FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | LONG-TERM FINANCE Early Access to Pension Savings: International Experience and Lessons Learnt © 2019 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff and consultants of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. 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FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | LONG-TERM FINANCE TABLE OF CONTENTS EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 3 Introduction 3 Literature Review 3 International Practice 5 Types of Access 6 Examples of Hybrid Savings Schemes 7 Case Study: Central Provident Fund - Singapore 10 Impact of Early Withdrawal on Pension Savings – A Stylized Example 11 Conclusion 12 BIBLIOGRAPHY 13 APPENDIX 1: ACCESS TO PENSION SAVINGS BY COUNTRY 15 EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 1 2 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | LONG-TERM FINANCE EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT1 Introduction2 T he objectives of a well-designed pension system are poverty reduction in old age and income smoothing throughout an individuals’ lifetime. Over the last thirty years, changing demographic trends have caused a shift from ‘pay as you go’ and occupational defined benefit (DB) schemes - where the obligation for paying for retirement income is with the state and employers - to defined contribution (DC) schemes, where the obligation to save for retirement rests more with individuals. The transition to DC schemes did help establish a Literature Review strong link between contributions during working The need for pre-retirement liquidity often arises, life and benefits during retirement, for individuals. due to lack of short-term ‘emergency’ saving and However, an increasing challenge has been indebtedness. As noted by the NEST Insights balancing genuine needs for some pre-retirement paper (2017): “high-cost and unpredictable one- liquidity, access to savings and providing adequate off expenses such as the breakdown of a household income post retirement for individuals. The appliance can cause acute short-term financial need to get this balancing act right is being felt hardship for people whose disposable income increasingly as coverage of national social security after essentials is low. In addition, financial systems is expanded to include more of the non- shocks among low income groups can lead to debt salaried workforce which often has lower levels of spirals which can cause acute financial stress. Any income, more periods of unemployment and more severe or persistent pressure on liquidity can have irregular earnings. significant health effects, which can in turn affect productivity and earning capacity…. In an extreme This note surveys recent literature and country case, one could imagine for example, a short-term experiences to understand if and how countries financial shock such as the inability to afford a car address the need for pre-retirement liquidity in both repair having dramatic knock-on consequences mandatory and voluntary DC schemes. The note such as loss of earnings and increased debt.” also uses simple modelling to illustrate the impact of allowing access to pension savings on income There is limited systematic government action for adequacy after retirement. The report concludes addressing the need for these one-off significant with recommendations based on emerging best expenses for individuals. Not only does this practice. This note has been prepared by Fiona Stewart and Himanshi Jain of the World Bank and Will Sandbrook of the National 1 Employment Savings Trust (NEST). 2 This note addresses accessing pension assets before retirement. The question of how pension savings should be paid out at / after the retirement age (via a lump sum, programmed withdrawal, annuity payment) is a separate issue worthy of analysis and discussion. EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 3 represent a policy challenge in its own right assets and those with less education, not only but it also presents threats to the adequacy and have the least amounts of savings in retirement sustainability of retirement systems, as when faced accounts, but also the highest withdrawal rates with extreme financial hardship individuals in (NEST insights, 2017). For example, in the UK it many countries more often than not turn to these was claimed that pension savings constitute a major long-term savings. source of wealth for lower income workers, who may otherwise be excluded from other financial Research has shown that when faced with adverse services (such as mortgage loans), and therefore shocks, limited access to retirement savings can access to savings should be granted. However, in fact help increase the overall welfare of these consumer interest groups argued that giving workers individuals. For example, recent research by access to pension savings in case of hardship, (e.g., Agarwal et al. (2014) on Singapore’s mandatory for mortgage arrears), would leave them open to DC plan has shown that early access led some pressure from lenders and creditors to meet arrears individuals to make sub-optimal savings decisions, using their pension wealth. but that providing some degree of access to pensions savings may allow liquidity constrained consumers This