312 Chapter 7 Retirement PlansSome workers prefer DC plans simply because they like the feeling of having control
over their retirement plan. Even if there are no mathematically measurable benefits to
this, it is nonetheless true that many people prefer a sense of control and ownership. On
the other hand, though, many others dislike DC plans for precisely the same reason. A DC
plan requires workers to make choices they may not want to have to make, and to keep up
on things they may not want to have to keep up on. Someone whose retirement is depen-
dent on a DC plan will probably be watching the stock market’s performance much more
closely than someone relying on a DB plan.Social Security Privatization
Much has been made over the past decade about proposals to “privatize” Social
Security. This has been particularly (though not exclusively) advocated by conserva-
tive commentators and Republican politicians. As it is presently constructed, Social
Security operates like a DB plan, providing retired workers with income for life on
reaching retirement. (The formula used to determine someone’s benefit is extremely
complicated, but it follows the same general principles that the benefit increases with
the number of years worked and amount earned.) Advocates of privatization argue that
it would be better to replace this system with something similar to a defined contribu-
tion plan, where instead of paying taxes into “the system” for years, workers would
have some or all of their taxes put into investment accounts, which they could manage
for themselves.
There are many different competing proposals for how such a system would work,
but by far the largest challenge to any sort of change comes from the way that the present
system is funded. An employer with a DB plan is required to set money aside and invest
it over the course of each employee’s career so that when the worker retires there will
be adequate assets in place to provide the promised benefits. Social Security, though, is
funded on a pay-as-you-go basis. Most of the Social Security taxes that you pay today are
used right away to pay benefits to current retirees. While at present the system does have
a “trust fund” of assets set aside to provide future benefits, it is not nearly adequate to pay
for all of the future benefits promised under the present system.
If Social Security were to be privatized, the most difficult question to answer is where
the money would come from to pay benefits to current retirees. If the taxes that you now
pay to fund the benefits of current retirees are instead directed to your own account, where
will the money come from to pay those benefits? There are many other challenges to priva-
tization, of course, and while we may eventually see such a change to the system, these
challenges make it hard to see how it could happen in the near term at least.EXERCISES 7.1
A. Defi ned Benefi t PlansInterglobal Consolidated Useful Products Corporation has a defi ned benefi t pension plan for its workers. On retirement
at age 65, the plan provides 1.75% of the 3-year fi nal average salary for each year of service, up to a maximum of 60%.
Exercises 1 to 4 are based on this DB plan.- Calculate the pension benefi t that would be paid for the following years of service and last 3 years’ salaries.
a. 20 years; $42,045; $43,188; $45,657
b. 30 years; $42,045; $43,188; $45,657