The time will come when we look back at “baby boomers” as the golden generation, possibly the last that could reasonably expect to have both a job for life and a guaranteed income – equal to two thirds of final salary – for retirement.
Of course, they aren’t the first generation to benefit from good pension provision. The Roman emperor Augustus kept his soldiers from rising up with the promise of a pension equivalent to 12 times their salary, after 20 years’ service. The modern pension is attributed to German chancellor Otto von Bismarck, who introduced it for those aged 70. But baby boomers are the first to enjoy something neither ancient Roman nor 19th-century German retirees could expect: longevity.
The life expectancy of a German in Bismarck’s time was – and not by coincidence – 70 years. In any case, both he and Augustus had a fairly reliable resource with which to pay for their promises – vast amounts of taxable youngsters entering into the workforce.
Today’s retirement vista couldn’t be more different. “Worldwide the combination of increased longevity and falling birth rates means the ratio of younger people to people aged 65 and over is falling quite rapidly,” says Brendan Kennedy of the Pensions Authority, which regulates occupational pension schemes and personal retirement savings accounts (PRSAs).
“The State pension is at the core of pension provision but in Ireland, and in every other country I can think of, demographic changes are putting pressure on that. Here the State pension has held its own in real terms, at around €12,000 or €13,000 a year, but most people will want more than that to live on in retirement.”
If that isn’t reason enough to start saving now for future retirement, there are plenty of others.
For a start, employers have long since reckoned that the traditional defined benefit pension, the one that promised to give you two thirds of your final salary in retirement, is unsustainable.
The result has been a mass migration to defined contribution schemes, where all you are guaranteed to get back is the investment returns accruing to the contributions made by you, and if you are lucky, your employer. It’s up to you to make it last. The problem is that poor bond yields and interest rates have hit those returns hard. “The low interest rate environment has being going on so long now that we can’t assume it is something that will simply resolve itself. It is an enormous challenge to the savings system,” says Kennedy. And not alone has the retirement age been pushed back – to 68 by 2028 – but the likelihood of the state pension scheme remaining in its current form is diminishing.
Unsustainable
A research report from Milliman, commissioned by the Society of Actuaries and PublicPolicy.ie last year, into the financial sustainability of the State pension in Ireland, found the system as it currently stands to be unsustainable but with no easy way of improving it.
Any proposals for change would involve hard policy choices, such as increasing even further the age at which it kicks in, to changing the current approach to indexation (which would see it eroded by inflation, should inflation return). A further option would be to increase PRSI contribution rates.
Means testing could even be mooted, though how that could be countenanced legally, given that individuals contribute to their State pension through PRSI payments over their lifetime, is hard to fathom. Then again, as the controversial pension levy – which raided occupational pension schemes to the tune of €2.4 billion during the financial crisis – showed, anything is possible.
“No government party wants to take on the elderly electorate, but they might be prepared to take on the wealthy elderly,” says one financial advisor. “All it would take would be for one left wing-leaning party to get in and introduce means testing, and the universal system would never be returned.”
The mass migration of company schemes from defined benefit to defined contribution schemes makes pensions, never an easy topic, even harder.
“The days when you didn’t have to worry about your pension, when you didn’t have to make any investment decisions because your trustees looked after all that, are gone,” says Shane McInerney, wealth advisor at Davy.
“Now you have all sorts of options in relation to what you can do with your fund, what age you want to retire at and how you draw down your pension. It has all changed massively and in a very short space of time.”
At the same time, “the complexity and inflexibility of pensions are putting people off starting to save at an earlier age. This means that people miss out on the significant benefits of compounded returns.”
He believes the introduction of a flexible mandatory or automatic enrolment scheme, one that allows individuals the right to access some of their savings for major life events such as a deposit for a house or sickness, is the best way forward.
“Auto enrolment in some guise appears to be close. The flexibility option would make a pension significantly more attractive to people, especially younger workers,” says McInerney.
Something needs to be done however, because it’s not just the government and pensions companies that are starting to fret, citizens are too.
Retirement objectives
“When we asked Irish people how confident they were about reaching their retirement objectives, 39 per cent of those surveyed said they were not confident they are on track to meet their retirement goals, compared with 15 per cent in the US and 28 per cent in the UK,” says Ann Prendergast, managing director at State Street Global Advisors Ireland. “Some 50 per cent of the people we surveyed said they expect to have to work either full- or part-time after retirement age.”
There is, she says, a realisation that pensions are not going to be as large as they need to be, a fact that Irish people’s traditional risk aversion when it comes to investments may be exacerbating.
“I think people do want to be helped, they know there is an issue here to be addressed,” says Prendergast, who says 80 per cent of Irish respondents think automatic enrolment in a pension scheme would be a good thing.
Another option could be for people with defined contribution schemes to push back drawing them down for 10 to 15 years, particularly if they remain working. “A lot of providers are thinking about it,” says Prendergast. “But when we posed it as a question in surveys, the response wasn’t overwhelming.”
Little wonder, given that even Roman soldiers were allowed a retirement.
Do the maths
Never underestimate the power of compounding. A 30 year-old on a salary of €37,500, wishing to retire on a pension of two thirds of final salary at age 65, is aiming for a retirement income figure of €24,750 per annum.
Taking the State pension of €12,132 into account, that leaves a shortfall of €12, 618 to be funded.
Our 30 year-old would therefore need to contribute 25.3 per cent of their salary to their pension to ensure they reach their target.
By contrast if that person puts off starting a pension – because they want to save for a house or pay for childcare – by the time they hit 45 they need to be contributing just over half (50.4 per cent) of the same salary to reach the same destination.
