The first in a series of four articles, this first article looks at why we need to review our approach to managing our wealth in retirement? There are important reasons which are specific to the times we live in. The World we have created has built up expectations of retirement that in many cases will simply not be realistic. Financial structures designed and built in the low inflation 1960s are not able to fulfil their original functions, in part due to an ageing population.
Great commercial opportunities from the introduction of some incredible new technologies are approaching. Whilst holding great potential for these new companies, they are disruptive technologies that will cause the collapse of some more "traditional" business models.
So what do we have to do to secure our financial futures and that of our family members? Some of the older methods of planning and modelling need updating. We need to think about the future more than we look back. We will be wise to plan and control our own destiny rather than relying on others, we need to care enough to take the time to identify our needs, measure the risks, devise a strategy and monitor the results. Regularly!! Yet this process is full of unknowns. We may need help to execute this successfully.
Our research and experience has been brought together to start that process of assisting you with Wealth Management for retirement. In this paper we consider the World we live in and the current pension structures. In following articles to be published shortly we will consider the differences in investment conditions for the next 30 years by comparison to the last 30 years and a framework for your financial future.
The World we live in
There are four factors which are changing and will continue to change during our retirement period. Some of these changes are of such scale that we cannot ignore them. Others are consequence of a changing world that need to be managed so that the first set of changes do not overwhelm us.
Age of the World Population
By 2018, for the first time
ever, the global number of adults aged 65 and over will
outnumber children under the age of five.i
In the developed World, by 2020, for the first time ever, the number of adults aged 65
and over will outnumber people under the age of 20.
The effect of these statistics is already having a significant impact on pensions and healthcare systems. However, much of the problem with the pensions and healthcare system is not discussed in polite society, at least not in the depth that it needs to be. Having some insight into what is happening gives you the power to plan accordingly. Here I examine those points that need discussing in relation to the financial management of your retirement.
The promises that have been made cannot reasonably be expected to be met as a result of the ageing population.
$78 Trillion !!! A recent analysis by a team at Citibankii found that in the top 20 OECD countries the total liability for underfunded or unfunded pension promises is $78 Trillion. The fact is, that with ageing populations, it is not likely that all the promises that have been made will be kept.
Changes in People age 65+ as a % of the population
In this paper we explore the current pension position of Government, Company and Personal Pensions and look at what this means for individuals, what to expect as a consequence, and critically, how to plan for the epoch we will call YELL (Youngsters Exceeded by Long Livers). For example, we note that all the proposed solutions for Government and Company pensions are good for Governments and companies, but not for the individual who is expecting the pension. In the age of YELL, it is the youngsters who will likely have to take the biggest cuts. Yell they may well do!
It is clear from the figures above that the current pensions are unlikely to be met. Remedial action is necessary and in some countries action is already being taken. The retirement age has been increased to age 67 in countries including Australia, UK, Netherlands and Germany. The Netherlands and UK have already passed legislation to link pension commencement age to life expectancy. Most pension systems in the developed world were designed to fund for a pension for 12 years. The proposal is now to take the average life expectancy and deduct 12 years from this figure to arrive at the age where people can start taking their government pension. This will give a state pension age of 73 in most developed countries. Indeed, in the UK and Netherlands a gradual change will happen to introduce these changes.iii
Future rises: A potential timetable for future pension ages rises by UK insurer Standard Life
The current system of planning for retirement
Whilst the section above covers Government pensions they cannot be said to be "planned" for. They are what they are and we have no choice about paying tax (social security) to pay for them. This next section reviews non-government pension planning. It is clear that we will have to become much more self-sufficient in planning for our retirement. The reason is simply that we will live longer, perhaps as long as 30 years in retirement and this is causing great strain upon our own resources.
Company pensions consist of two types, defined contribution and defined benefit (final salary). A defined contribution pension is similar to a personal pension but with the employer possibly contributing to the pension and often with additional death benefits. Companies setting up a pension from scratch will use this style of pension as the company's liability is only to pay a set amount to the pension. The liability is known at the outset.
Defined Benefit Pensions require a sponsoring employer to meet a future pension amount for an employee, often expressed as a proportion of the employee's final salary. These schemes transfer the liability to the employer to ensure there is sufficient in the fund to meet all these future employee pensions. Lower than expected investment returns, longer life expectancy and regulatory requirements all affect how much a company has to contribute. With a defined benefit scheme if there is insufficient money in the fund to meet these pension liabilities, the scheme is said to be in deficit. Deficits are a huge problem around the world for this type of pension due to the factors mentioned above. As an example, in the UK the figures are as follows:
- The aggregate deficit of the 5,945 schemes in the PPF 7800 Index is estimated to have increased over the month to £322.8 billion at the end of February 2016, from a deficit of £304.9 billion at the end of January 2016.
- The funding ratio worsened from 80.5 per cent to 79.8 per cent.Total assets were £1,272.7 billion and total liabilities were £1,595.5 billion.
- There were 4,956 schemes in deficit and 989 schemes in surplus.
To give a balanced view of this information, this deficit of £322.8 billion would likely be reduced if interest rates were to increase. Recovery plans suggested by the Citibank analysts for defined benefit schemes include:
- Selling the pension scheme and liabilities to an insurance company.
- The sponsoring company issue debt (Corporate Bonds) with the money raised being added to the pension fund.
- Allowing employers to have much longer periods to try to "rescue" the pension through additional payments to the scheme perhaps allowing up to 30 years for the rescue.
- Allowing pensions and other benefits paid to members of the scheme to be reduced.
Personal pensions are exactly that; personal. They are not dependent upon an employer and stay with you for life. You contribute to the pension and the monies are invested. The level of pension that you get each month in retirement is entirely dependent upon the amount of money in the pension pot. Whilst personal pensions seem the ideal solution from a government and employer perspective there is a cost to Government. In many countries, tax relief is given against contributions to personal pensions to encourage people to save for their retirement. The scale of that tax relief, in the light of the matters discussed above for Government pensions, is being reduced as a cost cutting measure. In the UK, for example, there is a lifetime allowance (LTA), a maximum amount that you can have in your pension without incurring additional, penal taxation. The LTA started at £1.8 Million as the amount you could accrue in a pension in your lifetime. From 2016, this has been reduced to £1 Million, a 44% reduction. Similarly, in Spain the annual amount that can be contributed to a pension has fallen by 30% to just 8,000€ a year.
In the next article, we consider what is happening in the equity market causing possiible structural change as most pensions have a large equity element.
i. Prudential Global Investment Management
ii. Citibank, The Coming Pensions Crisis March 2016
iii. Department of Worls and Pensions UK, Review of State Pension Age, March 2016
iv. Pension Protection Fund UK, PPF 7,800 Index, March 2016 Update
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.