Last month, the Government Accountability Office (GAO) issued a stunning report, “The Nation’s Retirement System: A Comprehensive Re-evaluation Is Needed to Better Promote Future Retirement Security” (GAO-18-11SP), on the U.S.’ retirement preparedness. In the report, it notes, “The U.S. retirement system, and the workers and retirees it was designed to help, face major challenges. … individuals are increasingly responsible for planning and managing their own retirement savings accounts … [M]any households are ill-equipped for this task and have little or no retirement savings.” The report ends with a very strong recommendation, or plea, that, “Congress should consider establishing an independent commission to comprehensively examine the U.S. retirement system and … improve how the nation promotes retirement security.”
Coincidentally, the U.S. Treasury also issued a report, “A Financial System That Creates Economic Opportunities,” that makes the case for in-pension plan retirement income options and the importance of funding infrastructure. The U.S. government can have an immediate impact on the retirement challenge, create a liquid in-plan retirement income option, and raise funding for infrastructure by issuing a new type of long-term bond, one we call SeLFIES—Standard of Living indexed, Forward-starting, Income-only Securities. SeLFIES address many of the challenges raised in the GAO and U.S. Treasury reports and are also advantageous to the U.S. Treasury.
Individuals seek a guaranteed, real income, ideally from retirement through death, and to lead a lifestyle comparable to pre-retirement. At the same time, the Treasury seeks to ensure that individuals can make independent, informed financial decisions and accumulate a retirement nest egg. The GAO notes three main challenges to achieving this goal: access to retirement plans; insufficient savings; and the complexity of investing and decumulating. Typically, low-income or part-time employees work for firms that neglect to offer retirement plans—and even if they do, many of these employees cannot participate for a host of reasons. A number of states, Oregon being the first, are stepping into the breach to create plans that offer access to uncovered private-sector workers.
Inadequate savings disproportionately affects women and some minorities and is caused by insufficient real wage growth, high debt levels and increased longevity. Further, the complexity of retirement planning leaves many confused about what constitutes adequate savings. They are overwhelmed by the information provided and the absence of a robust and uniform method to calculate income replacement rates. The attempts by Richard Thaler, Ph.D., winner of this year’s Nobel Memorial Prize in Economic Sciences, to nudge individuals into pension plans and increase savings over time, via automatic enrollment and automatic escalation, help; however, they fail to address the “how much is adequate” question.
Finally, there is uncertainty over what to invest in and how best to decumulate. Most adults can barely answer questions about compound interest, the effects of inflation or the benefit of diversification. The Department of Labor (DOL) provided safe harbor guidance about appropriate investments, but investing in existing assets is risky relative to the retirement objective, because these assets fail to provide a simple or low-cost cash-flow hedge against desired retirement income. Even a portfolio of traditional, “safe” government securities, unless heavily financially engineered—at some cost—would be risky because of the cash flow, and potential maturity, mismatch between traditional bonds and the desired retirement income stream.
The Treasury report notes, “Because annuities are the only financial services product that can provide a guaranteed lifetime income stream … [they] are an important contributor to the Core Principle of empowering Americans to save for retirement.” However, many hesitate to buy annuities because they can be complex, opaque and illiquid; investors fear not being able to bequeath the annuities to heirs.
SeLFIES address many of these issues. Governments could issue a new, low-cost, liquid and safe ultra-long bond instrument. SeLFIES start paying investors upon retirement and pay real coupons only—say, $5—indexed to aggregate per capita consumption—for a period equal to the average life expectancy at retirement, e.g., another 20 years. Instead of current bonds that index solely to inflation, SeLFIES cover both the risk of inflation and standard-of-living improvements.
SeLFIES are designed to pay people when they need it and how they need it, and greatly simplify retirement investing. A 55-year-old today would buy the 2027 bond, which would start paying coupons when he turns 65, in 2027, and keep paying for 20 years, through 2047.
In this way, even the most financially illiterate individual can be self-reliant with respect to retirement planning. For example, if investors want to guarantee $50,000 annually, risk-free for 20 years in retirement to maintain their current standard of living, they would need to buy 10,000 SeLFIES—i.e., $50,000 divided by $5—over their working life. The complex decisions of how much to save, how to invest, and how to draw down are simply folded into an easy calculation of how many bonds to buy.
Besides being simple, liquid, easily traded at very low cost and with low credit risk, SeLFIES can be bequeathed to heirs. SeLFIES do not address all issues, including longevity, but go a long way toward improving retirement security.
These securities are a good deal for governments, too. In fact, governments are the biggest beneficiaries. SeLFIES not only improve retirement outcomes for all defined contribution (DC) plans, but also have spill-over benefits for the current administration and future ones. First, cash flows from SeLFIES reflect synergistic cash flows for infrastructure spending: namely, large cash flows upfront for capital expenditure, followed by delayed, inflation-indexed revenues, once projects are online. Financing infrastructure has been a challenge and a priority for the current administration. Second, SeLFIES give governments a natural hedge of revenues against the bonds, through value-added taxes (VATs).
The looming retirement crisis needs to be addressed by timely innovation, because the longer that governments wait, the higher the cost to the taxpayer. SeLFIES improve retirement security, fund infrastructure and can be created immediately, at low cost, without waiting for an independent commission or changing regulations!
Robert C. Merton, Ph.D., recipient of the 1997 Alfred Nobel Memorial Prize in Economic Sciences, is the School of Management Distinguished Professor of Finance at the MIT Sloan School of Management. He is also Resident Scientist at Dimensional Fund Advisors, a global asset management firm headquartered in Texas, and University Professor Emeritus at Harvard University.
Arun Muralidhar, Ph.D., is adjunct professor of finance at George Washington University, Academic Scholar Advisor at the Center for Retirement Initiatives at Georgetown University, as well as founder of Mcube Investment Technologies and AlphaEngine Global Investment Solutions. He has served as a consultant to Overture Financial (consultant to California’s Secure Choice Board) and has authored a new manuscript, “Fifty States of Grey: An Innovative Solution to the DC Retirement Crisis.” These are the personal views of the authors and do not reflect the views of any of the organizations or universities with which they are associated.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.