An Ideal Retirement System by CFA Institute
The provision of financial security in retirement is critical for both individuals and societies as most countries are now grappling with the social, economic and financial effects of ageing populations. The major causes of this demographic shift are declining birth rates and increasing longevity. In short, this means that a growing proportion of every country’s population will be in retirement and therefore not directly contributing to the economy’s production. Yet at the same time, most retirees are looking to maintain their pre-retirement living standard and to have access to quality medical and aged care services in their later years.
Inevitably this is placing financial pressure on current retirement systems (whether they be in the public or private sector), whilst the growing importance of the aged population also means there is increasing political pressures for these services to be provided. While these demographic effects have been evident for some years, it is only in recent times that many countries have appreciated the significance of them. 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.
Significant changes will be needed as an increasing proportion of the population in the future will have retired from employment and be relying on their savings and/or the government. In light of this challenge, is there an ideal retirement system to respond to these problems and, at the same time, deliver an outcome that provides adequate benefits that can be sustained over the longer term and is trusted by the community?
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This report, prepared by Mercer for the CFA Institute, is designed to answer this question. However, it is worth noting at the outset there is not a single retirement system that can be applied to all countries. 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.
Notwithstanding these important differences, there are certain principles, features and characteristics that are likely to lead to better outcomes for all those involved. This report concentrates on these high-level objectives, leaving it to each country to apply them to its own situation for the challenging years ahead.
Ten Principles For An Ideal Retirement System
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 amongst 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.
Setting The Scene
A single retirement system, whether it is publicly or privately funded, does not exist in isolation from other financial resources in retirement. There are always multiple sources of income or financial support and it is therefore important that a holistic perspective be adopted when considering the development of any retirement system.
In its influential report Averting the Old Age Crisis, the World Bank (1994) recommended a multi-pillar system for the provision of old-age income security, comprising:
Pillar 1: A mandatory publicly managed, tax-financed public pension.
Pillar 2: Mandatory privately managed, fully funded benefits.
Pillar 3: Voluntary privately managed, fully funded personal savings.
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