of choices in the average plan hasn't increased. By the way, 401(k) plans continue to replace conventional defined-benefit plans at these large companies: 64% told Hewitt Associates that the 401(k) plan was the company's primary retirement plan, up from 55% in 2003.
Put the results of the two Hewitt studies together, and they spell death of Social Security reform -- at least any reform that would please my readers who feel the current program is paternalistic and coercive. To get around this propensity that nearly half of workers spend their retirement money when given a chance, any private-accounts program would have to ban withdrawals before retirement. To make workers use the power of compounding and the risk-reducing power of asset allocation, it's likely that any program of private accounts would be built around a few indices and life-cycle asset-allocation models.
Not much choice in that alternative, I'd say.
At Either End
It's not that a program of private accounts, or Social Security itself for that matter, needs to be paternalistic or coercive. We could design a retirement system that lets workers save and invest to the best of their abilities -- and achieve whatever success or failure the market brings. Some would do far better because they're good savers, smart investors or have better luck. Some would do worse, maybe much worse, because they don't save enough, are inept investors or have bad luck.
The current Social Security system is designed to take care of that last group. It is paternalistic and coercive in exchange for a guarantee that everyone receives some amount of income in old age that will keep them from abject poverty. That's why it's most accurate to think of Social Security not as an investment program but as retirement insurance.
Anyone who wants to design a system less paternalistic and coercive must honestly confront what we know about how workers now save and invest with their 401(k)s. The evidence says that a completely free and non-coercive system will produce many workers who will confront poverty in retirement.
There are two ways around this problem for those who want Social Security built on freedom and responsibility.
Trying to Teach
First, we could add a huge educational component to any plan for private accounts in the hope that educating investors would reduce the number of failed retirement savings accounts. Some companies take that route with their 401(k) plans, offering more investment education and hiring outside advisers. The jury is still out on the result.
Second, we can decide that freedom and responsibility are so important that we'll accept the consequences of failure. Workers who fail as retirement savers and investors, or who are simply unlucky, will just suffer the consequences. The increase in extreme poverty in old age would be trumped by the increased freedom.
I haven't yet heard anyone who laments the paternalism and coercion in the current system admit they're willing to accept this trade-off. Their arguments are based on a belief that a completely free retirement system would result in nothing but winners. Markets just don't work like that. On evidence, neither do saving and investing for retirement.
Until I do hear someone from the let-me-invest-my-retirement-money-how-I-want camp honestly confront the question of what happens to those who lose in that system, I'm unwilling to take the complaints of paternalism and coercion in the current system very seriously.