Reforming retirement systems is a more urgent imperative globally as the coronavirus pandemic claims jobs, lowers economic growth and investment returns and threatens to choke funding for already underfunded pension plans. The pandemic is also hastening the imminent insolvency of the Social Security Trust Fund, according to a recent report by the Penn Wharton Budget Model. In the two recession scenarios the report laid out, the trust fund would run out of money in 2032 or 2034 – between two to four years earlier than pre-pandemic projections.
But there is still hope for retirees, if policymakers, employers, and plan sponsors can purge retirement systems of their drawbacks and bring new financial products to fund them, according to a recent research paper by Olivia S. Mitchell, Wharton professor of business economics and public policy and executive director of the School’s Pension Research Council. Retirement systems must also provide for the long-term care needs of retirees, and build on recent moves to cover “gig economy” workers or freelancers, part-timers, and temporary workers, her paper stated.
Fixing the ‘Accumulation’ Stage
For the accumulation stage, Mitchell calls for separating pensions and health care from employment. That would dramatically expand coverage to all citizens, irrespective of whether or not they hold a job. Next, with retirees living longer, they can better fund their golden years if they also delay their retirement and work longer, she wrote. Retirement plans could also be tweaked to incentivize delayed retirement.
The way pension systems are designed also needs reforms. The trend of retirement systems moving away from defined benefit plans to defined contribution plans will continue to gain more traction, Mitchell noted in her paper. Defined contribution plans shift more of the onus of funding pensions to the beneficiaries, instead of saddling employers or plan sponsors entirely with that responsibility. In defined-contribution plans, a worker’s contribution is often matched by an employer contribution.
How pension plan sponsors invest the contributions or make portfolio allocations, is critical to the funding of plans, and so that also needs fresh approaches, according to the paper. Employees and retirees could also find useful advice in portfolio allocations from fin-tech firms and robo-advisors, or algorithm-based financial advice, the paper stated.
Fixing the ‘Payout’ Stage
In planning for the payout stage, beneficiaries could convert their retirement accounts into annuities, so that they get a pre-determined annual payout, while also protecting themselves against outliving their pensions, Mitchell noted. In fact, many countries mandate doing so, and even a 10% allocation into annuities helps greatly, she pointed out in her paper. She also recommended that integrating annuities be part of plan design from the outset, for instance in the context of a target date fund, as it can be difficult to add annuities after people retire.
Policymakers around the globe could help strengthen retirement systems in several ways, according to Mitchell. First, they could help generate and make available “better quality and more granular data” on mortality and morbidity patterns. Such data will help insurers factor in longevity risk when calculating annuity premiums.
Second, they could help develop “a consistent and economically coherent set of guidelines” for measuring and forecasting social security and pension assets and liabilities through time. Also useful would be mechanisms to better assess the long-term care needs of an aging population.
Third, retirement systems could do more to encourage delayed retirement, by undoing practices that set relatively young retirement ages to qualify for benefits. This is most useful when paired with policies that discourage employers from hiring older workers, the paper stated.
Agenda for Policymakers
Delinking the provision of benefits from employment and extending benefits to gig economy workers were other important areas where Mitchell saw roles for policymakers. Some firms such as Uber and Lyft are changing the status quo by helping drivers obtain low-cost insurance, she noted. Policymakers in many cases have responded to workers’ needs in the aftermath of the pandemic, including facilitating sick leave policies for those who fall ill or have to take care of unwell family members, she added.
If real returns remain low for years, it will be critical for workers to save far more than they did in the past to cover their golden years.
More broadly, policymakers could help strengthen social safety net programs that provide unemployment benefits, housing, medical care, and food security, the paper suggested. Mitchell cited efforts by Denmark in subsidizing 75% of the wages paid to workers at firms hit by the pandemic, and by Germany to extend loans to affected firms and thus help them stave off bankruptcy.
A Stage Set for Clashes
These reform proposals are set against the backdrop of rising tension between governments and retirees. Cash-strapped governments are eying retirement funds with an interest in using them for revenue, while retirees are concerned with how to finance their later years.
In recent years, some policymakers have sought to levy taxes upfront on contributions, known as “Rothification.” Advocates of such a policy note that the government currently “forgoes” about $100 billion in annual taxes on pre-tax contributions. “Some of that does come back later when people retire and pay taxes on their benefits,” Mitchell said in a recent Knowledge@Wharton article.
The push to tax retirement contributions upfront poses other risks as well. “Moving to a system that taxes pension contributions instead of withdrawals will lead to later retirement ages, particularly for the better-educated. It would also reduce work hours and lifetime tax payments and increase consumption inequality in retirement,” the researchers wrote.
Why the Urgency
The present time is right to revisit retirement systems, according to Mitchell. Amid the pandemic’s spread, capital market values shuddered, health care systems staggered with millions of infected patients, joblessness shot up, retirement funding shrank, government tax revenue contracted, and unprecedented government spending had become the new normal. The global stock markets lost about $20 trillion in March 2020. Poorer nations will feel the economic pains more, since their health care systems are ill-equipped and their national budgets are strapped for funds, she said.
Retirement systems will become increasingly important as a source of income as declining fertility and rising longevity will continue to spur the growth of aging populations around the world, she added. This is supported by estimates by the World Economic Forum that the retirement savings gap will grow by 5 percent each year to reach $400 trillion by 2050.