Personal Pension  

Defusing the timebomb

This article is part of
Retirement Freedom and Responsibility - March 2015

Despite the ongoing repairs to global economies in the aftermath of the financial crisis, an even bigger danger threatens financial markets worldwide.

A looming retirement crisis, though seemingly far on the horizon, has a destructive potential of far greater magnitude.

First, let us remind ourselves of the growing scale of the problem. According to International Monetary Fund research, the public pension expenditure for advanced economies reached 9.1 per cent of gross domestic product in 2010, compared to 3.8 per cent in 1960. Projecting the estimates forward, that burden on growth is expected to rise to 11.9 per cent by 2050. The emerging economies do not fare much better despite much younger populations: by 2050, the average pension drag on their GDP is likely to be 8.5 per cent.

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So, how did we get into this mess? Mainly by living longer but not retiring much later; by consuming today and not saving enough for tomorrow; and, especially in the West and in China, by enjoying childhood but then having fewer children.

The growing problem begs an obvious question: is there an ideal retirement system that could provide a solution?

First, the government must take the lead by providing an overarching framework and clear objectives. Many countries already have retirement systems that are diversified across a number of pillars: these usually include a mandatory public pension, a mandatory and fully-funded occupational or personal pension, and a voluntary fully-funded option. Such a combination is supported by multiple stakeholders, including individuals, employers and the government representing the interests of a number of generations of the wider community. The inevitable tensions between these stakeholders need to be balanced by the retirement framework to ensure fairness and sustainability.

The greatest challenge to any voluntary savings regime is the all-too-human temptation to consume now and postpone contributions when retirement seems far away. Also, most people avoid having to make a decision about their retirement, thereby wasting precious years of accumulation. In such circumstances, behavioural economics suggests that paternalistic nudges may have a positive influence, pushing some non-savers towards savings.

Modern patterns of employment mean that most people are likely to change jobs several times during their career. Therefore, occupational pension savings should be portable and all contributions and accrued benefits should vest with the individual immediately.

Retirement savings mainly provide for a stream of income during retirement. However, some flexibility in drawing upon the savings to suit preferences and a variety of needs may incentivise contributions during the accumulation phase. An ideal system would allow drawing on a limited portion of the savings as a capital sum during retirement.

The total cost of the retirement system, including all direct and indirect costs of investment and its administration, will have a significant impact on the investment returns, and therefore on the value of the savings on retirement. To encourage efficiency at every level of the system, there should be open and fair competition among providers of various services, and all costs should be made as transparent as possible.