How a New Bond Can Improve Retirement Security

Abstract

There is a growing retirement crisis, and most of the focus has been on the fact that individuals are not saving enough for retirement, may not have access to pension schemes, and find it difficult to choose from a wide range of retirement investment products. However, the bigger issue might be that the assets and financial products available to investors, including those that offer legal protection to plan sponsors, may not be appropriate for the typical individual saving for retirement. As Merton (2014) notes, the model adopted to plan for retirement for the majority of the population focuses on wealth at retirement as opposed to the level of retirement income that an individual can earn. As a result, current assets and many products are risky from a retirement-income perspective. All else equal, with respect to retirement income, individuals retiring a few years apart can have vastly different outcomes (making retirement outcomes a function of one’s conception or retirement date), and this impacts policymakers (and potentially individuals worried about retirement security). A new bond has been proposed to improve retirement security; it includes a forward-start (tied to date of retirement), income-only (because individuals need steady income), real cash-flow stream (linked to appropriate indexes), for a fixed period (tied to average life expectancy). This paper examines standard portfolio choices (e.g., 60/40, target-date funds), along with holding this new bond in isolation, from a retirement-income perspective to demonstrate how this new bond, either individually or when used in standard portfolio choices, could improve retirement outcomes. The paper concludes with a Monte Carlo simulation that further validates the value of this new bond given the potential risks to all investment choices for reasonable future equity, interest rate, and inflation scenarios.

Keywords: Retirement Bond, BFFS, SeLFIES, Retirement Security, Retirement Income, Annuity Pricing, Monte Carlo Simulation, Historical Simulation

JEL Classification: G10, G11