Economist's View: Mortgaging the Nest Egg

Mark Thoma sees people borrowing against their retirement accounts and worries about the future:

This is why I wonder about the long-term participation rate in "opt out" retirement accounts that are being promoted as a way to deal with the retirement security problem. How many people will opt out of these accounts when economic conditions for the household deteriorate temporarily for some reason? And once they opt out, will they opt back in? People who are motivated enough to borrow against their retirement accounts - almost one fifth in 2007 - would also be motivated enough to opt out of an automatic savings plan. Many of the studies, at least the ones I have seen, do not track people over long periods of time where this type of deterioration would be present, and they do not follow people through a recession when the pressure to opt out would be greatest. I'm not saying we shouldn't have these programs, they do help some people save, and even if some people opt out at least they have a source of funds to use when times get tough. The point, though, is that the people most likely to opt out are the very ones we would like to see participate in savings programs so that they have more than just Social Security available during their retirement years. Because of that, we should be careful not to place too much emphasis on opt-out types of mechanisms for solving the retirement security problem. These accounts may not provide as much of a boost as we hope to key segments of the population.

The idea of making 401(k) plans "opt-out" by default, rather than "opt-in", is a good one as far as it goes. But it's not clear how far it will go. "Opt-out" is a milder form of forced savings--call it "fiercely encouraged savings". I myself have been known to advocate forced savings as an antidote to the moral hazard problem: even if we eliminated Social Security, the feckless and reckless would know that we will not let them starve in old age; therefore, they will go about their merry ways in the expectation that the rest of us will take care of things later.

But there's a big problem with forced savings: it's not clear that it works as long as people can borrow. This is probably less of a problem with social security benefits, but it's not zero; a surprising number of seniors enter retirement with a lot of debt. And obviously, we're seeing that 401(k)s have this problem in spades.

Comments

The borrowing problem is aided and abetted by Washington. My guess is that most borrowing is for houses and college tuition. Relaxation of rules on retirement funds has been concentration in these areas.

We are still mentally in the pre-Reagan era where housing was a prime tax shelter. Politicians find it an easy source of no current cost pork.

College tuition is largely a rate of increase problem again aided by government expenditures.

Posted by Dave Moelling | February 29, 2008 8:40 AM

One thing to keep in mind is that 401(k) plan loans are limited to the lesser of $50,000 or 50% of the employee's vested account balance. Thus, though there are some unfortunate aspects to allowing plan loans, there is a fairly tight limit on the amount of retirement savings that can be run down. Also, the loans are paid back through payroll deductions over time or, if the employee leaves the job, become taxable (normally with a 10% penalty as well) if not repaid in full.

Thus, in light of these limits and repayment rules, and the (probably reasonable) concern that people may be less likely to make 401(k) contributions in the first place if they can't be accessed in an emergency, probably is a good reason not to tinker with the rules too much.

Posted by Michael Collins | February 29, 2008 8:47 AM

Hell, a lot of old people get in to credit card debt once there only source of income is social security.

THe credit card companies either aren't checking up on this or are continuing to offer cards to people making 12000 a year...

Posted by toxic | February 29, 2008 8:48 AM

Social security is a joke. A very bad and unfunny one. Currently, unfunded social security and medicare costs are upwards of 90 trillion. That's oh, 30 years or so of the current federal budget.

Does it never occur to anyone that this coerced ponzi scheme might be, in large part, why people are so hard pressed they have borrow from their retirement accounts to make ends meet now? By reducing the numbers of jobs available (the employer portion is no small drag on job creation)? By reducing folks current income to the point where people can't AFFORD to save anything they can count on actually being there?

Posted by Swells | February 29, 2008 9:28 AM

what I find funny is, everyone lectures and moans about the failure of Americans to save (famiously negative savings rate) when we all know that people respond to incentives.

The incentives are wrong. We should stop expecting people to act against their interests and fix the incentives.

Posted by Doug_S | February 29, 2008 9:28 AM

even if we eliminated Social Security, the feckless and reckless would know that we will not let them starve in old age; therefore, they will go about their merry ways in the expectation that the rest of us will take care of things later.

True, but how many people are so f/reckless that they would actually do that if it weren't the norm? That is, is the bigger problem with Social Security that it merely makes it possible to live on the dole in your old age, or is it that it creates a culture in which there is no stigma attached to doing so?

