Retirement vs. Decumulation

Australians retire with millions of dollars. It’s not that Australia is necessarily wealthier than any other country, although they certainly rank high on a per capita basis. Rather, they happen to reach retirement age with millions of dollars in their retirement savings accounts. The source of (and credit for) their wealth is the Australian government who forces workers to save close to 10% of their salary in an investment account, and it’s employers mostly who contributing to that pot. To put it in very simple terms, if your quoted salary is 100,000 AUD per year, your employer will guarantee and pay another 10,000 AUD which flows into your ‘super’ pot as it’s called.?

So, after a few decades of being forced to save that much money every year, and if the money is invested at a reasonable rate of return, it’s not surprising it accumulates to millions of dollars at retirement. To my knowledge, no other country has such a widespread system of forced retirement savings, also known as mandatory Defined Contribution (DC) Individual Account (IA) plans.?

The problem with all these millions of AUD is that retiring Australians face a huge dilemma of what to do with all this money. Now sure, that sounds like a super problem to have, but it’s a scary one when you are looking at large sums that must finance your golden years. Australian’s can continue to invest the funds in many different investment products, or withdraw their money and spend it slowly, or they can even yank it all out and buy a boat, which some do. They have lot of choices with complex income-tax and old-age pension implications, which can all be rather paralyzing. It often leads to some very peculiar outcomes, which I’ll get to in a moment.?

The Australian scheme has been in place for almost three decades now and has offered plenty of time to gauge how retirees behave and what they actually do with their accounts as they continue to age and progress thru the lifecycle. In fact, one very large employer plan in Brisbane, a lovely city in Queensland on the east coast of Australia, has carefully tracked the retirement finances of tens of thousands of retirees during the last thirty years.?

Sadly, many of the people who retired in their late 60s and early 70s, were no longer alive three decades later, but the money in those account are subsequently transferred to surviving spouses, children and beneficiaries. And yet, after digging into all that spending and investing data researchers in Brisbane noticed something very peculiar.

The Brisbane discovery, which is what I’ll call this little nugget, was that on average the amount of money in their retirement account when the died was equal to the sum they had when they had retired decades before. Members of the plan died with a balance that on average was what they retired with. If they started the retirement journey with a million dollars, they ended with a million dollars. If they only had half a million in their pot when they exited the labour force, then they left this world with half a million dollars, etc.?

Now sure, the Brisbane discovery was on average (and loosely defined) and there were many exceptions to this result, but the behavioural implications of what this meant were even more interesting.

Remember that their pension pot wasn’t sitting under their mattress or deposited in a safe bank earning little interest income. The money was allocated to stocks, bonds and many other investment asset classes over the 10, 20 or even 30 years of retirement. In other words, these accounts fluctuated over time, bobbing up and down with markets and interest rates. These pots earned dividends, interest and realized capital gains over time, which means that they increased and decreased from day to day and year to year. But on average retirees adjusted and fine tuned their spending -- or what economists call consumption – so that the balance of the pension pot followed a flat trajectory over the long run.

How exactly? Well, if the pot grew in one year, the owner spent a bit more. If the pot shrunk, the owner would cut back and perhaps have one less “shrimp on the barbie”, to overuse the Australian phrase.

Australians had retired, but on average they didn’t decumulate.?

Decumulation is a relatively recent word, according to the Merriam Webster dictionary, and is a noun defined as the “disposal of something accumulated.” Unfortunately the word retirement is often used interchangeably with the word decumulation, but those are two very different terms. There are many experts in the field of economics, sociology, psychology, medicine, and gerontology that study -- and give advice -- on retirement. The former is about lifestyle choices, withdrawing from the labour force, spending time, etc. It's a huge and massive field. In contrast, I study and am interested in decumulation, how people are doing it, how it should be done, and whether there are things that governments and industry can do to make decumulation more efficient.

I should note that Australia aren’t the only group who need help with decumulation, although they do provide an extreme and current example. In the U.S., researchers have documented a similar albeit more nuanced phenomena, and one of the leading economists who has worked to uncover the drivers of decumulation is Professor James Poterba at MIT, with various colleagues.?

If I can quote from his article: “The relatively modest age-related changes in wealth…suggest that the distribution of wealth near the end of life may be largely determined by wealth at age 65.”

My main message is that retirement and decumulation should be treated as distinct domains of activity and expertise.

Technically speaking decumulation is an extraordinarily complex mathematical optimization problem for which insurance, risk management and stochastic control is the proper apparatus and modeling lens.?Consumers who want (good, reliable) advice on this matter will have to pay more than they did for simple, easy, passive accumulation advice. To be clear, retirement is a slow ongoing progression in which people gradually withdraw from the paid labour force, often involuntarily and abruptly, with many non-financial externalities.??

Intermediaries in the financial services industry must be careful not to veer from the technical domain of decumulation assistance – also encompassing the timing of retirement benefits such as Social Security -- into the nebulous region of retirement planning.?

Eager 30-year-old advisors, brokers and insurance agents with little in the way of life experiences or financial assets (to be very blunt) should refrain from counseling financially successful middle-aged couples in their 50s, 60s and 70s, on exactly when they can afford to stop working, withdraw from the labour force and/or disengage from their commercial network. I suggest they leave that sort of advice to gerontologists, social workers, psychologists and perhaps even family members who are in the best position to assess non-financial externalities.?

In sum, I would encourage my audience here today of Retirement Quants to limit expertise and conversations to decumulation planning, perhaps such as helping retired Brisbanites spend a bit more.