Proposed New Approach to DC Drawdown

[elacsaplau]

Yes, that's the principle underlying all pension funds governed by Trust Deed and Rules, that the fund can trundle on if the employer goes bust.

The schemes with which I am familiar obliged the trustees to determine the scheme upon notice of cessation of employer contributions. Theoretically, if the TD&R didn't expressly prescribe this, the trustees could possibly trundle on but the likelihood of this happening is, I would suspect, remote. That's in Ireland - in the UK, also a trust based model, given the proper protections that exist to members upon plan cessation (unlike here), I'd suspect the trustees trundling on would be even a remoter possibility.

I agree with your seed corn analysis if we were talking about seed corn. I wasn't talking about irredeemable bonds - my figures were based on 10 year treasuries and I don't see much confusion - certainly none that materially detracts from the substantial point.

Irish pension funds do not accumulate tax free! Very common misconception. No tax is levied in Ireland but other jurisdictions levy tax which may or may not be recoverable. Dividend With-holding Tax (DWT) in the US is the primary, but not exclusive example, of this.

Though ironically reality seems to have exceeded expectation in most situations.

Duke - so I suppose we can surmise that the hot date does often go well - giving rise to not alone a free lunch but breakfast also!

Oh, I was thinking about your crazy thought experiment - I think I can assuage your concerns of social upheaval on the island. The money will be invested overseas meaning that the Paddies get a higher slice of the worldwide cake. It then becomes, not an act of further inter-generational wealth transfer within Ireland, but rather a patriotic Paddies first measure. Mostly kidding around here....

Better go and do some real work now....

 

[Duke of Marmalade]

Duke - so I suppose we can surmise that the hot date does often go well - giving rise to not alone a free lunch but breakfast also!

My expectations were always low on that front

Oh, I was thinking about your crazy thought experiment - I think I can assuage your concerns of social upheaval on the island. The money will be invested overseas meaning that the Paddies get a higher slice of the worldwide cake. It then becomes, not an act of further inter-generational wealth transfer within Ireland, but rather a patriotic Paddies first measure. Mostly kidding around here....

Better go and do some real work now....

I think Colm is more ambitious for his proposal than being merely a Paddie solution to a Paddie problem.

 

[Colm Fagan]

I posted twice by accident! This is to delete one (I can't see how to just delete a post: I have to replace it with some text)

 

[Colm Fagan]

The schemes with which I am familiar obliged the trustees to determine the scheme upon notice of cessation of employer contributions.

I'm no pensions expert, but I understand that the requirement you mention applies to schemes where there are active service employees and where employer pension contributions are required to ensure that promised benefits can be provided. For retired members, the employer is not making any further contributions, so the requirement doesn't apply. I nonetheless recognise the validity of the concerns that you and others have raised about the continued involvement of the employer post retirement. I spoke to a joint meeting of the IAPF/IIPM in Cork this morning, and an alternative approach, which does not involve the employer's continued involvement, was prompted by a comment from one of the attendees. (Thank you, John) I hope to produce Mark II of my proposals soon, to address this concern.

I wasn't talking about irredeemable bonds - my figures were based on 10 year treasuries and I don't see much confusion - certainly none that materially detracts from the substantial point.

I accept that irredeemable bonds were an extreme example. Nevertheless, 10-year treasuries would also enjoy a substantial price pick-up from falling interest rates. Furthermore, we must recognise that the bull market in bonds of the last 30 years or so, when interest rates fell from double digits to low single digits, will not be repeated in future. The seed-corn of falling interest rates has been well and truly devoured.

Irish pension funds do not accumulate tax free! Very common misconception. No tax is levied in Ireland but other jurisdictions levy tax which may or may not be recoverable. Dividend With-holding Tax (DWT) in the US is the primary, but not exclusive example, of this.

I recognise the problem of DWT very well from my own investing activity. The Apple dividends that accrue to my ARF every quarter have 15% taken off the top, and I can't get the money back. It's nice not to have to pay CGT though. Also, the Irish and UK dividends paid to the ARF have no further tax deductions (except for UK REIT's - another hornet's nest!).

I think Colm is more ambitious for his proposal than being merely a Paddie solution to a Paddie problem

Duke, you're absolutely right. I see this as a world-wide problem and I would like to see my proposed approach being applied world-wide eventually. I don't know if you're being serious with your thought experiment. If you are, there's no need to worry. The proportion of total investments represented by DC pensions is trivial in the wider investment world, so will have no material impact. Also, think of all the extra work there will be for young, able-bodied people if wrinklies have lots more cash to splash around!

 

[elacsaplau]

I spoke to a joint meeting of the IAPF/IIPM in Cork this morning, and an alternative approach, which does not involve the employer's continued involvement, was prompted by a comment from one of the attendees. (Thank you, John) I hope to produce Mark II of my proposals soon, to address this concern.

That's great - I actually do wish you well - the central themes are great - just trying to advise you of the probable very marked reticence of employers - look forward to seeing Mark II.

I recognise the problem of DWT very well from my own investing activity.

- Whats the story with tax?
- There's no tax
- Not true
- I know well it's not true

 

[Duke of Marmalade]

I don't know if you're being serious with your thought experiment.

Not terribly serious but I do think the macro socio-economic aspects of pension provision are intriguing. Imagine a situation where the only factor of production was Labour. Then all pension provision would need to be by social transfers. Luckily capital is also a major factor of production. So a situation is plausible whereby the pensioner claim on society is based on its ownership of capital (supporting your proposal) and not on social handouts.

