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10 Keys to a Robust Retirement System

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Current retirement systems around the world are under strain as the birth rate falls and the population ages, according to a report released in March by the CFA Institute and Mercer.

Furthermore, “although the current extent of these changes varies between countries due to local factors, the impending retirement of the baby boomers in many developed economies has highlighted the problem,” the authors wrote.

While acknowledging that no one design can answer every country’s retirement needs, the paper attempts to put forth a basic design for an ideal retirement system. Additionally, the prevailing retirement system doesn’t exist in isolation from individuals’ other resources.

The paper referred to a 1994 recommendation from the World Bank that suggested there are three tiers of a robust retirement system: a mandatory public pension; mandatory privately managed benefits; and any voluntary private benefits individuals fund themselves.

The World Bank argued in a subsequent paper that a multitier system is better able to respond to the objectives of a country’s retirement system than focusing on just one of those tiers, and is a more effective way of managing the various risks a retirement system faces over time.

“Each system must take into account that country’s particular social, economic, cultural, political and historical circumstances, including its stage of economic development, the breadth and depth of its capital markets, the current state of its pension system, as well as the balance between informal and formal labor markets,” according to the Mercer paper.

Keeping those many particulars in mind, there are 10 high-level objectives that a well-designed system must address, according to Mercer and the CFA Institute. The paper assumes retirement income comes from four possible sources: a government-funded pension to address poverty among the elderly; a mandatory system funded throughout an individual’s working years; voluntary savings specifically for retirement; and other private savings.

Here are 10 recommendations from the paper that should be incorporated into a multitiered retirement system to maximize success for the most people:

1. The government must establish clear objectives for the whole retirement system, including the complementary roles of each pillar, and incorporate the provision of a minimum income to alleviate poverty among the aged population.

2. A minimum level of funding should be made into a pension system for all workers with contributions by employers, employees and the self-employed, as well as for those of working age who are receiving certain forms of income replacement. In effect, this means every worker will have a retirement account with an entitlement to future benefits.

3. There should be cost-effective and attractive default arrangements, both before and after retirement, for individuals who do not wish to make decisions.

4. The overall administration and investment costs of each pension arrangement should be disclosed with some competition present within the system to encourage fair pricing.

5. The retirement system must have some flexibility as individuals live in a range of personal and financial circumstances. This flexibility includes recognizing that retirement will occur at different ages and in different ways across the population.

6. The benefits provided from the system during retirement should have an income focus but permit some capital payments or withdrawals during retirement, but without adversely affecting overall adequacy.

7. Contributions (or accrued benefits) at the required minimum level must have immediate vesting and portability. These accrued benefits should only be accessible under certain conditions, such as retirement, death or permanent disability.

8. The government should provide taxation support to the funded pension system in an equitable and sustainable way, thereby providing incentives for voluntary savings and compensating individuals for the lack of access to their pension savings.

9. The governance of pension plans should be independent from the government and any employer control.

10. The pension system should be subject to appropriate regulation including prudential regulation of pension plans, communication requirements and some protection for pension scheme members.

— Check out Fixed Indexed Annuity Sales Displacing Some VA Products at BDs on ThinkAdvisor.