16 of 23 people found the following review helpful:
4.0 out of 5 stars
Interesting proposal to fix our retirement system, August 20, 2008
This review is from: When I'm Sixty-Four: The Plot against Pensions and the Plan to Save Them (Hardcover)
A little background on myself before I start the review: I have read over 200 books on investing, so I count myself lucky if I learn 1 new thing for each new book I read. I'm an engineer, so in my opinion, my pay falls in the middle-class segment of the US. I have been a big fan of index fund investing since 1990.
Near the beginning of this book, the author argues the typical 70-80% replacement ratio of income at retirement is too low......she argues it should be 100% for the average worker and more than 100% for low income workers......primarily due to high future medical expenses. Kotlikoff likes to blast the 70-80% replacement rule-of-thumb and says it is way too high for most people because of a conspiracy in the investment community (mutual funds, brokerage firms) to tell people to over-save........because the higher the level of savings........the higher the profits for the investment community. If you run the numbers for different cases, you will find the 70-80% rule-of-thumb varies dramatically from maybe 40% up to 100% depending on the specific household.
The author argues that with no pension and no social security, the average worker would need to save 20% of every paycheck and get a return after taxes and fees of 4% to create their own pension. She argues that most people will never save this much unless they are forced by the government to save.
The author speculates that most people don't buy annuities because either they fear they will die too soon to collect the payouts or they feel they can invest it better than an insurance company.
On page 129, the author constructs an interesting table comparing the risk of defined benefit versus defined contribution pension plans. The author correctly argues that most employees in 401K plans pay excessive fees which dramatically reduce their net worth at retirement. One percent annual fees can easily reduce the ending value of a retirement portfolio by 30 to 40% over a 30 year working career.
The author advocates that 401K's should be forced to offer an inflation indexed annuity with survivor rights.
The author repeats some often cited statistics......which remind us that we may intend to work until we die, but poor health or company problems force many of us to retire before we want to. The statistics include 36% who retired when they wanted to and 57% who retired before they wanted to. Of the 57%, 70% were forced to retire because of health reasons, 44% because of job related issues, and 9% to care for a family member.
She said that DC plans like 401K's cause people to retire when the stock market is good and keep working longer when it is bad.
Although this book is chocked full of interesting statistics, probably the most interesting part is her proposal for fixing the American retirement system. Her proposal is:
-keep the Social Security system intact (the worker and the company must continue to contribute a total of 15.3% of pay to the government)
-add a new system and an additional tax of 5%
-the new system is managed by the government similar to the Thrift plan for federal workers
-upon retirement, the money in the new system must be converted to an annuity with inflation indexing and survival benefits. A lump sum payout is not an option.
-if you are covered by a traditional DB pension plan, you can keep it and you are not forced to join the new system
-401K plans remain but the pre-tax contribution feature is abolished
-each worker gets an inflation adjusted $600 tax break to make up for the new 5% tax and the lost 401K tax savings
-workers can contribute additional after-tax dollars to the new plan
She contends that Social Security plus her new system would increase the replacement rate for lower income workers from 56% to 86% and high income workers from 34% to 64%.
Wilfred Pareto, the Italian economist, found that in several European countries in the late 1800's and 1900's.....roughly 20% of the population had 80% of the wealth. This observation led to this phenomena being called Pareto's Law or the 80:20 Rule. You will find the same 80:20 phenomena still applies to the US today. If you were one of the 80% back in the late 1800's, then you relied upon your family and the church for support in your older years. Of course your life expectancy around 1900 was only about 50. Pareto's law seems to indicate that only about 20% of the humans save and invest while 80% do not. Based upon Pareto's Law, I would agree with the author that 100% of the population would not save 15% to 20% of their income if there were no Social Security or pension plans.
The current Social Security system is a pay as you go system, with worker's contributions coming into the Government, but then being immediately being sent to retired workers. It is also a relatively progressive system, with wealth being transferred from higher income workers to lower paid workers.
I ran a little scenario when a freshly graduated engineer started work back in 1979 at $18,500 a year (the average starting pay back then). I figured out how much the engineer and his company contributed to Social Security each (the contribution rate has been raised from 8.1% back in 1979 to 15.3% in 2008).......then invested this amount at the stock market's 10% historical return. By age 66, the engineer's contributions would have grown into $4,356,000 and using the traditional 4% safe withdrawal rate........could pay him a pension of $174,000. The Social Security system will only pay this engineer a pension of around $27,000. This illustrates the poor deal that Social Security is for higher paid workers who have the discipline to save and invest a portion of their income in low cost index funds.
I am usually an advocate for free markets and less government. One of the few things our government does do well is to manage the retirement savings of our federal civilian workers via the Thrift plan. This plan offers basic investment options with rock bottom low annual expense ratios.
I agree with the author in that the current 401K plan design is a disaster. One could argue the current 401K plan design is the ultimate Law of Unintended Consequences example. A benefits consultant trying to figure out how to increase the amount of deferred compensation for executives.......ends up creating the 401K system that basically is wiping out our traditional defined benefit pension plan system. Who in their right mind would design a retirement plan where the workers have no choice about who their 401K provider is and have no choice in the annual expense ratios they must pay?
