You don’t have to … if you’re prepared to work forever
You don’t have to save for retirement. Not if you don’t want to retire, that is.
Retirement is not a natural right. No species in nature has a right to retirement. Just think of other animal species: individual members go on searching for sustenance by themselves until the end, although some more advanced species, in which the older members are intuitively considered wiser, do look after their elders, such as elephants, great apes and whales.
Retirement is granted by most modern human societies as a social right. The terms are set out by legislation or declaration, which of course can be amended. The Universal Declaration of Human Rights (adopted by the United Nations General Assembly in 1948) says that “Everyone, as a member of society, has the right to social security …” and “Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family …” Notice that these go much further than retirement security: they apply to all phases of life. But also notice that, in reality, these are declarations of social intent from human beings to each other, not granted by nature. And in a famous US court case (Flemming v Nestor, 1960) the US Supreme Court ruled that Social Security benefits are not a property right, and can be taken away by Congress. So much for the commonly used (and misleading) word “entitlement.”
Clearly, then, the terms of human retirement and its benefits are not guaranteed, let alone permanently. And therefore it makes sense for individuals (and groups of individuals, like families or workers) to consider how to arrange for this extremely valuable condition and its benefits to be made reliable. And since retirement implies no further working, and therefore no further earned income from work, it also implies that the finances for retirement must be arranged to provide for it.
In turn, those finances come from two potential sources. One is saving, in advance of retirement; in other words, while working. The other is transfer payments, from those currently working to those currently retired.
It’s very tough, at the start of one’s working career, to think of how desirable a condition retirement is. There’s no experience of how pleasant it is. What we do experience, even at the start of a career, is how pleasant a vacation is, in the sense that one’s paycheck continues even though one doesn’t report in for work. That’s the analogy I use when thinking about saving for retirement. Wouldn’t it be nice for one’s paycheck to continue, without having to continue working? And yes, one can arrange for it if one sets aside a portion of one’s own current paycheck and accumulates it so that later it becomes the source of one’s own personally generated paycheck. That analogy can become a powerful motivating force: “I’m creating my own permanent paycheck, for when I want to stop working.”
As a sidebar, it’s more important to first create an emergency fund, because the need for dealing with unexpected emergencies is inevitable in every life. And it undoubtedly conflicts with saving for retirement. I deliberately say that it’s more important than accumulating a retirement fund, because of the simple philosophical notion that “first you survive, then you thrive;” and the emergency fund is a survival mechanism, while the retirement fund is for thriving, to get you to the luxury of generating your personal paycheck.
Covid has produced some startling evidence of the importance of the emergency fund, particularly when it is non-existent. Australia permitted early withdrawal of retirement (aka superannuation) savings in 2020, and by September of that year (reader Martin Lindsay mentioned in a comment on that blog post) 3 million Australians (out of a total population of 25 million) had withdrawn more than A$34 billion – I make that an average withdrawal of over A$10,000. Martin added that a survey of 3,000 employees of a large construction company found that a quarter of the people making withdrawals made their decision within a day; that most couldn’t estimate the impact on their retirement balance – indeed, only one-in-five came close to estimating the impact of the early withdrawal on their future retirement balance; and roughly a quarter of surveyed members withdrew almost their entire account balance.
Peru, Chile and Bolivia have also allowed early withdrawals from retirement savings accounts (Bolivia in small amounts). Peru’s first five rounds of withdrawals led to a total withdrawal equal to 8% of 2021 GDP. Chile’s three rounds of permitted withdrawals led to a total withdrawal equal to 16% of its 2021 GDP. I’d guess that, as in Australia, people have no idea what impact this will have on their retirement prospects.
How large, how significant, are those amounts? I had no idea. So I tried to convert them to a framework I’m more familiar with. What would 16% of the USA’s 2021 GDP have been? Answer: almost US$4 trillion. Imagine if Americans had withdrawn that sum from their retirement savings: a mammoth amount! We’d have seen headlines all over.
I mention all this simply to demonstrate the importance of having an emergency fund in the first place, because it’s clearly an urgent and emotional need.
Moving right along, though, I’ll assume that the emergency fund exists, and that we’re now focused on the retirement fund, to generate those personal paychecks that enable us to enjoy our desired lifestyle without having to report to work every day until we pass away.
The calculator on my website enables you to estimate roughly where you stand, as regards the ability to generate your own paycheck for as long as you (and your partner) live.
Your total paycheck potentially comes in three parts. One is from any pension that is (at least currently) legislated by government – often called a “universal” (yeah, right!) pension (subject to affordability, of course – more on this in a moment). The second is from any defined benefit pension that one or more of your employers promised you. (Again, this is subject to whether the employers have put enough money into their pension funds to keep their promises – unfortunately, that’s not always the case.) The third is from whatever savings you have accumulated yourself, whether formally in a possibly tax-favored way, or informally just by setting aside money by spending less than you earned.
It’s that first source I want to focus on, in the rest of this blog post. And in particular, the kind often described in jargon as “pay as you go” (PAYG for short), in which there is no money invested by the government, but instead the current generation of taxpayers pays in money that is immediately used to pay out pensions to earlier generations, the government essentially acting as a flow-through mechanism. Many (most? all?) “universal” pension systems operate on this immediate transfer basis.
For example, when the US Social Security pension system was established in 1935, payments (taxes) started in 1937, and benefit payments in 1940, to those aged 65 and over. Obviously those first couple of years of contributions weren’t nearly enough to pay the promised pension benefits to the taxpayers for the rest of their lives. The financing idea was simple: the current revenues from taxpayers would be used to pay pensions to the older generation, who had paid little or nothing towards their new Social Security “entitlement.” (For example, Ida May Fuller received the very first Social Security check, a few months after her 65th birthday. She continued receiving monthly benefits until she died at a few months older than 100! She was supported by transfer payments from the next generation, obviously, not by her own contributions.)
