We’ve been hearing about the pensions’ time-bomb for so long now that, like the house alarm in the distance, it has become easy to ignore.
For years we’ve known of the challenges facing the State’s pension planning; for every one retired person, there are currently six people in employment but by 2050, that could fall to less than two.
Who would have thought that the good old days were when all we had to worry about was demographics?
Now we have the additional strain of low interest rates and historically low bond yields making it harder than ever for fund managers to keep investment returns on an upward trajectory.
On top of that comes the impact of years of austerity, when the concept of saving for tomorrow was soundly trumped by the need to pay for today.
Figures from the Central Statistics Office, published earlier this summer, show just under half (47 per cent) of all workers aged between 20 and 69 have a pension – either a workplace provided occupational scheme or a personal pension – compared with 54 per cent in 2008.
And just three out of every 10 self-employed people had a pension at the end of last year, compared with almost half (46 per cent) at the beginning of 2008.
Of those who do not have a pension, the most common reason – at 39 per cent – is that they cannot afford one.
The proportion of workers who expect the State social welfare pension to be their main source of income rose from 26 per cent in 2009 to 36 per cent last year.
Yet even for those in occupational schemes there are major uncertainties ahead, with the gap between fund values and liabilities at some of the biggest companies in the country widening alarmingly.
“The problem is the low interest rate environment, allied to a lesser extent to the fact that people are living longer,” says Brendan Kennedy, chief executive of The Pensions Authority, the regulatory body for occupational and personal pension schemes.
In relation to the State pension, the need to bridge this gap has prompted recent hints from government about the need to extend retirement age.
Expenditure on State pensions is set to rise from €7 billion in 2016 to €8.7 billion in 2026. Already we have seen the rise in the age of eligibility for the State Pension from 66 to 67 in 2021 and 68 in 2028.
With employment contracts still typically specifying that compulsory retirement take place at 65, any such changes represent a further gap in retirement funding that individuals need to consider.
Dramatic
Extending working lives is just one way to plug the shortfall. Another is to increase the amount of contributions required.
“If I want to retire at 65 with a pension of €1,000 a year, for example, that is going to cost €25,000 to do given the typical lifespan. If we go back 15 years, when interest rates were higher, that same liability would have cost you just €10,000. Saving for retirement is more expensive than it was,” says Kennedy.
Globally the sector has bee oving towards target date funds’.With these, the pension scheme member invests in the fund with the target date closest to his or her intended retirement date, for example 2030, and the investment manger will manage the fund according to market conditions and the length of time to retirement.
“We are seeing growing interest in target date funds as a one-stop-shop for investing for retirement,” says Alaistair Byrne, senior defined contribution investment strategist with State Street Global Advisors.
“Typically that means equities and other growth assets, such as real estate, high yield bonds and so on, when the members are some way from retirement and moving into lower risk assets such as government bonds and cash when the retirement date is closer.”
In an environment in which returns are hard to find, another way of adding to the bottom line is to take out costs.
At present there are around 160,000 pension schemes in Ireland, ranging from major occupational schemes including thousands of people to small individual schemes. Such a number is inefficient with regards to economies of scale and the ability to negotiate better deals, he points out.
One way of cutting costs would be to introduce some kind of universal scheme. While such a move is a policy decision, and outside of The Pensions Authority’s remit, Kennedy does believe there is scope to improve pension coverage simply through better communications.
Plagued by acronyms – ARF, AVC, BOB, PRSA – and backed up by the kind of legalese that comes of “defensive writing”, the sector “needs simplified, easy to run and easy to understand schemes”, he says.
Challenges
The problem, however, is that all the challenges facing the sector risks undermining what remains a very good idea; the need to provide for tomorrow, today. Pensions remain a highly tax-efficient way of doing that.The other factor which may unwittingly depress demand for pensions is the constant reiteration, by the industry, of the need to start young.
While it is true that the younger you start, the bigger the pension pot you can expect, that fact shouldn’t preclude those who haven’t started early from starting at all. The fact is, while the best time to start a pension is always going to be decades ago, the second best time is now.
“Don’t let perfect be the enemy of good,” says Kennedy. “The current State pension is €233 a week. The desire of people to do better than that hasn’t changed. The incentive to save hasn’t changed and the need is still there, it’s just much tougher to do.”
The good news is that lack of awareness is not an issue. “Surveys show people are more aware of pensions now than before but awareness alone hasn’t been enough. All it may have done is increased people’s guilt about not having a pension,” says Kennedy.
Human cost
On the plus side, the rise of the concept of ‘financial wellness’ indicates there is a greater understanding – among industry professionals, individuals and employers alike – of the role well-managed finances can play in a person’s overall physical and mental health.
“There is a human cost to financial stress, an emotional cost, and if people can be helped, through financial wellness programmes and good investment advice, you are going to see better outcomes,” says Andrew Fahy, head of tax and financial planning at Investec.
This is the case at all stages in life but particularly at retirement. “We are seeing increasing life expectancy, medical inflation and nursing home costs,” says Fahy.
“If you are lucky enough to have a pot of cash when you retire, it’s important to manage it, to have a plan and to revise that plan as you go along.”
