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Guaranteed Returns in Retirement Savings Plans: Are They Worth the Cost?

Summary of Publication

Several states have recently created state-sponsored retirement savings plans for employees of small businesses, and many other states are considering doing the same. A key element in the design of such plans is the decision whether to provide a minimum level of guaranteed returns to savers. Continued concerns about retirement security—as well as lingering apprehension from the 2007–09 financial crisis, which showed just how quickly assets accumulated over a lifetime can lose their value—are behind the desire for guaranteed returns.

Guarantees are a classic example of the economics dictum that it is impossible to get something for nothing. In principle, rate-of-return guarantees are simple: they protect savers from losses and ensure that they receive a minimum return on their investments. In practice, however, guarantees raise a number of complex issues and are more costly than one might think. First, someone—the saver, the plan sponsor, or the taxpayer—has to pay for the guarantee. When the government pays, it tends to severely underreport the real economic costs of the guarantee in budget documents. Those costs are resources that must be forgone to finance the guaranteed return. Guarantees offered by private insurers reflect their true economic costs more accurately, and they are often quite expensive.  Second, the net benefits of rate-of-return guarantees may not be as obvious as they seem, because (a) markets often respond quickly and (b) social security, Medicare, and housing constitute the majority of most people’s retirement resources.

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