worry that access to pension savings could to better smooth consumption. Evidence from expose vulnerable individuals to even higher early access to withdrawal funds permitted in some financial risk and losses has also prompted strict Pacific island countries hit by a natural disaster has rules around early access to pension funds in some provided evidence that if the shock is large enough countries. In 2011, after a call for evidence on early or the amount allowed for early withdrawal is not access, the UK government dropped a proposal to ‘too generous,’ a onetime early withdrawal can provide early access to pension saving (excluding improve welfare (Guo et. al (2018)). That said, specific cases of hardship), citing limited and most countries cover natural disaster risks through inconclusive evidence on the positive impact unconditional cash transfer programs rather than by for under-saving groups or significant benefit to allowing access to pension savings. individuals facing financial hardship.3 However, the dangers of accessing pension In addition to the direct risk to individuals, there savings are only too apparent. Pension savings are indirect impacts on the pension system from can be depleted to such an extent that inadequate allowing early access to funds. High volumes of retirement incomes are provided. Even in the case withdrawals would force fund managers to increase of accessing pension funds for housing, this can portfolio liquidity which would reduce opportunities leave individuals ‘asset rich but cash poor’ (as is to investment in long-term instruments, thereby the accusation with the Singapore system – see reducing their ability to take advantage of illiquidity following case study). If the loan is not paid back, premiums and generate higher returns. Analogously, individuals put both their home and their retirement since financial emergencies tend to be unexpected savings at risk. Importantly, even in systems and urgent, accessing funds directly from a pension without such a direct ‘early access’ link, risks to fund invested to deliver long-term returns could retirement savings can flow through indirectly for lead to very poor ‘value’ withdrawals if they take example, through contribution holidays, to fund place at an inopportune moment in terms of market debt repayments or more fundamentally through conditions. The impact on pension fund asset reduced earnings capacity, for long-term savings. allocation and performance from allowing access to pension savings for the purpose of switching Research has shown that more vulnerable between pension fund providers is examined in individuals, especially those with no other financial Pedaraz Morales et al (2017). See HM Treasury, (2010), ‘Early Access to Pension Savings’ 3 EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 4 Providing for early access would also require whether the contributions to the DC scheme are additional administrative costs - especially if mandatory or voluntary. For example, it could be suitably rigorous verification standards are put argued that countries such as the US can afford in place to ensure that the funds withdrawn are to be more liberal with access to their DC ‘401k’ used for the stated purpose and are needed due retirement savings since old age poverty alleviation to ‘financial hardship.’ Where retirement income is addressed through social security, whilst is the only goal, managing a single account is by heathcare costs in the country are substantial and design the most efficient way of managing pension rest with individulas. Evaluating access to other portfolios. However once these goals are somewhat forms of savings before implementing rules on in- opened up, the position becomes more nuanced. service withdrawals is also important. For example, in the African context where informal sector There are also implications for tax systems, as in workers may not have access to bank accounts to many DC schemes pension contributions receive cover emergency liquidity needs, allowing access a tax exemption in order to incentivize long-term to savings might be more critical. savings. To prevent tax avoidance, unwinding tax breaks on early withdrawals is required. Indeed, in In short, a ‘one-size fits all’ approach as far as some countries additional penalties are imposed on policies on early access to pension savings are early withdrawals to act as a deterrent. For example, concerned is not appropriate. This section discusses in the United States, withdrawals before age 59.5 how different countries have chosen strategies more years are taxed as ordinary income, and in addition, approporiate to their circumstances. This survey of a 10% tax penalty applies. rules for in-service withdrawals shows that they differ depending on whether contributions to the The following section of the note provides an scheme are mandatory or voluntary (See Appendix overview of countries that either allow early access for details). of some sort, or which have or are considering dual-account structures that utilize some aspects Access to mandatory pension savings is rare and, of the pension system infrastructure to also serve when allowed, is highly restricted and requires a additional savings goals or purposes. repayment of the withdrawn amount. The systems in Canada4 and