DIY Replacement for Social Security or DBP

[kyounge1956]

Whenever the topic of Social Security or pension underfunding comes up, it evokes comments such as

You're going to pay for that pension one way or another, I'd rather trust that money to myself, than some entity that may be bankrupt 30 years down the road when I need that money.

One in the hand is worth two in the bush.

or

...for you and for most on this site, having no company pension scheme or opting out of the one on offer, will work out better.

Social Security provides a retirement income that:

• starts at 62 (or pays more if you delay a few years),
• is adjusted for inflation,
• has no stock market or interest rate risk,
• continues for the rest of your life,
• even if you become mentally incompetent, and
• can continue to pay benefits to a beneficiary who outlives you

A defined pension benefit may lack the inflation adjustment, and you may be able to start drawing benefits before age 62, but otherwise has the same characteristics as SS. So this is a thought experiment: as a do-it-yourself investor, how would you replicate—or even improve on—Social Security or a defined pension benefit?

 

[TN_INVEST]

as a do-it-yourself investor, how would you replicate—or even improve on—Social Security or a defined pension benefit?

The best part about SS is that it is a forced retirement savings plan. I for one think the folks on this website could/would manage their money nicely, but I also know the average person out there would/could not. If they could, we'd see a lot more folks with $1million dollar nest eggs.

Having said all of that, I still don't care for all the government intervention. I'd very much like to be able to self-direct my SS tax.

 

[Huston55]

I'm 56 and hoping to FIRE shortly so, this thread was of interest to me. I think part of my answer to this question will likely be fixed annuities. With mine and my wife's SS plus an Air Force Reserve pension, a fixed annuity would be a way to ensure enough "essential" income, leaving us room for a more common asset allocation with the remainder of our portfolio, and we would worry less about market performance. I'd very much like to hear thoughts from others, especially regarding fixed annuities.

 

[Midpack]

I don't know of any way to mimic SS or a DBP except some form of annuity. I plam to consider annuitization as an option for one day, but now is the worst time (low interest rates) for anyone if it can be delayed at least.

 

[rescueme]

...now is the worst time (low interest rates) for anyone if it can be delayed at least.

And when is the best time, if you look at SPIA as a "income vehicle" for retirement?

Just one who has an SPIA (and purchased in a low-interest period) and sees this comment tossed around a lot (sometimes as "fact").

So what are you going to live on, if you don't have that SPIA (assuming the SPIA is funded with your retirement investments - not speaking of SS or pension plans, which may even eliminate the SPIA option)?

 

[MichaelB]

I don't know of any way to mimic SS or a DBP except some form of annuity. I consider annualizing an option for one day, but now is the worst time (low interest rates) for anyone if it can be delayed at least.

I view annuities the same, but had the same thought 10 years ago when effective returns on annuities were higher. My mistake is focusing on rate of return instead of looking at the income guarantee. IOW, not knowing how to value the most important part of the annuity.

A strategy I saw mentioned a few weeks ago stuck in my mind: when rebalancing, instead of shifting assets from equities to fixed income, use the equity proceeds to invest in annuity, and build it up over time. Something to look into.

 

[rescueme]

IMy mistake is focusing on rate of return instead of looking at the income guarantee. IOW, not knowing how to value the most important part of the annuity.

You understand.

Per my old standard: "In retirement, cashflow is everything"...

Folks tend to look at (SPIA's) as an investment; it is not. It is much like SS or a pension, in that view, as a source of retirement income. I understand the confusion...

 

[chinaco]

No you cannot do it on your own (by yourself)... there is the effect of pooling money from multiple lives.

And even if you could get others individuals to participate... I am pretty sure it is illegal.

I suppose your could buy TIPS (e.g. build a ladder) till you are 105... some period longer than you might possibly live. That would be DIY... but you would not have the pooling of money and... the credit risk of the USA.

You could buy a lifetime payout annuity from an insurance company.... but that is not a DIY situation.

