Earn-ability vs. pension

This is part 2 of a short journey into the topic of “pension”, how it is losing relevance and what can be done to fix it. Part 1 here.

Since writing about pension last week, I have been thinking about how outdated the entire concept actually is.

Sometimes, it takes a crisis to understand where things are broken. In the case of pensions, the near collapse of the defined benefit model and the unattainable reality of a defined contribution one are the triggers.

Does it makes sense to talk about “pension” in a time when salary compression and increased life expectancy make it almost impossible to save up enough? Is a low income life and and an even lower income (long) retirement really a desirable state?

As it often happens, reframing the problem is the best answer to a difficult question. Instead of trying to save up enough for a long period without income, let’s allow people to earn longer.

Let’s imagine this system for a moment:

As you start working, you save up a certain percentage of your income. This is part savings part insurance, where insurance is a bigger component early on. As you go along and save up, you accumulate “years of insured income”, basically a period of time where you can afford not to work.

Imagine now that the startup or business you have been working on fails after a few years. That was your first job and you can only afford a full year of not working (the insurance component kicks in here).

In the case of a longer, uninterrupted, career, that one year would eventually become 5 or even 10 years of not working. This would allow you to quit your job and learn a new skill, or open a new activity.

At the basis of this system is the principle of resilience, or “anti-fragility” if we want to borrow a popular term. The goal is to fill gaps of non-income, helping people in the process of updating/upgrading themselves in order to remain relevant and independent.

How does this compare to existing pension systems? In Denmark, for example, government policies intervene forcing a specific outcome: accumulation of pension savings. They do this through tax breaks for pension savings and lower taxation on pension returns. The catch: pension savings cannot be withdrawn before the established pension age (now 70)[1].

In perfect “traditional economic” playbook, the policymaker assumes that given a clear incentive (the tax break) an equally clear behaviour (increased pension savings) will follow. While this might work on some segments of society, it ends up having the opposite effect on others. Younger people who feel daily the instability surrounding their career are much less inclined to lock money away for a mythical retirement age. What for?

The Danish one is a clear example of a policymaker forcing a deterministic view of the world (you first work, then retire) on a completely uncertain situation (what the world will look like 30–40 yrs from now for the young working generation). The result is an obvious short-circuit.

As skilfully explained in this post: “rather than engineering specific outcomes, government’s role as system stewards is to create the conditions in which interacting agents in the system will adapt towards socially desirable outcomes”. In our case (pensions) the “socially desirable outcome” is having as many people as possible able to sustain themselves economically throughout their life, including at an old age.

Focusing on the higher level outcome would allow policymakers to abandon an outdated, industrial-age, view of life and work and embrace instead a more flexible approach that recognises a new reality.

Instead of promoting the (false) promise of pension, let’s give people the ability to earn.

[1] It is technically possible to withdraw pension savings before time, but only after paying a “fee” of 60% on the deposit. Considering that the highest marginal tax is 54–55% this is an extra 4–5% fee even for the high earners that have deducted their entire savings from the highest bracket.

Originally published at www.buildingsquared.com.

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