Australia allow controlled access in clearly defined cases of disability or terminal International Practice illness, severe financial hardship as determined by The trade-off between poverty avoidance at old the plan trustee, payment to a beneficiary following age and poverty avoidance at a younger age (by the death of an account owner or temporary residents allowing for early access to long-term savings) permanently leaving the country. There continue to depends critically on what the overall pension be restrictions on the use of withdrawn funds even environment is and whether other safety nets / among these exceptions e.g. withdrawal of funds by health insurance is available to individuals. The the disabled are limited to disability-related home or polices on ‘early access’ also differ depending on vehicle modifications, and palliative care.5 4 Since December 21, 2010, Ontario has permitted ‘locked in retirement account (LIRA)’ holders to withdraw up to 50% of their LIRA balances upon transfer to a ‘life income fund (LIF)’, as long as the holder is at least 55 years old and the distribu- tion is made within 60 days of the transfer. Those with less than C$21,000 (in 2014) across all of their locked-in accounts may also withdraw all of these balances if at least age 55. 5 Withdrawal of funds in cases of severe financial hardship in Australia is limited to individuals under age 55 and 39 weeks who have received government income support payments for at least 26 consecutive weeks. The withdrawal needs to be approved by the plan trustee and has to be between AU$1,000 - AU$10,000 to cover reasonable and immediate family living expenses only (Beshears et al.,2015). EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 5 Where DC systems are voluntary, some access the accounts of savers under age 55, 0.4 dollars may be allowed, partly as a way of incentivizing simultaneously flows out of the individual individuals to sign up to such schemes. Some early accounts, not counting loans (Sabelhaus et.al access (before age 55) from voluntary schemes 2015; Munnell et.al, 2015). Research also found is allowed in New Zealand and Fiji. Voluntary that in 2012, 21% of all employees eligible for a occupational pension schemes, sponsored by loan had taken one, and the average loan amount employers, allow for some early access in Germany6, was 13%8 of the individual’s account balance.9 10 Denmark, Netherland, Sweden, the United States Other studies found that outstanding loans and and Belgium. withdrawals tend to offset about 40% of the positive effect of auto-enrolling workers into company 401(k) schemes, the main pension saving plans pension plans.11 Such findings should be balanced sponsored by employers in the USA, have some against the arguments that allowing such access of the most liberal access rules. They allow for can incentivize individuals to remain enrolled in ‘hardship withdrawals’ for medical expenses, these systems, and against the potential costs of education, principal residence purchase, funeral, alternative mechanisms of finding equivalent sums, eviction, and unemployment, subject to payment of most particularly the risk of turning to high-cost personal income tax and a 10% penalty on amounts debt.12 withdrawn. Loans are limited to no more than 50% of savings or USD 50,000 whichever is lower, interest is charged and the maximum repayment Types of Access period is five years7. The 401(k) accounts can, The ways in which individuals can use their pension but is not required, to be moved to an Individual savings for other purposes differs by country. Some Retirement Account (IRA) or to another employer’s of the common methods include: 401(k) once the individual no longer works for the sponsoring employer, which provides considerable (a) Permanent withdrawal: which allows access scope for liquidation before the withdrawal to funds without repayment obligations (e.g. eligibility age of 59.5. Denmark, Australia and the United States – under cases of extreme financial need); Despite these penalties, withdrawal levels and costs to the system are high. For example, it is (b) Loan and repayment: where an individual estimated that for every 1 dollar contributed to borrows directly from his or her pension fund and 6 Riester pensions allow for early withdrawals of up to 100% of the accumulated balance for the purchase of owner-occupied housing. Otherwise, account holders are barred from making withdrawals before age 62 (age 60 for contracts concluded before 2012). 7 The repayment schedule may be extended if the money is to be used as down payment for a home 8 https://www.ebri.org/pdf/briefspdf/ebri_ib_012-13.no394.401k-update-2012.pdf 9 The default rates are fairly low, with only 1 in 10 loans failing to be repaid, and this occurs mainly when switching jobs. 10 Pre-eligible withdrawals from the IRA can be made by paying a 10% penalty tax. Tax penalties do not apply to withdrawals related to total disability, death, or medical costs that exceed 7.5% of adjusted gross income. 