02/17/2005: "It All Comes Down to DB versus DC"
Maybe I’ve mentioned this before, but my highly diverse professional career happens to include some heavy experience with putting retirement programs into place. I thus have something to bring to the party on Social Security discussions. Perhaps you’ve been subjected to some of the jargon acronyms associated with retirement, particularly the most significant ones: DB for “Defined Benefit” and DC for “Defined Contribution.” Understanding these terms takes you a long way towards understanding the fundamental issues of Social Security reform. While we at SherWright.com normally focus on Dittohead translations, translations of bureaucratese jargon acronyms aren’t so far removed from Dittohead to be inappropriate for a site such as this. (A greater concern is that such translations don’t have nearly as much opportunity for laughs, but we’ll look for targets of opportunity!) Anyway, a Defined Benefit retirement plan, sometimes called a 403(b), promises the retiree a specific amount of money every month. Prospective retirees know exactly how much they will have to meet expenses. Such plans are unpopular with employers, since they have to constantly reevaluate pension investments to ensure that they will be able to make these payments, which look to the employer much like a payroll. Social Security as currently structured is a DB plan. It’s not as hard for the government to administer its DB plan because, unlike employers, the government is relying on a stream of revenues from workers to cover payments to retirees. In other words, there is no real investment portfolio (the Social Security Trust Fund is an accounting device, not an investment portfolio). Employers greatly prefer DC – Defined Contribution plans, also called a 401(k) plan. The accounting is very straightforward. The employee puts in a defined about with each paycheck, the employer may match it, it all gets stuck into investment accounts, and the retiree gets whatever is in those accounts when they retire. If all the investments go south, their retirement plans could take a big hit (consider the Enron DC, where employees were required to invest in Enron stock). So which plan is better for Social Security? My take is that many people already have but DB makes more sense for a safety net program, particularly when a great many people will already have a 401(k). If your 401(k) does an Enron, a 401(k)-like Social Security could well have done the same thing, if the drop is related to a market-wide drop. Keeping Social Security as a reliable floor on which to base retirement planning makes more sense to me that making it a weak-sister imitation of your corporate retirement plan. So why does Bush like DC? The same reason that employers do: you stick a certain amount of money out every month and what the retiree gets at the back end is what they get. If it’s not enough to keep them out of poverty, well, that’s what they get for playing the markets!