The future of Social Security is on the political agenda.  The Bush administration is promoting "privatization".  Lawmakers and economists propose alternative plans.  Most proposals include a reduction of future benefits.

The Bush administration has endorsed PMAs ("Privately Managed Accounts") as the answer to the Social Security funding problem.

In the late 1970s public corporations began lobbying the federal government to change the nature of pension benefits, from defined benefit plans to defined contribution plans, such as 401k plans.

In 1981 their lobbying paid off, and the tax regulations were changed to allow for a tax deduction for employee contributions to such plans. 

Until then, employers had typically provided retirement benefits in the form of a pension:  a guaranteed payment, based on the worker's highest earning years, lasting the worker's lifetime (and often for the spouse's as well), including disability benefits.

The 401k plan was a different beast.  The worker was allowed to contribute a portion of salary to an individual account, owned and managed by the worker.  

Why do you think corporations prefer 401k plans to pension plans?  Because it's better for the worker?  No, because the risk is borne by the worker in a 401k plan, and by the corporation in a pension plan.

Do workers earn higher returns in 401k plans?  No, administrative and transaction costs are MUCH higher for 401(k)s than for pensions. The CalPERS pension plan costs are 0.37% of assets per year.  THe average 401k costs 2% of assets per year. 

From 1990 to 2002, CalPERS earned 8.5% annually, after expenses.  The median 401k plan participant? 4.9% after expenses.

In another case, the state of Nebraska compared returns of a group of state employees in a 401k-type plan to the return of their state pension fund.  The 401k-type average returns?  Between 6% and 7%.  The pension?  11%.

The Bush plan implies that payroll taxes will be diverted to PMAs, which are destined to earn higher returns than Social Security provides.   Perhaps a more manageable step is to first improve the Social Security Administration's efficiency, effectively increasing those returns.

Sounds like a wonderful product, doesn't it?

But the insurance provides coverage only for the costs associated with restoring your identity and repairing your credit rating.  The coverage is typically limited to $20,000.

This insurance does not protect you from the most catastrophic effects:  loans taken out in your name, large purchases, withdrawals from your accounts.  Nor does it restore your good credit rating.

The coverage does NOT provide reimbursement of the value of your personal time required to recover from the damage of identity theft.

Let's hope that the insurance companies create a product to protect against the real risks of identity theft.

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First, let's think of your financial plan summarized in a single graph:  your year-by-year investment assets until age 90.  A desirable plan projects sufficient assets to fund your life-time objectives, with sufficient assets at the end as a cushion against various types of risk.

Next, think about how your survivors would fare financially if you died tomorrow.  Would your spouse work?  Take time off for grieving?  Hire a nanny?  Remarry? 

Then, let's imagine recreating the plan, to generate the same chart.  If, for example, you are the primary earner in your family, what would the graph look like without your expected earnings? 

If your death significantly changes the graph, the gap should be funded by life insurance.  The amount of insurance needed is defined as the lump sum that would be needed now to fund your family's objectives if you were to die tomorrow.