 

[ERD50]

Social Security provides a retirement income that:

• starts at 62 (or pays more if you delay a few years),
• is adjusted for inflation,
• has no stock market or interest rate risk,
• continues for the rest of your life,
• even if you become mentally incompetent, and
• can continue to pay benefits to a beneficiary who outlives you

So this is a thought experiment: as a do-it-yourself investor, how would you replicate—or even improve on—Social Security or a defined pension benefit?

Good thread topic. However, I think you are putting SS on a bit of a pedestal that it doesn't deserve. As I understand it, there is no 'lock box'; SS is funded out of the general fund, and we are now spending 1.4x what we take in. So I don't think we can view SS as low risk as you imply. This past week, the President said he couldn't guarantee that SS checks would go out, and the debt deal we got projects increasing debt - it just keeps getting worse. The 'cuts' are just reduction in the growth of the debt, not real cuts as we would think of them.

Put another way - it's not really apples-to-apples to compare a privatized account with the govt SS 'account' because there is a lot of smoke-and-mirrors there. That's one of my problems with it.

I think the govt could (with lots of conditions and external checks and balances) be in a good position to handle the distribution of that private account once it has been accumulated. They should be able to provide the annuity side of it, averaging out that longevity risk for us, at near zero cost. We should have the option of annuitizing some/all of it, so we could decide to pass some on to heirs if that is desired. Or even just let the actuarial rules apply to choose to pay $X or X% at death to a beneficiary, at whatever cost (reduced benefit) is needed.

We would either need some sort of forced savings, and/or some real education on this topic. Even to the point of signing a waiver if you don't have enough withheld form your paycheck. Something like "I, ERD50 have read and understand that I am not saving enough for my retirement. I have other sufficient sources of retirement funding, and/or agree that due to my lack of funding my public retirement account, I will forego future retirement government support. I agree to live under the bridge in a cardboard box if it comes to that." - OK, not quite like that, but close.

Another way to view this whole things is - it seems odd to think of SS as providing any 'better deal' than anything else (other than the ability to spread longevity risk). It is our money going in, and our money coming out. No value is created anywhere along the line. Where is the 'magic' in SS?

Maybe 'magic' is a good word, it seems to me that much of what you describe as benefits, are really 'sleight of hand tricks' - when you say "no stock market risk", really? The economy has tanked, govt revenues are down because of that, govt spending is up to pay unemployment and attempts to stimulate the economy... so the funds available to pay those SS checks are dwindling. There is definitely risk there, it is just sort of hidden by the accounting. At least that is how it appears to me.

That's not meant to criticize what you wrote, I just think it deserves to be looked at in a different light. Discuss

-ERD50

 

[kyounge1956]

No you cannot do it on your own (by yourself)... there is the effect of pooling money from multiple lives.

And even if you could get others individuals to participate... I am pretty sure it is illegal.

I suppose your could buy TIPS (e.g. build a ladder) till you are 105... some period longer than you might possibly live. That would be DIY... but you would not have the pooling of money and... the credit risk of the USA.

You could buy a lifetime payout annuity from an insurance company.... but that is not a DIY situation.

I don't know of any way to mimic SS or a DBP except some form of annuity. I consider annualizing an option for one day, but now is the worst time (low interest rates) for anyone if it can be delayed at least.

My question was not intended to exclude purchase of annuities. I think Midpack is right—annuities in some form would be required to reproduce the SS/pension characteristic of continuing for life (and potentially to a survivor).

 

[Midpack]

And when is the best time, if you look at SPIA as a "income vehicle" for retirement?

Just one who has an SPIA (and purchased in a low-interest period) and sees this comment tossed around a lot (sometimes as "fact").

So what are you going to live on, if you don't have that SPIA (assuming the SPIA is funded with your retirement investments - not speaking of SS or pension plans, which may even eliminate the SPIA option)?

