As a journalist specializing in financial news, I often examine global trends to provide insights for our readers at OverTraders.com. This week I’ll be looking into retirement systems from across the globe. I’ll contrast them with the U.S. model and examine what they might teach us to improve retirement security here on the homefront.
We all want a comfortable retirement. Countries take very different approaches to achieve that goal. While the U.S. grapples with debates around privatization and funding, other countries have implemented innovative strategies that offer valuable lessons. By learning from these models abroad, we can learn valuable lessons about how to fix our own system.
The 2023 Mercer CFA Institute Global Pension Index is out, providing a deep dive into retirement systems around the globe. This index proactively holds countries accountable based on adequacy, sustainability and integrity. It is the fulcrum upon which alternative and competing approaches come to be compared. The Netherlands is always at the top — an exemplar of a comprehensive system that successfully balances these two important facets.
The five best performing countries in terms of retirement security are Norway, Switzerland, Iceland, Ireland and Luxembourg. It is these nations’ mix of policies and practices that has led to their high performances. Even though the U.S. has improved some, it’s far behind these trailblazers.
Understanding Auto-Enrollment
Overview of Auto-Enrollment
Through that success, auto-enrollment has rise to the level of one of the most powerful tools for getting more Americans saving for retirement. This method uses automatic enrollment for employees in a retirement plan such as a 401(k). They still have the option to opt out if they do not want to participate. Inertia is the greatest killer of good ideas and smart action. Even when people intend to save for retirement, they have trouble following through with active enrollment. By removing the action required to enroll—making enrollment the default—participation rates can triple or quadruple overnight.
Other countries have successfully adopted auto-enrollment at a national level. The UK’s automatic enrolment system, rolled out in 2012, compels employers to automatically enroll eligible employees into a pension plan. Employees pay in a set percentage of their salary, similar to Social Security, with employers matched contributions. This has created a significant spike in public pension participation, especially from younger workers and lower-income earners.
The success of auto-enrollment will depend on a number of factors. First, we should figure out a contribution rate that most employees can afford to make the default. It needs to be high enough to ensure meaningful savings over the long term. Second, employees need to be unequivocally told about the advantages of joining and how to opt-out. Third, the investment options provided should be suitable for a variety of risk tolerances and investment time horizons.
Success of Auto-Enrollment
America has already reaped the rewards of auto-enrollment from employer-sponsored retirement plans. More than half of all companies have incorporated this provision into their 401(k) plans, resulting in increased participation and savings. The U.S. can follow a simple but bold path by expanding auto-enrollment even further. Or they could roll it out at the state or national level, similar to what the UK has done.
This is where auto-enrollment becomes a key benefit. It’s because it addresses the behavioral biases that frequently derail people from saving. Procrastination, financial illiteracy, and the assumed difficulty of planning for retirement may lead to continued low participation rates. Auto-enrollment overcomes these barriers by making saving the easier, smarter choice the default.
Though auto-enrollment is a useful tool, it’s not a cure-all. Together with it, providing financial education is crucial. This guidance serves to protect Americans’ ability to make deliberate and informed decisions about the utilization of their hard-earned retirement savings. Employees must be incentivized to raise their contribution rates over time, so they can grow the nest egg that will allow them to thrive in retirement.
Strategies for Enhancing Retirement Savings
Optimizing Retirement Savings Accumulation
Accruing enough to retire on comfortably takes more than just a singular focus on savings. The most important of those strategies is getting people to save early and save often. It turns out compounding power is pretty magical stuff! Those modest contributions, especially if you start making them early in your career, can dramatically enhance your retirement savings.
Perhaps just as important is the fact that they have high contributions. Most financial planners will tell you to put away a minimum of 10-15% of your income over your working life into retirement savings. While this might sound intimidating, it’s usually very attainable through what’s called a ramp-up approach that allows you to add more money each year. Don’t leave free money on the table—maximize your employer’s matching contributions! This is free money that can double or even triple your retirement savings.
They point to the critical importance of investment choices. Diversifying investments across different asset classes, such as stocks, bonds, and real estate, can help to manage risk and maximize returns. Target-date funds, which automatically adjust the asset allocation as one approaches retirement, can be a convenient option for those who are not comfortable managing their own investments.
