I ran across an article in the New York Times op-ed section two weeks ago, “Paying for Old Age,” by Henry T.C. Hu and Terrance Odean. Hu and Odean have come up with a novel idea that would allow people to retire with a steady stream of income without fear of outliving their money. If it sounds like an annuity, it is.But there is a catch…it is a government-guaranteed annuity. This product would act like an inflation-adjusted bond, but any risk associated with it would be insured by the federal government. These annuities would compete with those issued by private insurers, but there would be not risk of default by the insurer, as has occasionally happened in the private sector.
I mulled this idea over for a few weeks, hence the delay in writing about it. Then it occurred to me that a government-guaranteed annuity is not that new and novel after all. Think of Social Security. It is often claimed that Social Security is an “insurance” program, but funny, it does not act like one.
Compare the current system to a government-backed annuity. Social Security is mandatory. All pay into it. The payroll tax revenues are spent on special obligation bonds, but these bonds are not traded on the public market. In essence, Social Security “premiums” are not invested, but spent on other government programs, thus creating a pay-as-you-go system. Benefit payouts are calculated based
on an individual's highest earning years without regard to individual life expectancy. Benefit payouts are adjusted annually based on inflation. But benefits going to today's retirees are being paid by today's workers. Private insurers would be certain to fail if they behaved this way.
A government-guaranteed annuity, on the other hand, would be voluntary. As the article states, payouts would be adjusted based on interest rates on government bonds, mortality tables and other things. While some may argue that everybody will want to purchase government-guaranteed annuities and stay away from the private market, I tend to disagree. For one thing, many investors are not big fans of annuities. If the demand for the government annuities is high enough, this will drive the interest rate down on them, making them perhaps less attractive than private market annuities. Furthermore, there will always be retirees who will opt for withdrawing money from their retirement accounts on their own (without the guarantee of an annuity) if they think they can get a higher rate of return with their own investments.
Being that Social Security will pay a negative rate of return to future generations, why not allow payroll taxes to be converted into personal retirement accounts? Then at retirement, individuals could decide how to take their distributions. Of course this would depend largely on the government’s ability to behave like sound insurance, which they have poorly demonstrated so far.