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:
- 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.
- 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.
- 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.
- 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.
- 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.
