Wednesday, December 31, 2008

New Public Policy Required Around Retirement

One of the most negative consequences of the current financial collapse is the effect on pensioners who live off savings. Their portfolios have collapsed. Government regulation forces them to remove a certain percentage of their savings every year, so they are forced to sell assets that have dropped greatly in value - resulting in an unfortunate forced situation of “buy high sell low”.

Now, back when I studied financial management, the rule of thumb was that you should have the percentage represented by your age in non-risky savings. If you’re 60, then only 40% of your savings should be in risky assets, with the rest in fixed return assets. It is obvious from the plight of seniors that this rule of thumb is no longer followed.

The reason, I imagine, is that it is not possible to get a high enough return on secure assets. The Rule of 25 tells us that to live off investment income, you need to save 25 times your desired income. To retire with $50,000/year income, you need to save $1.25M. This rule is based on a return of 4%. Where do people get a 4% real return (return above inflation)? Not from anywhere safe, certainly. That makes us have to contemplate a Rule of 50: to get $50K, you need to save $2.5M.... that kind of saving is simply beyond the ability of most people. (It also requires a higher interest rate while saving, which entails more risk.) If we moved to a Rule of 50 paradigm, we would need to rethink RRSP limits, which currently have an upper ceiling of $20K/year. But even that doesn't help when we have the severe business cycles of the last ten years, during which we have had two catastrophic market events (the tech bubble and subprime meltdown) that wiped out much of people’s savings.

Government bureaucrats and educators all have pensions and benefits till death, and many of them don’t seem to comprehend that most of us don’t have that security, and must finance our retirements through savings. That’s not the hard part though. The hard part is managing the savings so that we can actually retire on them. We are pressured to find investments with decent returns. Most of us aren’t gamblers – we try to find mutual funds that balance risk and return in a responsible way – but we’ve still lost our shirts twice in the past decade. The market bounced back after the tech bubble, but many investments were lost forever, whether we sold or not.

What is needed is a new approach to public policy around retirement savings that is based on the reality of most people. We have a crisis coming with the aging population, and it is a crisis of poverty. Affluent, hard-working people are facing a retirement in poverty – through no fault of their own. We saved, but the unavailability of appropriate savings options and the severity of business cycles have meant that we will have inadequate funds to live on. Sure, we can downsize and cut back, but how will we pay for our prescriptions, walkers and home care? The current system, designed by bureaucrats who have lifetime benefits attached to their pensions, is simply inadequate.

As the "bulge" of the baby boom is 10-15 years away from retirement, we need to make some changes to avoid human catastrophe. As we reregulate the financial industry we need to ensure the following:

* Citizens have appropriate places to invest retirement savings.
* Business cycles are less severe.
* There is more public education about investment, and better regulation of claims made by banks.

In addition, I think we need to consider some more dramatic and controversial ideas:

* Health benefits for seniors need to be improved, including prescriptions and prosthetics.
* Public service pensions should be scaled back and CPP/SocSec should be scaled up, resulting in a more equitable treatment for citizens.

Update: Funny that I wrote this just before things started to really get bad.

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