The three pillar approach to retirement

Governments the world over are struggling to cope as the number of people who are retiring grows. Not only are more people retiring, but we are living longer, and we are just coming out of a Pandemic which will slow economic growth. According to one study, indexing benefits and retirement ages to longevity did not ensure the financial viability of the social security system. Another study suggested that individuals bear a larger share of the responsibility for determining their retirement security.

Retirement System Risk Management Implications of the New Regulatory Order published in 2016 by Oxford Press examined issues concerning retirement and looked at the idea of individuals saving for their own retirement and found that scenically, 37.9 percent of individuals with university education save for retirement, compared to 27 percent of individuals with secondary education and 22.2 percent of individuals with primary education or less. The old-age saving gap seems to be much wider between the tertiary and secondary education groups, compared to the gap between secondary and primary education or less.

However, the idea that we should allow people a choice of investment options is one that still holds today because governments believe that allowing choice may increase retirement savings.

A survey of households by the Board of Governors of the Federal Reserve System (2014) found that almost half of respondents had given little or no thought to retirement savings. Among those who had, many either did not plan to retire, expected to keep working into retirement to pay for expenses or did not know how they would pay for their retirement. Nearly a third had no retirement savings or pension. These retirement planning challenges had been exacerbated by the Pandemic, which resulted in many respondents delaying their planned retirement.

Firms have also shifted from defined benefit (DB) pensions to defined contribution (DC) pensions, where employees have to decide how much money to put into their retirement funds and how to allocate their pension wealth. But DC plans have their critics, who draw on the behavioural economics and finance literature. For instance, one study found that the elderly suffer from greater cognitive, gender, and education gaps than other groups. As a result, they are less likely to have savings accounts, own shares in a company, or have private pensions. Another study reported that financial literacy is a significant determinant of retirement planning for all age groups, with elderly people suffering from the highest levels of financial illiteracy.

One study reported that peer effects drive retirement plan participation decisions. Another found evidence that an individual’s decision about how much to save for retirement was affected by small changes in his environment and that network effects influence participation decisions. Instead of education, proposed a method of influencing decisions about retirement saving plans based on the principles of ‘automatic enrollment.’ This involved implementing acute autoenrollment, sensible default options, and opportunities to increase savings rates and rebalance portfolios automatically. Such design features help less sophisticated investors while maintaining the flexibility for more knowledgeable participants.

Financial security for the elderly and economic growth is best served when governments adopt three pillars of old age security:

(1)           A publicly managed pension system with mandatory participation and the limited goal of reducing poverty among the elderly.

(2)           A privately managed mandatory savings system.

(3)           A voluntary savings incentive.

The first pillar caters to redistribution, the second and third cover savings, and all three co-insure against the many risks of old age. Spreading the insurance function across all three pillars creates greater income security for the old and provides greater insurance than any single pillar system.

Among the benefits of voluntary saving is the relative ease of accessing and mobilizing funds, and the prevention of potential labour market distortions. Yet voluntary savings programs may produce social costs, particularly when they involve fiscal incentives.

To develop measures to improve the financial well-being of the elderly and incorporate an element of self-control in retirement planning, policymakers must first understand retirement savings patterns.