By: Phillip Longman
How to save our kids from poverty in old age
The federal government spends more than $500 billion a year on policies designed to help individuals acquire or build assets. The three most expensive of these policies--the mortgage interest deduction, the property tax deduction, and preferential rates on capital gains and dividends--together deliver 45 percent of their benefits to households with average income exceeding $1 million. "Put another way," concludes a report commissioned by the Federal Reserve, "the poorest fifth of Americans get, on average, $3 in benefits from these policies, while the wealthiest one percent enjoy, on average, $57,673."
What if we re-crafted our wealth accumulation policies so that they primarily helped average Americans build assets? Nothing could be more American. It's what the Homestead Act did. It's what the GI Bill did. And here's another example of how it could be done for the next generation of Americans.
Every child born in the U.S. gets a Social Security number. Going forward, every child should get at the same time what could be called an American Stakeholder Account. Parents, grandparents, and anyone else who cared to could contribute funds to a child's stakeholder account, as could children themselves. Children whose families qualify for the federal child tax credit would have up to $500 added to their accounts each year by the government. Contributions from all sources would be capped at $2,000 per year.
When an account holder reached eighteen, he or she could begin withdrawing a portion of the accumulating funds, but only for the purpose of pursuing post-secondary education and training. At age twenty-five, the account holder could use a portion toward buying a first home or starting a business. But a substantial remainder would be earmarked for retirement.
Now let's add another important feature. Throughout their working lives, members of the next generation of Americans would be required to contribute 4 percent of their earned income to their stakeholder accounts. Their employers would have the option of contributing another 2 percent. Low- and middle-income households would be eligible for up to $500 per year in government matching funds. Upon retirement, the balance built up in these accounts would be automatically converted into an annuity--a stream of monthly benefits that would flow for the rest of the account holder's life.
That last part is important. One big problem with saving for retirement through today's 401(k)s or IRAs is trying to figure out how long you'll live. Guess wrong, and it's easy to outlive your savings. You can mitigate that risk by turning your nest egg over to a private investment company when you retire in return for a promise that it will pay you an annuity of fixed monthly payments for the rest of your life. But aside from the risk of that company going broke, most people are shocked when they find out how little those monthly payments are.
Stakeholder accounts, however, could offer more generous and safer monthly annuity benefits. A big reason why annuities purchased in the private market today pay so little is what actuaries call "adverse selection." People who buy annuities tend to be people in good health who reasonably believe they would outlive their savings if they didn't purchase them. This phenomenon raises the price and lowers the benefits of annuities for everyone. But the problem is solved if it becomes mandatory that people convert their stakeholder accounts into annuities beyond a certain age, such as, say, sixty-seven. As economist James M. Poterba has written, "Requiring all persons to annuitize their retirement account balances at a specified age is one way to substantially reduce the degree of adverse selection in the annuity market."
How would the funds building up in a person's stakeholder account be invested before retirement? Much as they are under the federal government's wildly successful Thrift Savings Plan, which oversees the retirement accounts of more than three million federal workers, including members of Congress. Under that program, participants have a choice of five different investment vehicles (including bond funds, stock funds, and mixed "life-cycle" funds) provided by carefully regulated private-sector investment firms. Stakeholder accounts would offer a similar range of choices, but the default vehicle into which all retirement savings would flow, unless an account holder specified otherwise, would be an index fund that offered a ratio of stocks and bonds that adjusted automatically according to the account holder's age.
Because of the size of the Thrift Savings Plan and its ability to have some of the administrative functions performed by government agencies, it is able to negotiate substantial discounts on the fees charged by investment companies, adding to participants' returns. The American Stakeholder Account plan, because it would serve a much wider population, would enjoy even larger economies of scale.
You could think of stakeholder accounts as both a childhood savings program and a fully funded "add-on" to Social Security for the next generation. Why is that important? Social Security is not about to go broke. But it at best replaces only about a third of most people's income in retirement, and even sustaining current benefits will require a substantial increase in taxes due to the aging of the population. With the inevitable continued decline of the number of workers covered by traditional, defined-benefit private pension plans, and the manifest failure of today's 401(k)s and other defined-contribution plans to adequately prepare many Americans for retirement, stakeholder accounts are vitally needed to ensure the old-age security of the next generation.
