The Issues Facing Pension Systems

As populations get older there is a common economic problem facing developed and emerging economies. The rise in life expectancy and the inflating of the median working age is leading to a strain on pre-existing pension systems, and creating a future that leaves younger generations in strife, as the dependency ratio reduces to new lows. These issues are already visible in Japan which has seen a major increase in the amount of retired workers, and a large change in their dependency ratio.

Currently, most countries have a retirement age of around 60-65, meaning that some individuals will spend more time retired than working. In Australia there is no government set retirement age, however, there is a ‘preservation age’ which is the age you are able to start taking money from your superannuation, and a ‘pension age’ which is when you are able to receive a government pension. For individuals born in the last few decades, their preservation age is 60, and their pension age is 67. [1]

For governments to begin making a positive change they must pass reform to increase the retirement age, and to create other incentives for remaining in the workforce, such as increasing the age you can access a pension and other benefits. Such as Australia has done over the past few years, increasing the pension age from 65 to 67, and the preservation age from 55 to 60.

However, that is only the start of the problem. Currently, the main drivers in this issue are increases in life expectancy and falling birth rates, both lead to a smaller workforce supporting a growing population of retirees. There are a few other additional factors that are exemplifying this issue further.

One of those factors is a lack of easy access to pensions, which has made it hard for individuals to save for their retirement, it also makes it difficult for individuals who are self-employed, or working in the informal sector to begin saving.

Another is a long-term low economic growth environment, which has led to significantly low than average portfolio returns for pension funds. Low interest rates have also lead to an increase in future liabilities, increasing the strain on long-term investors and pension funds.

A third factor is globally low levels of financial literacy, which has made it harder for individuals to properly manage their own pension as they are unable to make well-informed decisions for their own savings. This is especially the case for countries like China and India, who are respectively placed 97th and 116th in the world for financial literacy rates. Whereas countries like Canada, Australia and the US are placed 4th, 9th, and 14th. [2]

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There are also inadequate savings rates, meaning individuals are extremely unlikely to have the amount saved that they require, putting the burden of their pension growth into the performance of their investments, which as mentioned earlier, is difficult due to low levels of financial literacy, and low economic growth. Currently, some countries do not have minimum contribution rates to pension schemes, those that do like the UK, and US have rates at a minimum of 4-9 percent in the US and 8% recently in the UK due to the UK Personal Accounts scheme, however previous to that the rate was only 3%. These tied in with low participation rates, at 50% in the US and 40% in the UK, only exaggerate the issue. Whereas Australia has a minimum employer contribution rate of 9% and a participation rate of 90-95 percent. [3]   

Finally, there is a high degree of individual responsibility to manage one’s pension, increasing portfolio risk, and reducing the certainty that one will be in a sound position during retirement.

All these factors put together are exemplifying the current deficit in the retirement savings gap. This gap was estimated to be ~$70 trillion, in 2015, with the US making up 40% of that gap. However, according to projections made by the World Economic Forum, this gap will increase at a rate of 5% or $3 trillion every year with current policy measures in place. This increase can be better summarised as costing $28 billion every day. By 2050 the aggregate retirement savings gap will be ~$400 trillion. Serious measures need to be put into place to ensure that the gap can be reduced, or even to slow down its rate of growth.

Before governments can begin passing legislation to tackle this issue, they first need to consider a set of principles into their decision-making. One of the principles that governments need to incorporate into their future policy decisions it to adapt to the changes in the workforce. This means catering to individuals who continue to work after the age of 65, which has increased over 100% over a period of 30 years. Jobs are also more mobile, individuals no longer remain at one company for large periods of their working life, this means that governments need to create pension systems that don’t rely on companies, opting for a more centralised system of pension savings management. This system should also allow for more increased flexibility of savings, incentivising individuals to save more when they have access to additional income. It may even be worth considering a system where small portions of every purchase made by an individual are placed into a savings account.

Another principle should be to reduce the risk and responsibility of individuals, opting for a collective defined contribution systems, like those presently in place in Canada and the Netherlands. These systems work by pooling individuals savings into a trust, rather than investing on an individual basis. Theses trusts are then managed by trustees of the fund, reducing the risk from making complex investment decisions without having the knowledge required to make them. This system is still relatively new, and data is limited on its performance, though current speculation from economists and investors is that this system will have an increased rate of return over other standard funds.

A final principle that should be considered is the need to be conscious of the other financial needs on an individual. According to a Mercer study of US workers, the most pressing concern for individuals of all ages was immediate financial concerns, with retirement income only becoming a high priority after the age of 50. This means that governments need to find ways to incentivise individuals to save now, finding a way to show individuals that their current level of saving is inadequate for their current retirement needs.

To conclude there should be a few changes that every government needs to consider. or enact to being making change. Firstly they need to review the national retirement age, they need to make saving easier, they need to increase the financial literacy of their citizens by introducing programs into schools and targeting vulnerable individuals, they also need to aggregate and standardise pension date for citizens to have a more complete picture of their current financial position. Hopefully with these measures enacted we’ll be able to create a more positive environment for future retirees, and for the younger generations who are beginning to enter the workforce.

 

 

References:

[1] SuperGuide, ‘What is the retirement age in Australia?’, SuperGuide [website] 2016, https://www.superguide.com.au/how-super-works/retirement-age-australia accessed 27 June 2017

[2] Standard and Poor’s Rating Services Global FinLit Survey, The Financial Literacy around the World Report

[3] Ashcroft, J. (2009), “Defined-Contribution (DC) Arrangements in Anglo-Saxon Countries”, OECD Working Papers on Insurance and Private Pensions, No. 35, OECD publishing, © OECD. doi:10.1787/224843410213

All other data and information is from:

Wheeler, Rachel. “We’ll Live to 100 – How Can We Afford It?” World Economics Forum (2017): n. pag. Print.

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