I agree annuities can be a best option in some situations, that's why I said it is one of several Plan B's for me. But interest rates are clearly at historic lows, essentially can't go any lower, so annuities are more expensive now than historically.

For anyone who has retired at all recently, hopefully they pulled the ripcord in Otar's green zone, IOW with a nest egg (much) greater than needed for calculated SWR, 4% or whatever your plan --- in which case you have more than needed to buy an annuity now. Instead, I'd use that to generate cash to live on for now (as I am, but just retired) until interest rates rise (and they certainly will, just a matter of when), and then buy an annuity cheaper later or when you cross your annuitization hurdle.** Note my first post included "if it can be delayed."

For someone who is at or below Otar's red zone threshold, the risk is too great to wait, and you're probably forced to act on an annuity now, unfortunately at a historically higher than normal cost.

**This has been shared here before, but here's the best annuitization strategy I've seen FWIW http://spwfe.fpanet.org:10005/publi...mulation_ A New Strategy for Managing Ret.pdf

 

[kyounge1956]

Good thread topic. However, I think you are putting SS on a bit of a pedestal that it doesn't deserve. As I understand it, there is no 'lock box'; SS is funded out of the general fund, and we are now spending 1.4x what we take in. So I don't think we can view SS as low risk as you imply. This past week, the President said he couldn't guarantee that SS checks would go out, and the debt deal we got projects increasing debt - it just keeps getting worse. The 'cuts' are just reduction in the growth of the debt, not real cuts as we would think of them.

Put another way - it's not really apples-to-apples to compare a privatized account with the govt SS 'account' because there is a lot of smoke-and-mirrors there. That's one of my problems with it.

I think the govt could (with lots of conditions and external checks and balances) be in a good position to handle the distribution of that private account once it has been accumulated. They should be able to provide the annuity side of it, averaging out that longevity risk for us, at near zero cost. We should have the option of annuitizing some/all of it, so we could decide to pass some on to heirs if that is desired. Or even just let the actuarial rules apply to choose to pay $X or X% at death to a beneficiary, at whatever cost (reduced benefit) is needed.

We would either need some sort of forced savings, and/or some real education on this topic. Even to the point of signing a waiver if you don't have enough withheld form your paycheck. Something like "I, ERD50 have read and understand that I am not saving enough for my retirement. I have other sufficient sources of retirement funding, and/or agree that due to my lack of funding my public retirement account, I will forego future retirement government support. I agree to live under the bridge in a cardboard box if it comes to that." - OK, not quite like that, but close.

Another way to view this whole things is - it seems odd to think of SS as providing any 'better deal' than anything else (other than the ability to spread longevity risk). It is our money going in, and our money coming out. No value is created anywhere along the line. Where is the 'magic' in SS?

Maybe 'magic' is a good word, it seems to me that much of what you describe as benefits, are really 'sleight of hand tricks' - when you say "no stock market risk", really? The economy has tanked, govt revenues are down because of that, govt spending is up to pay unemployment and attempts to stimulate the economy... so the funds available to pay those SS checks are dwindling. There is definitely risk there, it is just sort of hidden by the accounting. At least that is how it appears to me.

That's not meant to criticize what you wrote, I just think it deserves to be looked at in a different light. Discuss

-ERD50

OK, I'll discuss. I meant, taking SS/DBP "at face value". Stable lifetime real income, low risk, survivor benefit, etc, is what pensions or SS were supposed to provide. How close can DIY-ers come to replicating these qualities? By "no stock market or interest rate risk" I was trying to describe the fact that with SS or a pension benefit, it doesn't matter what year you retire. Your benefit doesn't change if the market crashes the day after you retire, and you don't get a lower monthly income if interest rates happen to be very low when you start drawing benefits; the amount you receive is based on your age when you retire and your income while working (plus years of service with that employer for a DBP).

