WEBVTT 00:00:00.000 --> 00:00:01.919 Welcome back to the Deep Dive. We're here to 00:00:01.919 --> 00:00:05.559 give you the clearest possible shortcut to, well, 00:00:05.679 --> 00:00:08.679 really understanding the big topics. Today, we 00:00:08.679 --> 00:00:10.419 are diving into something that affects almost 00:00:10.419 --> 00:00:13.880 everyone. Retirement security. It's a universe 00:00:13.880 --> 00:00:17.850 of... you know, acronyms, jargon, complex math. 00:00:18.230 --> 00:00:20.589 It honestly feels like it's designed to be confusing. 00:00:20.769 --> 00:00:23.190 So our mission for this deep dive using the great 00:00:23.190 --> 00:00:25.530 source material you send over is to just cut 00:00:25.530 --> 00:00:27.890 right through all of that noise. We want to give 00:00:27.890 --> 00:00:30.030 you a really clear map of the two foundational 00:00:30.030 --> 00:00:32.810 types of retirement plans. We're talking defined 00:00:32.810 --> 00:00:35.969 benefit or GB plans, the classic pensions you 00:00:35.969 --> 00:00:38.350 think of from your parents' generation, and then 00:00:38.350 --> 00:00:41.229 defined contribution or DC plans, which are, 00:00:41.289 --> 00:00:43.509 you know, pretty much the global standard now. 00:00:43.609 --> 00:00:46.399 They represent Totally different contracts, really. 00:00:46.539 --> 00:00:49.119 OK, let's unpack this. I think that's the perfect 00:00:49.119 --> 00:00:50.920 way to frame it. The whole thing, this entire 00:00:50.920 --> 00:00:53.399 deep dive, it really boils down to one simple 00:00:53.399 --> 00:00:56.020 question. What exactly is the employer promising 00:00:56.020 --> 00:00:58.460 to define? Is the guarantee about the benefit 00:00:58.460 --> 00:01:00.380 you'll get years from now? Or is it just about 00:01:00.380 --> 00:01:02.460 the contribution they'll make today? Precisely. 00:01:03.079 --> 00:01:07.180 In a defined benefit or DB plan. The employer 00:01:07.180 --> 00:01:09.280 guarantees a specific payment. It could be a 00:01:09.280 --> 00:01:11.060 monthly check for life, a lump sum, whatever. 00:01:11.359 --> 00:01:13.980 But that final amount, it's predetermined by 00:01:13.980 --> 00:01:16.480 a formula. You know what you're getting. But 00:01:16.480 --> 00:01:19.659 in a defined contribution, a DC plan, it's the 00:01:19.659 --> 00:01:22.480 formula for the contribution that's known. You 00:01:22.480 --> 00:01:23.780 know, what you and your employer are putting 00:01:23.780 --> 00:01:26.840 in. But the final benefit, that's totally up 00:01:26.840 --> 00:01:29.439 in the air. It depends entirely on how your investments 00:01:29.439 --> 00:01:31.879 do. You won't know the real number until the 00:01:31.879 --> 00:01:33.879 day you retire. So it's the difference between 00:01:33.879 --> 00:01:35.980 a contract that says, we promise you'll get $5 00:01:35.980 --> 00:01:39.040 ,000 a month when you're 65 versus one that says, 00:01:39.120 --> 00:01:41.640 we promise to put $5 ,000 in an account for you 00:01:41.640 --> 00:01:44.500 every year. But good luck. That's a great way 00:01:44.500 --> 00:01:46.640 to put it. It seems like a simple tradeoff, but 00:01:46.640 --> 00:01:48.459 I imagine the consequences for who holds the 00:01:48.459 --> 00:01:50.579 risk for liability are just massive. They're 00:01:50.579 --> 00:01:53.760 enormous. And U .S. law, especially the Internal 00:01:53.760 --> 00:01:56.319 Revenue Code, draws a really sharp line between 00:01:56.319 --> 00:01:59.560 them. A D .C. plan is basically... Any plan with 00:01:59.560 --> 00:02:01.920 individual accounts where your benefit is solely 00:02:01.920 --> 00:02:04.340 based on what's in that account, the contributions 00:02:04.340 --> 00:02:07.840 plus any earnings, a DB plan. It's simply defined 00:02:07.840 --> 00:02:10.340 as any qualified pension plan that isn't that. 00:02:10.479 --> 00:02:13.240 The structure itself dictates who is responsible 00:02:13.240 --> 00:02:15.460 for what. All right, let's start with that older 00:02:15.460 --> 00:02:17.520 model then, the one that sells the promise of 00:02:17.520 --> 00:02:20.969 certainty, the defined benefit plan. Historically, 00:02:21.009 --> 00:02:22.889 these were the gold standard for governments, 00:02:23.189 --> 00:02:25.849 public sector jobs, and those huge industrial 00:02:25.849 --> 00:02:28.270 companies that really dominated the middle of 00:02:28.270 --> 00:02:31.030 the 20th century. Our sources even say that these 00:02:31.030 --> 00:02:33.389 pensions were sometimes used as a form of deferred 00:02:33.389 --> 00:02:35.370 pay. Like instead of a bigger paycheck today, 00:02:35.430 --> 00:02:37.569 you get this promise of security tomorrow. And 00:02:37.569 --> 00:02:40.710 that context is so important because if it's 00:02:40.710 --> 00:02:43.409 a promise of deferred pay, the employer has to 00:02:43.409 --> 00:02:45.370 be the one to carry that liability. They manage 00:02:45.370 --> 00:02:48.520 the fund. They make the investment choices. this 00:02:48.520 --> 00:02:50.819 is the critical part, they bear all the investment 00:02:50.819 --> 00:02:53.900 risk. If the market tanks or interest rates fall 00:02:53.900 --> 00:02:56.639 off a cliff, it's the employer's job to step 00:02:56.639 --> 00:02:58.740 in and make up the difference. So the employee 00:02:58.740 --> 00:03:01.199 gets that certainty, but the company gets all 00:03:01.199 --> 00:03:03.259 the volatility. Okay, but here's the part I think 00:03:03.259 --> 00:03:05.599 most people don't get. What happens on the flip 00:03:05.599 --> 00:03:09.020 side? If the investments do amazingly well, who 00:03:09.020 --> 00:03:11.750 gets that extra money? That surplus. It goes 00:03:11.750 --> 00:03:13.530 right back to the employer, the plan sponsor. 00:03:13.729 --> 00:03:15.229 And when you think about it, that makes perfect 00:03:15.229 --> 00:03:17.810 sense structurally. Since they're legally required 00:03:17.810 --> 00:03:20.409 to cover any and all deficits to pay you that 00:03:20.409 --> 00:03:22.949 promised benefit no matter what, they also get 00:03:22.949 --> 00:03:25.430 to keep any of the upside. For the employee, 00:03:25.669 --> 00:03:27.909 the target is always just that preset benefit. 00:03:28.110 --> 00:03:30.389 It doesn't matter if the fund is at 80 % of its 00:03:30.389 --> 00:03:34.849 goal or 120%. Wow. That sounds incredibly risky 00:03:34.849 --> 00:03:37.009 for a company, especially today. I mean, how 00:03:37.009 --> 00:03:38.669 do they even start to calculate how much they 00:03:38.669 --> 00:03:40.960 need to put in each year? That is the million 00:03:40.960 --> 00:03:43.560 -dollar question, and it's the job of an actuary. 00:03:43.860 --> 00:03:46.199 This is why the employer's contributions are 00:03:46.199 --> 00:03:49.319 so uncertain. They aren't fixed. They are, as 00:03:49.319 --> 00:03:52.610 the jargon goes, actuarially determined. And 00:03:52.610 --> 00:03:55.189 this process is basically corporate fortune telling. 00:03:55.389 --> 00:03:58.030 The actuary has to project all these highly uncertain 00:03:58.030 --> 00:04:00.409 variables, you know, decades into the future. 