The gap between expected or promised Lifetime Financial Security (LFS) benefits and what can likely be provided will hit nearly $16 trillion among 21 countries by 2050, according to a report from Group of Thirty, an international think tank of financiers and academics.
The report said that in real terms at 2017 prices, the gap will grow to $15.8 trillion in 2050 from $1.1 trillion in 2017, which represents a financial gap equivalent to 23% of GDP in 2050. This is based on current expenditure patterns, expectations of income in retirement, and policy settings, including planned changes. It comprises approximately 90% of global GDP and 60% the world’s population. The Group of Thirty said this will happen even with optimistic assumptions for economic growth, wages and rates of return on pension investments.
The report listed two key explanations for the rising trend in the global pension gap, which hit both the demand side and the supply side. It said that despite existing planned changes to official retirement ages, the combination of increasing dependency ratios and of static replacement rates increases the gap on the demand side. On the supply side, assumptions of a protracted low rate of return on financial assets limit the growth of wealth accumulation and income generation to help close the gap and meet that demand.
“Planned existing changes to the retirement age in many countries are falling well short of what is necessary to have a significant impact on the LFS gap,” said the report. “If public policies and individual behaviors do not change, many countries’ systems for providing LFS will face a severe crisis, threatening either unaffordable public expenditure pressures or inadequate income provision for retirees.”
Because people are living longer, and fertility rates are falling worldwide, the existing approaches to closing the gap are unsustainable, said the report.
“People cannot save the same amounts during their working years as they do currently, retire at the same age as today, and still receive the same retirement payouts, unless future generations pay additional taxes to enable them to do so,” the report said. “And there are almost certainly political limits to how much of the burden can be shifted to future generations of workers.”
To combat this double whammy, the Group of Thirty said it is inevitable that countries will be required to make some tough adjustments and identified three policy “levers” that will have to be used.
These three levers include increasing the retirement age and enabling people to work longer; increasing taxes and incentivizing savings; and reducing retirement income. The Group acknowledges that it likely won’t be politically feasible, or even desirable, to rely on just one of those levers alone.
For the first lever to be enough, the retirement age would have to rise more than proportionately with life expectancy, which would significantly reduce the number of years of retirement. For the second to work alone, significant increases in savings or taxation rates would be needed. And if the third one is relied on alone, severe reductions in replacement rates would be required in ways that the Group of Thirty said will not be socially equitable. It said it is only realistic to adopt a balanced mix of the three main levers.
“All governments, workers, retirees, and populations (as voters) face the complex and difficult challenge of securing Lifetime Financial Security for all,” said the report. “No single lever could close the ever increasing LFS gap; the scale of the challenge is simply too large.”