The 10 Keys to a Retirement System That Works
When clients ask you whether the hodgepodge of social security programs, private savings accounts, and employer-sponsored retirement plans that we collectively rely on will be sufficient to provide them with a comfortable living after they stop working, you probably have an easy answer at the ready.
“Ha!”
At least that’s what most advisers say. And statistically speaking they’re often right. Both public and private pensions and retirement savings plans around the world are in a sorry state, so there is little downside to counseling clients to save more money just in case these instruments won’t be enough to support them. The worst-case scenario is that clients will die without spending all their money.
But it’s time for the conversation between clients and advisers to level up. Though meeting the global retirement challenge is a daunting task, it’s also a nuanced one. Reflexive cynicism is not just unhelpful, it’s a missed opportunity.
Think about it: If you are in the business of advising clients and don’t have a working understanding of how their mosaic of private, employer-, and government-based programs works, can you even say you advise them? If you understand their situation but not the global ideal, how will you improve their outcomes?
It’s about more than just your clients, too. Whole countries need to come up with a coordinated approach to help ensure that their citizens don’t end up impoverished in old age.
If someone asks you what we can do as a society to confront the coming retirement crisis, how will you answer? With snark or considered thought? If it’s the latter, I’ve got a hot tip for you:
Keep Reading for the Next Six Minutes
CFA Institute thinks a lot about what a retirement plan should look like, and together with the consulting firm Mercer, developed a nice and easy 10-point list. Don’t let that stop you from reading the whole report, but the list is pretty comprehensive.
If I were you, as I read through this, I’d keep in mind that it’s meant to be relevant at the global level. Every country has its own set of circumstances and the situation where you live might be very different from the lay of the land where I am. Here in the United States, the trustees of the Social Security program are not mincing words. Their 2014 report has, in its third sentence, the following quote:
Neither Medicare nor Social Security can sustain projected long-run program costs in full under currently scheduled financing, and legislative changes are necessary to avoid disruptive consequences for beneficiaries and taxpayers.
What kind of changes? Well, making sure we fulfill each of these 10 objectives is likely a great start:
- The government must establish clear objectives for the whole retirement system, including the complementary roles of each pillar, and incorporate the provision of a minimum income to alleviate poverty among the aged population.
- A minimum level of funding should be made into a pension system for all workers with contributions by employers, employees, and the self-employed, as well as for those of working age who are receiving certain forms of income replacement. In effect, this means every worker will have a retirement account with an entitlement to future benefits.
- There should be cost-effective and attractive default arrangements, both before and after retirement, for individuals who do not wish to make decisions.
- The overall administration and investment costs of each pension arrangement should be disclosed with some competition present within the system to encourage fair pricing.
- The retirement system must have some flexibility as individuals live in a range of personal and financial circumstances. This flexibility includes recognizing that retirement will occur at different ages and in different ways across the population.
- The benefits provided from the system during retirement should have an income focus but permit some capital payments or withdrawals during retirement, but without adversely affecting overall adequacy.
- Contributions (or accrued benefits) at the required minimum level must have immediate vesting and portability. These accrued benefits should only be accessible under certain conditions, such as retirement, death or permanent disability.
- The government should provide taxation support to the funded pension system in an equitable and sustainable way, thereby providing incentives for voluntary savings and compensating individuals for the lack of access to their pension savings.
- The governance of pension plans should be independent from the government and any employer control.
- The pension system should be subject to appropriate regulation including prudential regulation of pension plans, communication requirements and some protection for pension scheme members.
Policymakers, your work is cut out for you. I was actually surprised when I went through the various programs that impact me as a US citizen. I thought that the first objective would be one of the easier ones to fulfill — and was surprised to find myself totally wrong. For instance, the stated mission of the Social Security Administration (SSA) is to “Deliver Social Security services that meet the changing needs of the public.” That’s way too vague to be helpful. What does it even mean?
But at least now we have a framework to organize our concerns around where we used to have only frustration. As you go through the items listed here, consider hooking up with a CFA Society in your country to lobby for the changes that you believe are necessary.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: Jeff Kulak, 2014
Why does thinking about retirement system automatically veer towards pensions? And why does private bodies have to dig its heels into these programs (in whatever manner). Individuals should be at liberty to decide on their saving pattern – amounts, timing, risks and returns. You create a inefficient gigantic system like pension and then you suggest that it should be tax efficient, low cost etc. The fact is the aggregate money goes into the pockets of governments to fund wasteful projects. Instead of encouraging private savings through private channels, why do you suggest creating inefficient monoliths? And where is the discussion on current deficit status of pension funds?
Ashok —
The discussion on the deficit status is forthcoming — stay tuned. I think your question misses a pretty big point: in many cases the people most in need of help in retirement are those who simply do not have the freedom to boost their private savings any further. To address the issue, it’s likely that action will be needed at the individual, employer, and governmental level to boost savings rates and increase the probability that the folks now marching off towards retirement will have a good go of it.
