When I’m 64? Looks like us Brits Will Be singing the blues until we’re 75 at this rate..!

A recent report from the Centre for Economic and Business Research (CEBR) shows that the embattled British people will be only able to retire at the ripe old age of 75 in the future. This is in large part due to the very low yields on government bonds which depresses annuity rates. Seems what we save on one hand with low mortgage rates we lose on the other!

The excessive savings of emerging countries, in particular China, is also acting as a depressant on yields. Workers will have no choice but to extend their working life and/or increase dramatically the provisions they make for the future, certainly if they want to retain some semblance of their present standard of living. Either that or continue to cross their fingers with the lottery draws!!

Many commentators expect the system to be radically overhauled in the next few years as the difference between obligations and the resources set aside to fund them continues to rise exponentially. With an ageing population and falling birth rate, these demographics are not specific to the UK but to many of the developed nations and in particular Japan. Governments the world over will have no choice but to raise the retirement age and enforce increased contributions. Don’t bet against a cut in future benefits too. All in all, not an enticing recipe for our old age…

The UK government in fact has already approved new legislation through the Pensions Bill (October 2012) and which pushes forward the current retirement age. Currently a man can retire at 65 and woman at 60 but in 2020 both will have to wait until 66. Not surprisingly there has been a backlash by many women’s groups in particular!

Since 2000, it has been increasingly tough for pension managers to generate decent returns from investing in safe assets like Gilts. Nominal returns have been decreasing and real returns are negative in certain cases. With the Bank of England’s policy of printing money, any future inflation will also act as a tax on all retirement funds and so add to the accumulation of liabilities and thus requiring even more money to be put aside. Seems we are damned both ways…

Several factors are contributing to what is arguably the biggest economic issue of this century. First of all, life expectancy is rising and so extending the period of retirement. Secondly, we no longer have the baby boomers of the post WWII period puffing out the workforce and making large NI contributions. Put simply, the ratio of workers per retiree which can be interpreted as a “support” ratio is falling away sharply.

In 1970, there were 4.3 workers per each retiree in the UK but in 2010 the ratio dropped to 3.6 and is expected to drop even further, to 2.4 in 2050. This is a material time bomb for our country. Unless there is a campaign that can lead to a second generation of baby boomers (doubtful in the current austerity climate), the problem must be solved on the contribution side, which means accepting a lower standard of present living on order to enjoy a similar one when we retire. Either that or emigrate to a country less burdened with the problem like Australia, or even book yourself into Dignitas at 75!!!

Unfortunately the problems don’t just stop here. Credit Suisse released its Yearbook a few days ago where several economists analysed various asset class returns over a prolonged time scale to investigate how these returns profiles may be changing. They came to the conclusion that the investment landscape has changed much since 2000 and that the typical expected annual real return around 6% to 7% is a thing from the past. Applying the same assumptions that were applied for the last 50 or 75 years will probably result in an overestimation of future returns. We have entered a new low return era as real returns are depressed. According to the Yearbook, the equity premium (the prize received by holding risky assets) may be around 3% to 3.5% now and expected real returns on a 30-year bond may be around zero. That is a massive shift in actuarial assumptions.

A marginal difference in the rate of return for an investment spanning over 30 or 35 years, which is the case with a pension fund, results in very large difference in terms of the present value of the fund, meaning one’s retirement payments will be much less than expected. This is scary for all those starting a career now but not less scary for those who are just nearing retirement age as Governments will most likely use all the tricks in the book to make your pension decrease. The cash injections given by central banks around the world aren’t helping as they create the double whammy of increasing inflation and also artificially decreasing the rates of return on safe assets. Perhaps the best way forward would be to simply enter a short bond fund and take the other side of the trade.