I suspect that it's the latter. I think people would be much less inclined to rely on Social Security if it were seen as welfare for old people than they are now, when it's seen as a middle-class entitlement.

By the way, your abuse of the phrase "of the week" is really getting out of hand. That printer's been the gadget/object of the week for months on end.

Posted by Brandon Berg | February 29, 2008 9:37 AM

What is especially hilarious is that people Thoma will lament the fact that some people are prone to borrow against a portion of their retirement accounts, but then have literally nothing intelligent to say about the fact that we borrow and spend the entire social security surplus.

Posted by Yancey Ward | February 29, 2008 9:42 AM

I once borrowed from my 401k to buy a car. I paid the money back over a year, including a nominal interest rate. Funny thing was, during that time period I was my own best investment: my car loan beat the returns of everything my 401k was invested in. Win-win.

Yancy: Spot on. You have to wonder...

Posted by TakeFlight | February 29, 2008 9:53 AM

many people are so f/reckless that they would actually do that if it weren't the norm?

At least half I would say.

Posted by jmo | February 29, 2008 9:53 AM

"Currently, unfunded social security and medicare costs are upwards of 90 trillion"

Yes when calculated over the Infinite Future Horizon which is to say until the heat death of the sun. We don't calculate any other government program in this way, nobody suggests that we take all future military expenditures, which are equally unfunded, and project them forward so why social security and medicare? I know the standard answer, some programs are mandatory and some discretionary but in practice this is totally bogus. The mandatory programs are totally exposed to change by Congressional action while some discretionary programs are not going to go away, as an example we won't be eliminating the military or the courts. That $90 trillion figure is a thoroughly dishonest talking point promulgated by people who hate government social programs to start with.

An honest discussion would have us looking at these future expenditures as a percentage of GDP in any given future year, a simple aggregation of dollar figures unadjusted for inflation and projected over the Infinite Future is just to inject GIGO into the dicourse. Garbage In, Garbage Out.

Social Security is currently running surpluses in excess of $200 billion a year and given historic trend growth will continue to for decades to come. Assertions that it is unfunded to the tune of $4.7 trillion over the 75 year actuarial window or $12.7 trillion over Infinite Future are based on some very dodgy and overly pessimistic assumptions about growth in the out years.

The Medicare assumptions are equally bogus and assume that politicians will not act in the face of an ever increasing bill. People calling for change now under the assumption that change later will be impossible are arguing out of both sides of their mouth

Posted by Bruce Webb | February 29, 2008 1:02 PM

Yes when calculated over the Infinite Future Horizon which is to say until the heat death of the sun. We don't calculate any other government program in this way

Right, and how many other government programs are based upon entitlement transfers that no politician wants to touch with a fifty-foot pen, and are directly dependent upon accellerating demographic trends?

Posted by anony-mouse | February 29, 2008 1:28 PM

" but then have literally nothing intelligent to say about the fact that we borrow and spend the entire social security surplus."

What is the alternative? People have the most amazingly naive views about the nature of money and investing generally. If Social Security collects more in any given year than it spends it has a number of choices. It could convert that into stacks and stacks of $500 bills and store them in a warehouse in Bethesda putting them at risk of theft, fire and rot. Or it could enter into the precious metals market and buy gold. But in neither case would they be earning anything. In the event the dollars are invested and as a matter of law invested in an interest earning security that is not only regarded as the world's safest but also has yields that are 100% predictable. Every excess penny sent to Social Security is invested in U.S. Treasury bonds. You can examine a list of these bonds complete with yields and terms here:
http://www.ssa.gov/OACT/TR/TR07/VI_cyoper_history.html#wp152208
People can and do spin around like dervishes and contort themselves into pretzels trying to explain why the Special Treasuries in the Trust Funds are nothing like the regular Treasuries we market to the public but all the arguments are fundamentally bogus and rely on political events that would never occur in real life.

You give money to someone. They promise to give it back with interest and maybe back that with a piece of paper. They spend the money. That is the description of a Ponzi scheme. That is also the description of depositing your paycheck in the bank, or paying an insurance premium. The difference between your bank and a Ponzi scheme is that the banks performance is backed by the Federal Government, the same Federal Government that is backing the securities in the Social Security Trust Fund, which is the same Federal Government that trys to ensure that the Benjamin in your wallet doesn't get hyperinflated away before Monday.