11 See TIAA Institute, (2018), ‘Potential vs. Realized Savings Under Automatic Enrollment’ https://www.tiaainstitute.org/publication/potential-vs-realized-savings-under-automatic-enrollment 12 Independent, 2nd August 2018, ‘Using pension pots to buy homes makes sense - and will boost enrolment rate’ https://www.independent.ie/business/irish/using-pension-pots-to-buy-homes-makes-sense-and-will-boost-enrolment- rate-37176106.html EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 6 is required to pay it back (e.g. housing loans in not be penalized (e.g. via credit scores). The bank Switzerland13, self-managed funds in Australia); would take over the collateral, and the individual would no longer have the possibility of using this (c) Pensions as collateral: ‘pension pledging’ facility again. This option would be more efficient which refers to the possibility of using pension than a withdrawal of funds, and consequently assets as collateral. By allowing a pension pledge preferable in countries where such standardized or collateral, pension funds essentially provide a loans could be made available. third-party institution with a guarantee that the member’s pension savings will secure a loan or (d) Hybrid savings models: includes a‘feeder fund’ part of a loan from the lending institution (usually or ‘sidecar’ account, which consists of a saving banks). Occupational pension plans in South Africa product, linking liquid savings and pension savings often provide such services to their members to together. Under this arrangement, contributions access lower cost housing loans.14 Offering pension paid into the combined account structure would savings as a pledge instead of providing a direct at first be distributed between liquid and illiquid loan has the following advantages: accounts. When the balance in the liquid account reaches a predetermined threshold level, known • The loan is provided by a financial institution as the ‘savings cap’ all contributions thereafter go and not from the retirement fund – allowing entirely into the illiquid retirement account. If at investments to continue to earn investment any point the saver withdraws funds from the liquid returns. account, reducing the balance to a level below the savings cap, future contributions would once again • The pension fund would not need to incur start being divided between the liquid and illiquid additional costs of building expertise in lending, accounts. expose themselves to the risk of late payments or be concerned about eroding fund assets to finance the loan book. That said, offering this Examples of Hybrid Savings Schemes service does involve significant administrative Such schemes are currently being considered or costs to track pension assets that are subject piloted in various countries, including the US, to liens. New Zealand and the UK.15 The NEST Insight Though not yet operational in other countries, there paper (2017) explains how the motivation for a has been a discussion of using accrued pension ‘sidecar account’ comes from the notion of ‘mental rights rather than assets as collateral. In order to accounting’, according to which people tend to keep the cost low, the loan would need to be highly manage their finances in distinct ‘jars’ for distinct standardized. In order to avoid overuse of the fund, goals, either literally or metaphorically.The paper the interest rate charged on this loan should be argues that given the interconnectedness of financial higher than loans offered in the banking system. In needs, people need to be able to move resources case of (standardized) default, individuals should between jars. In practice, where they cannot, the 13 As of 1 July 2012, Switzerland tightened its rules on accessing pension funds for purchase housing. Households must now provide at least 10% of the property’s value as equity other than pension assets from a minimum total amount of 20% equity necessary to purchase housing property, and new borrowers are required to reduce their loan-to-value ratio to a maximum of two thirds within 15 years. 14 A parallel paper to this note on Pensions Savings and Housing Finance is currently being prepared. 15 This is being run by the National Employment Savings Trust (NEST), in collaboration with Professor Brigitte Madrian, at Harvard Kennedy School, Will Sandbrook, Matthew Blakstad, Michelle Cremin and Clare Hodgkinson, NEST Corporation, London. EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 7 outcomes can often be sub-optimal and inefficient. representative study of American adults looking at For example, in the absence of liquid savings, the attitudes to such a model and, in particular, at trade- most common mechanisms for funding unexpected offs between different design options and features. peaks in consumption or falls in income are Some of the nascent state ‘auto-IRA’ programmes borrowing through credit cards, personal loans or have considered or are considering building in ‘payday’ loans, or from friends and family or, where sidecar-like features. Recent draft legislation was possible, reductions in ‘essential’ spending. This, introduced at the federal level seeking to make in turn, results in people simultaneously servicing it easier for employers to offer a sidecar scheme a high-cost debt while incurring relatively lower within their 401(k) plans. offsetting returns on any savings that do exist. The sidecar model attempts to break this inefficiency Similar proposals for ‘rainy day’ sidecar accounts by allowing for regulated access to savings to meet have been proposed for the KiwiSaver scheme