How Will You Pay For Your Retirement? Defusing The Pension Savings Time Bomb
We are not saving enough for our retirement. Around the world, the retirement (or pension) savings gap – the difference between the amount of money people will need in retirement and the amount of money that is being saved – is at an all-time high. And it’s getting worse as we get older.
The global retirement funding problem is getting bigger because of the current environment of low interest rates and investment returns; sluggish economic and wage growth; inadequate private savings; and changes to in-work benefits, such as the decline of defined benefit pension schemes.
This has enormous implications for everyone. While most people might look forward to living longer, we should also expect to work longer. People joining the workforce today can now expect to be working into their seventies.
We will also need to save more to make sure we have enough for our retirement. An aging population puts more pressure on health care, but also on the burden of pension funds – with more people accessing their pensions for longer.
Unless we address the shortfall in funds, the world is sitting on a retirement savings time bomb.
1. The Demographic Challenge
On average, life expectancy has been rising by one year every five years. The global population over the age of 65 is estimated to grow from 600 million today to 2.1 billion in 2050.
The combination of rising life expectancy and declining fertility rates is resulting in increasingly dependent societies – whereby more and more retirees depend on the contributions of fewer and fewer younger workers. The ratio of working age people to those in retirement is predicted to plummet from 8 workers per retiree today to 4 per retiree in 2050.
An aging population presents significant challenges. Expenditure will rise due to the growing costs of providing pensions, health and social care, while tax revenue is likely to fall due to the smaller workforce.
2. The Widening Savings Gap
The world is not saving enough in preparation for this demographic shift. Most countries around the world face a retirement and pensions savings gap, with workers not currently saving enough of their salary to enjoy an adequate income in retirement.
The combined savings gap of the world’s six largest pension saving systems – the U.S., U.K., Japan, Netherlands, Canada and Australia – is expected to reach $224 trillion by 2050, a sum five times the size of the current global economy.
3. Regional Challenges
Each country faces its own set of challenges based on its demographics and the structure of its pension system. Countries such as the U.S. and the U.K. rely more heavily on workers contributing to private pensions, while France and Germany have larger public schemes.
For those countries with a focus on private pensions, governments and businesses need to encourage people to save more. In the U.K., U.S. and Canada, savers will need to put away between 11 percent and 18 percent of their earnings every year in order to afford a comfortable retirement.
For countries with a more generous state provision, there are serious questions over the affordability of their systems in the long-run, as a larger proportion of the population enters retirement. While countries such as Greece are battling pension cuts, others such as Portugal and Canada, are increasing funding. Recently, Canada’s largest public pension plan, The Canada Pension Plan Investment Board (CPPIB) announced an almost two percent investment return. The Dutch are banking on a similar approach, looking to fund deficits with increased investment returns.
4. Funding the Gap
Lack of retirement readiness, complex financial markets and increasing life expectancy are compounding the issue for employers. What steps can be taken to improve the situation and help organizations reduce the risk while helping their employees make better decisions? Paul Rangecroft, North America Retirement Leader, and Michael Clare, Head of Aon’s UK Retirement & Investment Business, suggest the following:
- Greater employee accountability – more of the responsibility for funding retirement benefits has been transferred from employer to employee. Employers need advice on how to help employees navigate their financial security and create participant-friendly retirement plans
- Need for deeper expertise – “As internal demands on time increase — and resources are stretched at plan sponsors — and, while many mature pension plans become more focused on de-risking rather than chasing absolute returns, we are seeing that some organizations lack the internal resources needed to develop and execute sophisticated investment and liability strategies that would optimize the results for the plan. This expertise and focus is needed to effectively balance short-term goals with long-term direction,” says Rangecroft.
- Managing employer risk – the cost of pension liabilities continues to increase and employers also have more fiduciary responsibility for defined contribution plans. Clare explains, “employers need new strategies for managing these growing risks, while also looking out for the best interests of their plan participants.”
Closing The Gap
As people around the world live longer, the pressure on saving enough for retirement grows. While people accept that they might have to work longer than expected, they should also start saving more now to fund a comfortable retirement. This requires better education, both from governments and employers – along with policies and initiatives that encourage people to take action.
On the employer side, from encouraging employee accountability to better managing the risk, new strategies will be required. The more aware workers become of the risks they face by not saving – and having the appropriate support and knowledge to do so – the better prepared they will be to defuse the savings time bomb before it goes off.
“The anticipated increase in longevity and resulting aging populations is the financial equivalent of climate change. We must address it now or accept that its adverse consequences will haunt future generations, putting an impossible strain on our children and grandchildren.” – Michael Drexler, Head of Financial and Infrastructure Systems, World Economic Forum
- Global Pension Timebomb: Funding Gap Set to Dwarf World GDP – World Economic Forum, May 26, 2017
- The Global Savings Gap – International Longevity Centre, July 19, 2017
- A World Without Retirement – The Guardian, March 29, 2017