Compulsion is the best solution for pension provision


Up to the late-19th century, everyone provided for his or her own retirement either by saving or by using “The Waltons method” of having large families, who would take over the farm and run it when you got too old to do it yourself. It was only in the 20th century that old-age provision was deemed to be a government/employer issue and the people’s personal savings were to top this up for a luxury retirement of cruises and wintering in Florida.

It now looks like the 20th century was an aberration for pensions. Those DB plans that covered the majority of the workforce were suited to the particular mode of large-scale heavy engineering industrialization and were feasible because firms were constantly expanding and most people didn’t live for long in retirement.

Now, increases in longevity have moved the average amount of time spent in retirement to 20 years and the forecast decline in the proportion of the population and the workforce means that it’s no longer possible for these plans to maintain their benefit levels. Most plans are severely underfunded now and have been closed to new entrants in a desperate attempt to reduce future liabilities. The 20th-century model is dead.

The 21st century is an era of high labour mobility with loose ties between the employer and the employee and increasing longevity. This means that people either have to work much longer or provide the income that they will live on in retirement themselves, as the paternalistic link between employer and employee is broken.

The question is, How are we going to move people from being passive recipients of pensions to being active accumulators of wealth in order to achieve the means to retire? Retirement needs to become a goal that people aim at, rather than something that just automatically happens when you hit a certain age.

The reality is that every monthly paycheque needs to cover six weeks of living expenses for the average worker, who works for 40 years and then spends 20 in retirement. Canadians who don’t plan for this are assuming that the money to cover the extra two weeks of living will come from someone else—just as in their childhood, their mother and father supplied all their needs.

There are a number of ways we can structure the system in order to clarify for people the issues around retirement. First, we need to identify clearly the roles that each group has in providing for the future income flow of retirees.

The 20th-century model saw retirement as a three-way combination with the government providing the basic level of retirement income, designed to provide a minimum level of income below which no citizen would fall. The employer was seen as providing the bulk of the income through a subsidized plan, frequently requiring a contribution from the employee and the government via tax breaks and the employee finally could do some extra saving, which essentially topped up the pensions to give a certain level of luxury on top of the rest. Today, these groups should play a different role in the pension provision arena.

Governments need to cut back on the per capita amount spend on pensions as this will spin out of control in the next couple of decades.

The International Monetary Fund forecasts that the Government of Canada will need to increase pension spending by slightly more than 2% of GDP between 2010 and 2030. And the government’s own forecast is that by 2036, the cost of old age security and the Guaranteed Income Supplement programs will have quadrupled from their 2009 level (doubled when inflation is taken into account). Therefore, a more realistic role for them is to provide a floor level of income to give a basic safety net to all citizens. This floor level, similar to the one being introduced in the United Kingdom, should be a flat rate and avoid any means testing, as means testing always introduces distortions into the system and create disincentives to saving.

The more complicated role is to define that of the employer. In reality, it’s hard to see why an employer is involved in any way with the provision of employee retirement benefits, tax distortions aside, and these should be removed.

A more sustainable approach would ensure that the employee is clearly focused on the need for personal savings to provide income in retirement. The gradual abolition of the pension retirement age in western countries will contribute to this: instead of retiring at a set age, workers will become more focused on retiring when they have amassed sufficient funds to do so.

The employees’ own role in provisioning their own retirement income needs to move centre stage. This is the rock upon which the only feasible pension system can be built. It’s unpleasant, and undoubtedly risky, for the political classes to ram home this message to the workers, but it is the only responsible course of action. Throwing massive future liabilities onto employers or taxpayers is neither reasonable nor sustainable.

Workers need to realize that without action on their own part, they will eke out their retirement years on a very basic safety-net pension provided by the government. Some will do so and this is a tragedy, but a tragedy of their own making.

Compulsory pension saving can play a huge part in ensuring that there is a strong level of savings across the general population. If all workers were forced to contribute to a retirement account from their wages, they would be forced to engage with the retirement process right from the beginning of their working life. This would ensure that every worker had some savings and was regularly updated with the progress and the investment results, ensuring rapt attention to the details.

Tom Murray is head of product strategy at Exaxe in Dublin. The views expressed are those of the author and not necessarily those of Benefits Canada.

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