PROJECT M
 
Darren McShane
Anthony Webb
Wolfgang Mader

How to spend it

Spending your savings should be easy, but retirees across the globe make surprisingly irrational choices when it comes to decumulation

© istockphoto

How to spend it

Spending your savings should be easy, but retirees across the globe make surprisingly irrational choices when it comes to decumulation


Wolfgang Mader

Darren, Anthony, discussions about retirement often focus on the savings phase. Are we paying enough attention to the decumulation phase?

Darren McShane

This is an issue of sequencing. Modern contributory pension schemes are a relatively recent phenomenon in Asia, Latin America, Africa and Eastern Europe. Like Hong Kong, these regions are preoccupied with fostering a savings culture. It naturally follows that attention turns to the payout phase after accumulation is in place. Having said that, there is much interest globally in how the decumulation phase is developing as countries are heading off into different regulatory directions. Apart from the debate around lump sums versus phased withdrawals versus annuities, there are some interesting developments around hybrid approaches in the UK and Netherlands, which provide longevity protection through pooling.

Anthony Webb

I agree that, worryingly, many households have no plan to tap into their wealth in retirement – and frankly, I have to include myself in that category. But the key problem is still the low level of wealth accumulation. Unfortunately, decumulation will not be an issue for many in the US. The median 401(k) plan and Individual Retirement Account balance for a household aged 55-64 currently is $111,000. This amount is insufficient to create a lifetime income stream; it is a buffer to pay for fixing the roof or the boiler. These households will be mainly dependent on social security and will be living on the borderline of poverty. Americans with greater wealth are often apprehensive about healthcare and longterm- care costs and seem reluctant to spend their savings. So if we want these groups to feel comfortable about spending down, we have to help them manage the risk of unexpected healthcare and long-term-care costs.

Wolfgang Mader

What can the financial industry do to help?

Darren McShane

The industry can help people prepare for example, by providing basic education and a toolset that allows people to work through the challenges of pension saving and spending in a transparent, cost-effective way. Advice frameworks around decumulation can be problematic as many things can go wrong here. Most choices on the topic are highly complex and cannot be undone later.

Anthony Webb

I fully agree. We have to increase financial literacy, raise awareness of longevity risk and the protection annuities can afford – which for many outweighs their perceived disadvantages such as the high prices that result from adverse selection. Unfortunately, retirees with, say, $1,000,000 in their 401(k) plan, an amount that puts them at the upper end of the distribution of 401(k) wealth, are likely to view the offer of exchanging that amount for a lifetime inflation-indexed income of $45,000 annually as a pretty poor deal – even though it may be the best option for some of that group. So it is a challenge for the insurance industry to get across to people that an annuity provides valuable insurance against outliving one’s wealth, and should not be thought of as a risky gamble they will lose if they die prematurely.

Wolfgang Mader

That’s right, annuities are a crucial piece in the decumulation puzzle, and I say that as an asset manager. More comprehensively, though, products need to combine the saving and the spending aspect for workers to begin planning as early as possible.

Wolfgang Mader

What do you think of automated advice?
PRODUCTS NEED TO COMBINE THE SAVING AND THE SPENDING ASPECTWolfgang Mader

Anthony Webb

It might be a way of lowering the cost of and increasing access to advice which today mainly goes where the money is, that is, to high-net-worth individuals. But like a video of a personal training session, it may not be as effective as face-to-face advice in achieving changes in behavior.

Darren McShane

There is some scope for automation of advice if you accept that there is an empirically correct way to save for, and spend in, retirement. Machines can provide these solutions. There are regulatory challenges, however, and I note that in Australia regulators have made some steps in this area, but like all areas where technology and policy cross, this will take some time to develop.

Wolfgang Mader

Let’s come back to the role of annuities. Do you have some thoughts on this, Darren?

Darren McShane

Too many. By way of background, let me say that we don’t mandate a payout solution here in Hong Kong. From a purely technical perspective, annuities are the answer to individual uncertainty and increasing life expectancy. On the other hand, they are incredibly hard to price, and the lack of demand makes them even more expensive for those who choose them. They also don’t sit well within some cultures, such as Asia, where people neither want to give up on flexibility nor bet against their own life expectancy with an insurance company. Annuities clash with bequest motifs, which are strong in Asia, and finally, raise serious issues about counterparty risk. When you add all this up, annuities are not an easy sell in Asia; the Dutch model of risk pooling might be more suitable.

Anthony Webb

And then some annuities are better than others. Advanced life deferred annuities, for example, where payments kick in, say, at age 80, are a clever idea, but I am willing to bet that their sales numbers are pretty low.

Wolfgang Mader

So if you don’t mandate annuitized payouts, Darren, what is your view on lump sums and individuals’ control over them?
HAVING A SPENDING PLAN THAT YOU FEEL CONFIDENT WITH WILL INCREASE HAPPINESS IN RETIREMENTAnthony Webb

Darren McShane

Until the end of 2015, the only recognized withdrawal form from our pension scheme in Hong Kong is a lump sum. This is the easiest for all sorts of reasons, including operational efficiency. From the end of this year, however, phased withdrawals are also allowed. Outside that, people are of course free to buy an annuity, but no one really does. So, in effect the usual options are available, but this raises the question of the most suitable approach. Some of the possibilities mentioned earlier would seem to be the long-term solution, perhaps defaulting parts of the lump sum over a certain amount into a deferred life annuity or greater use of the “Dutch model” of longevity risk pooling.

Wolfgang Mader

However, the problem with the Dutch approach is that benefits can be subject to cuts outside the saver’s control. One cohort may receive significantly more income than the following, which possibly makes the system unfair.

Darren McShane

Right. And the Dutch model may only work in the Netherlands or other places where the system is based on the collective involvement of unions and employers. That sort of dynamic is pretty rare elsewhere.

Wolfgang Mader

The challenges of decumulation are further complicated by the current low-yield environment. Targeting certain return levels, one needs to turn up the risk dial. As a consequence, asset managers should manage risk in the saving and spending phase dynamically to avoid large losses. At the same time, the industry experiences regulatory pressure to lower fees.

Darren McShane

Well, I was relatively smug about this when presenting at a recent OECD conference, because our pension funds have high equity exposure, and equities do well in a low-yield environment. With the recent Chinese stock market tumble, I am not quite so smug anymore. Broadly speaking, low interest rates reduce income from any retirement product. And it makes the decision to buy an annuity more difficult, as those who buy now may miss out. If interest rates rise, people who buy after the rise earn a better income stream. Yet once an annuity is bought, that decision is locked in for the rest of the person’s life.

Anthony Webb

I think this is a false argument. There are many other factors affecting annuity income streams and we don’t know how they will play out. For example, life expectancy may increase further and today’s annuity rates may turn out to be a pretty good deal.

Wolfgang Mader

Spending on experiences rather than consumer goods is the psychologist’s recommendation to be happy. What can the financial industry do to make retirees in the spending phase happy?

Darren McShane

Happiness is a difficult concept for a regulator to deal with. We will make sure savers have as much money as possible and it will be their decision how to spend it. I should say, however, that uncertainty makes both markets and individuals unhappy. So more plannable payout structures are a plus, but they also have to maximize wealth.

Anthony Webb

I agree. Having a spending plan that you feel confident with will increase happiness in retirement.

Wolfgang Mader

Gentlemen, thank you very much for your time.

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