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Guaranteed Retirement Accounts: Good Idea Or Not?

Introduction: 

In 2007, an organization called The Economic Policy Institute issued a policy paper, written by a college professor named Teresa Ghilarducci. The paper was titled: "Guaranteed Retirement Accounts: Toward Retirement Income Security. "

There were three major points being made in that paper.

First, tax breaks given by retirement vehicles such as 401k programs and IRA's were unfair because the primary beneficiaries of those programs are wealthy people

Second, when tax breaks are given to individuals, the money that is placed into 401k programs and IRA accounts prohibit the government from collecting more tax revenues

Third, the middle class and the poor need to have a better retirement system than the current 401k plans and IRA accounts and those should be run by the government and not be left to individuals who are not equipped to manage their own retirement funds

What You Should Know:

While the conversation about retirement plans and how we might make them better for all Americans has gone largely unnoticed by most people, over the last 6 years, different "think tanks" have quietly been examining the inequality of our current retirement programs and looking for a "different way" to fund American retirement.

As recently as this year, the President suggested in his budget that there should be limits on the amount of money that an individual should be able to shelter in a retirement account and that there should be a limit as to how much income that retirement account should provide.

What I Know:

In a New York Times article, written July 21, 2012, Ms. Ghilarducchi makes these points:

Seventy-five percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts. The specter of downward mobility in retirement is a looming reality for both middle- and higher-income workers. Almost half of middle-class workers, 49 percent, will be poor or near poor in retirement, living on a food budget of about $5 a day.

To maintain living standards into old age we need roughly 20 times our annual income in financial wealth. If you earn $100,000 at retirement, you need about $2 million beyond what you will receive from Social Security.

My plan calls for a way out that would create guaranteed retirement accounts on top of Social Security. These accounts would be required, professionally managed, come with a guaranteed rate of return and pay out annuities. This is a sensible way to get people to prepare for the future. You don't like mandates? Get real. Just as a voluntary Social Security system would have been a disaster, a voluntary retirement account plan is a disaster.

So, what exactly is Ms. Ghilarducci's plan to save American retirement? From that policy paper:

Workers and their employers would each contribute 2.5% of pay to an individual GRA. The government would provide an annual $600 credit (indexed for inflation) to offset workers' 2.5% contribution.

The contributions would accumulate in a federal retirement fund that would earn a 3% inflation-adjusted minimum return, which is pegged to the long-term growth rate of the U.S. economy.

Account balances would be converted into annuities that would provide a life-long stream of income at retirement. Workers could opt out of a GRA if they participated in a qualified pension or savings plan that met new federal standards.

Now, going a little further into the proposal we find this:

By design, GRA account balances would be converted into inflation-indexed annuities that, together with Social Security, would provide workers with adequate retirement incomes after a lifetime of work.

For example, an average earner who earns $40,000 per year would accumulate $152,095 in a GRA and receive a life-long stream of income of $10,366 per year adjusted for inflation. With Social Security, this would replace 71% of pre-retirement income.

A high earner (with an annual income of $60,000) would attain a 61% total replacement rate, because he or she would receive a lower Social Security benefit relative to income, whereas a low earner ($20,000 per year) would attain a much-needed higher replacement rate of 89%.

In order to guarantee the solvency of this plan into the future:

Only the federal government has the size, stability and long-term investment horizon to smooth investment returns and provide a minimum rate-of-return guarantee. Contributions and investment earnings would accumulate in a federal fund, called the Guaranteed Retirement Account fund.
This fund would be professionally managed like any large, pooled pension fund and would be overseen by an independent board of trustees appointed by the president and Congress. The funds would be invested in a balanced, conservative investment portfolio that could include American infrastructure bonds.

Summary and Conclusion:

There is no doubt that many Americans are not prepared for retirement. For any number of reasons, Americans approaching retirement age are beginning to realize that many of them have a significant problem--not enough money.

While on the surface, a Guaranteed Retirement Account sounds like a good idea. The devil is in the details, however.

It concerns me that someone who is called a "high earner", that is someone who makes $60,000 a year would get less in retirement under this plan than someone who makes $40,000 a year.

It concerns me that the plan targets a 3% return on investment money in the GRA fund.

It concerns me that the money in the fund is going to be managed "like any large pooled pension fund and overseen by an independent board of trustees appointed by the President and Congress."

It concerns me that the money will be invested in a "balanced, conservative investment portfolio that could include American infrastructure bonds."