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Data & Research May 26, 2017
Retirement Savings Shortfalls to Soar If Policies Do Not Change
Longevity, lower investment returns, and inadequate savings are contributing to a growing shortfall in what individuals will need for a longer retirement, a report says.
Reported by Rebecca Moore
Since the middle of the last century, life expectancy has been increasing rapidly, a report from the World Economic Forum notes. On average, it has been increasing by one year, every five years. Babies born today in 2017 can expect to live to older than 100.
To understand the scale of the retirement challenge from increasing life expectancy, the group estimated the size of the shortfall in retirement saving—the retirement savings gap. It also projected these calculations to 2050 to determine how quickly the gap will grow if measures are not taken to increase saving levels.
The calculations assume that for most individuals, their retirement needs will be met by a combination of income from three sources: Government-provided first pillar pension, employer (public or private sector) retirement plans, and individual savings.
The retirement savings gap for 2015 was estimated to be approximately $70 trillion, with the largest shortfall being in the United States ($28 trillion). Looking at the U.S. specifically, the gap is growing at a rate of $3 trillion each year, and will reach $137 trillion by 2050. This increase is the equivalent of five times the annual U.S. defense budget, according to the report.
One obvious implication of living longer is that individuals are going to have to work for a longer time, the report suggests. “The expectation that retirement will start early- to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy,” researchers write.
The report also notes that absent any change to retirement ages, or expected birth rates, the global dependency ratio (the ratio of those in the workforce to those in retirement) will plummet from 8:1 today to 4:1 by 2050.
Another thing affecting the shortfall is that over the past 10 years, long-term investment returns have been significantly lower than historic averages. Equities have performed 3% to 5% below historic averages and bond returns have typically been 1% to 3% lower. This puts an increased strain on pension funds as well as on long-term investors that have commitments to fund and meet the benefits promised to current and future retirees. Individuals have also been impacted and have seen smaller growth in their retirement balances than in the past.
Further, to support a reasonable level of income in retirement, 10% to 15% of an average annual salary needs to be saved. Today, individual savings rates in most countries are far lower. The report contends this will continue to be a challenge unless the importance of higher savings rates is better understood and communicated.
NEXT: Policy implications“To protect against poverty in old age, we believe that retirement systems should be designed to provide a level playing field and equal opportunity for all individuals,” researchers write. “A well-designed system needs to be affordable for today’s workers and sustainable for future generations to ensure that all financial promises are met.”
The report notes that healthy retirement systems contribute positively towards creating a stable and prosperous economy. Ensuring that the public has confidence in the system, and that promised benefits will be met, allows individuals to continue to consume and spend through their working and retired years. “If this hard-earned confidence is lost, there is a significant risk that retirees will moderate their spending habits and consumption patterns. Such moderation would have a negative impact on the overall economy, particularly in countries where the size of the retired population continues to grow,” the report says.
The popularity of defined contribution (DC) retirement plans has been growing steadily over the past few decades and they now account for more than 50% of global retirement assets, the report notes. The way these plans are designed puts a high level of responsibility on individuals to manage their retirement savings. This includes deciding how much to save each year, which investments to choose, how long they are likely to live, when they should retire, and how to withdraw their savings when they do decide to retire full-time. The group contends that the information reported to individuals often does not make it easy to make informed decisions to try to meet a target level of retirement income. For example, the account balance does not help individuals understand what they would likely receive as a monthly income, and the investment return achieved does not help determine whether to increase savings rates, stay employed longer and delay retirement or take more investment risk.
To close the retirement savings gap, there are three key areas the group says governments and retirement policymakers should focus on which will have the biggest impact on the overall level of financial security:
- Provide a “safety net” pension for all;
- Improve ease of access to well-managed, cost-effective retirement plans; and
- Support initiatives to increase contribution rates.