00:04:00.590 --> 00:04:02.990 They have to estimate life expectancy for the 00:04:02.990 --> 00:04:05.090 whole employee group, project future interest 00:04:05.090 --> 00:04:08.550 rates, guess at employee turnover, and then based 00:04:08.550 --> 00:04:10.849 on the specific benefit formula, calculate how 00:04:10.849 --> 00:04:13.009 much cash the sponsor needs to put in today to 00:04:13.009 --> 00:04:15.590 make good on that promise 30 or 40 years from 00:04:15.590 --> 00:04:17.970 now. So if the actuary suddenly revises their 00:04:17.970 --> 00:04:20.160 projections. like people are living three years 00:04:20.160 --> 00:04:22.699 longer or they expect lower interest rates for 00:04:22.699 --> 00:04:24.839 the next decade, the company's required contribution 00:04:24.839 --> 00:04:27.000 for that year could just skyrocket. It could, 00:04:27.120 --> 00:04:28.980 and it often did. I mean, that uncertainty is 00:04:28.980 --> 00:04:31.600 exactly what created the huge balance sheet volatility 00:04:31.600 --> 00:04:33.720 that really started pushing public companies 00:04:33.720 --> 00:04:36.740 away from the DB model back in the 90s and 2000s. 00:04:37.000 --> 00:04:39.699 The contribution is a moving target, but the 00:04:39.699 --> 00:04:42.240 benefit... from the employee's perspective, is 00:04:42.240 --> 00:04:44.860 rock solid. Okay, so let's make that benefit 00:04:44.860 --> 00:04:47.639 more concrete. How is that guaranteed payment 00:04:47.639 --> 00:04:50.259 actually figured out for the worker? There are 00:04:50.259 --> 00:04:52.420 really two main ways it's done. The most common, 00:04:52.519 --> 00:04:54.660 especially for, you know, big professional firms 00:04:54.660 --> 00:04:57.060 and corporations, is the final average pay plan, 00:04:57.199 --> 00:05:01.269 or FAP. Under this model, your benefit is a percentage 00:05:01.269 --> 00:05:03.810 of your average earnings over a certain number 00:05:03.810 --> 00:05:06.329 of years at the very end of your career, say 00:05:06.329 --> 00:05:08.550 your final five years. You take that average 00:05:08.550 --> 00:05:11.370 salary, you multiply it by your years of service, 00:05:11.550 --> 00:05:13.930 and then you multiply that by a fixed percentage, 00:05:14.009 --> 00:05:17.870 like, say, 1 .5 % or 2%. Right. So if you worked 00:05:17.870 --> 00:05:20.529 for 30 years and your average salary in those 00:05:20.529 --> 00:05:23.149 last five years was $100 ,000 and the factor 00:05:23.149 --> 00:05:26.750 is 1 .5%, you'd get $45 ,000 a year for life. 00:05:26.930 --> 00:05:30.850 Yeah. 30 times 1 .5%. Exactly. And you can see 00:05:30.850 --> 00:05:33.149 how that design really incentivizes you to stay 00:05:33.149 --> 00:05:34.930 with the company for a long time and to climb 00:05:34.930 --> 00:05:36.550 the ladder because those last few years have 00:05:36.550 --> 00:05:38.829 the biggest impact. It really rewards that loyal 00:05:38.829 --> 00:05:41.290 long term employee. A simpler version, which 00:05:41.290 --> 00:05:43.329 you see a lot in union contracts, is the dollars 00:05:43.329 --> 00:05:45.970 time service formula. This one is super transparent. 00:05:46.209 --> 00:05:48.949 You get a set dollar amount per month for every 00:05:48.949 --> 00:05:51.439 single year you work. That sounds much, much 00:05:51.439 --> 00:05:53.459 easier to get your head around. It is. If the 00:05:53.459 --> 00:05:55.759 plan says you get, I don't know, $80 a month 00:05:55.759 --> 00:05:58.899 for each year of service, a retiree with 40 years 00:05:58.899 --> 00:06:01.319 knows immediately, okay, I'm getting $3 ,200 00:06:01.319 --> 00:06:04.779 a month. It's a clean, simple promise. That certainty 00:06:04.779 --> 00:06:06.699 is definitely the main appeal. But I want to 00:06:06.699 --> 00:06:08.839 bring in the global context here because the 00:06:08.839 --> 00:06:11.579 UK example in our source material shows how regulators 00:06:11.579 --> 00:06:14.639 can make that promise even stronger by tackling 00:06:14.639 --> 00:06:17.860 a huge risk, inflation. Oh, that's a critical 00:06:17.860 --> 00:06:20.490 point. In the US, a traditional... private DB 00:06:20.490 --> 00:06:22.990 pension usually isn't required to adjust for 00:06:22.990 --> 00:06:26.129 inflation after you retire. But in the UK, it's 00:06:26.129 --> 00:06:28.509 the law. For their registered pension schemes, 00:06:28.709 --> 00:06:31.310 benefits have to be indexed to inflation, the 00:06:31.310 --> 00:06:33.990 consumer price index, up to a certain cap, often 00:06:33.990 --> 00:06:36.930 around 5 % a year. And that's huge. A fixed payment 00:06:36.930 --> 00:06:39.230 of, say, $4 ,000 a month sounds great when you're 00:06:39.230 --> 00:06:42.870 65. But after 15 years of even just 3 % inflation, 00:06:43.230 --> 00:06:45.750 that payment has lost nearly 40 % of its buying 00:06:45.750 --> 00:06:48.319 power. It's been eroded. The UK rules basically 00:06:48.319 --> 00:06:51.240 say we recognize that living a long time combined 00:06:51.240 --> 00:06:53.620 with inflation can destroy your retirement security. 00:06:53.899 --> 00:06:55.620 So we're going to mandate protection against 00:06:55.620 --> 00:06:57.839 that. So when it's time to actually get paid, 00:06:57.939 --> 00:07:00.920 the standard method for a DB plan is an annuity, 00:07:00.939 --> 00:07:03.860 right? A stream of payments. That's right. The 00:07:03.860 --> 00:07:06.300 default payout is almost always a life annuity. 00:07:06.699 --> 00:07:09.160 The plan guarantees you equal periodic payments, 00:07:09.360 --> 00:07:12.379 usually monthly, for the rest of your life. This 00:07:12.379 --> 00:07:15.000 completely manages the employee's longevity risk. 00:07:15.199 --> 00:07:17.779 You can't outlive your money. And on top of that, 00:07:17.939 --> 00:07:20.480 these plans usually have built -in protections 00:07:20.480 --> 00:07:22.899 for a spouse. For example, a joint distribution 00:07:22.899 --> 00:07:25.259 where a surviving spouse continues to get a portion 00:07:25.259 --> 00:07:27.600 of the payment, maybe 50%. That's usually the 00:07:27.600 --> 00:07:29.740 default option. You have to get your spouse to 00:07:29.740 --> 00:07:31.800 sign a waiver to choose something else. What 00:07:31.800 --> 00:07:34.139 if you don't stay until retirement? Say you leave 00:07:34.139 --> 00:07:37.139 after 10 years. You're vested. So you've earned 00:07:37.139 --> 00:07:39.680 that benefit. What happens to it? You absolutely 00:07:39.680 --> 00:07:42.600 keep your vested benefit. If you leave early, 00:07:42.819 --> 00:07:45.759 that benefit essentially becomes frozen or deferred. 00:07:45.759 --> 00:07:48.000 It just sits in the pension trust until you hit 00:07:48.000 --> 00:07:49.980 the plan's normal retirement age and then it 00:07:49.980 --> 00:07:52.699 starts paying out. There is a small account rule, 00:07:52.800 --> 00:07:55.389 though. If the plan allows it. And the lump sum 00:07:55.389 --> 00:07:58.550 value of your benefit is less than $5 ,000. The 00:07:58.550 --> 00:08:00.629 plan can just pay you out in a lump sum when 00:08:00.629 --> 00:08:02.129 you leave. It's an administrative convenience. 00:08:02.589 --> 00:08:04.850 Which you would then presumably roll into an 00:08:04.850 --> 00:08:07.269 IRA or another plan to keep it tax deferred. 