Pension funding that do take care of future

This article appeared originally in Gulf News: link to original article

Pensions deal mainly with how many young people are contributing to an elder’s funding.

The IESE Business School in Spain, as quoted in the Financial Times, estimated that 3.6 people contributed to the pension of one 65-plus retiree, and estimates that number to drop to 2.5 by 2030 and 1.6 in 2050. Spain is currently reforming its pension system, knowing that unless it can attract 26.5 million immigrants over the next 40 years, its pension system will drain the budget and future. The reform, from 2019 onwards, will introduce a sustainability factor into its pension funds’ model to link pension payments with life expectancy.

This means that the longer elder people are expected to live, the annual payments will be less during their retirement. Not only that, Spain has increased retirement age to 67.

The reason, why I chose Spain as an example, is to show how it has set parameters on how many young people should pay for one retiree, its immigration quotas and reforms, that it hopes will move things from the status quo.

Let’s assume that Spain cannot attract enough immigrants to bridge the gap between its youth and retirees, currently estimated at 665,000 a year.(Only 70,000 arrived in 2010.) We are also assuming that Spain will have to depend on its own population to fund pensions.

To understand this better, keep in mind that ageing populations are the ones in danger’s way while others can still fix their systems. What more can Spain do to save its pension system from a future collapse and possible failure to pay retirees?

The same goes for the UK, which has also increased retirement age to address similar issues. In the US, Illinois and Detroit and a few pension funds in California are at risk. Hong Kong too will face a serious pension problem. Not only from an ageing population, but also because of a drop in birth rates, which means that the ageing population is not being replaced. There won’t be enough people working in the future to pay for pensions.

For the issues listed, retirement ages have been increased and immigration, presumably, encouraged. What next?

The solutions I suggest are:

• Countries at risk must first work to reduce their unemployment rates. A 25 per cent unemployment within a 47-million population in Spain means you have some 12 million without jobs. In other words, 12 million less contributing to pensions funds. If foreign investments cannot be attracted and increased government spending dilute pensions further, one way to address this is by encouraging people to establish their own ventures.

• As in Sweden and Latvia, individuals should be able to view their future pension benefits and be given the option to adjust their contributions accordingly. Such a method takes the pressure off governments, and also allows future pensioners to adjust their own contributions based on changes in annual inflation rates, changes in currency values, changes in standard of

living, and perhaps a change in one’s current financial position.

For example, individuals who have just settled their loans could increase their contribution percentage to increase future savings and benefits.

The second point works better for younger generations, but is not limited to them. At a certain point, ageing populations will have young populations again and vice versa.

With increasing life expectancies, what Spain is doing is quite good. If countries decide they want to have things the way they are now, they should at least link pensions to inflation, cap salaries if they are not yet, and reduce basic salaries dramatically while making up for it with other allowances.

The last point should only be carried out in parallel with providing individuals investment options that match how much they earn and how much they can possibly save. This should also go hand in hand with awareness on saving part of disposable income and obtaining bank financing to invest and not spend on consumables.

Remember, an investment today with an average X annual inflation means capital gains of X multiplied by number of years towards retirement. It also means receiving annual return which can be reinvested. There is no such thing as I don’t know what to invest in.

Options are limitless, and there are professionals out there to provide you with proper advice. Now the thought that I want to leave you with is this: why not get your pension entitlements or end of service benefits every time you switch jobs, and invest the proceeds?

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