Dangerous Assumptions

Historically speaking, this phase of life we call “retirement” is a new concept. The idea you could stop working at a certain age was unknown until quite recently. People worked as long as they physically could, then died quickly unless they had family or servants to care for them. That was normal and accepted.

Now, we have different expectations, at least in the developed world. We think life should end with a decade or two of relative leisure. The challenge is that leisure isn’t free. The population that isn’t working to support itself needs some kind of funding mechanism... and that’s where it starts getting complicated.

Ideally, retirement would be self-funded, with people accumulating savings during their working years to be spent in retirement. This is easier said than done. Many people either can’t or don’t save enough, for a wide variety of reasons.

But the real problem is the large number who think they’re ready for retirement but actually aren’t. I described some of the reasons last month in Pension Sandpile, but it’s actually even worse. Not only are the sandpiles going to collapse, but millions will be under them when they do.

Today, we’ll look deeper at this problem. As you will see, modern pension plans and retirement schemes depend on assumptions no one should take for granted, yet practically everyone does.

Highly Sensitive

The “underfunded pension plans” we hear about are typically defined benefit (hereinafter DB) plans. That means the beneficiaries (i.e., retired workers) are promised certain payments on a defined schedule for life. Sometimes they get healthcare benefits, too. What isn’t defined so clearly is where the money will come from and how much is needed.

We need to understand the difference between “underfunded” and “fully funded.” I’m going to try and explain this with a simplified example. (Readers with pension expertise will recognize I’m omitting many details. They’re important but tangential to the point here).