00:08:07.810 --> 00:08:10.230 Ideally, yes. That's the whole point. OK, speaking 00:08:10.230 --> 00:08:13.129 of limits, the employer has no limit on how much 00:08:13.129 --> 00:08:14.790 they can contribute. They have to put in whatever 00:08:14.790 --> 00:08:17.209 the actuary says. But the final benefit that 00:08:17.209 --> 00:08:20.069 you can receive is actually capped by U .S. law. 00:08:20.230 --> 00:08:23.290 Yes, that's a key anti -abuse rule in the Internal 00:08:23.290 --> 00:08:25.990 Revenue Code. The benefit itself is capped. For 00:08:25.990 --> 00:08:28.389 2025, for instance, the maximum annual benefit 00:08:28.389 --> 00:08:31.310 you can get at retirement age is capped at $275 00:08:31.310 --> 00:08:34.850 ,000. And just as important were the salary used 00:08:34.850 --> 00:08:37.230 in the formula to calculate that benefit is also 00:08:37.230 --> 00:08:41.690 capped for 2025. That's at $345 ,000. Wait, hold 00:08:41.690 --> 00:08:43.529 on. Let me make sure I get that. So if you're 00:08:43.529 --> 00:08:45.909 a CEO making, say, a million dollars a year, 00:08:45.970 --> 00:08:49.460 and your pension... uses that final average pay 00:08:49.460 --> 00:08:52.480 formula. The plan can't use your million -dollar 00:08:52.480 --> 00:08:54.519 salary in the calculation. It has to pretend 00:08:54.519 --> 00:08:58.279 you only made $345 ,000. Precisely. That compensation 00:08:58.279 --> 00:09:01.000 limit and the benefit cap work together to ensure 00:09:01.000 --> 00:09:03.340 the plan is a broad -based retirement vehicle, 00:09:03.600 --> 00:09:06.000 not just a massive tax shelter for the company's 00:09:06.000 --> 00:09:09.059 highest earners. If those executives want a pension 00:09:09.059 --> 00:09:11.659 based on their full salary, the company has to 00:09:11.659 --> 00:09:14.019 set up a totally separate, non -qualified plan 00:09:14.019 --> 00:09:15.799 that doesn't get all the same tax advantages. 00:09:16.120 --> 00:09:18.279 Okay, with all this... complexity, the unlimited 00:09:18.279 --> 00:09:20.279 liability for the employer, the strict caps. 00:09:20.659 --> 00:09:23.440 It's easy to see why companies want it out. But 00:09:23.440 --> 00:09:25.580 let's talk about the two big inherent flaws that 00:09:25.580 --> 00:09:27.440 really push them away, starting with the kind 00:09:27.440 --> 00:09:29.879 of strange way benefits build up. The first major 00:09:29.879 --> 00:09:32.299 issue is what's called the age bias in these 00:09:32.299 --> 00:09:34.980 traditional plans. They have a J -shaped accrual 00:09:34.980 --> 00:09:38.039 pattern. What that means is the actual value 00:09:38.039 --> 00:09:41.559 of your promised benefit grows very, very slowly 00:09:41.559 --> 00:09:44.039 when you're young. The real cost to the employer, 00:09:44.200 --> 00:09:46.710 the amount of cash they have to pump in, only 00:09:46.710 --> 00:09:49.230 accelerates dramatically in your mid -career 00:09:49.230 --> 00:09:51.389 once you've got a lot of years of service and 00:09:51.389 --> 00:09:53.889 you're getting closer to retirement so funding 00:09:53.889 --> 00:09:56.590 the pension for a 25 year old is cheap because 00:09:56.590 --> 00:09:59.669 that money has 40 years to grow but for a 55 00:09:59.669 --> 00:10:02.289 year old the employer has to dump in a huge amount 00:10:02.289 --> 00:10:04.519 of cash right away Because there's only 10 years 00:10:04.519 --> 00:10:06.940 left. That's exactly. And this cost acceleration 00:10:06.940 --> 00:10:09.740 based on age often made it more expensive to 00:10:09.740 --> 00:10:12.500 hire or keep older workers. It even led to age 00:10:12.500 --> 00:10:15.000 discrimination lawsuits. The whole system was 00:10:15.000 --> 00:10:17.139 built for a world where you stayed at one company 00:10:17.139 --> 00:10:19.000 your whole life. It really punished people who 00:10:19.000 --> 00:10:21.159 moved around. And that ties right into the second 00:10:21.159 --> 00:10:24.590 big drawback, portability. Right. DB plans are 00:10:24.590 --> 00:10:26.529 just not very portable compared to DC plans. 00:10:26.769 --> 00:10:29.049 If you switch jobs, you often end up leaving 00:10:29.049 --> 00:10:31.289 behind this small deferred benefit that won't 00:10:31.289 --> 00:10:33.870 pay out for decades. And even if you can take 00:10:33.870 --> 00:10:36.190 a lump sum, an actuary has to do this complex 00:10:36.190 --> 00:10:38.570 calculation to figure out the present day value 00:10:38.570 --> 00:10:40.809 of that future promise. And the number often 00:10:40.809 --> 00:10:44.309 feels, well, pretty small to the employee. This 00:10:44.309 --> 00:10:47.009 lack of portability just made DB plans a bad 00:10:47.009 --> 00:10:49.490 fit for a modern mobile workforce. They were 00:10:49.490 --> 00:10:52.029 better for stable institutions, you know, governments, 00:10:52.129 --> 00:10:54.659 utilities. where people tend to stay put. But 00:10:54.659 --> 00:10:56.679 really, the single biggest reason for the global 00:10:56.679 --> 00:10:59.559 shift away from them was just the risk. The open 00:10:59.559 --> 00:11:01.779 -ended, unpredictable risk of people living longer 00:11:01.779 --> 00:11:04.139 and markets underperforming was just too much 00:11:04.139 --> 00:11:06.019 for corporate balance sheets to handle. Before 00:11:06.019 --> 00:11:08.179 we move on to DC plans, we have to talk about 00:11:08.179 --> 00:11:10.539 the hybrid that tried to solve this, the cash 00:11:10.539 --> 00:11:13.440 balance plan. Ah, yes, the cash balance plan. 00:11:13.860 --> 00:11:16.379 It's a perfect example of some clever financial 00:11:16.379 --> 00:11:19.639 engineering. Legally, it's still a defined benefit 00:11:19.639 --> 00:11:21.960 plan. So the employer is still on the hook. It's 00:11:21.960 --> 00:11:23.740 still subject to all the strict funding rules. 00:11:24.220 --> 00:11:26.940 But, and this is the clever part, the benefit 00:11:26.940 --> 00:11:29.899 is defined in a way that looks and feels just 00:11:29.899 --> 00:11:32.779 like a defined contribution account. So the employee 00:11:32.779 --> 00:11:34.480 just sees an account balance that goes up every 00:11:34.480 --> 00:11:38.000 year. Exactly. The benefit is defined as a stated 00:11:38.000 --> 00:11:40.120 account balance that gets two types of credits 00:11:40.120 --> 00:11:43.139 each year, an employer contribution credit, which 00:11:43.139 --> 00:11:45.779 is usually a percentage of your salary, and a 00:11:45.779 --> 00:11:48.659 guaranteed interest rate credit. So the employer 00:11:48.659 --> 00:11:51.799 promises your account will grow by, say, 4 % 00:11:51.799 --> 00:11:54.399 a year, even if the actual fund investments only 00:11:54.399 --> 00:11:57.539 make 1 % or if they make 10%. But isn't that 00:11:57.539 --> 00:11:59.240 guaranteed interest rate just a different way 00:11:59.240 --> 00:12:01.159 of saying the employer still holds all the investment 00:12:01.159 --> 00:12:03.039 risk? I mean, does this really change anything 00:12:03.039 --> 00:12:05.240 for the company or just how the employee feels 00:12:05.240 --> 00:12:07.740 about it? It mostly changes the perception for 00:12:07.740 --> 00:12:10.179 the employee. It makes the plan way easier to 00:12:10.179 --> 00:12:12.059 understand. It feels more portable because they 00:12:12.059 --> 00:12:15.139 see a number, a balance, not some weird formula. 