IN THE FILM Back to the Future, Marty McFly transported from 1985 to the year 2015 in the Doc’s DeLorean time machine. The fact that they had flying cars in the future shows how far away 2015 seemed to those in 1985.
Now while it is a disappointment that in 2016 we do not have flying cars, it does get me thinking about retirement planning and how people, including myself, tend to underappreciate how close the future actually is.
For example, take the year 2050. For me, 2050 sounds like something from a sci-fi film. Yet that’s the year I’ll reach the state retirement age of 68. Around 34 years into the future may sound far away, but it’s not from a savings perspective.
Effectively communicating to people the need to begin planning for retirement as early as possible in their working career is the real challenge for the pension industry.
Unfortunately, the numbers suggest that people are only thinking about how much they need to have saved to comfortably retire much too late in their career. Many people face the cold hard reality of having inadequate savings when they retire to fund an enjoyable retirement.
What about the state pension?
Yes, there is a state pension, but it is unfunded since it is backed by no assets, paid through the current tax take and is only going to cover basic sustenance. In other words, the current workforce in Ireland funds the state pension for those pensioners who have reached retirement.
That’s a burden maybe we can afford at present with a population that has an estimated five workers for every pensioner. However, the inevitable tipping point awaits, with the ratio of workers to pensioners continuing to drop as the population ages and is expected to fall to a ratio of 2:1 by 2050.
The role of government
There is no doubt that the government must play a much bigger role in heading off this potential time bomb because large groups of people face retirement with inadequate pension provision, and the issue of unfunded state pension liabilities can only get worse.
Sadly, in recent years, the government has taken a step backwards in addressing this pension crisis and if anything, has only served to make the problem worse.
How could they better motivate people to save more for retirement than apply a sneaky little pension levy on private pensions? Looking for bailout money for the banks would be a start – just raid the €25 billion National Pension Reserve Fund. Its purpose was to prepare for the impending pension crisis as the population ages.
Of course, then there is the elephant in the room, the egregious public service pensions – particularly at the high end – that are unfunded and to be paid by, you guessed it, the taxpayer trying to save through a private pension.
So what needs to be done?
Well, the OECD has recommended that coverage in funded pensions needs to be increased and can be achieved through “compulsion; soft-compulsion, automatic enrolment; and/or improving existing financial incentives”, arguing that a compulsive sign-up is the “the least costly and most effective approach”. These options need to be explored further.
At a scheme level, Invesco continues to work with trustees on education for members on the subject of pensions, removing unnecessary levels of complexity, and providing and utilising more useful communication tools that can drive engagement.
Companies also need to play their part. A matching contribution demonstrates to staff a company’s commitment to the future of their employees, encouraging member participation.
Above all, the looming pension crisis is a reminder of the need for a secure social system that can meet the needs of our ageing population.
Individuals must also take responsibility to begin planning for their retirement. The earlier people start contributing the better, no matter how small the contribution is, as it becomes as much a habit as anything else.
Of course, the subject of pensions and investments can be confusing for people. However, when it comes to saving for retirement, be it through a corporate pension scheme or a personal retirement account, below are three simple things people should remember:
1. Tax-advantaged savings plan – I have found the term ‘pensions’ only serves to confuse people, most of all the commonly heard expression ‘buy a pension’. While talk of a pension might conjure the image of your granny going to the post office, when saving for retirement it simply refers to a tax-advantaged savings account. Save more now and pay less tax.
2. Your retirement savings – It is your money and you can do what you want with it. Retirement savings schemes provide individuals with online access and a range of investment options. While individuals will regularly check their bank account, retirement savings garner much less attention.
If individuals took more interest early in their career and reviewed their investment options, the online planning tools, the projected end wealth outcome and the impact of increasing contributions, they might strike a different balance between spending now and saving for the future.
3. Phases of retirement planning – This is important because it puts the focus on the now in terms of saving over your career, but also understanding that your investment strategy will change as you near retirement.
Individuals will have a range of investment options available to them during the savings phase, from low risk to high risk. Then at retirement, the size of your accumulated savings will dictate what is the most tax efficient way to take that money.
The key point here is the flexibility around the investment options during the savings phase, but also how an individual wishes to take the benefits at retirement.
The bottom line
While it may seem like I am sounding the alarm in terms of people waking up to the need to plan for retirement, there is clearly a balance to be struck in terms of planning for the future and actually living in the present.
Still, asking the right questions now can leave you better positioned to enjoy the future, flying cars or no flying cars.
Vincent McCarthy is head of investment consulting at Invesco.
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