Lipscomb at Davos
By Barry Stowe
(Dean’s Note: Barry Stowe, Lipscomb Alumnus and CEO of Prudential Corporation Asia, is attending the World Economic Forum’s invitation-only annual meeting at Davos, Switzerland this week. He is filing daily dispatches.)
I suspect that not many of you are planning to retire on your Social Security income alone…while there is virtual certainty that you will receive your benefits, the amount you receive won’t be adequate to support you in reasonable comfort. There are other countries, most notably in Europe, that provide their citizens with much higher levels of benefits, amounts that are adequate to support a modest, middle-class lifestyle. This sounds great until you realize that these programs face solvency issues that even confiscatory tax rates can’t solve (The French are now able to demonstrate their patriotism by paying taxes of close to 75% of income). So governments all over the world are trying to figure out how to create retirement income schemes that are both adequate and sustainable. No one has solved it…at least not yet.
The World Economic Forum is in the midst of the debate on this issue, and a policy group organized by WEF (of which Prudential is a member) has been working on solutions based upon the World Bank’s ”Four Pillars” approach…that is to say the four essential elements of successful retirement provision. These are:
1. Public retirement programs (think US Social Security) that provide for basic needs. These are contributory (you have to pay in order to participate) and are typically funded on a pay-as-you-go basis (there is no “trust fund”…current contributors fund current beneficiaries).
2. Private, employer-based retirement plans that can be either voluntary or mandatory (required by law) and either defined benefit (a traditional pension that pays a percentage of working income in retirement) or defined contribution (such as a 401K where your employer pays a percentage of your income into a fund). These can include contributions from employees as well as employers.
3. Individual savings…very simple but very important.
4. Longer working lives…for instance, changing retirement age from 65 to 67…and allowing retired individuals to continue to work part-time without forfeiting retirement benefits.
On Friday morning I helped lead a discussion on this extremely important topic. The timing could not be better. In most countries around the world populations are aging and the resulting stress on social protection systems is growing with each passing month. The situation in America is very difficult. Historically, Americans retired around age 65 with their home paid for, a pension, Social Security and enough money in the bank for the occasional luxury. With life expectancies meaning that most people only lived for five to seven years in retirement, the economics worked. Today, most Americans pass age 65 with a home that is mortgaged, savings equal to less than two years of working income and a 401K that isn’t large enough to provide a stable income for more than a few years. This is exacerbated by ever-longer life expectancies…a healthy 65 year old faces the realistic prospect of a 20 to 25 year retirement. These economics do not work.
Our discussion this morning focused on how the private sector can help solve the issue of retirement, and specifically how we can design the “employer” pension plan of the future. Here’s what we can up with…I wonder if you will like it:
FINANCIAL LITERACY…key to solving problems is understanding them. It is important that Banks, Insurance Companies, Financial Planners, whoever you use to craft your own plans, help you understand the gravity of the issue and the fact that individuals MUST save significantly more than they have been over the past generation.
PORTABLE PERSONAL PENSIONS…people change jobs much more frequently today than they did in the past, so it would be helpful to have a single, portable pension that travels with them through their career. This would eliminate the situation where individuals have multiple, small accounts and would eliminate the loss of benefits when individuals leave a job before they “vest”.
Employees would be required by law to contribute 10% of their income to their pension every year…employers would be required to at least match that 10%. This seems like a loss of choice for freedom loving Americans…but in an environment where people clearly have lost the discipline to save, it may well be the only sensible solution. I fear the alternative to this would ultimately be additional government provision to those who failed to save. I personally would rather give up some freedom rather than pay the additional taxes required those who didn’t have the good sense to prepare for their retirement.
“DRAW DOWN”…After you’ve spent a lifetime accumulating assets you need to figure out how you’re going to live on them in retirement. It is sensible for some portion of one’s savings to be “annuitized”…a lump sum paid in return for a guaranteed income for life. Some countries require this (or provide major tax incentive to do so). This is what that old-fashioned Defined Benefit pensions did for your parents, and you can do it yourself. Annuities provides a level of certainty that there will always be an adequate level of income…even if you live significantly longer than you expect. And chances are, you will live longer than you expect.
The seed of the broad solution to the retirement problem is in the Four Pillars above…not some of them but the combination of ALL of them. Key to this will be more savings by individuals…enabled by government policy (why is there a maximum on IRA contributions?)…but ultimately emphasizing the individual’s responsibility to provide for himself. Just like our parents did.