00:12:15.419 --> 00:12:17.639 But for the employer, you're right. The fundamental 00:12:17.639 --> 00:12:19.519 risk is still there. They still have to make 00:12:19.519 --> 00:12:21.639 up the difference if the fund's investments don't 00:12:21.639 --> 00:12:24.600 hit that guaranteed rate. The cost volatility 00:12:24.600 --> 00:12:27.399 is still there. It's just hidden behind a structure 00:12:27.399 --> 00:12:29.820 that looks more stable to the worker. It was 00:12:29.820 --> 00:12:32.240 a smart evolution designed for a younger workforce. 00:12:32.559 --> 00:12:35.649 It's still a DB plan at its core. All right. 00:12:35.649 --> 00:12:38.529 Now let's cross over into the modern world. Defined 00:12:38.529 --> 00:12:42.129 contribution plans. If DB was all about the employer 00:12:42.129 --> 00:12:45.230 managing risk for the group, DC is all about 00:12:45.230 --> 00:12:47.850 the individual managing their own future. The 00:12:47.850 --> 00:12:50.830 whole mechanism is a different species. DC plans, 00:12:51.129 --> 00:12:53.210 and this includes the 401k and profit sharing 00:12:53.210 --> 00:12:55.330 plans we all know in the U .S., are built around 00:12:55.330 --> 00:12:58.690 one thing. The individual account, every single 00:12:58.690 --> 00:13:00.649 participant gets their own account, and every 00:13:00.649 --> 00:13:02.950 dollar contributed goes right into that specific 00:13:02.950 --> 00:13:05.629 account. And those contributions from your salary 00:13:05.629 --> 00:13:07.990 from an employer match are then invested in the 00:13:07.990 --> 00:13:10.029 market, usually with the employee making the 00:13:10.029 --> 00:13:12.690 choices from a menu of options. Correct. And 00:13:12.690 --> 00:13:14.970 the returns on those investments, good or bad, 00:13:15.210 --> 00:13:17.870 go directly into your individual account. That's 00:13:17.870 --> 00:13:20.620 the whole structure in a nutshell. The final 00:13:20.620 --> 00:13:22.720 benefit you get at retirement is based solely 00:13:22.720 --> 00:13:24.820 on the contributions and whatever investment 00:13:24.820 --> 00:13:27.139 performance you achieved. The contribution is 00:13:27.139 --> 00:13:29.899 defined. The outcome is not. OK, here's where 00:13:29.899 --> 00:13:32.940 it gets really interesting, because that structure 00:13:32.940 --> 00:13:37.240 creates this fundamental massive shift. in who 00:13:37.240 --> 00:13:39.600 is responsible for what. It is the absolute core 00:13:39.600 --> 00:13:42.220 of the change in the global retirement contract. 00:13:42.500 --> 00:13:46.220 In a DC plan, the entire investment risk and 00:13:46.220 --> 00:13:49.000 also the entire reward is on the shoulders of 00:13:49.000 --> 00:13:51.659 the individual employee. The employer's duty, 00:13:51.820 --> 00:13:53.960 for the most part, ends when they make the required 00:13:53.960 --> 00:13:55.759 contribution and make sure the investment options 00:13:55.759 --> 00:13:58.980 they offer are prudent. This is a huge transfer 00:13:58.980 --> 00:14:01.019 of liability from the corporate balance sheet 00:14:01.019 --> 00:14:03.519 directly to the individual family's budget. And 00:14:03.519 --> 00:14:05.779 that risk is not trivial. When you look at the 00:14:05.779 --> 00:14:07.960 data on the potential downside, it's not just 00:14:07.960 --> 00:14:10.360 about maybe having a little less. The numbers 00:14:10.360 --> 00:14:12.480 show the potential for a complete failure to 00:14:12.480 --> 00:14:15.100 fund a reasonable retirement. The data is, frankly, 00:14:15.200 --> 00:14:17.620 quite sobering. Our source material points to 00:14:17.620 --> 00:14:19.940 international simulations that show a huge amount 00:14:19.940 --> 00:14:22.220 of downside risk. And it varies a lot depending 00:14:22.220 --> 00:14:24.860 on when and where you retire. This isn't just 00:14:24.860 --> 00:14:27.559 theory. It's measured exposure to failure. I 00:14:27.559 --> 00:14:29.419 mean, look at the numbers for European D .C. 00:14:29.460 --> 00:14:32.299 participants. The simulations show that in countries 00:14:32.299 --> 00:14:35.679 like France, Italy and Spain, there's a 10 percent 00:14:35.679 --> 00:14:38.659 chance, a one in 10 chance of retiring with a 00:14:38.659 --> 00:14:41.480 real replacement ratio as low as 0 .25, 0 .20 00:14:41.480 --> 00:14:44.220 or even 0 .17. And for anyone who doesn't live 00:14:44.220 --> 00:14:46.500 and breathe this stuff, a replacement ratio is 00:14:46.500 --> 00:14:48.379 the percentage of your pre -retirement income 00:14:48.379 --> 00:14:50.720 that your retirement savings can replace. A ratio 00:14:50.720 --> 00:14:53.179 of 0 .17 means your retirement income is only 00:14:53.179 --> 00:14:59.100 17. It's a guaranteed severe drop in your standard 00:14:59.100 --> 00:15:01.379 of living. It confirms that when the individual 00:15:01.379 --> 00:15:04.240 bears the full market risk, a very bad outcome 00:15:04.240 --> 00:15:07.539 is a real measurable possibility. And on top 00:15:07.539 --> 00:15:10.399 of that, D .C. plans bring longevity risk right 00:15:10.399 --> 00:15:13.159 back to the individual. Most people retire with 00:15:13.159 --> 00:15:15.460 a lump sum, and then it's up to them to figure 00:15:15.460 --> 00:15:18.059 out how to make it last for maybe 30 or 40 years. 00:15:18.580 --> 00:15:20.639 They bear the risk of outliving their savings, 00:15:20.860 --> 00:15:22.740 a risk that the DB plan's annuity completely 00:15:22.740 --> 00:15:25.379 solved for them. Let's talk about the complexity 00:15:25.379 --> 00:15:27.340 of the U .S. system, which has all these strict 00:15:27.340 --> 00:15:29.639 and, frankly, confusing limits on contributions. 00:15:30.120 --> 00:15:32.419 We know the thrift savings plan for federal employees 00:15:32.419 --> 00:15:34.840 is the biggest D .C. plan in the world. But for 00:15:34.840 --> 00:15:36.679 the average person, trying to figure out the 00:15:36.679 --> 00:15:38.600 contribution caps feels like trying to solve 00:15:38.600 --> 00:15:41.929 a puzzle. It really can be. For 2025, the U .S. 00:15:41.950 --> 00:15:44.490 system has multiple layers of limits. There's 00:15:44.490 --> 00:15:46.529 an absolute hard ceiling for all money going 00:15:46.529 --> 00:15:48.710 into tax advantaged accounts in a single year. 00:15:48.750 --> 00:15:50.769 That's employer, employee, everything. It's the 00:15:50.769 --> 00:15:53.970 lesser of $70 ,000 or 100 % of your pay. That's 00:15:53.970 --> 00:15:56.169 the total deferral limit. OK, so $70 ,000 is 00:15:56.169 --> 00:15:58.870 the absolute max that can go in tax advantaged. 00:15:59.159 --> 00:16:01.559 Correct. But then separate from that, there's 00:16:01.559 --> 00:16:03.799 the limit on what you, the employee, can put 00:16:03.799 --> 00:16:07.100 in from your own salary into a 401k. That limit 00:16:07.100 --> 00:16:11.340 is $23 ,500 for 2025. But then you get into catch 00:16:11.340 --> 00:16:13.460 -up contributions, which our sources point out 00:16:13.460 --> 00:16:15.899 are especially complex, with these weird age 00:16:15.899 --> 00:16:18.220 -based tiers. Right. This is where you can really 00:16:18.220 --> 00:16:20.580 see the legislative sausage making. Catch -up 00:16:20.580 --> 00:16:23.320 contributions are for older workers to let them 00:16:23.320 --> 00:16:25.879 save more as they get closer to retirement. Generally, 00:16:25.879 --> 00:16:27.860 if you're 50 or older, you can contribute an 00:16:27.860 --> 00:16:31.820 extra $7 ,000. But here's the weird part. The 00:16:31.820 --> 00:16:34.299 sources say that for the specific ages of 60 00:16:34.299 --> 00:16:36.960 through 63, the catch -up is even higher. It's 00:16:36.960 --> 00:16:40.820 $11 ,250. Why that specific three -year window? 