Defined Benefit Pensions Are An Enemy of the Poor

Defined benefit (DB) pension plans like Social Security and The Teachers' Retirement System of Alabama (TRS) are designed to provide a promised set of benefits to participants. The benefits are based on factors that include a person's age, salary, and number of years of work.

Across the U.S. and around the world, defined benefit programs are in decline because corporations and governments can't handle the uncertainty and because millions of workers prefer the control and portability that comes with an individually controlled defined contribution (DC) account.

Despite the popularity and simplicity of DC plans, the public sector in America remains largely entrenched and unwilling to shift away from DB plans. At the federal level, Social Security remains a politically untouchable entitlement; (does anyone else remember when George W. Bush intended to use his 2004 "political capital" on reforming Social Security?). And, we see similar resistance to reform at the state level here in Alabama and elsewhere because suggestions of reform imply mismanagement and mistakes.

In defending DB plans, supporters often claim DB plans do a better job of protecting the poor than a DC plan. Left to their own devices, the poor would not invest (and never mind that DC plans could regulate against withdrawals of assets). Thus, the "forced savings" aspect of defined benefit programs assures there will be some funds available for the poor in their later years.

Whether or not the poor would save enough if they weren't burdened by Social Security and, in many cases, public sector pensions is an open question.

There is, however, one aspect of defined benefit systems that tends to cause tremendous harm to the poor: the implicit bias in favor of people who live longer. Or, as my accountant friend used to say (with a nerdy grin on his face), "Scott, the key to knowing when to retire from a defined benefit system or when to start drawing your Social Security is knowing when you want to die..."

Most of us don't choose when to die. But, when we look at data of overall mortality patterns, a few facts are clear:

(1) Workers with more education live longer than workers with less education. According to a 2013 study, 25 year old Americans without a high school degree will die 10 years sooner than similar Americans who have completed college.

(2) Workers with higher incomes also live longer. In this fascinating graphic, residents of Fairfax County, VA have median incomes of $107,000 and life expectancies of 82 years (men) and 85 years (women). Not far to their west, however, residents of McDowell County, West Virginia have median incomes a little over $20,000 and life expectancies of 64 (men) and 73 (women).

(3) Average life expectancy at birth for black men is just 71; average life expectancy for white women, meanwhile is 81.

And, here's our final stylized fact:

(4) Defined benefit programs like Social Security and The Teachers' Retirement System of Alabama are not built to deal with variation! Each employee is entitled to the same formulaic benefits at the time of retirement, and the true amount they cash out is not based on how much they put in, but, rather, by luck and the numerous factors correlated with life expectancy.

As such, people lucky enough to live longer manage to...live long and prosper.

The tragedy for the millions of poor who die young, though, continues beyond their death. While DB plans do typically pay survivor benefits, the life expectancy of most spouses in poor families is also, unfortunately, quite low. And, once the survivor is deceased, it does not matter how much money was paid in over a lifetime: The children of the poor--instead of having the remaining funds from a DC account passed to them--have nothing. And, in classic progressive fashion, the poor person's wealth is "spread around" to other members in the system.

The system sounds outrageous and unbelievable, and liberals should be among the most outraged: A sacred progressive program of theirs is no longer...progressive. And, easy, obvious solutions that empower the poor through personal accounts are available and have worked in the private sector and in some states.

Like most problems involving the poor, the problem is not a theoretical one or a policy problem per se, but, rather, a political one: entrenched interests have strong incentives to protect the status quo against change.

And, when those in power dig in put their own well-being ahead of fact and truth, the result for us is that important issues for the poor and younger people--financial security, poverty alleviation, leaving our children something better--get evaded and ignored.