I only have a vague idea of how one would replicate these characteristics. My attempts at it would probably involve ladders—maybe ladders of TIPS or zero-coupon bonds during accumulation, and ladders of COLA'd annuities for the payout. That wouldn't totally eliminate interest rate risk but it would spread it out between many different years. Maybe it would be possible to develop a rule of thumb based on current interest rates and the saver's age that tells whether to put this year's savings into a bond or into a deferred annuity that starts to pay when you turn 62. I don't see how stocks could be included at all without also introducing the risk that a market crash could drastically affect either the eventual benefit amount or the ability to retire at 62.

And speaking of 62, one way a plan like this could be "better" than SS is that as a DIYer I could plan to make it possible to start taking (appropriately reduced) benefits at age 50 or 55. Age discrimination exists, and if I were trying to formulate a strategy to replace SS, I'd equip mine with an "emergency ripcord" in case I got hit by a late-career layoff or health problem. I was thinking about that in connection with this thread. If I do end up with money to leave to heirs, I'd give serious thought to trying to set up something they could draw on if they find themselves in that situation.

I really wasn't trying to start a "what's wrong with SS" thread. I'm curious to know how the intended qualities of SS and DBPs could be replicated, because IMO they have some real advantages over defined contribution plans.

 

[old woman]

If you were 18 trying to do this you would need to invest consistently for 40 years maybe in an annuity. You would also need life insurance to cover minor children and a spouse you might have someday. Also disability that would pay you and your minor children if you are disabled.

With SS a 18 year old worker is covered for disability and survivors benefits after 6 quarters so if they were working at 16 they are covered already. If they have a child or several and die or are disabled they will get payments for themselves and or children for life or until the children are grown.

Retirement is the easy part most 18 year old parents don't have the will to cover all the risk and unless forced wouldn't save for retirement and buy insurance to cover the rest.

 

[ERD50]

OK, I'll discuss. I meant, taking SS/DBP "at face value".

...

I really wasn't trying to start a "what's wrong with SS" thread. I'm curious to know how the intended qualities of SS and DBPs could be replicated, because IMO they have some real advantages over defined contribution plans.

OK (and I'll address this in a moment), I was just trying to be clear that if we constructed this for ourselves, it probably won't 'look' as 'good' as SS. The 'stability' of SS is just an illusion. Imagine if in our private account, if we had a turn-down, we just borrowed from our credit card and pretended we were OK. And when that ran out, we borrowed from our kids, and kept telling ourselves that we were doing fine because our stable monthly payment just kept coming in. With that out of the way...

I'd suggest what others have - buy an annuity - that is what you are describing. You can get them quoted for COLA and survivor benefits. Then work backwards to determine how much you need to save to come up with enough to buy that annuity at your retirement age. It's probably not going to look pretty, but often the truth isn't. But it would be an honest measure of what it takes to fund our retirement, instead of that other thing that I was done talking about

-ERD50

 

[kyounge1956]

If you were 18 trying to do this you would need to invest consistently for 40 years maybe in an annuity. You would also need life insurance to cover minor children and a spouse you might have someday. Also disability that would pay you and your minor children if you are disabled.

With SS a 18 year old worker is covered for disability and survivors benefits after 6 quarters so if they were working at 16 they are covered already. If they have a child or several and die or are disabled they will get payments for themselves and or children for life or until the children are grown.

Retirement is the easy part most 18 year old parents don't have the will to cover all the risk and unless forced wouldn't save for retirement and buy insurance to cover the rest.

You're right. I wasn't even thinking about the other things SS does. Insurance would certainly be needed to replicate the disability income and coverage for surviving minor children.

 

[GregLee]

I was just trying to be clear that if we constructed this for ourselves, it probably won't 'look' as 'good' as SS.

But even though our constructed version didn't 'look' as 'good', it would actually be as 'good'? Is that what you mean? Why do you use scare quotes? Is 'good' not necessarily good?

