Wake up call

At the end of a long working life, most of us hope our twilight years will be something we can enjoy. A comfortable retirement is seen as a just reward for decades spent at the coalface, a chance to live out dreams held on to for years. It could mean being able to travel, buying a boat or simply the opportunity to spend more quality time with family. However the traditional view of retirement is changing, bent out of shape by a range of external pressures, meaning that the post-work reality for many retirees will be a far cry from what they might have imagined.

A key factor in this shift is that we are living longer lives. Despite the much-vaunted threats of obesity-related illnesses and global pollution, the fact is that American life expectancy continues to creep steadily higher. The average person born today can expect to live a full 10 years longer than someone born in 1960. While longevity is generally a cause for celebration, it does raise some big implications for retirees, the most pressing being how this extra decade of life is going to funded. The problem of a growing number of retirees is compounded by a downward trend in the birth rate. Smaller amounts of people in work mean less taxes flowing into the government’s coffers, which means less money to support the burgeoning retired population “The fact is that as we move through the 21st century, the burden of paying for an ever greater amount of retired people is going to fall on a shrinking number of younger workers,” says independent pension adviser Henry Rice. “If things continue the way they are going, state-backed pension schemes are going to struggle to cope.”

To a greater or lesser extent, developed countries across the world are having to face up to the pensions time bomb. Take Greece for example. According to research carried out at the Cato Institute by economist Jagadeesh Gokhale, even before its current and future pension obligations are taken into account, the country’s debts total up to 113.2 percent of its gross domestic product. Add in the burden of supporting the retired and that figure jumps to an astonishing 875.2 percent of GDP. While that is an extreme example in a country where financial mismanagement has been the norm, even better run nations are facing a seemingly insurmountable pension bill. Germany, widely regarded as one of the most economically sound European countries, faces obligations of 418.2 percent of GDP. But before we start to dismiss this as a problem for the EU, it is worth noting that the US is in exactly the same boat, it’s national debt jumping from 83.6 percent of GDP to 500 percent when retiree benefits are included.

With 78 million baby boomers heading toward retirement, it’s not as if we have any right to be surprised by these developments. The growing demographic disparity between the old and the young has been gathering momentum for decades, but governments seem to be at a loss about how to tackle it.  The main issue is that the solutions to the problem, while potentially simple, are unlikely to be popular. Few in government seem keen to commit political suicide by advocating higher taxes, reduced benefits and an increase in the age of retirement. Asking the younger generation to start paying now for bills that won’t be due for decades, complete with the knowledge that they are going to have to work longer anyway, is a pretty tough sell. This is compounded by the fact that those politicians pushing such changes through are likely to continue to benefit from the current system.

In truth, state-backed pensions are only part of the problem. In 2004, the average social security payout for a retired man was $1076.10 a month or $12,913.20 per year. Considering that the average annual wage at the same time was $35, 648.55, retirees relying on nothing but social security are going to have to face a significant drop in income once they say farewell to work.  As a result, many make alternative arrangements, such as 401(k)s or employer sponsored pension plans.

In the past such investments were seen as virtually risk-free. Make your payments as planned and your golden years would be a breeze. Unfortunately, just like virtually every other financial product, pension funds have been hit hard by the recent economic meltdown. Retirement accounts have reduced in value from $4 trillion to $2 trillion since 2007, leaving many retirees facing significantly lower post-work payouts. According to the Employee Benefit Research Institute, it could take between two and a half and nine years for 401(k) values to return to pre-2008 levels, news that should strike fear into the hearts of anyone planning to retire within the next decade.

General Motors offers a particularly striking example of the downturn’s impact. “Our US hourly and salaried pension plans were overfunded by more than 20 percent at year-end 2007 and we do not expect to be required to make any cash contributions to these plans for the foreseeable future,” said then CEO Rick Wagoner, in the soon-to-be-bankrupt auto giant’s 2007 annual report.

The lesson of GM is one with worrying implications for millions of defined-benefit plans, many of which are held by public-sector employees. General Motors conceded increasingly generous retirement benefits to its people on the mistaken assumption that the good times were going to last forever. When the crisis bit, it was revealed just how mistaken these assumptions were. Cash reserves decimated by the collapse in sales, GM suddenly found itself struggling to keep its head above water. A particularly striking statistic is that, following round after round of cost-cutting layoffs, the company found itself supporting 10 retirees for every salaried employee. Some have drawn parallels between GM and the state of California, itself facing a massive pensions black hole in trying to fund the defined-benefit plans of millions of state employees.

Though defined contribution plans are now more common than defined benefit among private-sector workers, all this does is shift the responsibility onto individuals rather than organizations. Many choose not to pay into such plans, but even those that do face the prospect of shrinking payouts as the companies such funds invest in struggle to rebuild values in the wake of the financial crisis.

So how are today’s workers going to pay for tomorrow if many of the traditional routes seem so unreliable? Those wishing for some kind of magic bullet solution are likely to be disappointed. For many, a comfortable retirement is going to rely on delaying the end of work, or even taking on a part time job once their career finishes. This trend is on the up, with 18 percent of employees now saying they expect to work after retirement, compared to 10 percent in 2001. We are also seeing some governments starting to grasp the nettle of lifting the retirement age. At time of writing the new coalition government in the UK is proposing a one-year raise, with more to follow, in the hope of closing the funding gap. It’s too early to say exactly how things are going to pan out, but a concerted effort need to be made to tackle the problem sooner rather than later. One thing is for sure, it looks as though the future of retirement is going to be a lot less relaxing.

Year        Birthrate (Children per woman)    Life expectancy at birth
1960        3.65                                                69.77
1965        2.91                                                70.21
1970        2.48                                                70.81
1975        1.77                                                72.6
1980        1.84                                                73.66
1985        1.84                                                74.56
1990        2.08                                                75.21
1995        1.98                                                75.62
2000        2.06                                                77.03
2005        2.05                                                77.74
2008        2.1                                                  78.44