In the early years, when there were relatively many taxpayers and relatively few retirees, that worked fine. But obviously the ratio of taxpayers to beneficiaries is crucial for the financing scheme to continue successfully, because there is no fund of accumulated savings (hence the name PAYG). And today it’s equally clear that this PAYG financing scheme, everywhere in the world, is in increasing jeopardy, for two demographic reasons. One is that people are living longer than before, so the number of beneficiaries is increasing. The other is that people are having fewer children, so the contributions from future taxpayers can’t keep pace. Both of those reasons adversely affect the contributions-to-benefits ratio. Remember, we may think of these benefits as basic entitlements, but they’re not. Something has to change.
As one example, in the US, in 1940 when Social Security benefit payments started, there were 42 workers per retiree. Today the ratio is 3 workers for each retiree. By 2050 it will be 2 to 1. Clearly the burden on workers is a rapidly increasing one, and without changes to the arrangements, this method of financing is unsustainable.
As another example, in Japan the prime minister recently said that the country was “on the brink of not being able to maintain social functions” because of its falling birth rate. He added that the issue must be solved “now or never,” and that it “simply cannot wait any longer.”
There are fundamentally three ways to change the financing. One is to increase the retirement age (the age of “entitlement”) so that the ratio of workers to retirees goes up again (at least temporarily), even with a falling birth rate. Another is to cut the size of the retirement benefit (directly or indirectly – the latter by taxing it more heavily). The third is to increase the contribution (worker tax) rate, either by raising it as a percentage of pay or by raising the ceiling on which the tax (contribution) is levied. Or, of course, any combination of these approaches.
In Sweden, for example, the “target” retirement age will, from 2026, be linked to increasing life expectancy, so that the projected number of years of benefit payments per individual will no longer increase relative to the working years.
In France proposed changes to their PAYG pension system have incurred huge ongoing protests. Their statutory minimum retirement age used to be 60 until 2010, when it was raised (after much protesting) to 62, which is still among the earliest in the western world. The current proposal to raise it gradually to 64 (still among the earliest) is what is being massively demonstrated against. Clearly, once a group of citizens (in particular, a whole generation of taxpayers) is given an “entitlement,” it is extremely difficult to cut back on it.
Actually, an academic told me that there’s a reason why French workers of all ages, even the young ones, are so very much against raising the retirement age. They see that the benefits from French GDP accrue largely to the already wealthy: the upper class, as they see it. In their view, the one thing they themselves have ever gained is the reduction in the retirement age, from 65 to 60, by President Mitterrand (a socialist) in 1960, and they’re willing to fight to retain this one benefit. Demographics don’t come into it; to them it’s a matter of social justice.
Anyway, that takes me back to my fundamental point: that the surest way to give yourself the wonderful benefit of being able to create your own paycheck to enable you to enjoy retirement is to start saving for it.
Saving gives you control over the ability to generate your own paycheck to replace your work paycheck – in other words, the ability to retire and enjoy its benefits.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.
Don: This writing is succinct, clear and compelling. Well done.
Much appreciated, Paul, thank you. (By the way, I’m still struggling with my long-planned ESG post …)
Great post, Don! Can you pls send it to everyone from ages 0-55ish? Lol! I remember my family telling me not to rely on social security but to plan for my future myself. I’m so thankful that I did! I will benefit from social security at some point, but it will not be enough to support the lifestyle I want/hope to have. I think one of my kids appreciates the need to plan for her future but the younger one seems oblivious. I think there are way too many like her and worry about what that future state may look like!
Thanks, Cindy. I think your observations are spot on.
Most of what you said is true.Then there is the mismanagement and poor policies by incompetent governments.Case in point the Australian superannuation system. Its totally geared towards the wealthy and a vehicle to minimise tax. You can contribute $110,000.00 Per annum into super and get taxed at 15%, if not it get taxed at your marginal rate and that can be up to 45%. You can bring forward that contribution and contribute $330,000.00 for the next 2 years.
Essentially the tax payer is subsidizing your contributions. Its costing the Australian government $34 billion every year to subsidize contributions to super. The cost to the budget for the age pension is $40 billion. Most people on average incomes cannot afford to contribute $110,000.00 and minimise tax. See the absolute hypocrisy when governments say they have to raise the age of retirement because they cannot afford it. The french people are right in protesting.
Thanks for the heartfelt comments, Franklyn. What I wrote about were the principles that hold true everywhere. How countries choose to integrate long-term savings with their tax systems will vary across countries, as will the cost of tax subsidies. And those arrangements will not only dictate the ways in which citizens choose to conform, but will also generate some very emotional feelings about fairness.
Hi Don, again an insightful blog. Lots of practical and useful learnings. I always struggle (especially in these times of inflation) what amount should be kept ‘cash’ in the bank and not invested. Rising prices and rising taxation makes things very complicated, as costs are rising as quick as a tsunami. Are there ways to manage this dilemma? ( cash versus invested assets)
Thanks, Eric. Yes, inflation and taxes are hugely complicating factors — and they differ from country to country, so the only principle I can formulate that operates in every country is that they are important! Re cash and (growth-seeking) assets, my principle has been that cash (or, more accurately, securities with predictable outcomes, like bonds that match short-to-medium-term cash-flow needs) should be considered a form of insurance against bad outcomes from growth-seeking assets; and then the extent of that insurance depends on your tolerance for risk of unfavourable outcomes to your lifestyle. Blog posts #131 and #151 explain how I (try to) match my own tolerance to the extent of the risk. Hope those posts help take it into greater detail for you.