3 big roadblocks to getting the world ready for retirement, and 3 straightforward solutions
Dan Houston, Chairman, President and CEO
As the gaze of the financial world begins its yearly shift to Davos, I expect to hear a lot about retirement within the broader agenda of sustainable and inclusive economic development. Particularly in light of one projection (PDF), which calls for a global pension asset shortfall of $400 trillion (all figures in USD) by 2050. This potential shortfall reflects a convergence of multiple global factors, including: aging populations, longer life expectancies, and lower fertility rates—as well as low interest rates. Combine these with high levels of government debt, and businesses having to compete globally, and it’s pretty clear why responsibility for financial security continues to shift to individuals.
There are those who would call retirement security a crisis. But in my mind, it’s only a crisis if we fail to act. If the stakeholders—governments, employers, providers, asset managers, and individuals—fail to come together and address the issue.
The top 20 retirement systems around the world have more than $36 trillion in assets combined, according to this study. These systems are in various stages of maturity. Clearly though, we’re not starting from square one. And we know certain things are working—lessons we’ve learned from successes and failures around the world. There are vast differences between countries in terms of demographics, economic development, and the availability of social services for the elderly—so one size can’t fit all when it comes to solutions.
So I’m going to talk about three major global challenges as I see them, then move on to what we must consider as we work to clear a path to financial security for everyone.
What are the roadblocks?
Let’s break these factors into specifics:
1. Inadequate income in retirement
This really boils down to two issues, as people around the world live longer in retirement. First, public pension systems alone typically replace just a fraction of what’s needed for a secure retirement (and these systems are under pressure). Secondly, people simply aren’t saving enough, on their own or through voluntary retirement plans in countries where these plans exist. Global life expectancy at birth is up from 52.6 years in 1960 to 71.9 years in 2015, according to the World Bank. This huge leap in lifespan is creating a huge increase in the number of years we have to finance in retirement.
2. Lack of coverage
More than half of the world’s workforce is employed informally. It’s called different things in different countries, but I’m talking about temporary and part-time workers, contingent labor, and independent freelancers. Participants in what’s often referred to as the gig economy range from migrant workers to tech contractors. Whether workers take these jobs out of necessity or for the autonomy, variety, and mobility they offer, they’re generally not well covered by the mandatory and/or voluntary retirement systems that are available to the formal sector. Even in a more mature market like the U.S., lack of private coverage among smaller employers also contributes meaningfully to the problem. This report (PDF) shows 48 percent of U.S. businesses with 50 to 500 employees, and 76 percent with 10 to 50 employees, without any retirement plan at all.
What’s going to happen when all these workers who lack coverage hit retirement age?
3. Sustainability issues
Globally, we’re seeing a dramatic increase in the number of people reaching retirement age. In the U.S., where retirement age is about 65, one in five (22 percent) of the U.S. population will be of retirement age or older in 2050—that’s a 47 percent increase from 2015, according to this research (PDF).
But aging in the U.S. pales in comparison to Brazil, China, Hong Kong, and South Korea, where 65-plus as a percentage of the population is projected to more than double. Coupled with generally declining fertility rates, the effect is magnified. Dependency ratios (elderly per 100 working-age adults) in those countries are projected to at least triple between 2015 and 2050; and more than double in a number of other emerging markets, including Chile, India, Indonesia, and Mexico.
Worldwide retirement challenges: Age 65+ as a percent of the population
The projected depletion of the U.S. Social Security System’s old-age trust fund illustrates the point. According to this federal report (PDF), absent reform, after 2035, revenue from payroll taxes would only be sufficient to pay 77 percent of benefits to recipients.
Beyond the numbers, this issue reflects social challenges, too. Changing family dynamics play a rapidly expanding role in the global picture. Many family structures throughout the world are built on younger generations taking care of their elders. It’s an honorable tradition but an increasingly difficult responsibility to bear when fewer children are responsible for parents who are living longer.
Let’s talk solutions.
In this rapidly evolving landscape, everyone has a role—governments, employers, asset managers, providers and financial advisors, and workers.
In the interest of keeping it simple, I’ll offer some broad ideas for solutions.
1. Further pension reform.
While the U.S is one of the world’s more mature retirement markets, we struggle to create a system that is at the same time financially sustainable and capable of producing adequate income in retirement. We’re not alone in that. More than half of the countries within one OECD study had initiated reforms to improve the financial sustainability of their retirement systems, and more than half had initiated income adequacy reforms.
Past reforms around the world provide a good roadmap for future policy action and demonstrate some common-sense fixes. These include: higher contribution rates; longer contribution periods created by changing the statutory retirement age; mandatory or pension schemes to increase coverage; shorter qualifying periods to receive benefits; adding voluntary pension systems to complement public systems; improvements in benefits for low-income groups; and required annuitization to ensure a stream of lifetime income.
2. Replicate what’s working.
There are a small number of countries that have found good balance. In this 25-country study, five of the countries (Australia, Denmark, Netherlands, Singapore, and Sweden) were assigned a B grade or better for both adequacy of income for workers in retirement and sustainability of that country’s existing system. The common thread: Each of these countries have a mandatory, private, funded program.
The U.S. voluntary defined contribution (DC) system has also had some significant success nudging people to save for retirement, using tools like tax incentives and matching contributions. Americans have saved more than $13 trillion between private DC (primarily 401(k) plans) and Individual Retirement Accounts (primarily dollars rolled out of DC plans as workers change jobs or retire). For context, this amount exceeds the retirement assets in the next nine largest retirement systems in the world combined, as noted in this research study (PDF).
Lessons from the U.S. system? Employer-sponsored plans, using payroll deduction, can give workers the discipline to save they may not have on their own. We must continue to advocate for best-in-class plan design features like auto-enrollment (which gets employees into a pension plan right away), auto-escalation (which moves them to the savings rate they’ll need over time), auto-sweeping (which “sweeps” non-participating employees into a plan), and higher default savings rates.
3. Share the job of teaching people about personal finance.
According to this S&P survey (PDF), less than half of the adult population was found to be financially literate in 83 percent of the 143 participating countries. The time is now to engage, educate, and imagine a secure future for everyone.
Whatever particular mix of retirement reforms that countries in developed and emerging markets enact, I believe they’ll have to be accompanied by educational campaigns supported by government and the financial services industry. The good news is that today we have more ways than ever to reach the corners of the earth through a smart mix of human interaction and intuitive technology—things like virtual coaches and gamification of personal finance. We just need to focus on two basic but critical needs: understandable vocabulary and concepts; and tools that support decision making and remove barriers to action.
We have a lot to learn from each other as pension systems evolve market by market. But progress is possible by sharing our knowledge and the lessons we’ve all learned in the areas of coverage, investment diversification, and administrative efficiency, along with the bigger issue of getting people to begin saving early enough in their careers, and at a high enough rate, to maintain their lifestyle (or have a better one) in retirement.
It’s critical to building a stronger financial future, which ultimately benefits all of humanity.