The DC pension lottery writ large

There is a chart in a new report from the World Economic Forum that should give anyone designing a pension plan pause for thought. It shows what a lottery defined contribution pensions can be, with Japan a particularly good example.

Based on certain assumptions, the chart (on page 48 of the report) shows a hypthetical Japanese worker retiring just before 1990 would have enjoyed retirement income equivalent to 60 per cent of earnings after contributing 5 per cent a year for 40 years investing in a 60/40 combination of domestic equities and bonds. But the unlucky one retiring 10 years later would have had to survive on 10 per cent.

 This huge disparity was down to the stock market boom and bust and the big fall in interest rates in Japan that made annuities much more expensive.

The chart is there is illustrate one of the problems facing policymakers looking to enhance pension fund performance, which is one of 11 strategic options to improve healthcare and pensions that the WEF has identified as important for transforming a greying population into a “silver” one.

It is a timely reminder for anyone putting in a response to the investment consultation by the Personal Accounts Delivery Authority. Pada has a difficult task of designing a default fund for personal accounts (the UK’s new national pension scheme due to start in 2012) that will be sufficiently low risk and low volatility to avoid scaring people into leaving the scheme but still able to produce returns to meet the projections made in a government white paper for a 20 per cent replacement rate.

The WEF proposes a variety of actions to improve pension fund performance, including for governments to regulate investment options in DC plans, limit investment choice (because too much choice leads to less selection by members and more use of the default) and lower the investment risk taken in the run-up to retirement.

Pada’s approach will be highly influential. Will the WEF approve I wonder?

About the blog

FTfm is no longer updated but it remains open as an archive.

FTfm's specialist writing team offer their insights into the global fund management industry.

About the authors

Pauline Skypala has been editor of FTfm for four years having previously been deputy personal finance editor. She joined the FT in 1999 and has been writing on savings and investment issues throughout her career.

Steve Johnson, FTfm deputy editor, has been a journalist for 17 years, 10 of which have been with the FT.

Sophia Grene, reporter on FTfm, has been a financial journalist in print and online for 12 years.

Ruth Sullivan has worked as a financial/business journalist and foreign correspondent and for the past 10 years has been at the FT.