As
the U.S. and other developed countries increasingly look toward
defined-contribution systems as the solution to retirement security, many
people have suggested taking it one step further: Make participation mandatory.
Conceptually,
it makes sense. After all, if people won’t save enough on their own, it might
be best to give them no choice at all. But dig deeper into this idea, and all
sorts of unintended consequences arise, which should give all of us pause.
For
one thing, when it’s completely automatic, workers could become disengaged from
the process, further contributing to an already dismal level of financial literacy world-wide. Look no
further than our own “mandatory” Social Security system where most individuals
consume their benefits prematurely, forgoing more attractive lifetime income
payments.
Chile,
with one of the first mandatory defined contribution systems in the world,
recently saw public backlash from its first
batch of retirees who spent their entire careers contributing to the program.
Their retirement savings, and resulting lifetime retirement income, fell well below expectations. Not the type
of surprise any of us want to hear at our retirement party.
Although
many factors were at play here, a highly automated, opaque process that removed
employee involvement from the equation led to little worker engagement,
education and advocacy. In this case, ill-informed pension expectations were
built on a little known assumption that workers remained employed continuously
for 30 years—something unique to a country where entering and exiting the
formal workforce is common.
Another
well-known mandatory defined-contribution system—Australia’s—highlight a
different type of unintended consequence. In Australia, employers are currently
mandated to annually contribute 9.5%—rising to 12% by 2025—of an employee’s
salary. Workers in the defined-contribution plan their entire careers have been
rewarded handsomely with 2016 household balances averaging about US$314,000 (A$441,620) for those just
reaching retirement age.
What
is lesser known is almost the perfect correlation of household debt to retirement
savings levels since the program’s inception in 1992, according to
one research report. One could surmise: Families seeing a nice uptick each year
in their retirement accounts lulled many to take on more debt.
In
addition, Australia has faced claims of excessive investor fees, underperforming investment
options that may be the result of a system unintentionally designed
to limit employee engagement--creating what I believe is a governance structure
not so great on checks and balances.
These
countries and others highlight another piece that I think any mandatory system
would need: a retirement income default solution for when workers are ready to
retire. That is, if you are going to default the individual through the savings
process, taking them out of the picture you should follow suit on the drawdown
side where the risks and complications facing retirees dwarf the savings side.
Chile automates the transfer to a
lifetime-income option in the form of an annuity but Australia
doesn’t. In fact, Australia’s underdeveloped insurance market where individuals
could purchase guaranteed lifetime income—such as an annuity—essentially
doesn’t exist, leaving retirees to their own volition for managing down their
assets. No easy proposition.
The
U.K., meanwhile, has abandoned their defined-contribution lifetime income
default option for “pension freedoms,” which basically means
retirees are on their own. Not surprisingly, retirees appear to be making
less-than-ideal choices with their newfound freedom, like taking all their
defined-contribution savings in one lump sum upon retirement.
The
good news is that it appears that steps are being taken at the federal level in
these countries—Australia, Chile and the U.K.—to acknowledge and remedy many of
these deficiencies.
Back
in the U.S., we do know people need nudges, defaults and the like to counteract
our general malaise to save and our taste for immediate gratification. Although
still a work-in-process with plenty of weaknesses, our defined-contribution
retirement system to a large degree seems to be a good cultural fit for us.
Still,
while a pure voluntary defined-contribution retirement system is foolhardy,
it’s important to learn from other countries that a mandatory one also has
plenty of drawbacks.
Perhaps
there’s a middle ground in there that makes the most sense. First, the top
priority should be to continue to bring more U.S. workers into the retirement
savings system. And then, once in it, have a series of opt-out defaults as many
have already adopted for saving, followed by opt-out defaults for
systematically withdrawing those assets once a person retires. That may be our
best chance for delivering financial security.
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