00:16:40.940 --> 00:16:43.139 What is the logic there? That is a very recent 00:16:43.139 --> 00:16:45.440 change, and it's basically a legislative compromise. 00:16:45.820 --> 00:16:49.120 The idea was to give a final supercharged savings 00:16:49.120 --> 00:16:51.639 opportunity to workers who are right on the cusp 00:16:51.639 --> 00:16:54.299 of retirement and maybe fell behind. It's an 00:16:54.299 --> 00:16:56.519 attempt to let them cram as much as possible 00:16:56.519 --> 00:16:58.980 into that tax advantage window right at the end. 00:16:59.139 --> 00:17:01.000 And it's also worth remembering that all these 00:17:01.000 --> 00:17:03.480 numbers are indexed for inflation, but they only 00:17:03.480 --> 00:17:07.099 go up in increments of like $500. So the limits 00:17:07.099 --> 00:17:09.599 can stay flat for a few years until enough inflation 00:17:09.599 --> 00:17:12.319 builds up to trigger the next jump. It's a way 00:17:12.319 --> 00:17:14.420 for Congress to keep tight control over the tax 00:17:14.420 --> 00:17:17.319 revenue impact of these savings plans. Now, even 00:17:17.319 --> 00:17:19.200 though I'm the one picking my investments from 00:17:19.200 --> 00:17:21.799 the plans menu, the employer still has some legal 00:17:21.799 --> 00:17:24.160 responsibility, some liability, right? They can't 00:17:24.160 --> 00:17:25.950 just set it up and walk away. Oh, absolutely 00:17:25.950 --> 00:17:27.809 not. And this is something a lot of people don't 00:17:27.809 --> 00:17:31.190 realize. The plan sponsor, the employer, retains 00:17:31.190 --> 00:17:34.089 a significant fiduciary role. Even though you 00:17:34.089 --> 00:17:35.990 direct your own investments, the employer is 00:17:35.990 --> 00:17:37.930 legally responsible for the selection of those 00:17:37.930 --> 00:17:39.829 investment options and for choosing the plan 00:17:39.829 --> 00:17:42.230 administrator. They have to make sure the menu 00:17:42.230 --> 00:17:44.890 of funds is prudent, that it's diverse, and that 00:17:44.890 --> 00:17:47.529 the fees being charged are reasonable. If they 00:17:47.529 --> 00:17:49.970 don't, if they, for instance, only offer a bunch 00:17:49.970 --> 00:17:52.509 of high -cost, poorly performing funds, they 00:17:52.509 --> 00:17:55.369 can be sued by employees under ERISA. And they 00:17:55.369 --> 00:17:58.150 often are. And this whole shift, this move from 00:17:58.150 --> 00:18:00.529 D .B. to D .C., it's not just a U .S. thing. 00:18:00.789 --> 00:18:02.670 Looking at how other countries handled it really 00:18:02.670 --> 00:18:04.690 shows what a global phenomenon this has been. 00:18:04.829 --> 00:18:07.829 The transition from D .B. to D .C. is the dominant 00:18:07.829 --> 00:18:10.329 story in private sector retirement all over the 00:18:10.329 --> 00:18:13.289 world. The UK is probably the clearest case study. 00:18:13.450 --> 00:18:16.390 The shift there was driven almost entirely by 00:18:16.390 --> 00:18:18.230 employers who were dealing with rising pension 00:18:18.230 --> 00:18:21.089 deficits and new accounting rules that forced 00:18:21.089 --> 00:18:23.650 them to put those massive volatile liabilities 00:18:23.650 --> 00:18:25.809 right onto their balance sheets. And you can 00:18:25.809 --> 00:18:28.109 see the result in the numbers. UK employers used 00:18:28.109 --> 00:18:30.569 to contribute an average of 11 % of salary to 00:18:30.569 --> 00:18:33.450 their old DB plans. Now, for their DC plans, 00:18:33.670 --> 00:18:37.359 they only contribute an average of 6%. Wow. That 00:18:37.359 --> 00:18:39.720 5 % difference is basically the cost of the risk. 00:18:39.839 --> 00:18:42.200 And that cost has now been pushed entirely onto 00:18:42.200 --> 00:18:44.519 the employee who has to save that much more out 00:18:44.519 --> 00:18:46.259 of their own pocket just to get to the same place. 00:18:46.500 --> 00:18:48.859 It is a direct transfer of systemic risk. And 00:18:48.859 --> 00:18:50.819 you see the same story everywhere. Japan brought 00:18:50.819 --> 00:18:54.519 in D .C. plans in 2001. Germany, which has really 00:18:54.519 --> 00:18:56.819 strong labor protections, actually held out until 00:18:56.819 --> 00:18:59.619 2017. And even then, the plans could only be 00:18:59.619 --> 00:19:01.240 created through collective bargaining between 00:19:01.240 --> 00:19:03.640 unions and employers. It shows how sensitive 00:19:03.640 --> 00:19:06.619 the issue is. What about Singapore? Their system 00:19:06.619 --> 00:19:08.759 seems like the most established purely D .C. 00:19:08.839 --> 00:19:11.500 structure out there. Singapore's Central Provident 00:19:11.500 --> 00:19:14.359 Fund, the CPF, is a fascinating national experiment. 00:19:14.700 --> 00:19:17.660 It's a compulsory government mandated D .C. scheme 00:19:17.660 --> 00:19:20.759 for the entire country. The government sets high 00:19:20.759 --> 00:19:22.940 mandatory contribution rates for both the worker 00:19:22.940 --> 00:19:25.220 and the employer, but the money goes into individual 00:19:25.220 --> 00:19:28.099 accounts. The final payout is based on those 00:19:28.099 --> 00:19:30.599 contributions, plus some very structured investment 00:19:30.599 --> 00:19:33.700 returns. It shows how a mandatory D .C. system 00:19:33.700 --> 00:19:36.460 can work on a national scale. You also see a 00:19:36.460 --> 00:19:38.759 similar trend in India, where their national 00:19:38.759 --> 00:19:41.400 pension scheme, a D .C. plan, replaced the old 00:19:41.400 --> 00:19:43.559 DB system for government workers who joined after 00:19:43.559 --> 00:19:47.220 2004. The momentum is just undeniable. When we 00:19:47.220 --> 00:19:48.940 talk about these huge promises, whether from 00:19:48.940 --> 00:19:50.880 a company or a country, the most important question 00:19:50.880 --> 00:19:53.240 is, where is the money coming from? And this 00:19:53.240 --> 00:19:55.640 brings us to a really crucial distinction, especially 00:19:55.640 --> 00:19:58.319 for government plans, funded versus unfunded 00:19:58.319 --> 00:20:01.039 systems. Right. This shifts the focus from the 00:20:01.039 --> 00:20:03.359 individual account to the whole macroeconomic 00:20:03.359 --> 00:20:06.579 structure. A funded plan is what we've been talking 00:20:06.579 --> 00:20:08.859 about in the private sector. Contributions are 00:20:08.859 --> 00:20:11.519 set aside in a trust, they're invested, and they 00:20:11.519 --> 00:20:14.099 are specifically reserved to pay for future benefits. 