Monday, 5 June 2017

The State Pension - Is It Sustainable?

I recently read a report (pdf)by the World Economic Forum which was looking at the implications for sustainable pensions resulting from increased longevity.

Since the 1950s life expectancy has been increasing at a rapid pace as a result of improved living conditions and advances in healthcare provisions. Half of all children born in 2017 are expected to live to 103 - that's 2120!  

This has massive implications for many aspects of our society, not least on welfare and retirement pensions. It is calculated that whereas today there are 8 workers supporting each pensioner, by 2050 there will be just 4 workers for every pensioner.

The chart below illustrates the retirement ages for the six countries with the largest pension systems.

Retirement age for most of these countries is 65 (with Japan the exception, at age 60).

The bottom bar represents the number of years of payments expected using life expectancy in 1960. This ranged from five to eight years of payments on average.


Looking at life expectancy in 2015, we can see that pensioners are now living eight to 11 years longer – and in the case of Japan, a whopping 16 years longer.



Retirement Savings Gap

The WEF have used OECD figures of 70% of pre-retirement income as a rough guide to assess the gap between current pension/savings provision. They have calculated the shortfall in savings to 2050 to see how much the gap will widen if measures are not taken to address the problems. The calculations assume that retirement income will come from a combination of state pension, private/works pension and individual savings.

In the UK the current savings gap is calculated at £6 trillion and is expected to grow at an average of 4% per year to reach £25 trillion by 2050. In the US, the savings shortfall is expected to grow by $3 tr each year, equivalent to 5x their annual defence budget. 

The largest growth will come from China and India who have the largest populations - there will be 600 million retirees in these two countries by 2050!


Closing the Gap

The WEF have made a number of suggestions to help secure greater financial security.

1 Make it easier for people to access well managed cost effective pension plans.

2 Support initiatives to increase levels of retirement savings rates.

3 Explore the concept of linking savings to spending - for example, a percentage of an individuals every purchase is electronically linked to that individuals savings account.

4 Look at collective DC pension schemes which pool retirement savings to reduce fees and spread risk (currently used in Canada and Holland).

5 Educate individuals regarding savings and probability of achieving a satisfactory retirement income based on current level of savings. People who start saving at the start of their career end up with double the savings compared to those who delay by 10 years.


Conclusion

The message is clear - we are all living longer than ever before and our state pension system will need to change as otherwise they will become unaffordable for tomorrows taxpayers.

As a result, younger people entering the workplace today will need to take more responsibility for their retirement income. The WEF believes workers need to save between 10pc and 15pc of their annual salary to support a reasonable level of income in retirement.
In recent years the government has grasped the nettle and the state pension age will increase to 66 from 2020 and will be reviewed every 5 years. It could well rise to age 70+ by 2050.

Currently, half of all workers have made no private pension provisions. The introduction of auto enrolment will start to improve things but the current rate will be just 8% including employers contribution. Its a start but needs to go further.

When I started out in the world of work in the early 1970s, I was fairly confident the state pension would provide a significant proportion of my retirement income at age 65 yrs.  Some 45 years later and yes, I will start to receive my pension at 65 and I am told the starting amount will be £8,500 which is roughly the ballpark figure I always expected.

If I were starting out today, I am sure I would not be so optimistic. As I suggested in a recent article on national debt levels - young people need to give some serious thought to retirement savings.

Leave a comment below if you have any thoughts on the state pension.

14 comments:

  1. linking saving to spending would involve a huge monitoring infrastructure which Big Brother and the advertisers would love. Get a receipt for those left wing books as it will boost tour pension...

    Life expectancy growth has slowed over the last 5 years, and for some groups, American middle-aged whites, has actually reversed, as poor diet and lack of exercise kick in.

    People don't save as a combination of not having the spare cash, not valuing their future selves as much as their current ones, and belief in a welfare state safety net. Not sure which of these beliefs we can change!

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    1. Yes, I have seen some recent reports which show it has slowed in recent times but life expectancy in the UK is still growing and each extra year will add considerable burdens to future taxpayers.

      As for increasing savings, there are many complex reasons why people do/don't save but if more people became more aware of the situation they have the opportunity to do something (or not) and take more responsibility (or not) for their well being down the line.

      I understand the 'big brother' aspect but think there may be some merit in trialing a 'save as you spend' method - many purchases are now done by card and I am sure someone could come up with a way to divert an agreed percentage of the cardholders payment to their online 'future fund'.

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    2. Would you be happy for all your prices to rise by 5% for such a scheme if you felt confident you had a plan in place for your retirement? Would the high processing cost of recording all those micro-transactions sit well? It would generate a quick return to cash handling that stores wouldn't like and encourage under-the-counter transactions, as unlike VAT, people could opt to avoid it when colluding with shops. I can see problems with distributing the take if one half of a couple bought a car, etc, the problems just multiply.

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    3. As I suggested vicarage, there would need to be a trial to assess how feasible such a scheme would be and see what practical issues arose but worth a try imho.

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  2. "for some groups, American middle-aged whites, has actually reversed, as poor diet and lack of exercise kick in": that it's reversed is presumably a matter of fact. Why it has reversed is presumably mere speculation, inevitably made with a puritan slant.

    Personally I'd throw his report from the WEF straight into the bin.

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  3. Interesting thoughts and comments!