You give $100,000 to the Feds, they give you a Treasury note, they spend the money on whatever they want. Only in the Social Security context does this perfectly ordinary transaction become some sort of sinister form of theft and fraud.

The Social Security surplus could, and in my opinion should, be invested in non-Federal asset classes, if only to suppress this kind of baseless talk, but even if it was it would still be a matter of some entity borrowing and spending that surplus. Its called investing. People need to slow down and think about the nature of money and the reality of cash flows to and from the Treasury Department, the surplus had to be invested somewhere, putting it in a form backed by the Full Faith and Credit of the United States seemed and seems reasonable enough, once you pry the layers of obfuscation away.

"literally nothing intelligent" Well that is a case of the pot calling the kettle black, you clearly have not spent an instant actually thinking through the reality of Social Security financing. See you at Economist's View.

Posted by Bruce Webb | February 29, 2008 1:33 PM

Bruce, if I give money to myself, then give myself an IOU, then spend the money, have I "invested" it?

No, because the person with the IOU and the person who needs to pay it back are one and the same, and must both rely on the same income stream, namely, mine. My future income will not increase as a result of lending the money to me. This is a slightly different situation than when I give the money to somebody else to spend/repay: now I have two income streams working for me, my own, and that person's, so, unlike in the self-loan case, my expected future income goes up as a result of my sacrifice today.

Thus the problem with SS financing: not that the SS admin will, as an independent entity, go bankrupt, but the fact that it is not a meaningfully independent entity. It's all part of the same government, which has but one income source: money from taxpayers like us. Lending the money to itself does not increase its income one cent.

And, speaking of not thinking through reality, investing, as ordinarily used, generates increased productivity as the money is spent on profitable new ventures and the creation of wealth. Treasuries, not so much.

Posted by Rob Lyman | February 29, 2008 1:57 PM

Bruce Webb,

I knew that comment would bring forth another idiot claiming that the government can earn a return on its own liabilities.

Now, if I could only figure out how to earn a return on my own mortgage, I would have it made.

Posted by Yancey Ward | February 29, 2008 2:11 PM

I wrote a check to myself for 500 million dollars.

Weirdly, I'm not for the Forbes list of richest Americans.

Posted by toxic | February 29, 2008 2:59 PM

Bruce Webb, thanks for your reply. I want to make one preliminary point. Were a corporation to attempt financing it's pension liabilities the way the government finances its social security liabilities, the people that run that corporation would be put in jail to rot. The simple fact of the matter is that the money that is paid into social security today is spent today. That means that the payments that have to be paid out later will have to come from funds collected at that time. That is not how insurance works. That is how a ponzi scheme works.

I don't oppose governments or social programs sui generis. I oppose coerced participation in such programs.

Posted by swells | February 29, 2008 3:09 PM

If the government were going to truly invest the Social Security surplus to earn future returns, it would have to invest in capital-physical and human. Now, the government does invest in infrastructure, education, and research, but those investments and their returns are not tied to any particular funding. Back in 1983, when we restructured the funding of SS, it might have made a great deal of sense to tie the surplus funds to income-earning infrastructure such as roads, bridges, airports, and railroads. It might have made sense to invest in the bonds of other, stable, reliable foreign countries like the UK, Germany, or Japan. However, for the most part, we did not do this- we consumed most of the surplus funds in non-productive ways, which is the usual way government works.

Posted by Yancey Ward | February 29, 2008 3:43 PM

I never cease to be amazed how the words "Trust Fund" can invoke a forty-IQ-point mental retardation in people who are otherwise intelligent enough to, in theory, understand basic principles of investing and economics. If only our government had figured out how to translate the phrase into Arabic and then shower leaflets upon Al Qaeda training camps and the Iraqi Republican Guard coffee break room, we could have saved ourselves two expensive wars.

Posted by anony-mouse | February 29, 2008 4:06 PM

Toxic:
I wrote a check to myself for 500 million dollars. Weirdly, I'm not for the Forbes list of richest Americans.

Not yet, but you will be once you fine yourself three times that amount for bouncing a check.

