What Does It Cost To Guarantee Returns?

Abstract

The financial crisis has dramatically demonstrated how a collapse in equity prices can decimate retirement accounts. The crisis highlights the fragility of existing 401(k) plans as the only supplement to Social Security and has sparked proposals to reform the retirement income system. One component of such a system could be a new tier of retirement accounts. Given the declines in the share of earnings Social Security will replace, these accounts would bolster replacement rates for low-wage workers and increase the security of middle- and upper-wage workers who increasingly rely on their 401(k) plans to supplement Social Security. However, these new accounts could face the same risk of collapse in value seen over the past year in 401(k)s. So policymakers may find some form of guaranteed return or risk sharing desirable to prevent huge variations in outcomes. This brief explores the feasible range and the cost of the first option – guarantees...