It is impossible to say, of course, exactly what the balances in stakeholder accounts would build up to over the decades to come. There are many variables at play, from returns on capital to average wages and the amount an individual adds or withdraws from the account at different times. But let's take a look at the likely outcome for a hypothetical child--let's call him Sam--born in 2013.
If Sam's account is endowed with $500 a year, it will grow to nearly $15,000 by the time he is eighteen, assuming an average 5 percent rate of return. (While there is no guarantee that the actual rate of return will be 5 percent, it's not an unrealistic number to use; between 1950 and 2009--a year when the stock market tanked--the average after-inflation return on the S&P 500 was 7 percent.) Assume that Sam spends $5,000 of the stakehold to get vocational training, and at age twenty takes a job as a plumber, a medical technician, or an auto mechanic, with a starting income of $30,000. Assume also that as Sam gains seniority, his income grows, by about 2 percent a year, reaching $77,000 by the time he is sixty-seven, and that along the way he contributes just the minimal 4 percent of income to the account annually. Under these assumptions, Sam's account would grow to more than $426,000 by age sixty-seven. Though we can't know what interest rates or life expectancy will be by then, it is not unreasonable to assume that this sum could be converted into an annuity paying roughly $35,000 a year for the rest of Sam's life (more if interest rates are high, less if life expectancy at age sixty-seven improves dramatically between now and then).
This is less than half of Sam's final salary. He would still need Social Security to live comfortably. But it's worth noting that he could also end up with nearly a million dollars at age sixty-seven if the average return turned out to be just 7 percent. It is also worth noting that under current law, Social Security collects about one of every eight dollars that most Americans earn, and going forward will offer only about a 2 percent return for Baby Boomers and less than that for future retirees, according to the General Accountability Office. Where will the next generation be if it does not have another way to pay for retirement?
Along the way, stakeholder accounts would offer many other benefits, both direct and indirect. For example, abundant social science research shows that just having a savings account, regardless of how much is in it, raises the aspiration of poor children to go to college and otherwise plan for the future. (See Dana Goldstein, "The 'Assets Effect' ".) Stakeholder accounts would also make it easier to reinstitute school banking programs, which, until they faded away in the 1960s, were an important means by which previous generations of Americans inculcated thrift and financial education in the young. Imagine how much more interesting it would be for an eighth grader to learn how to calculate compound interest if the question at hand were directly related to their own situation: How much more will his account be worth at age eighteen, for instance, if he doesn't spend $40 on a video game and deposits the money instead? And surely a high school student would be more interested to learn about how the U.S. economy works if she recognized that her increased knowledge would help her decide how to direct her own savings: Should she invest in stocks, bonds, or certificates of deposit?
The existence of stakeholder accounts would also make it easier for school districts, churches, and philanthropies to graft on so-called "conditional cash transfer programs," should they care to. These are programs, being tried in local jurisdictions with some success, that offer cash payments to students in exchange for desired behavior, such as good school attendance. A school district might, for instance, offer students a $500 deposit into their accounts if they achieved perfect attendance for a year.
Stakeholder accounts could also play a role in ameliorating the terrible damage done to the thrift ethic and finances of ordinary Americans by casinos and state lotteries. What if, when you bought a lottery ticket, a substantial portion of the sale was automatically credited to your stakeholder account? That way, if you didn't win the big prize--the most likely scenario--you'd end up with more savings, not less. (Such a lottery has been tried in Britain, something they call "Premium Bonds.") We could also use stakeholder accounts to turn casinos into savings institutions. All it would take is a provision that casinos divert a significant share of each bet to a gambler's stakeholder account.
Finally, and more philosophically, stakeholder accounts could help to solve a deep dilemma of American life. We honor the principal of equal opportunity, but children are manifestly not born equal when it comes to financial inheritance. At the same time, Americans tend not to believe in equality of result, and therefore are more averse than people in most other modern nations to redistributing income.
The progressive, more politically appealing solution, as the late American philosopher John Rawls once observed, is to predistribute property, so that all children start out with an equal stake. American stakeholder accounts would do this, at least to a small degree. If we were really serious about righting the country's growing inequality of wealth, we would entirely stop subsidizing the accumulation of wealth by people who are already rich, and use the proceeds to put more generous matching grants into the stakeholder accounts of children born into modest circumstances. Some children would still enjoy large advantages in life. But any resulting inequality of income would be easier for both winners and losers to live with if every child started out with at least some seed money. This stake, if well managed and combined with hard work and some pluck, could put the American Dream within all children's reach.