In 1965 André-François Raffray, a 47-year-old lawyer in southern France, made the deal of a lifetime. Charmed by an apartment in Arles, he persuaded the widow living there to make a deal: He would pay her 2,500 francs—then about $500—a month until she died, and in return she would leave him the apartment in her will. Since she was already 90, it seemed like a safe bet.
Thirty years later Raffray was dead and the widow, Jeanne Louise Calment, was still going strong. When she eventually passed away at 122, having become the world’s oldest person, the Raffray family had paid her more than twice the value of the house.
Underestimating how long someone will live can be costly, as overgenerous governments and indebted private pension programs have been discovering. They are struggling to meet promises made in easier times. Public pensions are still the main source of income for those over 65 across the Organization for Economic Cooperation and Development, but there are big differences between countries.
In both America and Britain, public provision replaces around 40% of previous earnings, but in some European countries it can be 80% or more. Where it makes up a big share of total pension income, as in Greece, Italy and Portugal, a shrinking work force increasingly will struggle to finance a bulging group of pensioners.
Private pension plans, which supplement state provisions, have been shifting from defined-benefit plans, whereby workers are promised a fixed amount of income in retirement, to defined- contribution plans, where workers themselves take on the risk. Such plans are good for employers but tricky for individuals, who become personally responsible for ensuring that they do not outlive their savings. The new stage of life now emerging between work and old age adds a further complication. To accommodate these changes, the financial industry needs an overhaul.
First, it has to update the rigid, three-stage life-cycle model on which most of its products are based. Second, it needs to resolve two opposite but equally troubling problems: undersaving during working life and oversaving during retirement. The first puts pressure on public sources, while the second leads to underconsumption as cash is left under the mattress. Third, the industry needs a more creative approach to the range of assets that retirees can draw on, including their homes, which so far have played little part in provision for old age.
“In a multi-stage life, the idea of hitting a cliff-edge retirement at 65 and then living off an annuity is outdated,” said Alistair Byrne of State Street Global Advisors, a money manager.
His clients, many of whom intend to work past normal retirement age, are asking for more flexibility to get at their savings at a younger age. They also want a secure income for the last phase of life.
“It’s not at all obvious that the traditional pension industry, which still sees life as a three-stage event, will survive this transition,” said Andrew Scott of the London Business School.
Many people simply do not save enough. Roughly 40% of Americans approach retirement with no savings at all in widely used retirement accounts such as IRAs or 401(k)s. In Britain 20% of women and 12% of men between 55 and 65 have no retirement savings, according to Aegon.
Nonetheless, with the demise of defined-benefit plans, the increase in the retirement age and the steady rise in life expectancy, most of today’s workers will need to save more than their parents did. Some of them do not earn enough to put money aside, but for many the problem is in the mind: They consistently underestimate how long they will live and overestimate how long their money will last.
One solution is to allow retirement funds to be used more flexibly, which may encourage people to save more. Nudges are unlikely to be enough, however.
“People need a push,” said Myungki Cho of Samsung Life’s Retirement Research Center in Seoul.
Some countries, such as Denmark and the Netherlands, provide such a push by making enrolment in pension programs more or less mandatory. Short of that, auto-enrollment, recently introduced in Britain, and auto-escalation— increasing contributions over time— also can make a difference.
At the same time, however, many retirees spend less than they can afford, which creates its own problems. Researchers Ronald Lee and Andrew Mason have found that, in most rich countries, the elderly are net savers. Since they cannot be sure how long they will live and what their state of health will be, and since they have no way of predicting inflation, interest rates and markets, some caution clearly is in order. Nonetheless, Chip Castille of Blackrock, an asset manager, thinks oversaving often is unintentional.
“It would be an extraordinary coincidence if you saved exactly enough for retirement,” he said.
© 2017 Economist Newspaper Ltd., London (July 8). All rights reserved. Reprinted with permission
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