From my research, the current Social Security system was partially created because Francis Townsend looked out one day in the 1930's and saw several elderly women scrounging for food in garbage cans. He publicized this scene and lobbied for a fixed monthly payment for our elderly citizens. This political pressure eventually helped to cause Roosevelt to sign the Social Security law.
I'm concerned that in a few years, many Baby Boomers will find themselves in the same condition as Townsend's elderly women. This may lead to a knee-jerk reaction by our politicians...who then create a plan much worse than the author's proposed plan. I might be able to live with the most of the author's proposed plan, if the workers who contribute the most also receive the most. I would like to see Social Security phased out over a 30 year period and replaced with a system somewhat like the author proposed.
Over-all, this book was very readable.....and if you like statistical data.....you will like the book. At least the author came up with a specific proposal to fix our retirement system, even if many people don't like the plan. It will be interesting to see if political pressure causes changes in our retirement system once significant numbers of the Baby Boomers reach retirement.
In this age of full disclosure, it can be noted that I am the author and publisher of the book INDEX MUTUAL FUNDS: HOW TO SIMPLIFY YOUR LIFE AND BEAT THE PROS. This book is an introduction to the concept of index funds is and is sold on Amazon. I am also a contributing author to the book THE BOGLEHEADS GUIDE TO RETIREMENT PLANNING available from Amazon with an estimated release date of October 2009. I have also written 21 short stories on investing which are also available on Amazon.
Other good books on investing which may help you become a member of the 20% of the population that has the wealth are shown below:
The Richest Man in Babylon
Bogle on Mutual Funds: New Perspectives for the Intelligent Investor
The Millionaire Next Door
The Four Pillars of Investing: Lessons for Building a Winning Portfolio
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition
The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life
The Bogleheads' Guide to Investing
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15 of 28 people found the following review helpful:
1.0 out of 5 stars
wrong on the economics, November 13, 2008
This review is from: When I'm Sixty-Four: The Plot against Pensions and the Plan to Save Them (Hardcover)
I could criticize the book based on the fact that the economics professor who wrote this book is by no means a respected authority: not a single publication in a reputable journal, only in fringe journals like the "Review of Radical Political Economics." But that's unfair, because sometimes even radicals can say intelligent things.
No, I criticize the book based on the facts.
1: The calculations are flawed. Let's start at the heart of the book: The need for a Guaranteed Retirement Account (GRA) that yields 3% real return. The flaw here is that even a portfolio 100% invested in the S&P500 index would have yielded a lot more than that over any post war 30 year window. $100 invested 30 years ago would be $746 today in real terms (accounting for reinvested dividends). The 3% savings plan would have yielded only $242 in 30 years. The S&P500 would have to drop to 314 points (i.e., another 65%) for the GRA to come out ahead of the stock market. That's all despite the last 30 years covering the horrendous 1980-82 recession, the 1991 recession, the 2001 bubble bust and the current dismal stock performance. Over the absolute worst 30 year window you still would have gotten around $400, still way ahead of the GRA. A more diversified portfolio, with international stocks, small cap stocks, some bonds etc. would fare even better in terms of risk-management and beat the socialized savings plan even more badly.
2: The calculations are even more flawed: The GRA is far from sufficient to afford a comfortable retirement, precisely because the yield is so awfully low. Invest 5% of your salary every month, assume 1% wage growth rate over the inflation rate (p.a.) and after 40 years you would have 36 times your final monthly salary in savings if you get only 3% real return. You can hardly afford to retire on that. If you wanted to preserve your real capital and thus withdraw only the 3% real return, you'd generate only 9% of your final salary in retirement income. How do you get to 70% of your final income? Social Security doesn't pay 61%! The answer is very easy: You hand over the money to the government who invests it in an annuity (~6.5%payout ratio p.a.). You generate about 20% of your final income, together with social security very low income individuals would get a replacement ratio close to 70%, everybody else would be lucky to get even 50%. Only problem is: if you die, the money is gone. The government has basically robbed you of your savings. She should change the subtitle to "The plot to socialize your savings and torpedo private ownership."
3: Let's look at the macroeconomic consequences. Savings that reach the equity market are put to productive use in corporations all over the country who produce goods and services and employ people. Who will keep providing the money for corporations when we stop saving in that vehicle? Will the government invest all the bonds it sells in the stock market? Might not be a bad idea if the stock market beats the 3% real over long periods. But the federal government running a multi-trillion dollar leveraged hedge fund, might make some people uneasy. The more likely outcome will be that the government uses the bonds to increase spending. And who should fill the void, the financing demand of equity markets and the supply of stocks that people sell when they cash in their traditional 401(k) plans, but no new investors want or can buy them because they are forced into the GRA? To a large part the market has to sell to foreign investors. The policy of socialized retirement accounts will actually exacerbate the indebtedness to foreigners. It will reduce the aggregate savings rate!
Let's just all hope that the prescriptions in this book are not followed!
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