in short term and contingency needs. New Zealand- partly in response to the fact that withdrawals to the system have been increasing by In the US, Prudential financial (2018) recently 25% a year recently.17 Individuals could be offered announced a similar pilot programme with some the choice to have their KiwiSaver contributions employer clients. Work by Madrian et al (working first deposited into an access account. Once this paper, 2018) has sought to identify the different reaches $1,000, contributions would then flow into legal and regulatory structures under which such a their long-term savings accounts. model could work. The AARP recently published a Source: Prudential/ AARP16 16 The ‘sidecar’ plan that could soon be attached to your 401(k)’, Market Watch, 28th October 2018 https://www.marketwatch.com/story/the-sidecar-plan-that-could-soon-be-attached-to-your-401k-2018-10-01 17 ‘KiwiSaver ‘rainy day’ plan could help families weather money crises’ June 12 2018 https://www.stuff.co.nz/business/money/104560032/kiwisaver-rainy-day-plan-could-help-families-weather-money- crises EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 8 Figures 1+2: Number and Amount of Kiwi Saver Hardship Withdrawals (NS $ million) Number Amount 16000 80 14000 70 12000 60 10000 50 8000 40 6000 30 4000 20 2000 10 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Source: Commission for Financial Capability Evidence on the need for separate accounts, to balance broader goals and objectives beyond a single focus short term savings needs with long term retirement on pension provision. Sub-accounts for retirement adequacy is supported by recent theoretical evidence savings and other purposes (housing, medical) are by Beshears et al. (2015). The authors attempt to built up and any residual savings from the non- calculate the socially optimal level of illiquidity retirement accounts is transferred to the pension in a stylized retirement savings system. The study account upon retirement. However, experience has assumes that a planner can set up a hybrid savings shown that in practice, individuals struggle to meet schemes, i.e., multiple accounts for households -a the saving cap and hence have little to no income to perfectly liquid account and/or partially illiquid be transferred to the illiquid account. For example, retirement savings accounts with early withdrawal in the Central Provident Fund (CPF) in Singapore, as penalties. Revenue from penalties is collected by of March 2017, S$200 billion had been withdrawn the government and is assumed to be redistributed by nearly 2 million members, predominantly to through the tax system. The study finds that under fund public housing18. It is estimated that only such a scenario the socially optimal system mirrors 6 percent of the total contribution rate of 37 percent the US system where one has (a) a liquid account is used to effectively finance retirement, resulting (e.g. personal saving account), (b) illiquid account in inadequate retirement income for the elderly (e.g. like the social security DB account in US) and (See Box). Malaysians also face the challenge of (c) an account with early withdrawal penalty of about the inadequacy of their savings upon retirement. 10% (e.g. like the 401(k)). In 2013, 69 percent of EPF members aged 54 were found to have savings below RM50,000 The mandatory Provident Funds in Asian countries, (US$12,280). 70 percent of retirees reported having such as Singapore and Malaysia, follow a similar exhausted their EPF savings within 3-5 years model – though it should be noted that there are (Asher et al., 2012). differences in the systems as provident funds have It is to be noted that the CPF in Singapore lists that its objective is not only to provide retirement svaings but also to assure 18 everyone owns their own home. EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 9 Case Study: Central Provident Fund - Singapore The Central Provident Fund of Singapore is a comprehensive social security system for citizens and permanent residents. It is a mandatory scheme that requires contributions from both employees (20% of employee’s income) and employers (17% of employee’s income)1. The total contribution2 is allocated to several accounts: • Ordinary account, to which 23% (of the 40% contribution) is allocated and used for housing, insurance, education, and other approved investments. • Medisave account, to which 8% (of the 40% contribution) is allocated for hospitalization and approved medical insurance costs. • Special account, to which 6% (of the 40% contribution) is allocated for old age and investment in retirement-related financial products. • A retirement account is automatically created on members’ 55th birthday.3 Housing funds can be used to purchase or refurbish a house, and/or to pay for a mortgage. Multiple properties can be covered. The funds can be used for private housing, but the vast majority of the assets are used to purchase public housing supplied centrally by the Housing and Development Board (HDB). The HDB receives an annual grant from the government to construct housing and provide mortgages (at subsidized rates, which results in a very small private mortgage market). All land in Singapore is state owned with property purchased on a 99-year lease. The housing program in