Many thanks for reading and for sharing your thoughts!
Will
Too much government Bill, what government initiatives have helped or protected citizens, and proved solvent over the long run? They can start teaching the virtues of savings in elementary school, as they did when I was a kid, but from there it should be up to the individual to plan for themselves. Not everyone can do this, but many figure it out
The government should provide taxation support to the funded pension system in an equitable and sustainable way, thereby providing incentives for voluntary savings and compensating individuals for the lack of access to their pension savings.
The governance of pension plans should be independent from the government and any employer control.
The pension system should be subject to appropriate regulation including prudential regulation of pension plans, communication requirements and some protection for pension scheme members.
Hi Larry —
As somebody with a significant learning disability, I will say that it’s clear to me that the Americans with Disabilities act, which allowed for me and many others to receive critical accommodations during elementary school, high school, and college, is one example of a government initiative that has helped or protected citizens without tipping us towards long term insolvency.
My intent in making this point isn’t to make you feel bad or propose massive government intervention, but rather to push back on the supposition that there is no such thing as a good government action. I just don’t buy your premise, but many thanks for leaving your comment and reading!
Hope all is well.
Will
Hello Will
I read your post and the comments you have received with great interest for a couple of reasons:
1. The change from DB to DC has shifted what was traditionally the obligation of the employer to the employee of looking after them (DB) for loyal services rendered whilst in employment, in their retirement years. You may argue that employee mobility has changed this paradigm. I would argue that the pressure of public listings and quarterly performance has increased the hire and fire mentality of companies (no, I am not a socialist, I am a conservative – in the US I think they are called Republicans, in Canada we have three parties, not just two – Conservatives, Liberals, and Socialists- (ok the Socialists are called NDP, or as a lovely lady recently told me – watch your language- that is a three letter word).
2. Being a conservative I am an advocate of keeping the involvement of big brother to a minimum, but I think the issue of not having funds to survive (note that I mean survive literally given increasing longevity and the very likely possibility of not having any money when you are in a nursing home, with little recourse of being able to make any money, and being totally dependent on this nebulous system we are talking about) will, if left unchecked and in the hands of the private sector, result in anarchy last seen in the French Revolution.
3. I am with you on points 1 & 2. Everyone I have spoken to agrees that there should be a sharing of risk between employer and employee. So we all contribute to these savings plans, which I have assumed are DC. What happens next? Fees that are independent of value added, risk of not being able to provide promised income in retirement because of a laissez faire approach to managing money – see Jason Voss’ post on benchmarks to which I will add this quote from a person I have a lot of respect for his outspoken views on the need for change in the industry – David Fisher, Chairman, Capital Group International, Inc. – Reflections and Insights: Provocative Thinking on Investment Management (February 2005) “I think that, although it is important to know and even measure the degree to which your portfolio is different from the benchmark, when you call that deviation “risk”, you are sending (this) wrong message: It’s OK to lose money as long as we do it somewhat slower than the benchmark.”
4. In the last sentence of point 2, do the words future benefit mean a pre-determined payout that retirees can depend on as guaranteed income or is this amount dependent on market performance?
5. The investment consulting industry (Mercers, Towers, Watson Wyatt, etc is like the investment industry – the need for change in both industries is imperative in both. Over reliance on consultants (I am in admiration of CFA Institute partnering with Mercer, where I have a lot of respect for individuals in that organization) will not necessarily reflect the views of the individual dying in understaffed and under ventilated (because they do not want people escaping from windows) prisons they call state-run nursing homes, or those people who have just retired and have suffered what they call a sequence-of-risk returns – meaning there is little way they can recover from the loss of what they have saved over their employment years.
6. Point number 9 – do you know the saying about having a fox manage the chicken coop? Enough said. Too much government involvement and oversight will, in my humble opinion, be too little. This is one area that cannot be left to the private sector.
On that note there is much to be admired from, and many insights that have not yet been implemented, from the investment industry itself, in particular the series on The Future of Life Cycle Saving and Investing.
My two cents for the cause.
Savio
Hi Savio —
I want to thank you for such a well-considered comment, and apologize for my circumstances at the moment. I’m just about to go on vacation, and am (I guess) technically on vacation right now. So I can’t respond in as much depth as I’d like.
But I do want to make one point, which is that as a millennial it seems completely strange to me that people quickly enter a political mode when talking about retirement. Why is that?
For those of us who expect to be in the workforce for the next thirty years at least, it seems kind of silly. There is nothing that can be done to keep a massive generation of elderly people from retiring, and it makes sense to acknowledge that they don’t have enough money. What we do about it is a big question, but it feels intuitive that individuals, employers, and governments will all need to act in some fashion to bring about a positive result.
Anyway, completely agreed that our industry has a lot to bring to the table in solving this crisis. We are getting better at advising our clients every year, and delivering improved service at reduced cost. I expect that trend to continue well into the future!
Thanks as always for reading —
Will