This article originally appeared in the NZ Herald.
The opening paragraph of The Coming Pensions Crisis, a recently released 120-page study by Citigroup, has the following sombre message: “What’s your dream for retirement? Is it living on the beach, travelling on cruise ships throughout Europe, spending time with the kids and grandkids, finally getting the chance to perfect your golf game? For a lot of people, the retirement dream is to retire early enough so that they can enjoy the fruits of their long working career while they’re still healthy and to live out their sunset years relaxing and enjoying the good life. However, the reality for many is that there isn’t enough money in the piggy bank to last throughout their retired life.”
According to Citigroup, the total unfunded or underfunded government pension liabilities for 20 OECD countries, excluding New Zealand, is a staggering US$78 trillion ($115 trillion), almost twice the US$44 trillion national debt of these countries.
In addition, corporate pension plans are also underfunded, particularly in the United States and United Kingdom.
The Citigroup analysis is not about subsistence-level pension schemes; it is about individuals having sufficient savings to maintain their pre-retirement lifestyle after they finish working. This includes travel, assisting their children and grandchildren and funding all non-state provided medical requirements.
To achieve this, individuals will probably need annual post-retirement income of between 50 and 70 per cent of their final pay. This is a demanding target, particularly with term deposits offering little more than 3 per cent a year at present.
In simple terms, a married couple with annual combined pre-retirement earnings of $100,000 – or $1900 a week – will require post-retirement income of between $50,000 and $70,000 a year to maintain their pre-retirement lifestyle.
This works out at between $950 and $1330 pre-tax a week.
As the current National Superannuation rate for married couples is $671.48 a week before tax, they will need a further $280 to $660 a week to achieve this 50 per cent to 70 per cent target.
This is a huge challenge in the current low interest rate environment. With savings invested in term deposits paying 3.0 per cent a year, a married couple would need retirement savings of nearly $500,000 to obtain an additional $280 a week and savings in excess of $1,100,000 to achieve an additional $660 a week.
These rough figures are based on the assumption that retirees wish to maintain their capital.
But low interest rates are not the only challenges facing the retirement sector.
One of the most important developments in recent years has been the substantial increase in life expectancy, mainly thanks to medical advances and healthier lifestyles.
For example, the average life expectancy in the United Kingdom increased by around 10 years between 1950 and 2000, an average of two years for every decade. Average female life expectancy in Japan is expected to be over 90 years by 2050 and 97 years in 2100.
As a result, the world’s population is forecast to grow from 7.3 billion today to 9.5 billion in 2050, with the 65+ age group representing 15 per cent of the total population in 2050 compared with 8 per cent at present. According to Citigroup, the 65+ age group will represent 33 per cent of Japan’s total population in 2050, 26 per cent in Europe and 24 per cent in China.
However, these estimates are uncertain because a breakthrough cure for cancer would lead to a major increase in life expectancy – and the number of individuals in the 65+ age group – while a new deadly disease could have the opposite effect.
The differences between defined benefit and defined contribution pension schemes have become increasingly important in light of the huge increases in life expectancy and the 65+ age group.
Defined benefit schemes are those where retirees are guaranteed a fixed income every week. Defined contribution schemes are those where there is no guaranteed weekly income and where income is totally dependent on the contributions to, and investment performance of, portfolios.
New Zealand Superannuation can be classified as a defined benefit scheme, whereas KiwiSaver is a defined contribution scheme.
Defined benefit schemes, where companies agree to pay their retirees up to 70 per cent of their final pay, are a major problem because retirees have lived much longer than anticipated and insufficient funds were put aside by these companies.
Citigroup estimates that United States S&P 500 companies have pension fund deficits of US$403 billion on total obligations of $2,027 billion, while UK FTSE 350 companies have pension deficits of 84 billion on total obligations of 936 billion.
These pension fund liabilities have been a major problem for NZX-listed Coats, formerly known as Guinness Peat Group.
As a consequence, companies have been switching their pension offering from defined benefit schemes to defined contribution schemes or opting out of pension obligations altogether. This has been a clear development in New Zealand over the past few decades, although employers are obliged to make contributions to the KiwiSaver scheme.
Most major countries have substantial unfunded long-term pension liabilities, including New Zealand’s universal Superannuation. Although these pension commitments are not strictly the same as government debt, they are still long-term liabilities as far as governments are concerned.
According to Citigroup, New Zealand ranks eighth out of 28 OECD countries in terms of the estimated increase in government pension expenditure as a percentage of GDP over the next 25 years.
Although the New Zealand Superannuation Fund will contribute to the payment of our pensions, the vast majority of these NZ Superannuation payments will have to be funded from current government revenue. This will put huge pressure on future taxpayers, particularly as the ratio of retirees to workers increases.
This could also create enormous political tensions as the 65+ age group supports higher pension payments, funded through taxes, with a corresponding transfer of wealth from the younger to older generation.
Citigroup has made a number of recommendations regarding the pensions crisis, including:
Governments should publish the amount of their unfunded pension obligations. Citigroup believes that the pensions crisis will not be addressed until the estimated US$78 trillion of pension liabilities in 20 OECD countries is fully identified and disclosed.
The retirement age needs to be raised and linked to expected longevity. For example, the original US social security system assumed 12 years of retirement and if this guiding principle remained, then the US retirement age should be raised to 73, saving the government an estimated US$4 trillion.
Governments need to develop policies to encourage private sector pension savings, including tax incentives. This is consistent with our KiwiSaver scheme.
One of Citigroup’s main points is that it is not tenable for governments to guarantee incomes to individuals who could live for 25 years or more in retirement.
The report makes the following comments on this issue: “Existing and vested commitments to individuals over the age of 50 should not, and politically cannot, be cut. But the level of future pension promises for younger workers must be reduced. This can be done by restoring the function of social security to act as a “safety net” that provides a basic minimum level of pension income for those who need it, rather than the prime pension provider for an ageing population”.
The pension debate will continue, but it is highly unlikely that in the long run New Zealand can afford a NZ Superannuation scheme payable to all individuals 65 and over that is based on a minimum of 65 per cent of the average weekly age for a married couple and is not means tested.
Disclaimer: This article originally appeared in the NZ Herald and is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.