Singapore has been very successful, resulting in 90% homeownership rate (80% in public housing). However, the flip side has been that the contribution rate for retirement savings has remained low (6%), and there has been little savings left in the other accounts to top up income post retirement. In 2016 withdrawals from CPF accounts amounted to over 50% of contributions. As of March 2017, S$200 billion had been withdrawn by nearly 2 million members, predominantly to fund public housing. This has resulted in Singaporeans being said to be ‘housing asset rich but cash poor’ in retirement.4 Concern about retirement adequacy has been growing as the Singaporean population ages..5 Notes: 1 The percentage contribution has fluctuated quite widely over time to reflect the financial fortunes of Singaporeans. At inception in 1955, contributions were 10% and gradually increased to 50% by 1984. However, during the East Asian economic crisis in 1997, for example, the CPF contribution rate was reduced from 40% to 30%. 2 Contributions are not uniform and decline with age. 3 Central Provident Fund website. Available online at https://www.cpf.gov.sg/members/aboutus/about-us-info/cpf- overview 4 Chua, B. H. 2014. Navigating Between Limits: The Future of Public Housing in Singapore. Housing Studies, vol. 29, pp. 520-533, 17 February 2014 5 Koh, B.S.K. 2014. Singapore’s Social Security System: A Review and Some Lessons for the United States. Pension Research Council, Wharton School, September 2014. Available online at http://pensionresearchcouncil.wharton. upenn.edu/wp-content/uploads/2015/09/WP2014-18-Koh.pdf EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 10 Impact of Early Withdrawal on the investment portfolios and consequently the Pension Savings – A Stylized returns which the asset managers could be expected to deliver. The administrative costs of managing Example these withdrawals would also have to be taken into In direct-withdrawal systems, unless the amounts account. withdrawn are repaid with interest, allowing for early withdrawals from DC schemes inevitably The modelling also assumes continued contribution leads to lower replacement rates (RR) at payments (i.e., 100% contribution density). retirement.19 The impact of early withdrawals on However, experience across countries shows RR is quantified using a stylized example. Assume that evasion, underpayment, job changes/losses, an individual starts contributing at age 30 and maternity leave, etc., which lead to temporary or retires at age 60. The contribution rate is 15% of permanent exit from the covered labour force, gross salary, the real return on investment is 3%, are commonplace, thereby reducing individuals’ and the asset management fee is 1% of assets.20 overall contributions to the fund. Table 1 below shows the reduction in pension The impact on retirement income is one of the savings under three scenarios: (a) no early reasons why dual-account models hold some (at withdrawal allowed; (b) one-off withdrawal of least theoretical) appeal. Increasing contributions 25% of accumulated savings after 15 years of to illiquid, or semi-illiquid pension products risks contributions; (c) individual withdraws 25% after both causing or exacerbating short-term financial 15 years of service and another 25% after 20 years hardship and triggering opt out or cessation from of service. As one would expect the impact is larger voluntary systems. By contrast, adding a tranche if early withdrawal is allowed and the reduction to the ‘required’ or ‘recommended’ contribution is severe if more than one withdrawal is allowed. that initially goes to a liquid-access account does In scenario (c), with multiple withdrawals, the not run the same risks. In practice, evidence is fund available for the individual at retirement that those on lower incomes can often create more is approximately 29% lower than the case of no capacity to save than they expect they will be able withdrawal. In a DC fund, the reduction in the size to manage (see, for example, the UK Savings of pension savings naturally leads to a reduction in Gateway pilots), and so over time it is reasonable to the amount of retirement income received. expect that such additional contributions will both increase short-term financial resilience and begin, The impact would likely be larger than these over time, to increase the flow of contributions to estimates suggest, as there would be an effect on pension products. Table 1: Reduction in Pension Savings at the time of Retirement as % of prevailing average wage for DC scheme (results subject to assumptions listed above) Reduction in fund 25% withdrawal after 15 years 14.2% 25% withdrawal after 15 years + after 20 years 28.9% The replacement rate is pension income amount divided by an individual’s final salary level. 19 Inflation rate is assumed to be 2% for the projection period, nominal wage growth is 3%, nominal return on investment is 5%. 