00:20:14.839 --> 00:20:17.460 Under ERISA in the U .S., this is the law for 00:20:17.460 --> 00:20:20.420 private plans. The money has to be there. An 00:20:20.420 --> 00:20:23.039 unfunded plan is completely different. It operates 00:20:23.039 --> 00:20:26.220 on a pay -as -you -go or PYGO basis. There are 00:20:26.220 --> 00:20:29.319 no significant assets set aside. Instead, the 00:20:29.319 --> 00:20:31.920 benefits being paid to today's retirees are paid 00:20:31.920 --> 00:20:34.859 for directly by the contributions and taxes coming 00:20:34.859 --> 00:20:37.359 in from today's workers. So current workers are 00:20:37.359 --> 00:20:39.839 paying for current retirees. It sounds efficient 00:20:39.839 --> 00:20:41.700 on the surface, but it seems like that system 00:20:41.700 --> 00:20:44.619 is totally dependent on having a stable or growing 00:20:44.619 --> 00:20:46.880 population of young workers. And that dependency 00:20:46.880 --> 00:20:49.720 is exactly why PAYGO is forbidden for private 00:20:49.720 --> 00:20:52.000 sector plans in the U .S. The risk of collapse 00:20:52.000 --> 00:20:53.940 if the company or workforce shrinks is just too 00:20:53.940 --> 00:20:57.259 high. And yet our sources are clear. PAYGO is 00:20:57.259 --> 00:20:59.299 the standard operating procedure for almost all 00:20:59.299 --> 00:21:01.539 public pension systems around the world in all 00:21:01.539 --> 00:21:04.059 the OECD countries. Where does something like 00:21:04.059 --> 00:21:07.319 US Social Security fit in? It's gigantic, but 00:21:07.319 --> 00:21:11.480 is it pure? It's technically a hybrid, but its 00:21:11.480 --> 00:21:15.079 soul is PAYGO. Social Security is a type of defined 00:21:15.079 --> 00:21:17.500 benefit plan. It's funded by the FICA payroll 00:21:17.500 --> 00:21:19.779 tax, which goes into the Social Security trust 00:21:19.779 --> 00:21:23.220 funds. Now, while those trust funds hold trillions 00:21:23.220 --> 00:21:26.059 in assets, mostly government bonds, the system 00:21:26.059 --> 00:21:28.180 still relies on current tax revenue to pay for 00:21:28.180 --> 00:21:30.339 the vast majority of current benefits. It's a 00:21:30.339 --> 00:21:33.160 massive intergenerational transfer. The trust 00:21:33.160 --> 00:21:35.519 funds are really more of a buffer for short -term 00:21:35.519 --> 00:21:37.740 gaps than a fully funded reserve like a private 00:21:37.740 --> 00:21:39.740 pension. Which brings us to the elephant in the 00:21:39.740 --> 00:21:43.819 room. Can a PAY -GO system survive when birth 00:21:43.819 --> 00:21:45.900 rates are falling and people are living longer? 00:21:46.200 --> 00:21:47.980 Well, according to the World Bank's analysis 00:21:47.980 --> 00:21:50.799 of these systems, the answer is a clear no, not 00:21:50.799 --> 00:21:52.700 without some kind of painful structural change. 00:21:53.140 --> 00:21:55.920 PAY -GO systems create an almost inevitable crisis 00:21:55.920 --> 00:21:58.279 that's driven by the rising dependency ratio. 00:21:58.299 --> 00:22:00.200 That's the number of retirees being supported 00:22:00.200 --> 00:22:02.880 by each active worker. Our sources lay out this 00:22:02.880 --> 00:22:05.380 grim but predictable lifecycle of PAY Go systems 00:22:05.380 --> 00:22:08.000 in three stages. OK, let's walk through these 00:22:08.000 --> 00:22:10.099 stages because this feels like a ticking time 00:22:10.099 --> 00:22:12.160 bomb for millions of people around the world. 00:22:12.319 --> 00:22:15.200 Stage one is the young stage. This happens right 00:22:15.200 --> 00:22:17.559 after the system starts. The population is young. 00:22:17.619 --> 00:22:21.099 It's growing. So you have maybe 15 or more workers 00:22:21.099 --> 00:22:23.740 paying in for every one person taking money out. 00:22:24.250 --> 00:22:27.309 The system is flush with cash. This surplus allows 00:22:27.309 --> 00:22:29.849 governments to be really generous, paying out 00:22:29.849 --> 00:22:31.970 benefits that are way better than anything you 00:22:31.970 --> 00:22:34.230 could get on the private market. This is Germany 00:22:34.230 --> 00:22:37.130 in the 1920s or Brazil in the 1950s. It creates 00:22:37.130 --> 00:22:39.589 this public perception that the system is a magic 00:22:39.589 --> 00:22:42.609 money machine. And those high expectations become 00:22:42.609 --> 00:22:44.950 politically impossible to walk back later on. 00:22:45.049 --> 00:22:48.039 Exactly. Which leads to stage two, the expanding 00:22:48.039 --> 00:22:50.579 stage. The ratio of workers to pensioners starts 00:22:50.579 --> 00:22:52.859 to fall, maybe down to eight or 10 workers per 00:22:52.859 --> 00:22:55.980 retiree. Governments, still trapped by the promises 00:22:55.980 --> 00:22:58.400 they made in stage one, start expanding the system 00:22:58.400 --> 00:23:00.559 to cover more people, but they keep the benefits 00:23:00.559 --> 00:23:03.079 high. This is when the system starts to build 00:23:03.079 --> 00:23:05.559 up huge amounts of what's called implicit debt. 00:23:05.819 --> 00:23:07.940 That's the value of all the future pension promises 00:23:07.940 --> 00:23:10.240 that have no money set aside to pay for them. 00:23:10.579 --> 00:23:13.500 This hidden debt can grow to 25 % or even 50 00:23:13.500 --> 00:23:16.519 % of a country's entire GDP, like we saw in Brazil 00:23:16.519 --> 00:23:19.180 and Turkey in the 90s. The system is broken, 00:23:19.279 --> 00:23:21.259 but the cash is still flowing, so nobody wants 00:23:21.259 --> 00:23:23.339 to fix it. And then finally, the demographic 00:23:23.339 --> 00:23:25.480 math catches up, and the system hits a wall. 00:23:25.619 --> 00:23:28.140 That's stage three, the mature crisis stage. 00:23:28.720 --> 00:23:31.680 The dependency ratio just craters. You might 00:23:31.680 --> 00:23:34.279 have six or fewer workers for every one pensioner. 00:23:34.319 --> 00:23:37.460 At this point, that implicit debt is so massive 00:23:37.460 --> 00:23:39.359 it threatens to bankrupt the entire country. 00:23:40.099 --> 00:23:42.380 Governments know they need to either cut benefits 00:23:42.380 --> 00:23:45.619 or raise taxes dramatically, but they face furious 00:23:45.619 --> 00:23:48.019 protests from the older generations who paid 00:23:48.019 --> 00:23:49.839 in their whole lives and demand what they were 00:23:49.839 --> 00:23:52.589 promised. So what happens? The politicians kick 00:23:52.589 --> 00:23:54.710 the can down the road. They postpone reforms 00:23:54.710 --> 00:23:56.789 and start raiding the country's general budget 00:23:56.789 --> 00:23:59.109 to cover the pension shortfall, with pension 00:23:59.109 --> 00:24:01.369 costs eating up a double -digit percentage of 00:24:01.369 --> 00:24:04.269 GDP. We see this playing out across much of Europe 00:24:04.269 --> 00:24:06.670 right now. It is the inevitable endgame for a 00:24:06.670 --> 00:24:09.890 pure PAGO system without painful reform. OK, 00:24:09.930 --> 00:24:11.230 let's bring it back to the U .S. private sector. 00:24:11.670 --> 00:24:14.029 For those funded DB plans that do have to set 00:24:14.029 --> 00:24:15.970 aside assets, there's a critical safety net, 00:24:16.069 --> 00:24:18.869 the PBGC. Yes, the Pension Benefit Guarantee 00:24:18.869 --> 00:24:21.910 Corporation. It's basically an insurance company 00:24:21.910 --> 00:24:24.950 run by the federal government. Most private DB 00:24:24.950 --> 00:24:27.910 plans have to pay insurance premiums to the PBGC. 00:24:27.990 --> 00:24:31.210 And in return, the PBGC guarantees a certain 00:24:31.210 --> 00:24:33.910 portion of your promised pension benefit up to 00:24:33.910 --> 00:24:36.269 a legal limit if your company goes bankrupt and 00:24:36.269 --> 00:24:38.859 the pension plan fails. It's there to make sure 00:24:38.859 --> 00:24:41.460 that workers don't lose everything if their employer 00:24:41.460 --> 00:24:43.900 goes under. It gets its money from those premiums 00:24:43.900 --> 00:24:46.099 and from the assets of the fail plans it takes 00:24:46.099 --> 00:24:48.579 over. But the PBGC itself was a staggering amount 00:24:48.579 --> 00:24:51.519 of liability. I seem to remember a crucial detail 00:24:51.519 --> 00:24:53.700 that its promises are not explicitly backed by 00:24:53.700 --> 00:24:55.299 the U .S. government. Why is that distinction 00:24:55.299 --> 00:24:58.140 so important? That is the crucial caveat that 00:24:58.140 --> 00:25:00.700 most people miss. Because it's not explicitly 00:25:00.700 --> 00:25:03.079 backed by the full faith and credit of the Treasury. 