The experience of various countries show unintended consequences of requiring pension-plan contributions
Recognizing that people are generally poor at making good decisions for themselves, more financial-services firms and policymakers are designing programs where the best long-term path is selected by default. That thinking is also being applied to the question of retirement saving, where mandatory participation in defined-contribution systems could be the cure to human indifference.
On the other hand, as is the case with digital payment systems, it could create a kind of disengagement.
“[W]hen it’s completely automatic, workers could become disengaged from the process, further contributing to an already dismal level of financial literacy world-wide,” wrote Bruce Wolfe, a principal at C.S. Wolfe and Associates and the founder and former executive director of the BlackRock Retirement Institute, in a piece for the Wall Street Journal.
He pointed to the example of Chile, which launched one of the world’s first mandatory defined-contribution systems. Recently, the first batch of retirees to spend their entire careers contributing to the program became outraged when they found that their retirement savings — and, consequently, their lifetime retirement income — fell far short of expectations. The problem resulted from many factors, including a highly automated, opaque process that fostered little worker involvement, 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,” Wolfe said.
Another unintentionally flawed system could be seen in Australia, he added. A current mandate for employers to contribute 9.5% of an employee’s salary — which will increase to 12% by 2025 — has led to an average household balance of US$314,000 among workers who just reached retirement after being enrolled in the defined-contribution plan their entire careers.
But Wolfe cited one research report that found a perfect correlation between household debt and retirement-savings levels since the program started in 1992. One possible story behind the numbers, he said, is that many families who saw nice upticks in their retirement accounts each year were convinced that they could afford to take on more debt.
He also pointed to accusations of excessive investor fees and underperforming investment options hurled at Australia’s super system, which “may be the result of a system unintentionally designed to limit employee engagement” that could have given rise to a governance system that’s lacking in 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,” Wolfe said, arguing that systems where individuals are put on a default path in savings should also lay an automated path on the drawdown side, where potential risks and complications are much greater.
“Perhaps there’s a middle ground in there that makes the most sense,” he continued. Focusing on the US, he proposed that the first priority should be to get more workers into the retirement savings system; once in it, they should be provided with a series of opt-out defaults, including ones for systematically withdrawing their assets upon retirement.