Posted by Brandon Berg | February 29, 2008 4:36 PM

I wrote a check to myself for 500 million dollars. Weirdly, I'm not for the Forbes list of richest Americans

Of course not. A check is an instrument which directs a third party to pay. What you should have done is obligate yourself to pay. The proper instrument for this is a promissory note, made out to yourself.

This legal advice brought to you at no charge.

Posted by Rob Lyman | February 29, 2008 5:20 PM

If we killed SS payouts next year and we stopped collecting FICA at the same time, the net impact would be to increase the deficit.
Fica will continue to be greater than the payouts for another 10 years or so.
This is one entitlement that has paid its own way for a long time.

Posted by Twink | February 29, 2008 6:27 PM

You give $100,000 to the Feds, they give you a Treasury note, they spend the money on whatever they want. Only in the Social Security context does this perfectly ordinary transaction become some sort of sinister form of theft and fraud.

As everybody points out, the government does not benefit from holding treasury bonds the because it's the issuer, not because of some property of the bonds. This is true of the bonds in the trust fund and normal treasury bonds and bonds in general. Company X bonds may be good for me and good for Company Y to hold, but they're not any good for Company X to hold because they're the bond issuer, so they have to pay themselves when the bond is redeemed. If we had, say, Canadian treasury bonds in the SS trust fund, we'd be in good shape.

Just contrast it with investing with a normal bond vs a treasury bond with the same yield:

Non-US gov't bond:
-Government gets $X of FICA revenues to pay for social security and invests them in bonds of entity Y.
-Entity Y adds $X to its budget and (hopefully)makes provisions to pay $X' back when the bond matures.
...Time passes...
-Government redeems bond for $X' and uses it to pay benefits.
-Entity Y provides those $X'. Hopefully it had a good plan for doing so, but as long as we get the cash, it's entity Y's problem, not ours.

US gov't bond;
-Government gets $X of FICA revenues to pay for social security and invests them in treasury bonds.
-$X are added to the general budget from the bond and appropriated.
...Time passes...
-Goverment redeems bond for $X' to pay benefits.
-$X' from the general budget are appropriated to pay for the bond, requiring $X' of additional taxes or that $X' be borrowed from a 3rd party to meet the general budget obligation.

As you can see in the second scenario, the money for paying the benefits has already been spent and needs to be raised again.

Posted by MattXIV | February 29, 2008 6:28 PM

Fica will continue to be greater than the payouts for another 10 years or so.

Nobody's arguing otherwise. We're just concerned about what happens in years 11-whenever.

This is one entitlement that has paid its own way for a long time.

This is a very weird mentality. It is accurate to say that this is one tax which has collected more than required for the special purpose for which it was imposed for a long time. But there are those of us who don't really care that much about precisely which pigeonhole the money comes from or goes to. The issue is the government's excessive consumption of GDP, and the fiscal, economic, monetary, social, and cultural effects thereof. Rearrange the deck chairs however you like; big tax increases on fewer (relatively speaking) workers are not good for anyone except the indolent oldsters who are getting the checks.

Posted by Rob Lyman | February 29, 2008 6:35 PM

I agree with you Rob - big tax increases on fewer (relatively speaking) workers are not good for anyone except the indolent oldsters who are getting the checks.

We all become indolent oldsters if we live long enough and like you said, it is good for them, ergo it is good for all of us. If it is good for all of us, then I am for it.

Posted by Twink | February 29, 2008 7:05 PM

Re: That means that the payments that have to be paid out later will have to come from funds collected at that time.

Yes, but that's true no matter what-- unless you think the government should simply lock up a lot of cash in Fort Knox and then come back for it later.

Re: That is not how insurance works.

Not exactly, but it does work, generally, the same way. What do you think would happen to an insurance company that had zero current revenue? Would it be able to pay out claims? Or would a bank with zero current revenue be able to pay out all demands on its deposit funds?

Posted by JonF | February 29, 2008 7:34 PM

We all become indolent oldsters if we live long enough and like you said, it is good for them, ergo it is good for all of us. If it is good for all of us, then I am for it.

I see no reason why we shouldn't jack up payroll taxes to 100% of pay in that case, and give the money to retirees. It's good for all of us!

Posted by Rob Lyman | February 29, 2008 7:39 PM