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Scaling the retirement savings mountain step by step

A skier descends from the top of a peak overlooking Davos, Switzerland (Thinkstock)

A skier descends from the top of a peak overlooking the Davos valley, Switzerland where the World Economic Forum 2014 is meeting (Thinkstock)

Global business leaders and governments have had plenty of time to adjust to the realities of a rapidly growing elderly population. Since the 1980s, average life expectancy in the United States and Europe has climbed by almost two years each decade.

In 1980 someone retiring at the age of 65 could have expected to live for another 13 years in the United Kingdom or Germany. By 2010 that had risen to around 18 years. Thanks to healthier lifestyles and advances in medical treatments, by 2050 that same person is expected to reach age 86-plus in both countries.

Yet, as world leaders arrive at this year’s World Economic Forum in Davos to discuss this and other burning issues, it still feels like the challenges of an ageing population have taken them by surprise.

This is despite something they’ve all known, a phenomenon pensions consultant Dr Ros Altmann describes as a “triple whammy”: a huge spike in post-war births; these baby boomers living much longer than their parents; and then having fewer children than their forbears. In some countries in Europe, couples are having an average of fewer than two children, effectively no longer replacing themselves. A similar picture emerges in the US.

Industry experts suggest business leaders have been left paralysed by the sheer scale of tackling the retirement savings gap over previous decades and many remain “caught in the headlights.”

An age-old problem

Falling birth rates in western economies post the 1960s have put further strain on governments, significantly reducing the number of workers able to support state pension plans.

In 1950, the old-age support ratio – which measures the number of working age adults to those aged over 65 – was more than 7 to 1 across OECD countries. By 1980 that ratio had fallen to just over 5 to 1 and it is expected to reach just over 2 to 1 by 2050. Some countries, such as Japan, are already at this level.

With most public pension schemes in western Europe funded by current workers, many experts believe they are already unsustainable. In Italy and Spain, for example, average earners receive an after tax income in retirement of over 70% of their previous earnings, with much of this funded by their governments.

Employers, too, are now facing tough choices with uncertain outcomes.

Many businesses have already cut back on more expensive final salary pensions with more expected to do the same. In a survey published last year by the UK's National Association of Pension Funds, just 13% of final salary schemes were open to new hires, down from 43% in 2005.

Sir Martin Sorrell, CEO of advertising agency WPP: People will need to work longer. (WPP)

Sir Martin Sorrell, CEO of global advertising agency WPP said people will need to work longer to close the pension and retirement savings gap. (WPP)

In the US such corporate plans are also now mostly closed to new members as many employers have switched to defined contribution 401(k) plans. Public employees in the US have increasingly been met with contracts that, for new hires, raise their retirement age or curb payout amounts for pensions.

Governments meanwhile are seeking to reduce payouts or raise retirement ages, often facing fierce resistance — witnessed by riots in France and Spain. In the US, amid calls by Republican leaders for further spending cuts, voices are growing to increase the age threshold for receiving full social security benefits. The business roundtable, an association of leading US CEOs, earlier this year called for the full retirement age to be increased to 70, up from 66 currently.

Employees in almost every sector will face having to put more money into their pension plans or working longer than they had planned.

Among the retirement topics proposed for debate at Davos 2014 are mandatory retirement ages, how to raise awareness among workers of how much they should be saving in pension pots and whether the auto-enrolment model offers solutions.

Jay Ralph, chairman of Allianz Asset Management, believes a lot can be achieved through improved communication by companies to their employees. Through simple changes such as requiring workers to opt out — rather than opt into — their employer’s private pension scheme, Ralph has seen typical employee contribution rates climb from 3.5% to 13.6% of salary. Similar auto-enrolment initiatives into 401(k) retirement accounts used in the US have also had positive results.

But Sir Martin Sorrell, chief executive of global advertising agency WPP, said that “people are going to have to become used to working longer” and that employers “need to think about lengthening peoples' tenure and service”.

Indeed such changes are already afoot. In the US, there is no longer a mandatory retirement age. According to US Bureau of Labor statistics, these days almost one-third of 65-to-69 year-old Americans work, up from less than 18% in 1985.

Germany has also raised its mandatory retirement age to help tackle the pensions timebomb, a move that is seeing the average age at major employers creep higher.

Such rises in employment among older workers should have a positive effect on economic growth, according to economists. But some fear of the impact it will have on younger people, particularly with youth unemployment in parts of the eurozone around 50%. In both Greece and Spain youth unemployment exceeds 50%.

Yet as governments grapple with the changing make-up of their populations, Sorrell believes that they will also have to get used to higher levels of unemployment.

“What we are seeing at the moment is a jobless recovery as companies are focusing on headcount. Some of the technology revolution that we are seeing such as 3D printing will further dramatically reduce the demand for labour,” a development, he said, that will put further strain on government finances.

Other factors risk clouding the picture too, according to Allianz's Jay Ralph.

Quantitative easing – the pumping of money into the economy by central banks in the wake of the credit crisis – has already increased the cost of pensions by artificially lowering interest rates.

Ralph fears it will continue to create uncertainty in the debate on pensions, long after it has ceased.

“When you get off the drugs of central bank policy does it lead to inflation, stagnation or both?” he said.

Davos leaders this year aim to move the debate beyond stereotypes and myths to address the consequences of an ageing population for society and business. But for Ros Altmann, one thing is certain. There is no getting away from the fact that people will have to work longer to afford retirement. But this does not have to be bad news.

She predicts another work phase of 10 or 20 years post-retirement where many older people will work part-time.

“It will be a much more individual decision. It will be much healthier for people and for society as a whole.”

“It's basically saying that there is a whole new phase of life out there if you're willing to grasp it,” she said.

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