20 The individual is expected to live for 20 years after retirement (based on mortality patterns of the world on average, and hence account for increase in Life expectancy over the next 30 years as estimated by the UN). EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 11 Conclusion Some controlled access to long-term savings for affordable housing, medical expenses, and The primary goal of a pension system should be emergency needs could be facilitated – but in a to provide adequate, affordable, sustainable and limited and controlled method. Using funds as robust retirement income. Pension funds should collateral rather than for outright withdrawal is a have a single objective which is to provide adequate preferable option. Standardizing access to loans pensions to individuals, and should be managed maybe the most cost-efficient option to provide with one portfolio (which can evolve through the liquidity for pension fund members. However, it individual’s lifetime), to meet this objective. This is recognized that in some situations lenders might goal is challenging enough, and one which sadly not be willing to extend credit based solely on the some of the systems around the world are falling pension fund assets which are subject to market short of. That said, there is evidence that policy- volatility. makers find it hard, particularly in individualized DC systems, to resist the argument that workplace Alternatively, a system with multiple accounts with ‘pensions’ should perhaps be opened up to other varying degrees of liquidity could be designed. goals. Once this happens, there is a legitimate Although not the optimal design for pension debate about how most efficiently to facilitate these savings, such products may prove attractive to other goals while preserving or even improving individual and encourage participation in voluntary pension outcomes. systems. This may ultimately be more efficient to the extent that the system is either explicitly or Fundamentally, to the extent that contribution levels implicitly evolving to serve additional objectives. and other parameters in private pension systems are How to balance these accounts will depend on strategically determined, they are almost invariably the overall pension system, access to savings, structured to deliver smooth income into retirement and the country context. For example, it could be assuming persistent contributions and reasonable argued that in the US the wholly illiquid account is returns. However, experiences from countries Social Security, and the 401ks serve as the sort of with well-designed DC plans has shown that they ‘middle-tier’ that can be used to withdraw money too struggle with inadequate retirement benefits from in cases of emergencies. However, in any due to one or more of the following reasons – country where income-replacement levels from low contribution density, lower than required pillar-one falls short of adequate protection, the contribution rates, movement in/out of labor force logic would suggest a second pillar with a wholly (particularly for women), low rates of return, high illiquid component, and then one or more liquid marketing and administrative expenses, low or even components. negative spread between real interest rates and real wage growth21, high cost of annuities due to low It is important to remember that no system, interest rates, anticipated mortality improvement however well designed, can make up for a short-fall and anti-selection in plans where annuitization is of contributions. The total going into the various optional. Since adequacy of income after retirement accounts needs to be sufficient. Letting people tap is already a concern for well-designed DC plans, their savings when total contributions are barely it is highly unlikely that these plans could then even sufficient to fund retirement will not serve any also meet secondary shorter-term purposes like policy goal. ‘emergency needs’. The challenge, therefore, is to balance the current best interests of individuals with their future retirement needs, without jeopardizing either for the sake of expediency. 21 This occurs in many rapidly developing countries EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 12 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | LONG-TERM FINANCE FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | LONG-TERM FINANCE BIBLIOGRAPHY Agarwal,S., Pan, J., Qian, W., (2018),’Age of Department for Work and Pensions (2017) Family Decision: Pension Savings Withdrawal and Resources Survey. London: Department for Work Consumption and Debt Response’ and Pensions Argento, R., Bryant, V. 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London: Money Advice Service. how employers can improve the wellbeing and BIBLIOGRAPHY 14 FINANCE, COMPETITIVENESS FINANCE, & INNOVATION COMPETITIVENESS & INSIGHT || LONG-TERM INNOVATION INSIGHT LONG-TERM FINANCE FINANCE APPENDIX 1: ACCESS TO PENSION SAVINGS BY COUNTRY Access Country Participation to Taxed Withdrawal purpose Withdrawal model pension Loan & Feeder- Pension Housing Health Other repay Permanent fund collateral Malaysia Mandatory Yes No ✔ ✔ ✔ ✔ Singapore Mandatory Yes No ✔ ✔ ✔ ✔ Denmark Quasi- mandatory Yes Yes ✔ ✔ Quasi- Netherlands No n.a mandatory Quasi- Sweden No n.a mandatory Switzerland Mandatory Yes Yes ✔ ✔ ✔ Australia Mandatory Yes Yes ✔ ✔ ✔ ✔ Chile Mandatory No n.a Sweden Mandatory No n.a Mexico Quasi- mandatory Yes No ✔ ✔ ✔ New Zealand Voluntary Yes No ✔ ✔ ✔ ✔ United Voluntary No n.a Kingdom United State Voluntary Yes Yes ✔ ✔ ✔ ✔ Source: Compiled using data from Huitron (2015) EARLY ACCESS TO PENSION SAVINGS: INTERNATIONAL EXPERIENCE AND LESSONS LEARNT 15