Jose Pinera: Exclusive Interview With The World’s #1 Pension Expert Are You Prepared to Survive Without Social Security?
by Dr. Mark Skousen, Chairman, Investment U
Thursday, February 15, 2007: Issue # 641
“Of all social institutions, business is the only one created for the express purpose of making and managing change Government is a poor manager.”
~Peter F. Drucker
Last month, I had the opportunity to interview José Piñera, a Harvard-trained economist who is considered the world’s foremost authority on Social Security reform. He’s met with practically every major government leader – from George Bush and Putin to China’s president Hu Jintao.
The Man Who Knows Best about the Flaws in Social Security
José Piñera was the Chilean labor minister who, in 1982, created the first private pension system in Chile. It has been remarkably successful. Because of pension reform, the country has one of the highest growth rates in Latin America, and the standard of living for the average Chilean has risen sharply since 1982.
According to Piñera, 31 countries now have some type of private social security program, and the number goes up each year. Here’s why these programs work, and how one “sector” of the U.S. economy has already found the solution to this pension fund problem
Piñera is an engaging speaker on a mission to raise the standard of living for millions – maybe even billions – by encouraging governments to give their citizens the chance to own their own pension accounts that they can direct, bequeath to their heirs, or donate to their favorite charity.
None of these options is currently available to Americans.
For example, if you die before reaching retirement age of 65, you get nothing from the Social Security system that you’ve paid into all your life, with the exception of a cheap burial. Can you imagine? According to the latest studies, if you live the average lifespan (now at 78 years), your return on your Social Security investment is 1%-3% a year, depending on how much you invested. That’s it. You could do better with a passbook savings account. And when you die, your heirs get nothing.
I know Social Security is a sacred cow in today’s world, and some of you may be offended by my views. But frankly, I hate paying into a system that is so poorly managed and ill-conceived. If I had my choice, I’d drop out of Social Security today, even though I’ve paid thousands into it for over 40 years. Unfortunately, in this lifetime, I won’t get the chance.
The China Factor is Big
I asked Piñera if the United States is going to be the last country to adopt a private Social Security system. “No,” he replied with a smile, “It will be France!”
Still, he said that all eyes are on China right now. If China adopts a private pension system, it would put them at a huge advantage over the United States, because it will create faster economic growth, as we have seen in Chile. Privatizing Social Security in China could force the U.S. to follow China’s lead.
According to Piñera, Chinese officials are deeply worried that an old-fashioned “defined benefit” plan (the kind we have in the U.S.) would be a disaster for China with their one-child policy and aging population problem.
How the Private Sector Solved Its Pension Problem
Interestingly, in the ongoing debate over the privatization of Social Security, one story has been overlooked: The private business sector in the United States has already faced the pension-fund problem and resolved it.
Here’s what happened.
After World War II, major U.S. companies added generous pension plans to their employee-benefit programs. These “defined benefit” plans largely imitated the federal government’s Social Security plan. Companies matched employees’ contributions; the money was pooled into a large investment trust fund managed by company officials; and a monthly retirement income was projected for all employees when they retired at 65.
Management guru Peter F. Drucker was one of the first visionaries to recognize the impact of this “unseen revolution,” which he called “pension fund socialism,” because this Social Security look-alike was capturing a growing share of investment capital in the United States. Drucker estimated that by the early 1990s, 50% of all stocks and bonds were controlled by pension-fund administrators.
But Drucker failed to foresee a new revolution in corporate pensions – the rapid shift toward individualized “defined contribution” plans, especially 401(k) plans.
Corporate executives recognized serious difficulties with their traditional “defined benefit” plans – problems Social Security faces today. Corporations confronted huge unfunded liabilities as retirees lived longer and managers invested too conservatively in government bonds and blue-chip “old economy” stocks. Newer employees were also angered when they changed jobs or were laid off and didn’t have the required “vested” years to receive benefits from the company pension plan.
Unlike Social Security, most corporate plans were not transferable. The Employment Retirement Income Security Act (ERISA), passed in 1974, imposed regulations on the industry in an attempt to protect pension rights, but the headaches, red tape, and lawsuits grew during an era of downsizing, job mobility and longer life expectancies.
The New Solution: Individualized 401(k) Plans
The new corporate solution was a spin-off of another legislative invention – the Individual Retirement Account (IRA). The 401(k) rapidly became the business pension of choice, and there is no turning back. These “defined contribution” plans solve all the headaches facing traditional corporate “defined benefit” plans. Under 401(k) plans, employees, not company officials, control their own investments (by choosing among a variety of no-load mutual funds). Corporations no longer face unfunded liabilities because there is no guaranteed projected benefit. And workers and executives have complete mobility; they can move their 401(k) savings to a new employer or roll them over into an IRA.
According to recent U.S. Labor Department statistics, there are about nine times more defined-contribution plans than defined-benefit plans. Almost all of the major Fortune 500 companies have switched to defined-contribution plans or hybrid “cash-balance” plans.
Companies that still operate old plans include:
- General Motors
- Procter & Gamble
- Delta Airlines
- The New York Times Company
IBM, a company that once guaranteed lifetime employment, has gradually switched to a 401(k) plan. Virtually all “new economy” companies, such as Microsoft, AOL, and Home Depot, offer 401(k) plans only.
Why Social Security Needs Reform
Congress could learn a great deal by studying the changes corporate America has made in pension-fund reform. In fact, Social Security is in a worse position than most corporate plans were.
Since less than a fourth of all contributions go into the Social Security “trust fund,” the government program is more a pay-as-you-go system than a defined-benefit plan, where most of the funds go into a corporate managed trust fund. As a result, the unfunded liability, or payroll-tax shortfall, exceeds $20 trillion over the next 75 years. To pay for so many current recipients, Congress has had to raise taxes repeatedly to a burdensome 12.4% of wages, and payroll taxes will need to be raised another 50% by the year 2015 to cover the growing shortfall. Few corporate plans require such high contribution levels.
Moreover, the Social Security trust fund is poorly managed, so much so that experts indicate that the annual return on Social Security is 3% for single-earner couples and only 1.8% for two-earner couples and single taxpayers.
Here’s What YOU Must Do to Survive Social Security
In sum, you can’t depend on Social Security to take care of your retirement planning needs. Our government – unlike business – is not prone to innovation. As Drucker notes, “Government can gain greater girth and more weight, but it cannot gain strength or intelligence.”
If you’re smart, you will contribute the maximum each year into your corporate 401(k) plan or individual retirement account (IRA). Social Security won’t guarantee you a “secure” future. As usual, you can’t depend on the politicians to provide for your future. You have to do it yourself.
Good Investing,
Mark
Today’s Investment U Crib Sheet
- How does the Social Security Administration determine retirement benefits? First, your actual earnings are adjusted to account for changes in average wages since the year the earnings were received. Then your average monthly adjusted earnings are calculated during the 35 years in which you earned the most. A “formula” is then applied to your earnings to arrive at your basic benefit, to be received at full-retirement age. The Social Security Administration sums it up this way, on its website: “The benefit computation is complex and there are no simple tables that we can present that will tell you how much you will receive.”
- When you invest in Oxford Club Investment Director Alexander Green’s “Perpetual Money” portfolio, you’ll know exactly what your “payments” will be The portfolio’s eight recommendations dish out a total of 96 dividend checks a year, and generate substantial capital appreciation as well. You can reinvest the dividends, receive them in cash, or use them to purchase new investments. And the amount of your payments is tied directly to how much you invest.
- Your Retirement Plan: Have You Calculated Your Number?
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