But, especially given the demographics, there are social limits to much of the cake pensioners can claim versus the active population.

 

[SPC100]

I know this is an old thread - but I saw some references to it and your pension proposal on some other threads, so went searching for this.

Previous posters have brought up any of the concerns I saw, in particular, that the ER premium turns out to be much lower than anticipated, there needs to be clear guidance in advance on what would happen, and who/if anyone would underwrite.

I have three questions
1. I understand it was the concerns about drawdown that inspired the solution. But why limit this just to folks entering drawdown stages? You mentioned elsewhere about an AE meeting recently, so maybe you already extended this proposal?
2. Any updates on if the state or any large employer are considering something like this?
3. is there a thread or place to follow along to see what progress you manage to make with this?

 

[Colm Fagan]

I understand it was the concerns about drawdown that inspired the solution. But why limit this just to folks entering drawdown stages? You mentioned elsewhere about an AE meeting recently, so maybe you already extended this proposal?

You're right! I expanded on the ideas in my February paper and submitted them to the DEASP as a possible solution to the Auto-Enrolment challenge. I attached them to Post #428 in the "New Sunday Time Feature - Diary of a Private Investor" thread. They were discussed later in that thread. I don't know if Brendan or someone else can transfer the discussion to this thread (which seems more logical) and also to change the title to include reference to AE. For ease of reference, I attach them again to this post.
In answer to question 2, no-one has yet indicated to me that they are considering implementing the proposed approach. I will be delighted to speak with anyone who is considering them - and I've retired from consulting so there's no fee!!
3: As mentioned above, see the discussion under the "Diary of a Private Investor" thread.

 

[SPC100]

Thanks. I'm reading it now.

For others here is a link to Post #428 in the "New Sunday Time Feature - Diary of a Private Investor" where there is some discussion on this (although intermingled with other topics).

 

[Colm Fagan]

I promised (in the thread referred to by @SPC100 above) to give an update on Monday’s seminar.

The main purpose of the seminar was to assess the technical feasibility of the proposed smoothing approach to auto-enrolment.

As I said in an earlier post, there was considerable support for the proposed approach, but also lots of questions.

My first slide to the seminar (attached) shows the advantages of the proposed approach compared with existing approaches to pension provision, almost all of which involve taking the foot off the gas just when the fund is at its highest earning power.

Arguably, the attached slide understates the potential upside of the proposed approach. It assumes that the “conventional” approach and the smoothed approach deliver the same returns up to 10 years before retirement. In practice, very few contributors take an unmitigated high-risk, high return approach to investment at present. That knocks a percentage or two off expected (with emphasis on the word “expected”) returns. Even a tiny difference in annual return can have a major impact over a long number of years.

The slide also assumes that costs are the same under both approaches. That is definitely not true, especially post retirement. Under the current regime, ARF holders need to get regular investment advice throughout their retirement. That advice is expensive. The cost hasn’t been factored into the Fund A calculations. There is no need for advice under the smoothed approach, since there is no investment choice. The only decision is how much to withdraw each year. A financial adviser doesn’t have any special skills in this area.

A considerable portion of Monday’s discussion centred on the two sentences in paragraph 16 of my submission:

“The integrity of the smoothing formula and its independence from outside influence are essential. Maintaining the integrity of the smoothing formula also ensures that auto-enrolment will operate on a mutual basis, with no need for financial underwriting or support from the state or an external financial institution.”

There was general agreement that the government will run a mile from the proposed approach if there is any risk of it (the government) being on the hook if things go wrong. It was also pointed out that, even if I’m right in asserting that the smoothing approach would have worked for the entire period from 1870 to now, that doesn’t prove it will work in future. We need to test its robustness by simulating a wide range of possible futures, by running (say) 10,000 simulations of possible developments in financial markets over the next (say) 50 years.

If the smoothing approach runs smoothly for the entire 50 years for all 10,000 simulations, then we can reasonably assume that the government will back it. But what if it doesn’t? What if everything is okay for (say) 9,950 of the simulations, each covering the next 50 years, but the fund goes insolvent without state intervention in the other 50 out of 10,000 simulations? Would the government be prepared to back the proposed approach in those circumstances? As an aside, the required solvency standard for (re)insurance companies is that everything should be okay for 9,950 of the 10,000 simulations. Would the government accept the same risk of being on the hook?

We must also define what we mean by “insolvency”. It doesn’t mean that there wouldn’t be enough money in the fund to pay beneficiaries the promised amounts as they became due. That point would never be reached, even in a worst-case scenario. The writing would be on the wall long before then. The real risk is of smoothed values exceeding market values by a considerable margin for several years, to such an extent that people under retirement age would decide to stop contributing and retired contributors would withdraw the maximum allowable each year. Thus, there would be no new money coming in, and continuing members would have to subsidise people making withdrawals at values greater than market values. In those circumstances, the trustees would have to wind up the fund and distribute its assets in proportion to members’ nominal account balances. It wouldn’t be the end of the world, but it would be embarrassing at the very least for the government of the day.

There is also the question of who’ll do the 10,000 simulations. We can’t expect people with demanding day-jobs to do the work for nothing. (And I no longer have the computer nor mathematical skills to do the job). Should the government commission a firm of consultants to do the work?