Addressing Income Adequacy and Longevity Risk
Providing enough income in retirement means thinking through important questions and focusing on the right things. The greatest challenge of all is longevity risk — that you will outlive your savings. As Americans are living longer, they must have a larger nest egg to outlast their expenses during retirement.
One way to address longevity risk is to buy an annuity. Unlike consignment, this choice ensures lifelong financial support. Retirement annuities provide guaranteed income for life. They provide you with guaranteed income, so you never have to worry about running out of money, regardless of how long you live. It’s crucial to conduct an honest appraisal of any annuity’s terms and conditions before buying one.
A second option is to work longer, if one is able to do so. In fact, retiring only three years later adds an average of more than $100,000 to your retirement savings. This means you’ll need to depend on those savings for fewer years. By delaying retirement, you’re able to continue earning income, all while making additional contributions to Social Security through payroll taxes. This can meaningfully increase your retirement income.
Navigating Choices in Retirement Plans
Balancing Choice and Guidance
The U.S. retirement system is notable for the extent of individual choice that it affords. People have to invest on their own and do all the work to build and manage their retirement accounts themselves. We have found that this knowledge is empowering to so many. Yet, it can be daunting for everyone else without financial savvy or time to actively invest.
One of the rubs of a choice-based system is that people are allowed to make bad choices. They may invest too conservatively, missing out on potential growth, or they may take on too much risk, exposing themselves to significant losses. They can not diversify their investments enough, or they can be swayed by their emotions during market ups and downs.
In order to meet these challenges it’s important to equip people with the tools and resources, like effective financial education and expert guidance, that they deserve. This could take the form of workshops, online tools, and/or one-on-one access to financial advisors. Our aim is to help you take control of your retirement savings and to keep you out of harm’s way.
The Transition to Hybrid Plans
Over the past few years, there has been increasing interest in hybrid retirement plans. These hybrid plans mix elements of traditional defined benefit pension plans with those of defined contribution retirement savings plans. These plans create an appropriate level of choice for individuals, while balancing that choice with some limited employer responsibility.
That hybrid plan can take many forms, one of which is a cash balance plan. In a cash balance plan, workers receive a guaranteed rate of return on their retirement savings. This framework is very much in line with that of a defined benefit plan. Like defined contribution plans, the accounts are individually owned and portable.
The second kind of hybrid plan is a target benefit plan. In a target benefit plan, the employer sets a target level of retirement income for employees. They then invest money to get employees to that goal. In reality, the income generated in retirement can be much different based on how investments perform.
Hybrid plans provide substantial benefits. They provide employees with a more stable retirement income than defined contribution plans. Yet at the same time, they provide much more control over investments than defined benefit plans. They’re cheaper for employers compared to standard defined benefit plans.
Conclusion and Recommendations
Summary of Recommendations for Pension Schemes
Based on the global models we've examined, several recommendations emerge for enhancing retirement security in the U.S.:
Expand Auto-Enrollment: Implement auto-enrollment at the state or national level to increase participation in retirement savings plans.
Promote Higher Contribution Rates: Encourage individuals to save at least 10-15% of their income for retirement, and take full advantage of employer matching contributions.
Provide Financial Education and Guidance: Offer access to high-quality financial education and guidance to empower individuals to make informed decisions about their retirement savings.
Consider Hybrid Plans: Explore the use of hybrid retirement plans that combine elements of both defined benefit and defined contribution plans.
Address Longevity Risk: Encourage individuals to consider purchasing annuities or delaying retirement to address the risk of outliving their savings.
Future Directions for Retirement Planning
These factors are new realities of increasing longevity, shifting demographics, and changing economic landscapes. We need to reform our retirement systems to reflect such changes and worsening realities. Advancing this change will be one meaningful step toward ensuring that all Americans are able to retire with dignity and security.
One of those hopeful directions is the creation of innovative new retirement products and services. This might be new forms of annuities, innovative investment strategies or other financial planning tools. It’s just as important, if not more so, to harness the power of technology to better democratize and reduce the cost of retirement planning.
A second important arena for future progress would be the field of financial literacy. Unfortunately, far too many Americans don’t have the fundamental financial know-how to take charge of their retirement savings and make smart long-term decisions. Financial literacy is the first step toward financial empowerment. It prepares them to better understand the tools available to shape their financial futures and reach desired retirement outcomes.
