From Pension Plans to 401(k) Plans (and the income gap widens))

From KPBS:

Voters overwhelmingly approved a measure to cut retirement benefits for government workers in San Diego on Tuesday.It would provide most new hires ... with a 401(k) in which a retiree’s income depends on how well their investments perform.

This shift from defined pension to defined contribution has already swept through the private sector and now it is beginning to enter the public sector. This just increases differences in wealth and income.


If you pay into a defined pension plan, your money is managed by professionals in a pool. They don't know if you will die at 102 or 62 but they can tell you with great accuracy what percentage of the pool of retirees will be dead by 72, by 82, and by 92. Also, they can't tell you which stocks or investments will do great and which will do poorly but they can tell you with some accuracy how investments will do over a period of 10 to 40 years. Their good and bad investments will balance out, some. 


Compare this with a 401(k) plan. Here an individual has to calculate at least two things that are largely unknown: their own date of death and their own rate of return on their portfolio. Based on this, they have to decide how much to save. And they have to decide in what to invest.


There are at least two ways that the shift to 401(k) plans increases income inequality. 


First, different people managing a 401(k) will make different choices about where to invest. The guy who invests in high-risk, high-return options in a bull market decade will find his wealth gallop ahead of the more cautious investor ... and find it collapse in bad times. With markets as volatile as they are now, there will inevitably be some people whose average returns are double-digit and some whose average returns are barely positive. Compounded over years, this means that two co-workers making the same salary may retire with wildly different amounts. (Two people, each contributing $7,000 a year. One has miserable luck and averages returns of 1% a year. The other has great luck and averages 15% a year. After 25 years, the first has less than $200,000 to live on; the second has nearly $1.5 million.)


Second, one may die soon and the other late in life. Even assuming that two people retire with $1.5 million, the estates they leave their children will be wildly different. If one lives to 105, his children may inherit debt. If the other lives to 65, his children may inherit a million. This, too, exacerbates differences in wealth and income, in the same way that being born to aristocracy or peasants will compound differences in wealth and income.


The movement into 401(k) plans is just one more way that the modern economy seems to be increasing the gap between the rich and the poor. On that basis alone it seems like a bad idea.