A recent publication “We’ll Live to 100 – How Can We Afford It?” by the World Economic Forum examines the connection between increasing longevity, a decreasing dependency ratio (the ratio of those in the workforce and those who are retired) and the sustainability of the current retirement system. Healthy pension systems are necessary to ensure a prosperous economy in the future; if retirees see that their post-retirement lifestyle is not sustainable from the time of retirement until they “depart this orb”, it will have a significant impact on their consumption habits. This would have an obvious negative impact on the global economy and its long-term stability.
Let’s start by looking at some demographic issues:
1.) Increasing longevity:
The global population aged 66 years and older will increase from 600 million today to 2.1 billion in 2050.
2.) Oldest age at which 50 percent of babies born in 2007 are predicted to still be alive:
Now, let’s look at some economic issues:
1.) Lack of access to pension plans: on a global basis, over 50 percent of workers are in the informal or unorganized sector of the economy (i.e. self-employed) and have limited access to workplace retirement plans.
2.) Inadequate savings rates: to support a reasonable level of post-retirement income, workers need to save between 10 and 15 percent of their annual earnings. This is particularly a problem where workers are covered by defined contribution plans which have no guarantee of benefits.
3.) High degree of individual responsibility to manage pensions: with the increase in the prevalence of defined contribution pension plans which now account for more than 50 percent of global retirement assets, individuals are now responsible for managing their own retirement savings. This requires the individual to have at least some knowledge about how much they will need to retire and what investments will provide the necessary returns to achieve their savings goals.
4.) Low investment return environment: thanks to the world’s central banks, returns on low-risk, interest-bearing investments that were traditionally the investment vehicle of choice for older investors, are well below historical averages with bonds yielding between 1 and 3 percent lower than historical values and equities yielding between 3 and 5 percent lower than historical values. Additionally, high asset management costs in this low return environment have further punished investors.
With that background, let’s look at the WEF’s calculations for the global pension shortfall. Their calculations assume that for most people, retirement will be financed using a combination of three sources of income; government, employer public or private sector pension and individual savings. The analysis also assumes that post-retirement income will be 70 percent of pre-retirement income, a level that is likely low for low-income workers who are likely to need an income replacement rate closer to 100 percent of pre-retirement income. Here is a graphic showing the size of the retirement savings gap in trillions of dollars in 2015 and in 2050 with the orange numbers showing the annual growth rate of the gap for the eight nations with the largest pension systems or populations:
The current $70 trillion retirement gap is composed of these components:
1.) 75 percent is unfunded government and public employee pension commitments.
2.) 24 percent individual retirement savings shortfall.
3.) 1 percent unfunded corporate pension commitments.
To close the current retirement savings gap and to prevent the gap from becoming a $400 trillion behemoth, the authors recommend that the steps need to be taken as follows:
1.) provision of a safety net pension for all to prevent those who do not have access to pension from dropping below the poverty line.
2.) improve ease of access to well-managed and cost-effective retirement plans; this is particularly a problem in economies like India’s which has a high percentage of informal workers who have no access to any type of workplace pension system. Governments could potentially make it compulsory that all employers automatically enroll all employees into retirement savings accounts.
3.) support initiatives to increase contribution rates through the use of phased-in automatic payroll deductions.
Unfortunately, in this time of extremely high levels of government indebtedness, it is highly unlikely that governments will be able to provide an enhanced publicly-funded pension system, in fact, the American Social Security system is facing insolvency in the next decade and a half. As well, companies are facing significant underfunding levels of their pension plans, making it unlikely that they will take steps to enhance their retirement plans, in fact, many companies are moving from a defined benefit to a defined contribution pension system which puts all of the onus for funding one’s post-retirement income on employees, many of whom have limited investing experience. With the looming demographic nightmare of a high number of retirees and a dropping number of workers contributing to the pension system, I would suspect that the retirement savings gap is destined to continue to grow, leading to a “cat food future” for many retirees.
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