Thursday, June 21, 2012

Working Harder for Longer? The Past, Present and Future of Retirement

We're living longer, so we're going to have to work for longer. That's the future of retirement, as the trend to lower retirement ages reverses over the coming decades. In contrast, the past up to the present - the period from 1970 to 2010 - was a story of declining retirement ages, as the graphic from The Economist shows.

The story notes that France under Fran├žois Hollande (seen as a major enemy of economic liberalism by The Economist) is an exception in reducing the retirement age from 62 to 60 as rich countries try to deal with the fact that people, especially men, are living longer. (The cost to France of lowering the retirement age is less than many expected because the rules make fewer people eligible.)

In the post-war period, the cost of pensions wasn't too high in many countries in the developed world because bad diets and bad habits meant retired men received the pension for a little while and then dutifully died to ease the burden on the state. Low unemployment until the 1970s also meant that the cost of other social payments was minuscule compared to what happened afterwards.

These days people are unobligingly living much longer making the cost to the state (i.e. taxpayers) more burdensome.

Note the difference in the graphic between official and effective retirement ages and the low 'official' level for Greek retirement, which varies dependent on professions as Michael Lewis points out:

The retirement age for Greek jobs classified as “arduous” is as early as 55 for men and 50 for women. As this is also the moment when the state begins to shovel out generous pensions, more than 600 Greek professions somehow managed to get themselves classified as arduous: hairdressers, radio announcers, waiters, musicians ...
However, the interesting part is the 'effective' retirement age in Greece is much higher than the 'official' figure, although the discrepancy has come down since the 1970s.

The Economist's graphic is based on data from the OECD, which has also produced some nice graphics to show the future state of retirement in the OECD. Basically the assessment is that public pension payments will be less in the future in the order of "20-25% on average". The OECD argues  "countries should focus on two main policies to address the growing pensions gap: later retirement and extending the coverage of private pensions."

The report also notes that the pace of pension reform has accelerated over the past few years. Major changes include:
  • increases in pensionable ages
  • the introduction of automatic adjustment mechanisms 
  • strengthening of work incentives
While "some countries have also better focused public pension expenditure on lower income groups", others in Central and Eastern European countries have pulled "back earlier reforms that introduced a mandatory funded component". These failures to extend pensions put Australia's compulsory system into perspective, where the government aims to increase super to 12% of wages by 2020.

But the pension age increases in the OECD are the biggest change, given the general direction for all countries, except Germany and Japan, over the 40 year period from 1970 to 2010 was for younger retirement ages:
Most OECD countries have already begun to increase pensionable ages, or plan to do so in the near future. Age 65 remains the modal age at which people normally draw their pensions, accounting for 17, or half, of OECD countries for men and 14 countries for women. But 67 – or higher – is becoming the new 65. Some 13 countries (12 for women) are either increasing pension ages to this level or, in the cases of Iceland and Norway, are already there. Italy, which links pension age and seniority requirements to life expectancy from 2013 and Denmark, which plans to link pension age to life expectancy from the mid-2020s, are forecast nearly to reach age 69 in 2050. The United Kingdom has accelerated the increase in the pensionable age, which will move from 65 to 66 by 2020 (6 years earlier than planned) and from 66 to 67 by 2026-28 (10 years earlier than planned).

As many of us with a defined-contribution superannuation profile heavy in equities in Australia realise, investment risk can be a real problem, especially if you are close to retirement (thankfully I'm not!).

Australian pensions are more heavily concentrated in equities than anywhere else in the world. (The figures are from 2009)

I feel for those who put extra capital into their super after Peter Costello's reforms only to see their tax-advantaged potential gains getting swallowed, spat out and then stomped on by the financial crisis.

Just to remind those who don't realise how bad things have been since the peak, here's a little chart of the share market over the past few years. Getting out of equities into cash at over 6000 would have been a very good move.

Note the comparison with the Dow.

Australia is not alone. According to the OECD:
The financial and economic crisis has exerted major stress on private pension arrangements. Most countries’ pension funds are still in the red in terms of cumulative investment performance over the period 2007-11 (-1.6% annually, on average, in real terms). Even when measured over the period 2001-10, the pension funds’ real rate of return in the 21 OECD countries that report such data averaged a paltry 0.1%. Such disappointing performance puts at risk the ability of private pension arrangements to deliver adequate pensions. The United Kingdom follows the general trend, with average real investment returns of pension funds of -1.1% over the period 2007-10 and -0.1% over the period 2001-10.
... one clear goal for policymakers should be to improve the design of default investment strategies so that investment risk is reduced as the worker approaches retirement. Such life-cycle investment strategies may need to be carefully regulated to ensure that workers are offered sufficient diversification and protection from market shocks in old age.

Too right! Australians are forced into super, so they need to take greater care in their asset allocation if they don't want to see their nest eggs diminished just before their retirement. Better to choose to work for longer than be forced to do so.

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