Pension systems in most countries have not existed long enough to develop experience with the payout phase. To date, systems have focused attention on the challenges in the accumulation phase such as expanding coverage, increasing savings levels, and getting savings into appropriate investment strategies. The challenges to efficiently pay benefits from accumulated savings are significant, and especially so in developing economies with smaller financial and insurance markets. However, it isn’t all bleak as options and new ideas continue to emerge.
So how does one create a sustainable, secure, and efficient payout system?
Lessons learned about the accumulation phase can be applied to better understand the payout phase. By limiting the number of options, creating effective default options, taking advantage of economies of scale and letting markets work, whilst establishing appropriate restraints on market forces, a sustainable payout system can be designed.
But one key question still remains.
Should we deliver retirement income as a lifetime annuity, through systematic withdrawals or in a single lump sum payment?
Annuities provide the best security and deliver income efficiently, but it is challenging to provide cost-effective annuity income for lower levels of wealth. Systematic withdrawals allow for distributing income over a long retirement period, but usually provide low and unpredictable levels of income at older ages.
On the other hand, lump sum payments actually meet the needs of some lower income populations very well, but also have the potential to leave people with no income later in life.
Are there other ideas that can make income last to the end of life?
Coordination of payouts with state pension systems can create effective protection against longevity risk. Shifting the focus of state pensions to cover the oldest ages may allow individual savings to provide stronger and more flexible coverage in the early years of retirement.
Countries like Chile, Sweden and Australia have developed innovative and useful solutions that address some of the key challenges faced in the payout phase. These ideas and many others are covered in the chapter: Paying the Pension: Markets, Products and Choices.
To find out more, don’t forget to check out our new book, Saving the Next Billion from Old Age Poverty to be released October 12, 2017.
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