The case for American Stakeholder Accounts.
The federal government spends more than $500 billion a year on policies designed to help individuals acquire or build assets. The three most expensive of these policies—the mortgage interest deduction, the property tax deduction, and preferential rates on capital gains and dividends—together deliver 45 percent of their benefits to households with average income exceeding $1 million. “Put another way,” concludes a report commissioned by the Federal Reserve, “the poorest fifth of Americans get, on average, $3 in benefits from these policies, while the wealthiest one percent enjoy, on average, $57,673.”
What if we re-crafted our wealth accumulation policies so that they primarily helped average Americans build assets? Nothing could be more American. It’s what the Homestead Act did. It’s what the GI Bill did. And here’s another example of how it could be done for the next generation of Americans.
Every child born in the U.S. gets a Social Security number. Going forward, every child should get at the same time what could be called an American Stakeholder Account. Parents, grandparents, and anyone else who cared to could contribute funds to a child’s stakeholder account, as could children themselves. Children whose families qualify for the federal child tax credit would have up to $500 added to their accounts each year by the government. Contributions from all sources would be capped at $2,000 per year.
When an account holder reached eighteen, he or she could begin withdrawing a portion of the accumulating funds, but only for the purpose of pursuing post-secondary education and training. At age twenty-five, the account holder could use a portion toward buying a first home or starting a business. But a substantial remainder would be earmarked for retirement.
Now let’s add another important feature. Throughout their working lives, members of the next generation of Americans would be required to contribute 4 percent of their earned income to their stakeholder accounts. Their employers would have the option of contributing another 2 percent. Low- and middle-income households would be eligible for up to $500 per year in government matching funds. Upon retirement, the balance built up in these accounts would be automatically converted into an annuity—a stream of monthly benefits that would flow for the rest of the account holder’s life.
That last part is important. One big problem with saving for retirement through today’s 401(k)s or IRAs is trying to figure out how long you’ll live. Guess wrong, and it’s easy to outlive your savings. You can mitigate that risk by turning your nest egg over to a private investment company when you retire in return for a promise that it will pay you an annuity of fixed monthly payments for the rest of your life. But aside from the risk of that company going broke, most people are shocked when they find out how little those monthly payments are.
Stakeholder accounts, however, could offer more generous and safer monthly annuity benefits. A big reason why annuities purchased in the private market today pay so little is what actuaries call “adverse selection.” People who buy annuities tend to be people in good health who reasonably believe they would outlive their savings if they didn’t purchase them. This phenomenon raises the price and lowers the benefits of annuities for everyone. But the problem is solved if it becomes mandatory that people convert their stakeholder accounts into annuities beyond a certain age, such as, say, sixty-seven. As economist James M. Poterba has written, “Requiring all persons to annuitize their retirement account balances at a specified age is one way to substantially reduce the degree of adverse selection in the annuity market.”
How would the funds building up in a person’s stakeholder account be invested before retirement? Much as they are under the federal government’s wildly successful Thrift Savings Plan, which oversees the retirement accounts of more than three million federal workers, including members of Congress. Under that program, participants have a choice of five different investment vehicles (including bond funds, stock funds, and mixed “life-cycle” funds) provided by carefully regulated private-sector investment firms. Stakeholder accounts would offer a similar range of choices, but the default vehicle into which all retirement savings would flow, unless an account holder specified otherwise, would be an index fund that offered a ratio of stocks and bonds that adjusted automatically according to the account holder’s age.
Because of the size of the Thrift Savings Plan and its ability to have some of the administrative functions performed by government agencies, it is able to negotiate substantial discounts on the fees charged by investment companies, adding to participants’ returns. The American Stakeholder Account plan, because it would serve a much wider population, would enjoy even larger economies of scale.
You could think of stakeholder accounts as both a childhood savings program and a fully funded “add-on” to Social Security for the next generation. Why is that important? Social Security is not about to go broke. But it at best replaces only about a third of most people’s income in retirement, and even sustaining current benefits will require a substantial increase in taxes due to the aging of the population. With the inevitable continued decline of the number of workers covered by traditional, defined-benefit private pension plans, and the manifest failure of today’s 401(k)s and other defined-contribution plans to adequately prepare many Americans for retirement, stakeholder accounts are vitally needed to ensure the old-age security of the next generation.
It is impossible to say, of course, exactly what the balances in stakeholder accounts would build up to over the decades to come. There are many variables at play, from returns on capital to average wages and the amount an individual adds or withdraws from the account at different times. But let’s take a look at the likely outcome for a hypothetical child—let’s call him Sam—born in 2013.
If Sam’s account is endowed with $500 a year, it will grow to nearly $15,000 by the time he is eighteen, assuming an average 5 percent rate of return. (While there is no guarantee that the actual rate of return will be 5 percent, it’s not an unrealistic number to use; between 1950 and 2009—a year when the stock market tanked—the average after-inflation return on the S&P 500 was 7 percent.) Assume that Sam spends $5,000 of the stakehold to get vocational training, and at age twenty takes a job as a plumber, a medical technician, or an auto mechanic, with a starting income of $30,000. Assume also that as Sam gains seniority, his income grows, by about 2 percent a year, reaching $77,000 by the time he is sixty-seven, and that along the way he contributes just the minimal 4 percent of income to the account annually. Under these assumptions, Sam’s account would grow to more than $426,000 by age sixty-seven. Though we can’t know what interest rates or life expectancy will be by then, it is not unreasonable to assume that this sum could be converted into an annuity paying roughly $35,000 a year for the rest of Sam’s life (more if interest rates are high, less if life expectancy at age sixty-seven improves dramatically between now and then).
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