Pension regulators should avoid setting guidelines that lead to default investment strategies that are too conservative, reducing the retirement income of workers, a new OECD report has found. Investing in the shares of listed companies tends to bring better retirement income outcomes, it says.
The OECD Pensions Outlook 2024 examines pension systems across the world’s most developed economies including Ireland.
It says that pension funds need investments in equities to represent a significant share of the portfolio of defined contribution (DC) pensions – pensions where the return is decided by the amount invested and the performance of those investments.
Equity investment has been rising steadily over the past 20 years, it finds, accounting for more than 40 per cent in 13 out of 38 OECD member countries studied and less than 20 per cent in only seven countries. Ireland was not one of the countries examined for this element of the OECD report.
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“Investing in equities leads to better retirement outcomes,” the report says, although it acknowledges that it can involve more volatile outcomes. Investing in stock markets works better over long periods, it notes, but is less suitable for workers in the years close to retirement as it can expose them to too much risk of a market downturn.
However, the report makes clear that default investment strategies that rely heavily on government bonds are too conservative because of the low, albeit safer, returns on offer.
The report observes that people who invest their retirement savings in the default option, which is the majority, tend to stay in that default even though it may not match their level of risk tolerance or the best option for the stage of their working life.
It also argues that people should consider staying invested in equities even while they are drawing down their pension under schemes like Ireland Approved Retirement Fund model.
Using economic modelling, it found that when investment in equities accounted for less than 20 per cent of the fund as it was being tapped in retirement, people would be better-off opting for a lifelong annuity in at least 75 per cent of cases. “By contrast, there is a 60 per cent probability of getting higher replacement rates when staying invested fully in equities during the payout phase and taking regular drawdowns instead of buying a lifelong annuity at retirement,” it said.
“Therefore, if individuals value flexibility and take regular drawdowns, large investments in equities would increase expected benefits. However, this comes at the cost of higher volatility of benefits and the risk of outliving one’s resources.”
The report also looks at equity release schemes that are marketed to older people, allowing them to release some or all of the equity in their homes to enhance their liquid assets or income.
While such schemes can be useful to older people, it says, it calls for appropriate regulation to ensure that people know what they are agreeing to and that it is the right strategy for their circumstances.
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