    I can only speak from my own experience. I was 35 when I woke up to the need to provide for myself, when I moved from a very large company to a much smaller one without a DB pension scheme. I immediately started to review my approach to how I was going to retire at an age that I wanted to. I set myself a target to have enough money to retire at age 55, but must confess that there was not a grand plan to achieve it; probably as the tools in 1993 where not there to help achieve Financial Independence. Through refining the plan, good luck, an inheritance and refining the original plan, I managed to achieve the goal at age 55.

    What's my point - the current generation need to understand what they need to do to achieve what they want. The Old Age Pension (OAP) was never part of my calculations but was always a bonus, I am just coming up 60 and won't receive it until I am 66, but I have more than enough money to live comfortably now and the OAP is a bonus not an requirement, but I will be annoyed if I don't get that bonus as I have paid into it for 39 years.

    The point at the end of it is we all need to take control of our lives; set some goals, make some choices and sacrifices to achieve them; stop paying for the Costa coffee on the way in to work, take your own packed lunch in etc. This from a smoker and someone who enjoys a bottle or 2 of wines, but i made my choices and lived with them and achieved what i wanted to.

    The ratio of pensioners to workers will be irrelevant if the state does not choose to look after them as it increasingly seems to do, but will be forced to review; they will be left to survive in penury, albeit with those who have not made any provision draining more then they put in, but those who have finding they can not pass on what they have accumulated as it will be depleted by providing for their later years unless they have found ways to protect it which is increasingly hard to do so.

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    1. Gareth,

      Thanks for taking the time to share your experience. You make some good points and I totally agree that younger people need to get a grasp of what is needed to achieve the outcome they require.

      One of the biggest problems is the availability of credit. As you say, the ubiquitous Costa on the go, I see local cafes full of students every morning ordering their 'full English', in the pubs every evening followed by a takeaway - all presumably on their student loans. I guess if everyone else is doing it....

      Most young people want it all and they want it today, and so long as easy credit is flowing I guess they can do it but I fear there will be a price to pay at some point down the line.

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    2. Hi DIY

      I'm not sure that the availability of credit is "One of the biggest problems"; i have had a Barclaycard since 1979, which meant that I had credit available to me more years ago than I care to remember. also when I wanted a car loan in 1983, my bank threw credit at me with a certain product that meant that I did not have to pay it off within a certain timeframe. Along came a child and suddenly we had to draw in the reins; such is life. We took stock and adjusted what we were doing an within a few years we were out of the jungle and never looked backwards - stayed within our means. "Most people want it all and they want it today", nothing has really changed, but maybe the discipline and it is easier to get out of jail these days

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  4. Hi DIY,

    You are spot on with the concern over the state pension - I have always assumed that by the time I get to the state retirement age I will not be entitled to anything as its likely to be means tested so I am planning on no support.
    I do feel that so few people realise that it would be relatively easy if they start young and just chuck some money aside regularly.
    Sadly most people struggle to think more than a few months or a year in advance, never mind 30+!
    Cheers
    FiL

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    1. Interesting stat ... in 1917 King George V sent out just 20 telegrams to those reaching the age of 100. Last year it was 6,000 and by 2050 it is estimated at 56,000!

      Yes I have heard a few people say they don't really expect to get a state pension as its likely to become means-tested. However, in his recent report, Cridland specifically addressed this and ruled it out as a possibility as the evidence suggested even for generations X and Y it would still represent a significant proportion of retirement income and the introduction of means testing would act as a disincentive to saving and also setting up a system would be expensive and not deliver sufficient saving to offset the costs.

      Having said that, its probably a good plan to work on the assumption that it will be a 'bonus' when you reach SPA!

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  5. I believe the pension age could rise beyond 75 years old by 2050 or the govt needs to cut down on pension contribution. That because the growth in the National Debt is unsustainable. 12 years ago, it was £0.5 trillion. Now, at the end of 2017 it will reach £1.73 trillion.
    So, what will the UK National Debt will look in 12 years time? Another tripling is possible because we are due for another recession soon.

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    1. Walter,

      I agree that an ever increasing national debt will have an impact on the government ability to maintain the state pension and will obviously impact on other spending areas such as NHS and welfare generally. Indeed this was the arguement outlined in an earlier article
      http://diyinvestoruk.blogspot.co.uk/2017/03/national-debt-and-state-pensions-start.html
      Debt is addictive but can be very damaging if not controlled. I remember the problems caused by the Callaghan Labour administration in the mid 1970s which ended in Healey going cap in hand for a bail out to the IMF who imposed strict conditions which led to severe cuts in welfare. This in turn led to the election of Margaret Thatcher in 1979 and thereafter a split in Labour and the formation of the SDP.

      Plus ca change!

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  6. I think the auto-enrolling scheme has ensured that many people have now started saving into pensions. However, they need to be made aware that just paying in a few % is not going to be anywhere near enough (even including the state pension) and that they need to have their own savings too.

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    1. I agree weenie, the workplace pensions will give a much needed boost to private sector workers but when fully rolled out next year the max will only be 8% of income going into the pension. That level may be just about OK for people starting early 20s and investing for the next 50 yrs but I think it would be better to introduce some smarter ways to operate such as adjusting the % based on a regular MOT review. In any event, as you suggest, it would be good to also have personal savings in addition but I guess a lot of people will carry on borrowing and spending blissfully unaware of what lies in store down the line.

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