00:25:03.839 --> 00:25:06.839 The PBGC technically has its own solvency risk. 00:25:07.140 --> 00:25:09.619 Now, politically, it's almost unthinkable that 00:25:09.619 --> 00:25:11.559 Congress would let it fail. The public outcry 00:25:11.559 --> 00:25:14.140 would be immense. But the lack of an explicit 00:25:14.140 --> 00:25:16.259 guarantee means the agency has to manage its 00:25:16.259 --> 00:25:19.339 own finances. If several massive pension plans, 00:25:19.420 --> 00:25:21.779 say from an entire struggling industry, were 00:25:21.779 --> 00:25:23.779 to all fail at once, it could theoretically drain 00:25:23.779 --> 00:25:26.299 the PBGC's funds, creating a whole new crisis 00:25:26.299 --> 00:25:27.740 that the government would have to scramble to 00:25:27.740 --> 00:25:30.329 solve after the fact. So even with this insurance, 00:25:30.670 --> 00:25:33.170 the risk of chronic underfunding is still a huge 00:25:33.170 --> 00:25:35.630 problem, especially when you compare public plans 00:25:35.630 --> 00:25:38.809 to private ones. A huge problem. And chronic 00:25:38.809 --> 00:25:41.109 underfunding is far worse in state and local 00:25:41.109 --> 00:25:43.690 government plans. The reason is really about 00:25:43.690 --> 00:25:45.829 accountability. The private sector was forced 00:25:45.829 --> 00:25:47.670 to get its house in order by the Pension Protection 00:25:47.670 --> 00:25:51.799 Act of 2006, the PPA. That law forced private 00:25:51.799 --> 00:25:54.119 plans to meet much tougher funding targets and 00:25:54.119 --> 00:25:56.720 to fix shortfalls much more quickly. But public 00:25:56.720 --> 00:25:59.160 plans are run by politicians. And politicians 00:25:59.160 --> 00:26:01.420 have a huge incentive to keep contribution rates 00:26:01.420 --> 00:26:03.700 low to make taxpayers and public unions happy 00:26:03.700 --> 00:26:06.059 today while pushing the cost of those promises 00:26:06.059 --> 00:26:08.640 onto future generations. They use less rigorous 00:26:08.640 --> 00:26:10.700 accounting and just habitually underfund their 00:26:10.700 --> 00:26:13.140 plans. It's why so many states and cities are 00:26:13.140 --> 00:26:15.740 in a permanent pension crisis. The need to stop 00:26:15.740 --> 00:26:18.160 private companies from doing that, from mismanaging 00:26:18.160 --> 00:26:20.140 funds or just walking away from it. their promises 00:26:20.140 --> 00:26:22.960 is exactly why the U .S. created this massive, 00:26:23.039 --> 00:26:25.839 incredibly complex legal framework called ERISA 00:26:25.839 --> 00:26:29.680 in 1974. ERISA, the Employee Retirement Income 00:26:29.680 --> 00:26:32.539 Security Act, is the Bible of U .S. retirement 00:26:32.539 --> 00:26:35.359 law. It came about after a series of high profile 00:26:35.359 --> 00:26:38.339 pension failures in the 60s. It's built on old 00:26:38.339 --> 00:26:40.819 principles of trust law, and it basically created 00:26:40.819 --> 00:26:43.640 a whole system of federal rules that override 00:26:43.640 --> 00:26:46.559 state laws for private sector plans. And the 00:26:46.559 --> 00:26:49.200 absolute heart of that whole system is the legal 00:26:49.200 --> 00:26:51.559 standard that managers of the money have to meet 00:26:51.559 --> 00:26:54.299 the fiduciary standards. The standard is incredibly 00:26:54.299 --> 00:26:57.339 high. Anyone who has discretionary control over 00:26:57.339 --> 00:27:00.880 plan assets is legally a fiduciary. And under 00:27:00.880 --> 00:27:03.220 ERISA, these fiduciaries must manage the money 00:27:03.220 --> 00:27:05.940 prudently, and this is the key phrase, in the 00:27:05.940 --> 00:27:08.240 exclusive interest of the participants and beneficiaries. 00:27:08.619 --> 00:27:11.059 Not for the company's benefit, not for the shareholders, 00:27:11.339 --> 00:27:13.720 but exclusively for the workers and retirees. 00:27:13.859 --> 00:27:16.880 And that standard has real teeth. If you violate 00:27:16.880 --> 00:27:19.299 it, you can be held personally liable for any 00:27:19.299 --> 00:27:21.980 losses the plan suffers. The threat of personal 00:27:21.980 --> 00:27:24.480 financial ruin is a very powerful motivator to 00:27:24.480 --> 00:27:26.559 act responsibly. That's a serious protection. 00:27:26.839 --> 00:27:28.880 But Arisa and the tax code also have rules to 00:27:28.880 --> 00:27:30.839 stop the system from just becoming a tax dodge 00:27:30.839 --> 00:27:33.059 for the wealthy, right? Right. Through a whole 00:27:33.059 --> 00:27:35.740 battery of anti -abuse rules. The nondiscrimination 00:27:35.740 --> 00:27:38.240 rules are designed to make sure a plan covers 00:27:38.240 --> 00:27:40.920 a broad swath of employees, not just the executives. 00:27:41.220 --> 00:27:43.819 And it ensures that the benefits don't disproportionately 00:27:43.819 --> 00:27:47.180 favor what the law calls highly compensated employees 00:27:47.180 --> 00:27:50.480 or HCEs. Plans have to run a bunch of complicated 00:27:50.480 --> 00:27:53.400 tests every single year to prove they're in compliance. 00:27:53.819 --> 00:27:55.920 So what happens if a plan fails one of those 00:27:55.920 --> 00:27:58.079 tests? What's the real world consequence? If 00:27:58.079 --> 00:28:00.440 it fails, meaning the plan is too generous to 00:28:00.440 --> 00:28:02.859 the HCEs compared to everyone else. There are 00:28:02.859 --> 00:28:05.599 a couple of ways to fix it. The HCEs might have 00:28:05.599 --> 00:28:07.779 to get some of their contributions back as taxable 00:28:07.779 --> 00:28:10.400 cash, or the employer might have to make extra 00:28:10.400 --> 00:28:12.799 contributions to the non -HCEs to balance things 00:28:12.799 --> 00:28:16.039 out. The law basically forces the employer to 00:28:16.039 --> 00:28:18.140 spread the benefits around if they want to keep 00:28:18.140 --> 00:28:20.420 the huge tax advantages of having a qualified 00:28:20.420 --> 00:28:23.119 plan. There's also a related rule called the 00:28:23.119 --> 00:28:26.160 top heavy rule. If a plan is found to be top 00:28:26.160 --> 00:28:28.140 heavy, meaning most of the benefits are going 00:28:28.140 --> 00:28:30.259 to a small group of owners or key executives, 00:28:30.890 --> 00:28:32.990 The law requires the plan to provide a minimum 00:28:32.990 --> 00:28:35.569 baseline benefit to all the other employees. 00:28:36.009 --> 00:28:37.890 It's another way to guarantee the rank and file 00:28:37.890 --> 00:28:39.950 gets something if the plan is skewed towards 00:28:39.950 --> 00:28:43.450 the top. So the company's desire to save on taxes 00:28:43.450 --> 00:28:45.750 is forced to align with the public policy goal 00:28:45.750 --> 00:28:48.309 of broad retirement coverage. Now, one of the 00:28:48.309 --> 00:28:50.609 most powerful protections and one that's hugely 00:28:50.609 --> 00:28:52.529 important for anyone facing financial trouble 00:28:52.529 --> 00:28:55.309 is the one that shields these assets from creditors. 