The 'stability' of SS is just an illusion. Imagine if in our private account, if we had a turn-down, we just borrowed from our credit card and pretended we were OK. And when that ran out, we borrowed from our kids, and kept telling ourselves that we were doing fine because our stable monthly payment just kept coming in. With that out of the way...

It's not out of the way. If that monthly payment does just keep coming in, is that illusory? It seems to be 'stable', in scare quotes, but it's not actually stable (no scare quotes)? Does this make any sense at all?

 

[youbet]

Don't forget SS is progressive. It pays a higher percentage of low contributions than of high contributions. How do you replicate the wealth redistribution property of SS?

 

[pb4uski]

I don't know of any way to mimic SS or a DBP except some form of annuity. I plam to consider annuitization as an option for one day, but now is the worst time (low interest rates) for anyone if it can be delayed at least.

I suppose that it would be theoretically possible to replicate SS or DBP cash flows with a ladder of CDs and bonds that mature at successive points in the future but it wouldn't be practical to do.

 

[ERD50]

Originally Posted by ERD50
I was just trying to be clear that if we constructed this for ourselves, it probably won't 'look' as 'good' as SS.

But even though our constructed version didn't 'look' as 'good', it would actually be as 'good'? Is that what you mean? Why do you use scare quotes? Is 'good' not necessarily good?

Right, because there are lots of ways to define 'good'. Like something that is good in the short term, but falls apart long term. That's a questionable kind of good.

The 'stability' of SS is just an illusion. Imagine if in our private account, if we had a turn-down, we just borrowed from our credit card and pretended we were OK. And when that ran out, we borrowed from our kids, and kept telling ourselves that we were doing fine because our stable monthly payment just kept coming in. With that out of the way...

It's not out of the way. If that monthly payment does just keep coming in, is that illusory? It seems to be 'stable', in scare quotes, but it's not actually stable (no scare quotes)? Does this make any sense at all?

That is what I'm saying. Something that is propped up by an outside force isn't stable in the same way as something that stands on its own.

If you can meet your needs with your income, but your neighbor needs to go into credit card debt to meet that same standard of living, he isn't as stable as you are. But there is the illusion of stability to anyone who does not know how that standard of living is being financed. Is it really that hard to understand?


-ERD50

 

[chinaco]

My question was not intended to exclude purchase of annuities. I think Midpack is right—annuities in some form would be required to reproduce the SS/pension characteristic of continuing for life (and potentially to a survivor).

OK... I thought by DIY.... you meant that you are going to directly manage the securities or program to produce the income.


The only thing that I know of is a Payout Annuity. Insurance Companies/Annuities, Pension Plans (private and govt run) are about it.

Matter of fact... some DC plan have included that option already. But not many. DW has a DC plan that explicitly lists a payout annuity as an option.

Other than acquiring enough assets to cover all of your life risks/events (at the extreme) and investing the assets fairly conservatively (i.e., mostly fixed/high grade)... I am not sure you could produce the same guarantee as an entity that pools money and back that pool with other resources (i.e., they mitigate the risk with other money they have collected from other pools of money or sources of money).


Another problem aside from SS and all of the benefits it cover (e.g, LTD, survivor, etc)....


Is healthcare... bear with me while I explain the connection.. it is related but somewhat indirect. SS and Medicare are two sides of the coin.

If you had to fund your healthcare and go into the private sector to buy health care there would be a couple of big obstacles (perhaps insurmountable) with the current systems available.

1. Private healthcare would cost you more... in theory and reality. So your SS clone income solution would need to pay the full premium for private healthcare. So you would need to add to your amount of payout to cover that expense. (FICA payment cover both). Your SS benefit alone is not all of the cost or funding.
2. In our current private system, if you became disabled or had real healthcare problems... private insurance companies might no insure you or use some pre-existing clause to deny you benefits. Since health problem can be non-determinant (huge health problems for a long time vs you just drop dead)... you would need to have a reserve to cover a lifetime of health care cost if private insurance refused to cover you.

