Pensions: why living longer has become a big problem
Almost every day comes an announcement by yet another employer that it is going to curtail or even shut its final-salary pension scheme.
Large deficits and rising underlying costs are the usual reason.
A key factor in those calculations is that the pensions that have been promised will have to be paid for much longer.
Why? Because on average our life expectancy continues to rise.
We are going to live longer; not just longer than our parents but even longer than experts thought we would live, just a few years ago.
For instance, in 1980, a 65-year old Englishman had a one in 1,000 chance of living to be 100 years old.
Just 30 years later, this figure has increased to one in 100.
In fact, over 10,000 people in the UK have received a centenary birthday card from the Queen.
How do we as a society pay for retirement when retirement itself is getting longer?
American civil war
The issue is highlighted by this example from across the Atlantic.
The American civil war ended in 1865 - but when was the last payment from an American civil war pension? 1914, 1944, 1974 or 2004?
The correct answer is 2004.
William Jasper Martin, despite being on the losing Confederate side, survived the civil war and received his veteran's pension of $50 per month.
When he was 81 years old he married Alberta, then 18 years old, and she then lived until 2004, dying at the age of 97.
Throughout this period of time she continued to receive her husband's pension benefit as she was entitled to.
No one could have predicted this anomaly and it meant that the cost of the pension was far higher than could possibly have been imagined when it was granted.
Predicting life expectancy
The majority of people in the UK significantly underestimate their own life expectancy.
Understandably, just over a quarter of people have no idea of just how long they might live.
Yet being able to plan financially for retirement requires even a basic level of understanding of longevity.
- A 30-year old woman in Newport, Wales has a one in five chance of living to 98 according to the most recent projections and
- A 60-year old man in Inverness has a one in five chance of living to 93 years according to the most recent projections.
Higher longevity is a growing burden not just for employer pension schemes but also the state and individuals, as they too need to find ways of funding longer retirement.
Employer pension schemes
Defined benefit pension schemes, which guarantee a set level of pension payments for the rest of their members' lives, are faced with a significant problem.
People living longer costs the pension scheme - and the company which sponsors it - more money.
This has left some of the UK's largest companies with yawning holes in their finances as they struggle to keep pace with their pension promises.
In their place are defined contribution schemes, which do not provide any guarantee over the amount of money the pension scheme will pay out to members on retirement.
Instead, members buy an annuity when they retire which will provide regular pension payments in retirement.
While these will continue until death, increasing longevity risk means that insurance companies are offering lower pension payments to offset the increased risk of longer life.
So we can expect to receive less money.
As it currently stands, the state will continue to make an agreed level of pension payment for life from retirement.
This presents a huge funding problem for the UK government.
The coalition announced it was reviewing the age at which pensioners can draw a state pension.
The government is thinking of increasing it to age 66 possibly as early as 2016, with further increases to the state pension age potentially to follow after that.
Longevity is not the only factor people struggle with when planning for their retirement.
The bigger-picture problem is the gap between expectation and reality.
Looking at the current data showing how much people were saving, when they expected to retire, and their expected retirement income, there is a startling gap between expected retirement income and the reality.
The gap has in fact been put at £1.2 trillion - equivalent to 80% of the UK's gross domestic product (GDP) in 2008.
On an individual basis, the reality gap equates to £50,000 per person of working age, which is equivalent to two years of gross salary for a worker on the UK average salary of £25,000.
What is the answer?
Put simply, we drastically need to reassess our expectations of retirement.
In living longer we need to start to consider a 'triangle of compromise': save more now; work for longer; or retire on less money.
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