By 2050, the six countries with the world’s largest pension systems will have a combined funding gap of $224 trillion largely due to demographic trends, according to a new study by the World Economic Forum.
The report found Australia, Canada, Japan, the Netherlands, Britain and the United States will face significant challenges in providing for their elderly populations in the future. “We see this [pension gap] as almost akin to a climate change issue,” says Han Yik, head of institutional investors at the World Economic Forum in New York. “And the reason we use that analogy is that it’s a problem now, but the problem will get to be much bigger if you don’t do anything about it.”
In determining the retirement savings gap, the report looked at the amount of money each country would need to replace 70 per cent of its senior citizens’ pre-retirement income.
Among the six countries, the United States has the largest pension gap, at $28 trillion in 2015, and will continue to have the highest deficiency with a projected $137-trillion shortfall in 2050. The report suggests Canada’s retirement savings gap will hit a projected $13 trillion in 2050, up from $3 trillion in 2015.
Canada’s retirement age needs to rise given the change in life expectancy, says Yik. He notes that in 1960, a retirement age of 65 made sense with Canadians expected to live only up to age 71. But life expectancy increased to age 82 in 2015.
“So that’s 11 years additional of benefits payments that need to be paid,” says Yik. “If you look at the fact that these pension systems were designed to pay out maybe, on average, six years of benefits back in the ’60s and now they have to pay out 17 years of benefit payments, that’s a huge blow to them. That’s what’s led to the underfunding right now.”
And life expectancy in Canada is expected to increase to age 87 by 2050, adds Yik.
Like other developed countries, Canada also has a low birth rate, which exacerbates the growing imbalance between retirees and the working population, says Yik. He notes the issue is especially significant for countries like the United States that rely on pay-as-you-go pension systems in which current workers fund the benefits of the past generation.
“To the extent that there’s a public system with a pay-as-you-go funding where there’s not individual funding or dedicated funding for the current generation, that’s where the aging population becomes acute,” says Yik.
While Yik says all countries should address the looming pension gap, he’s more optimistic about Canada’s pension system. “We’re fortunate in a lot of ways in that the large Canadian pension funds are sophisticated investors,” says Yik. “We have a strong level of governance where the pension plan is managed on one end but then the . . . [Canada Pension Plan Investment Board] manages the investment independently of the pension plan administration. And so that frees them to be able to take a long-term view of the investments.”
Besides the six developed countries noted in the report, the World Economic Forum also looked at China and India and found they’re not immune to the retirement savings problem. Adding those two countries to the equation boosts the combined retirement savings gap to $400 trillion by 2050.
And while China and India aren’t currently experiencing significant shortfalls, that will likely change in the future, says Yik. “For them, the problem is opposite [from the developed countries] in a lot of ways, in that they’ll have a lot of people who’ll become elderly because they have a lot of young people right now.”
The World Economic Forum suggested a number of steps for governments and policy-makers to consider, including:
- Increasing the standard retirement age so it aligns with current life expectancy;
- Making saving easier for everyone through mechanisms such as automatic contributions;
- Supporting financial literacy efforts;
- Ensuring people understand how much in benefits they’ll receive from each component of a national pension system; and
- Aggregating and standardizing pension data to give people a full picture of their financial position.