Those who would like to substitute private retirement accounts for all or part of Social Security’s guaranteed benefits contend that the choices opened up through such a substitution will be welcomed and well used. Against this, those who defend Social Security’s guaranteed minimum retirement income express the fear that too many households might fall victim to bad luck or bad management of their resources and end their lives in poverty. These contrasting views are hard to test, since almost every American worker participates in Social Security, so the outcomes of an alternative system are largely speculative.

A new paper by Jeffrey Brown and Scott Weisbenner of the University of Illinois, Who Chooses Defined Contribution Plans? (National Bureau of Economic Research, January 2007) offers important new evidence on how people behave when they are offered the choice of a guaranteed pension or a self-directed mandatory saving plan.

• More than half the employees offered a choice failed to exercise it. They simply accepted the default option.
• Those who did make a choice appeared to be significantly swayed by how the choice was framed in the written material they were given.
• Among those who did choose, more than a third opted for the self-managed plan, although it promised a nest egg significantly smaller than another new option.
• Those who chose the inferior self-managed option were better educated, with higher incomes than those who ended up with the other options.

In sum, the evidence suggests that only a minority of workers are likely to use new retirement options, and among those who do, a substantial proportion may act in ways that undermines the goal of a dignified retirement for every household.

In the late 1990s, the State Universities Retirement System of Illinois, whose 180,000 members have always been outside the Social Security system, offered new members two new options: besides the traditional guaranteed pension, they could opt for transferable retirement assets, which they could shift to another plan upon leaving their Illinois employment, or they could opt to create a self-managed retirement account.

The details of the options were not simple, but a number of brochures were prepared for new enrollees. During the first year that the three options were presented to new employees, nearly 60% chose one of the three options. But as the novelty of the new system diminished, that percentage declined to about 40%. The rest—those who failed to make a choice—were enrolled in the original pension plan.

Based on the brochures that describe the options, the reader easily could conclude that he or she first must decide whether to choose a self-managed plan or a guaranteed pension, and then must decide whether the pension should be transferable or not. In fact, evaluated purely on the basis of the value of the benefits and the cost to the employee, the transferable pension offered a substantially better deal than the self-managed account. Nevertheless, the self-managed plan was the choice of better educated, higher income employees.

One might argue that this elite among the employees could expect to do better than other employees with their retirement saving, but this is not what the evidence shows. In fact, as Terrance Odean and Brad Barber show in several papers (for example, "Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors" in the Journal of Finance, April 2000) the best way to do well as an individual investor is to diversify and hold a portfolio with minimal trading, something many investors, especially male investors, fail to do. (Of course, an investor with billions to manage can expect to do better than the average if he enters less liquid markets where he also faces higher risks; but this is not an option offered to an employee of the University of Illinois .)

Remember, these state employees of Illinois are outside the Social Security system. If they make bad investment decisions or if markets crash just before they plan to retire, they have no other pension to fall back (unless they have coverage from other jobs).

Creative, risky, even stupid investing is everybody’s right in a free country. But when security in old age is involved, not only for the investor but for people who depend on him or her, we need a minimum income that is guaranteed. Above that minimum, let the games begin.

It would be reckless to undermine the guaranteed minimum income that Social Security delivers.

Bernard Wasow is a Senior Fellow at The Century Foundation.