Friday, October 20, 2017

Old Age and Retirement

The World Economic Forum produced a white paper entitled “We’ll Live to 100-How Can We Afford It?” (Lead Author, Rachel Wheeler, Project Lead, May 2017) The basic premise of this white paper was the status of world-wide retirement plans and potential problems and reforms necessary to address those problems. The disclaimer in the white paper is that “…views in this White Paper … do not necessarily represent the views of the World Economic Forum or its Members…” In addition, these papers “… describe research in progress by the author(s) and are published to elicit comments and further debate.” The report is “… part of the Forum’s Retirement Investment Systems Reform project that has brought together pension experts to assess opportunities for reforms that can be adopted to improve the likelihood of our retirement systems adequately and sustainably supporting future generations.” The paper, in its entirety, can be accessed at  http://www3.weforum.org/docs/WEF_White_Paper_We_Will_Live_to_100.pdf  Our discussion in this posting is done without comment or endorsement of the contents of the white paper. However, in light of the positions taken by some candidates in the 2016 US Presidential election, it behooves us to look at some propositions being espoused in the academic community and conditions that exist in the international community.

Old Age

Life expectancy is increasing. For individuals born in 1947, the median life expectancy is 85 years; for those born in 2007, it is age 103. The increased life expectancy leads to a longer working career. If retirement age remains unchanged and current birth rates continue, the global dependency ratio (the ratio of the workforce to retirees) will decrease from 8:1 today to 4:1 by 2050. The position taken in the Forum’s white paper “…focuses on the sustainability and affordability of our current retirement systems.” Retirement “…system needs to be affordable for today’s workers and sustainable for future generations…"

Challenges to Retirement Systems
 
The primary causes of retirement systems problems, according to white paper authors, are increasing life expectancy and a declining birth rate. The authors identify five additional factors affecting global retirement systems:
  1. Lack of access to pensions- Many workers (especially the self-employed) don’t have access to pension plans or savings products. Over 50% of global workers work in the informal or unorganized sectors of the economy. Forty-eight percent (48%) of retirement age people don’t receive a pension.
  2. Low investment returns- Long term investment returns over the last 10 years have been significantly lower than historical averages. Equities have returned 3-5% below averages; bonds, 1-3% below. These lower returns have exacerbated pension plan shortfalls and reduced individual retirement savings balances.
  3. Personal responsibility for pension plan management- Defined benefit plans have been decreasing in number while the number of defined contribution plans has been increasing. Defined contribution plans now account for over 50% of global retirement assets. The investment risk has thus been shifted from the employer to the employee.
  4. Low levels of financial literacy- While investment risk has been shifted to the individual, the ability of those individuals to make sound investment decisions appears to be lacking. Most people are not able to correctly answer questions on basic financial concepts.
  5. Inadequate savings- Individual savings in all countries are well below the 10-15% level necessary to fund a reasonable retirement income.
The Retirement Savings Gap
 
Historically, retirement income has come from three sources: 1) governmental sources (Social Security, etc.), 2) employer pension plans, and 3) individual savings. According to the authors of the white paper, the world-wide retirement savings gap in 2015 is estimated to be approximately $70 trillion with the largest shortfall being in the US. Of that gap, 75% is in the government and public pension obligation, 1% in unfunded corporate pension plans, and 24% in lack of personal savings. This gap is predicated on a 70% income replacement in retirement.
 
The Findings
 
The authors of the white paper espoused three key areas to address overall financial security:
  • Provide a “safety net” pension for all persons
  • Improve access to effective, efficient retirement plans
  • Increase personal savings initiatives
The authors of the paper state:
 
“Poverty protection for the elderly should be the minimum requirement for any government pension system. It should be the responsibility of the government to provide a pension income for all citizens that acts at a “safety net” and prevents those who miss out on other forms of pension provision from dropping below the poverty line.”
 
“In countries where there are challenges to establish employer-based or individual pension schemes, introducing universal pension benefits may be the only way to significantly reduce poverty among the elderly.”
 
“Technology can make saving automatic by deducting contributions directly from employees’ pay before it reaches their personal accounts.” “Governments can make it compulsory for all employers to automatically enroll new employees into a retirement savings account and to contribute on their behalf.” (italics added)
 
Principles for Change
 
Authors of the white paper identified four principles that they felt should be addressed in retirement plan provisions.
 
Principle 1: The work force is changing. Occupations that are most sought after today didn’t exist 10 years ago. In addition, about 65% of today’s primary school children will work in jobs that don’t yet exist. The number of workers over age 65 is increasing; it has more than doubled since 1995. The number of employers for whom a person works over his/her career is increasing. That requires “re-tooling” work skills and portability of job benefits.
 
Principle 2: There is a gender imbalance. Retirement balances for women are 30-40% below those for men. Longer periods out of the workforce and lower salaries in general contribute to the lower retirement account balances. In addition, the longer life expectancy of women means those reduced assets need to cover a longer period of time. Unisex life expectancy tables and valuing work performed outside the workplace for retirement benefits could help alleviate this disparity.
 
Principle 3: Shared risks could reduce individual burdens. Collective defined contribution systems (as employed in some countries, such as Canada) could help with the burden on individuals for their retirement savings, account management, life expectancy, etc. Pooled money and risks could be based on “target” benefits. An example of such a plan, as presented by the authors, is shown below.


Defined Benefit Plan

Collective Defined Contribution Plan

Defined Contribution Plan
Pooled assets across all accounts
Pooled assets or notional accounts
Individual accounts
Predominantly employer contributions
Combination employer and individual contributions
Combination employer and individual contributions
Trustees determine investment policy and investments
Trustees determine investment policy and investments
Individual makes investment decisions
Trustees takes investment risk
Investment risk pooled
Individual takes investment risk
Trustees takes longevity risk
Longevity risk pooled
No longevity protection
Guaranteed pension
Target pension, not guaranteed
No target or guaranteed pension

Principle 4: All financial needs should be considered. People who save early for retirement will have much larger retirement savings than those who start later. However, retirement savings may not be a priority for younger employees. Therefore, the authors contend, the full financial picture (assets and debts) should be considered for financial need.

The Bottom Line

When one reads the World Economic Forum white paper and analyzes its recommendations, it is obvious that items presented are significantly different than what we have in the US today. However, as we examine our current public benefit systems (Social Security), it is also obvious that some changes must be made. Prudent financial planning means looking at alternatives and trying to plan for what “might happen.” Visit us at Paragon Financial Advisors to review your individual circumstances. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

 

           
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