OVERVIEW
In the U.S., only one in three workers has adequate savings for retirement at age 67. And the problem is not just confined to the U.S. People around the world are dealing with the rapid disappearance of the traditional employer-sponsored pension. The broader move from defined benefit (DB) plans to defined contribution (DC) plans puts additional pressure on personal savings and preparing an individual for an adequate retirement.
While DB plans guarantee employees a certain retirement income, DC plans require workers to save and invest properly if they’re to receive a reliable, regular income for the whole of their retirement. Longer lifespans coupled with inadequate retirement savings have made the prospect of enjoying a comfortable retirement increasingly uncertain.
Employers’ move from DB to DC plans is understandable: the long-term financial and longevity risks associated with guaranteed retirement benefits affects the balance sheet. Workers, however, tend to prefer the retirement income security DB plans can provide according to London-based Kevin Wesbroom, senior partner, Retirement Solutions at Aon.
This challenge has pushed several countries to find different ways to help solve the retirement savings equation.
IN DEPTH
Around the world, workers are being compelled to take more responsibility for their retirement savings as many employers move from traditional DB plans to DC plans.
“There’s a massive global trend away from defined benefit plans to defined contribution plans,” says Wesbroom. “Employers are looking to transfer the risk associated with DB plans.”
As workers look to cope with the changing retirement income landscape, several possible solutions are emerging.
The Netherlands And The U.K.: Sharing The Risk Through Collective Defined Contribution Plans
In some European countries, one possible compromise to the DB versus DC plan dilemma is the collective defined contribution (CDC) plan. CDC plans occupy a middle ground between DB and DC plans in delivering a more consistent, DB-style income – with employees collectively sharing the retirement plan risk.
The CDC approach has been employed in countries such as the Netherlands, and the U.K. government has recently confirmed it is considering introducing its own version of CDC plan in the near future.
“A lot of people are looking for what an old-fashioned pension did,” Wesbroom says. “Collective defined contribution pension plans could offer a different way to tackle the problem.”
CDC plans offer workers a retirement income structure in which employers’ plan costs are fixed, similar to that of a DB plan. The key is that members’ target benefit (typically the indexation on that pension) can be adjusted annually based on the plan’s performance, meaning plan members’ benefits could be reduced in difficult years. But those cuts don’t have to be catastrophic and can be restored when conditions improve.
“The experience of CDC plans in the Netherlands following the 2008 financial crisis is instructive,” Wesbroom says. “Employers cut payments and it was pretty unpopular. But, in fact, the average cut in Holland, for example, in the midst of the financial crisis was only 2 percent of income – there were harsher consequences for those in individual DC plans.”
Amid a government push for the development of Comprehensive Income Products for Retirement, Australia, with the fourth-largest retirement system in the world, is seeing growing interest in CDC solutions. Ashley Palmer, practice leader, Retirement Solutions at Aon Asia, notes that “CDC solutions have been considered by the some of the largest industry funds to deliver more secure member outcomes.”
A Regional Approach: The Pan-European Pension Product
The EU is also considering new types of savings vehicles to help tackle the retirement savings issue. A proposed Pan-European Pension Product (PEPP) is aimed at helping workers improve the way they save for retirement by offering a better option than many available across the fragmented European market.
EU leaders envision a wide range of financial services providers offering PEPP personal retirement-savings products. PEPPs would offer standardized features and would offer EU savers the ability to take their pensions with them when they switch employers or move to another country. The product also provides more choice and consumer protections.
Being able to offer their PEPPs across the EU would allow providers to benefit from scale and the ability to distribute PEPPs electronically across national borders.
While PEPP effort has been slowed by debate over regulatory issues, the European Commission has indicated hopes to have the plan approved this year.
The U.S. And Prioritizing Personal Savings: Helping Workers Become Better Savers
In the U.S., focus on retirement savings has been around the level of savings and efficiency of existing vehicles used for those savings rather than on the vehicles themselves. Recently, employers in the U.S. have started to more seriously explore retirement-income solutions within DC plans to help employees manage the longevity risk transferred to them with the shift from DB to DC.
Promoting sufficient savings levels remains important. According to Aon’s The Real Deal: 2018 Retirement Income Adequacy Study, to achieve financial independence by age 67, U.S. workers aged 25 or older should save 16 percent of their pay and employer contributions annually. Yet workers tend to save only between 4 and 7 percent, and their employers contribute an average of 5 percent of pay.
To help employees better prepare for retirement, many employers are looking to help their workers become better savers. Grace Lattyak, associate partner, Retirement Solutions at Aon, says, “Employers can have a significant impact on how much employees save by educating them on the impact of small changes in savings rates, creating or expanding automatic contribution escalation features in 401(k) programs and setting higher savings targets for matching contributions and contribution escalation.”
Employers may soon be able to support employees’ savings for retirement by offering multiple employer plans (MEP), in which businesses join together in a single retirement plan and are supported by a third-party sponsor. Plan sponsorship would become more feasible for employers, creating leverage as costs are driven down across a common platform and plan design. The result is more opportunity for organizations to use best-in-class approaches and for providers to arrange lifetime income for employees.
Communication, including tailored messages highlighting appropriate savings targets for different employee populations, is an important element of many employers’ efforts. Employers are also providing financial wellness education and tools to help employees budget better and save more.
Singaporean Biometrics: Compulsory Savings With Easy Access
In various parts of the globe, encouraging individuals – employees and retirement plan members – to participate in the savings process is a key part of improving retirement outcomes. Singapore’s Central Provident Fund (CPF) is a compulsory comprehensive social security system that allows workers to save for retirement costs, including health care and housing, and both employees and employers contribute to the fund.
Singapore’s government moves to incorporate biometrics to provide citizens easier access to public services. In 2018, the CPF board redesigned its smartphone app to allow users to use fingerprints or facial biometrics to log on – the first government agency to launch biometrics on a mobile app. Employing biometrics in the redesigned app allows fund members to easily access information on their various retirement savings accounts. The app has also improved its information display, further increasing ease of use.
“Across the Asia–Pacific region, most aspects of day-to-day life are done via a mobile device. A logical next step is the rise of financial wellbeing solutions to help solve the broader retirement-saving challenge. The most effective approaches are aimed at changing individuals’ behaviors to both money and savings through incentivizing smart habits,” Palmer explains.
China: Taking Steps Across Personal Savings And Private Pension Plans
Investing and incentivizing long-term savings is also critical. China, for example, is aiming to tackle both. A recent survey found less than half of China’s millennial population has begun to save for retirement. As the country’s population ages, and as more pressure is put on the state-run pension system, Chinese officials have been working to improve the retirement-savings environment.
In August 2018, the China Securities Regulatory Commission approved the country’s first target-date retirement funds. The new offerings, similar to target-date funds offered in the U.S., are intended to encourage Chinese workers to save more for their retirement.
China also has rolled out a pilot program aimed at bolstering the country’s private-pension plans by providing preferential tax treatment for contributions to individual retirement accounts, resembling the treatment of U.S. 401(k) accounts.
Finding Ways To Improve The Retirement Outlook
Retirement approaches reflect local customs, cultures and variances in state and private pensions, differing from country to country. As such, creative ways are emerging around the globe to help solve the issue. Indeed, many countries and regions might offer examples that can be copied elsewhere. “There isn’t a single answer to this challenge,” says Wesbroom. “Understanding emerging approaches is a first step in addressing aspects of the retirement savings challenge. Indeed, many might offer examples that can be copied elsewhere.”
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