America has moved to a system where nearly everyone is expected to save and invest for their retirement. Yet remarkably little attention has been paid to the big question: what should people do with their money when they actually retire? Neither the government nor the financial industry has any good answers. This leaves individuals ill-equipped to figure it out for themselves. Before the bulk of baby boomers reach retirement they will need a better solution. That will require the government and the financial industry to define their role in how people finance their retirement.
Starting in the 1980s many countries (America, Chile and later Australia, Britain, Sweden, Switzerland, Singapore and other Latin American and Nordic countries) moved to a regime where individuals had to save and invest to finance their retirement. Prior to this, pensions from the government or employers provided stable, predictable, and often inflation-adjusted income. As the typical retirement lengthened and populations aged, the old way looked unsustainable. Personal accounts, which shift the burden to individuals, became more popular. The individual account solution has well-known problems associated with the saving stage: people don’t save enough, pay too much for investment funds, and do not understand investment risk they are exposed to, as the recent economic crisis revealed. As these programs evolved, so have solutions and better regulation. Countries like Australia, Switzerland and Chile require people to save a large fraction of their income. Sensible and reasonably priced default investment options and savings rates help people make better decisions. Some countries, like Switzerland, provide a minimum return on the accounts’ assets. But even with best practices for the saving phase, major questions remain: When people arrive at retirement, what are they supposed to do with their life savings? How much can they spend each year and how should they invest their assets?
Those questions don’t have easy answers. If you over-spend you might run out of money. If you spend too little you needlessly scrimp. The cost of investment risk is bigger post-retirement because you don’t have years of future returns and income ahead of you. It’s further complicated by uncertainty. Most people don’t know how long they and their spouse will live. Aging diminishes ability to manage money and increases vulnerability to fraud. Research by economists James Poterba, Steven Venti and David Wise found many American retirees barely spend their wealth beyond what’s required. But they liquidate their assets, often selling their home, once they or their spouse has a significant health event and dies. Many people die with almost no assets left over.