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China Has A Long-Term Retirement Savings Strategy – So Should The US

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Late last month, Chinese authorities announced a pilot program for a new private pension system to encourage its citizens to save for their retirement. This is China’s first foray into an individual defined contribution system, and is a logical step considering the country’s aging population – people aged 60 and older amounted to nearly 19% of China’s population, according to the 2020 census, and the country is aging quickly.

While still a pilot program, the key components are common to other similar setups around the world. Rather than administering pensions through employers, it’s built so that people can save throughout their lifetimes into the same plan regardless of where they work. Chinese citizens will be able to choose their provider, creating a market environment where private institutions can compete based on performance, fees, and service.

Tax breaks will be introduced to encourage widespread participation. The incentive will be much needed – according to the National Bureau of Statistics, China’s average per capita disposable income in 2021 was 35,128 yuan (roughly $5,277). The new scheme will allow contributions up to 12,000 yuan per year to individual pension accounts, allowing for very meaningful savings.

The new plan “can provide more long-term, and stable funds to develop the real economy, via capital markets,” the China Securities Regulatory Commission (CSRC) said.

This program is a huge step for China, and it notably follows many of the same principles as the Australian model, which has been very successful over the last 25 years. In contrast, the American approach has become antiquated and ineffective.

Because of the way it’s structured, Australian superannuation far surpasses the American pension system in terms of facilitating financial inclusion. In Australia, 76% of the population is exposed to the capital markets via their super fund accounts. By contrast, in the US, just 51% of American households have any exposure to the very powerful engine of wealth creation – owning equity in companies (and the power of compounding).

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While on average the US and Australia have similar retirement savings per person, there is far greater wealth disparity in the US. According to recent data from Credit Suisse, the Australian median retirement savings ($238,000) is fairly close to the average ($484,000), compared to in the US where the disparity is far greater ($79,000 vs. $505,000). One in four Americans has no retirement savings at all. In other words, in Australia, retirement is for everyone, not just the fortunate few.

Aside from the financial implications, consider the realities of how work affects retirement. In the Australian, and soon Chinese, systems, savings follow the saver from job to job throughout their working lives, detached from various career moves they may choose to make. Compare that to the US, where the law that governs the pension system is fundamentally unchanged since it was written in the 1970s. At that time, the assumption was that employees would stay in the same company for their whole careers and retire with a defined benefit pension payment guaranteed by their employer. In that world, employer-centered pensions make sense, but that is not the world we live in 50 years later. Centering the system on the person, not the employer, would make sense by any modern standard.

The structure of the Australian system has yielded huge returns – something the Chinese authorities almost certainly made note of. According to a recent study from Willis Towers Watson, Australian pensions have achieved one of the highest growth rates of pension fund assets in the world over the long term. From 2000 to 2020, these assets grew by a compound annual growth rate of over 11%. As a ratio of the Australian GDP, pension assets have risen 112% from a decade ago.

This is unsurprising when considering how serious the Australian government is about long-term growth. For example, the Australian Prudential Regulation Authority (APRA) measures fund performance on a rolling basis over an 8-year measurement period. Funds which are more than 50 basis points a year below the benchmark are considered underperforming, with serious consequences, such as informing their participants of their underperformance and being prohibited from accepting new flows.

The Chinese have clearly studied which characteristics to adopt in their new pension scheme and which to leave behind. The new scheme will be rolled out to several cities on one-year trials before being introduced across the entire country, at which time you can expect the Chinese to become a formidable player in the global retirement market.

The next generation of Americans cannot both save for their own retirement and support the current older generation; those ages 65 and older will more than double over the next 40 years. It is past time to implement some of the same changes China is now beginning to put in place.

The current patchwork system of defined benefit plans, employer-based defined contribution plans and limited individual retirement accounts in the US has become a relic – too exclusive, furthering wealth inequality, and creating costly inefficiencies. Introducing a saver-centered, competitive, and well-regulated retirement system, and getting younger Americans saving for their retirements earlier, is necessary for the US to have the financial security and global competitiveness it needs.