Our current private system is lacking in the sense that you can be excluded through various means.

IOW - You could buy an annuity from an insurance company for guaranteed income... but the way Health insurance works today, you might very well be frozen out (refused)... Since people are more likely to have problems as they age... it is almost a certainty!

 

[chinaco]

I suppose that it would be theoretically possible to replicate SS or DBP cash flows with a ladder of CDs and bonds that mature at successive points in the future but it wouldn't be practical to do.

Bingo.

You would have to mitigate life event risks (e.g., longevity) with assets that are low risk in terms of investment type risk (to guarantee you do not lose it... have enough, and it is liquid.. available when needed).

Pooling money is the only technique to solve that problem short of having excess assets... IOW - being better off financially than they probably are. But... one has to get past the fact that others may wind up getting their money (that they paid in).

 

[rescueme]

But... one has to get past the fact that others may wind up getting their money (that they paid in).

That's the case with a "pure" SPIA (e.g. no riders), where you could die the day after the policy is issued. OTOH, money is for the living, not the dead (so what are you complaining about? ).

Anyway, don't current SS recipients get money paid by current wor*ers (e.g. "their money")? Sorry, I could not resist - even though I understand where you are coming from .

Anyway, most SPIA's have options such as inflation adjustment schemes, defined terms (length) of the policy etc, in which you give up a few dollars of monthly income to "protect" your premium.

For instance, while my SPIA is not inflation adjusted (since was purchased with the intent to provide higher immediate monthly income - without that option, for a limited time - till DW/me both drew SS). However, we did opt for the life (term) rider.

At the time of purchase (at age 59, for both of us), it was calculated that we (either/both) would live another 28 years, till age 87 and that was part of the policy. If we both passed before age 87, remaining payments would go to our estate - which addresses your concern. OTOH, if one/both would win the "longevity lottery" in living past age 87, the payments will continue (at 100%) till both are gone.

It's also easier to calculate an IRR return of the policy since we know the monthly payments x 28 years (336 minimum payments). And if one of us lives longer, the IRR return actually increases since payments continue after expected.

SPIA's are not for everybody, nor will fulfill every need. However, for us it acts the same as a company pension (which I don't - but DW does) operates. That is for a lifetime, normally without inflation protection. However, unlike a company pension, there is no reduction at age 62 (SS offset) nor reduction in payout to the spouse if the retiree dies, as my DW's single-life pensions will do. Additionally, a company pension (just like an insurance company) can be greatly reduced if the company goes under (as happened to both my FIL and BIL) and reduced payments are given by the PBGC. As for an insurance company paying for an SPIA? There are state programs that operate in the same manner to give you a certain level of protection.

More importantly (and just for us), it provides a good base of income in ER, which also allows us to delay our SS. In fact, we get to "trade up" from an income vehicle that is fixed to a superior lifetime, inflation adjusted income - AKA SS. And don't forget, the SPIA income does not stop/get reduced once we start SS.

We (or our estate) will never receive less than our premium, based upon a non-inflation adjusted total; in fact, we will receive a bit over 2x what the premium was. Could we do better by investing on our own? Quite possibly. However that is done, and increased risk taken with the remainder of our retirement portfolio. The SPIA is basically risk free (with the standard disclaimer of the insurance company viability). Of course, with the long term outlook of SS and discussion on this/other boards, SS may not be the only answer for everybody - especially much younger. We're both SS age (but delaying filing) so our SS outlook is a bit more positive.

For us, the SPIA (along with SS, DW's pensions, and other minor income) is just a bit more diversification in our retirement income streams; nothing more than all of us do (except those holding all cash/CD's - by at least one person on this board) in our overall investing.

Again (my mantra), "in retirement - cash flow is everything". We want to make sure that as one "spigot" dries up, there are others that continue to flow.