Navigating the River of Retirement

Olivia Mitchell has evaluated the four areas of risk—individual, pension system, country and global—facing Americans’ retirement prospects. She laid out strategies for individuals and policymakers to address these risks during a recent Wharton Webinar.

Individual risk, simply put, involves people failing to save enough and then living longer than they anticipate, said Mitchell, who is the International Foundation of Employee Benefit Plans Professor and executive director of the Pension Research Council. She pointed out that more than 60 percent of retirees hold less than $50,000 in financial assets. Arguing that this is a result of financial illiteracy, Mitchell cites a study she and her fellow colleagues completed that found that almost 80 percent of loan-holders in their 50s did not understand compound interest.

In order to mitigate individual risk, Mitchell suggested investing in yourself and others. An investment in your own human capital through continuing education helps you to remain attractive to employers, while investing in social capital helps to cement your place in your local community and family. To finance and insure individual risk, individuals should increase savings and invest in payout annuities, including reverse mortgages. According to Mitchell, annuities can be complex, and those individuals interested in these programs should thoroughly research them.

Olivia Mitchell

Because individuals typically fail to save enough funds for retirement, there is an increased reliance on public plans. But public and private pensions are collapsing, ever more so after the recent economic downturn. This economic crisis “had [a] profound effect on the retirement system of the world,” Mitchell noted.

Given these failures, Mitchell said, the pension system is changing from defined-benefit plans to defined-contribution plans like 401(k)s and 403(b)s. Mitchell advised that rational investors in defined contribution plans should balance expected returns and risk, make independent judgments, hold diversified portfolios, and pay close attention to investment fees and charges.

Mitchell also provided action items for policymakers, with ballooning pension costs in countries around the world in mind. For example, the gap between benefits and funding is growing in the U.S Social Security program; in order to address this gap, benefits will need to be cut by 25 percent to 35 percent over the long-term future. Mitchell advocated for action on this issue and steady fiscal and monetary policy in order to help address this concern.

Although the idea may be unpopular, Mitchell believes that the very nature of retirement is changing. A new partnership is needed to educate individuals about retirement, she said, and better regulated financial products and markets must be created for an “aging world.”

“You should start planning for retirement at 20, because if you open the book at 65, it’s going to be [too] late,” she warned.

Mitchell shared her insights on retirement risk with Wharton alumni on Feb. 23, 2012, as part of the Wharton Webinar Series, a lineup of talks by Wharton faculty expressly for alumni.

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