00:28:55.690 --> 00:28:58.450 This is the anti -assignment and anti -garnishment 00:28:58.450 --> 00:29:01.930 rule, and it is a cornerstone of ERISA. It means 00:29:01.930 --> 00:29:04.190 your pension benefits and the money in your qualified 00:29:04.190 --> 00:29:06.569 accounts are protected from your general creditors. 00:29:06.710 --> 00:29:09.009 You can't sign your benefit over to pay a debt, 00:29:09.130 --> 00:29:11.509 and it can't be garnished to pay off most personal 00:29:11.509 --> 00:29:14.269 debts. It's a deliberate policy choice to put 00:29:14.269 --> 00:29:17.180 retirement savings in a protected class. But 00:29:17.180 --> 00:29:19.680 there are a few exceptions, right? Especially 00:29:19.680 --> 00:29:22.380 when it comes to family court. Yes. Very limited, 00:29:22.440 --> 00:29:24.960 very specific exceptions. The main one is for 00:29:24.960 --> 00:29:27.839 divorce, alimony, or child support. But even 00:29:27.839 --> 00:29:30.180 then, it's not automatic. The court order has 00:29:30.180 --> 00:29:32.279 to meet a whole list of specific requirements 00:29:32.279 --> 00:29:34.519 to be considered a qualified domestic relations 00:29:34.519 --> 00:29:38.970 order or a QDRO. The QDRO is essential. Without 00:29:38.970 --> 00:29:41.890 it, the plan can't pay out. It basically reclassifies 00:29:41.890 --> 00:29:43.930 a portion of your pension as belonging to your 00:29:43.930 --> 00:29:46.150 former spouse, allowing it to be paid out without 00:29:46.150 --> 00:29:48.490 violating Arisa's anti -assignment rule. It's 00:29:48.490 --> 00:29:51.049 a high legal bar to clear. Finally, let's just 00:29:51.049 --> 00:29:52.990 quickly circle back to the solvency rules that 00:29:52.990 --> 00:29:55.430 Arisa uses to make sure DB promises are actually 00:29:55.430 --> 00:29:57.470 kept, especially since they were toughened up 00:29:57.470 --> 00:30:00.309 by the Pension Protection Act in 2006. The PPA 00:30:00.309 --> 00:30:02.809 made the minimum funding standards much, much 00:30:02.809 --> 00:30:05.349 stricter. Before PPA, employers had a lot of 00:30:05.349 --> 00:30:08.190 leeway. The new law forced private DB plans to 00:30:08.190 --> 00:30:11.190 target a 100 % funded status much more quickly 00:30:11.190 --> 00:30:13.829 using very conservative actuarial assumptions. 00:30:14.269 --> 00:30:16.910 If you fail to meet these standards now, you 00:30:16.910 --> 00:30:19.190 get hit with escalating penalty taxes and you're 00:30:19.190 --> 00:30:21.390 forced to make corrective contributions immediately. 00:30:21.730 --> 00:30:24.369 It took away most of the wiggle room. And we 00:30:24.369 --> 00:30:26.369 should also mention the distribution rules for 00:30:26.369 --> 00:30:29.049 spousal protection. ERISA says the default payout... 00:30:29.069 --> 00:30:31.410 a pension must be a joint and survivor annuity 00:30:31.410 --> 00:30:34.230 that means if the retired worker dies their spouse 00:30:34.230 --> 00:30:36.630 is guaranteed to receive a survivor benefit usually 00:30:36.630 --> 00:30:39.289 50 for the rest of their life if you want to 00:30:39.289 --> 00:30:41.329 take your pension in any other form you have 00:30:41.329 --> 00:30:43.809 to get your spouse's written notarized consent 00:30:43.809 --> 00:30:46.450 it's a powerful protection for surviving partners 00:30:46.450 --> 00:30:49.529 so this whole regulatory machine From fiduciary 00:30:49.529 --> 00:30:52.869 duties to funding rules, it's this dense web 00:30:52.869 --> 00:30:55.390 of checks and balances, all designed to make 00:30:55.390 --> 00:30:57.309 sure that when a private company makes a long 00:30:57.309 --> 00:31:00.869 -term promise, it's forced to keep it. So this 00:31:00.869 --> 00:31:02.809 deep dive has really laid out two completely 00:31:02.809 --> 00:31:05.650 different philosophies. The choice between defined 00:31:05.650 --> 00:31:08.609 benefit and defined contribution is, I mean, 00:31:08.630 --> 00:31:10.609 it's the difference between relying on a promise 00:31:10.609 --> 00:31:12.849 from an organization and relying on your own 00:31:12.849 --> 00:31:15.190 financial skill and market luck. The essential 00:31:15.190 --> 00:31:17.349 takeaway for you, the listener, is really about 00:31:17.349 --> 00:31:20.430 who holds the risk. In the DB world, the actuary 00:31:20.430 --> 00:31:22.990 takes the calculated risk for the employer who 00:31:22.990 --> 00:31:26.170 manages this big pool of money. In the DC world, 00:31:26.289 --> 00:31:28.390 you become your own actuary. You have to manage 00:31:28.390 --> 00:31:30.490 the investment risk, you have to manage the risk 00:31:30.490 --> 00:31:33.049 of living too long, and you bear the full cost 00:31:33.049 --> 00:31:35.210 if things go wrong. Let's just quickly recap 00:31:35.210 --> 00:31:36.890 those two biggest tradeoffs we talked about. 00:31:37.150 --> 00:31:39.690 You are trading a known benefit under a DB plan 00:31:39.690 --> 00:31:42.710 for a known contribution in a DC plan. And you're 00:31:42.710 --> 00:31:44.950 trading employer risk, where the company's on 00:31:44.950 --> 00:31:47.009 the hook for individual risk, where you and your 00:31:47.009 --> 00:31:49.049 family are on the hook. And we've seen that the 00:31:49.049 --> 00:31:51.369 global shift has been overwhelmingly toward that 00:31:51.369 --> 00:31:54.470 individual risk model. It's moved all that complexity 00:31:54.470 --> 00:31:56.650 and volatility off corporate balance sheets and 00:31:56.650 --> 00:31:59.470 onto the individual saver, even as the data suggests 00:31:59.470 --> 00:32:01.769 that many people in D .C. plans might end up 00:32:01.769 --> 00:32:03.529 with retirement incomes that are just deeply 00:32:03.529 --> 00:32:07.509 inadequate. And that brings us to our final provocative 00:32:07.509 --> 00:32:10.490 thought. Our discussion of PAYGO systems showed 00:32:10.490 --> 00:32:12.869 that even the big government -run pension systems, 00:32:13.029 --> 00:32:15.150 the ones millions of people see as their ultimate 00:32:15.150 --> 00:32:17.470 safety net, are facing an existential threat 00:32:17.470 --> 00:32:20.730 from demographics. That inevitable stage three 00:32:20.730 --> 00:32:23.410 crisis, when the ratio of workers to retirees 00:32:23.410 --> 00:32:26.109 falls off a cliff. So given that the global trend 00:32:26.109 --> 00:32:28.349 is to shift all this risk to you, the individual, 00:32:28.569 --> 00:32:31.289 through DC plans, and knowing that the public 00:32:31.289 --> 00:32:33.269 safety nets are themselves facing demographic 00:32:33.269 --> 00:32:35.349 headwinds that are forcing painful political 00:32:35.349 --> 00:32:37.869 choices, how prepared should you be to manage 00:32:37.869 --> 00:32:40.289 all of this risk on your own? In today's world, 00:32:40.369 --> 00:32:42.210 just relying on historical government promises 00:32:42.210 --> 00:32:44.470 might not be enough. It makes it critical for 00:32:44.470 --> 00:32:46.210 you to actually look into the funding status, 00:32:46.369 --> 00:32:48.910 demographic trends, and the dependency ratio 00:32:48.910 --> 00:32:51.390 of any public system you're counting on. Because 00:32:51.390 --> 00:32:53.730 that political promise you think is solid might 00:32:53.730 --> 00:32:55.880 just be backed by a mathematical certainty of 00:32:55.880 --> 00:32:56.759 future fiscal pain.