Pension systems around the world all face a common problem – the strain put on existing promises for retirement because of increases in life expectancy. The retirement savings gap is quite large in some countries already, and on a global scale is projected to grow significantly larger by the year 2050. In prior research the World Economic Forum determined that in order to close the gap we need to:
- expand coverage of savings systems to more individuals;
- use technology to increase the level of savings; and
- employ techniques to incentivize more savings while being cognizant that individuals may have more demands on their finances than only retirement.
However, in order to effectively address the growing retirement savings gap, it is also critical to optimize the investment of these savings to enable individuals to achieve good retirement outcomes with the money they have invested. A good retirement outcome provides a person with adequacy (a retiree’s needs are provided for), is sustainable (the risk of outliving one’s savings is low) and is flexible (allows individuals to respond to life events). In this paper, the authors focus on recommendations for policy-makers, sponsors of retirement plans and members of the asset management community that provide services to the retirement industry.
Given the strain on and relative decline of government or employer-based pensions (traditional defined benefit plans), retirement outcomes will increasingly depend on accruing assets in individual retirement savings accounts and then effectively managing those assets through retirement. Defined contribution (DC) plans have become the main vehicles for such savings.
In a DC plan, an individual contributes into an individual account that is then invested into a potentially wide range of different assets (cash, bonds and equity are common). This is known as the “accumulation” period. How the investments are structured depends significantly on a country’s policies. In this paper, the authors share the expected results for common/default DC strategies in several countries. Based on these results and other research, the authors encourage policy-makers and plan sponsors to consider the following for accumulation parameters in DC plans:
- Consider risk from the perspective of an individual saving for retirement
- Diversify the investment of saving accounts, by geography and asset type
However, the diversification of savings accounts by asset type has several practical challenges that need to be addressed. Introducing alternative asset classes is often challenging due to greater complexity of the underlying investment, lower liquidity (at both the individual and plan level), a vulnerability to corporate transactions if the plan is employer-based, and potentially higher and more complex fees. Some of these issues require further innovation from the investment industry to meet the demands of the DC savings market.
The “decumulation” phase is the period in which individuals withdraw money from their savings. How this is structured can vary widely between countries, and the relative benefit levels of social security systems can make meaningful differences. Personal circumstances differ significantly at this point and tend to be more complicated in comparison to when people are younger. Public policies ought to be developed while keeping in mind the three points highlighted for a good retirement outcome – adequacy, sustainability and flexibility.
Given the range and complexity of potential options and approaches, and the difficulty most individuals have making a choice, policy-makers should consider whether default decumulation structures would be beneficial, similar to the default structures that exist for accumulation. This will be highly dependent on each country’s retirement system. Policy-makers should also consider how to make the wide array of available information easier to understand for the individual choosing a retirement plan (including potentially numerous savings accounts, government benefits and employer-based pensions). Dashboard reporting or introducing auto-consolidation of savings accounts can help this effort.
Lastly, individuals also need access to effective financial advice, if default plans are not suitable. Advice must be comprehensible, accessible, priced effectively, transparent and aligned to the best interest of the advisee. The establishment of strong fiduciary rules by policy-makers should be of paramount importance to help meet these criteria.