I received the following from a reader this morning, making an excellent point:
I think that one of the biggest untold problems with 401k’s is rarely ever discussed (in reference to your posting Screwing Workers). I read an article in the Stanford Alumni magazine a while ago (wish I had kept the copy!) that said that one of the worse problems with our current focus on individual 401K’s was that this ties up so much more money in savings than what really would be needed for covering our retirements. The difference between a pension plan and a 401K savings plan is that one is a pooled plan and the other is an individual plan. If we go fully to an individual savings plan, then everyone must save every penny they would need for their maximal retirement lifetime (eg: I might live until I’m 100 years old, and therefore, I must save enough to cover 35 years of retirement — based on retiring at the age of 65). However, there are very few people that will actually live that long — and in fact, most people will not. In this scenario, if you bet you won’t live that long, then don’t save enough, and end up doing so — you are really out of luck! The other alternative is to join into a pooled insurance plan (what used to happen in a company pension plan), where you pool your savings with lots of other people. This allows you all to set aside some money to cover your retirement, but not as much as you would need to cover a full 35 years of retirement. Because some people die earlier and some die later, this balances out nicely for everyone as long as everyone’s combined share is enough to cover the whole pool’s requirements.
The important thing about pooling vs individual savings is that the amount of money that needs to be set aside is significantly lower than if each individual saved the entire amount they would need “just in case”. The article also pointed out that if this unnecessarily large amount of money was not set aside in personal accounts, then it could be used to cover other things we deem important — schooling, roads, etc.
There is something very strange about our latest love affair for private accounts. What is it about a society that decides that everyone much supply their own needs and scorns anything where we work together to solve problems? (And where does it end? When each of us is responsible for providing our own security, school, health?)
Thanks for your blog — it really has some very interesting and important topics.