We are heading for a pensions apartheid

we-are-heading-for-a-pensions-apartheid

Might middle-class savers’ dreams of financial security in old age be among the less obvious but most long-felt consequences of the coronavirus crisis?

Could COVID-19 divide senior citizens into the have-yachts and the have-nots in the form of pensions apartheid?

Is the oil price war between Russia and Saudi Arabia a chilling example of the military “rule of three”?

Once is bad luck, twice could be a regrettable coincidence, but three things going wrong at the same time can prove fatal.

It is not scare-mongering to ask these questions after global stock markets lost a third of their value in response to the combined threat of the coronavirus and plunging oil prices before staging a partial recovery towards the end of March.

Coming down from the clouds, macro-economics matter to more people’s personal finances than ever before because fewer paternalistic employers provide traditional, risk-free pensions these days.

Rising numbers of employers around the world prefer to prioritise whatever their business might be – from selling frocks to building tower blocks – while switching employees’ retirement funds from what is known as a “defined benefit” to a “defined contribution” or money-purchase basis.

Before your eyes glaze over, let me explain that all the jargon boils down to one thing – transferring all the investment risk from employers to employees.

Most private-sector pensions are no longer based on defined benefits, or employers’ promises to pay a certain amount of income in retirement. Instead, they are based on defined contributions, or whatever is paid in and how much it subsequently grows or shrinks depending on the performance of the underlying investments.

This means that the value of employees’ pensions at retirement in the future may bear the scars of stock market shocks today.

If you think pensions are boring, ask yourself how exciting poverty in old age is likely to be.

Many people who imagine they have no exposure to the stock market may actually have most of their life savings invested in bonds and shares because that is where most pension funds hold most of their assets.

Super-rich folk may shelter their wealth in art, diamonds, fine wines and gold bullion, but these assets are simply not practical, safe or cost-effective for ordinary people. Now, mainstream assets – such as bonds and shares – have caught a cold from the coronavirus.

For example, recent analysis of the UK’s Office for National Statistics (ONS) data found a dramatic widening of the gap between the wealthiest and poorest pensioners. 

According to UK investment platform AJ Bell, the pension income gap between the richest and poorest households has nearly doubled from £20,950 ($26,000) to £36,680 ($45,500) in less than a decade.

Tom Selby, senior analyst at AJ Bell, tells me: “Although average private pension incomes have risen substantially since 2010, this masks a widening gap between those at the top and those at the bottom. In fact, the disparity between the bottom fifth of savers and the top fifth has almost doubled.

“The pension incomes of the richest retirees are now 17 times higher than those of the poorest. Anyone wanting to avoid becoming a pension ‘have not’ needs to take responsibility by saving as much as they can afford today.”

Sad to say, that is easier said than done and many people would struggle to set aside any of their earnings for a time that might be decades in the future.

More positively, the younger you are, the more time you have on your side to make the magic of compounding work for your benefit, generating capital growth on capital growth and interest on interest.

Lest that sound a bit broad-brush, here is a financial parable based on fictitious twin sisters, Prudence and Extravaganza, based on mathematical fact.

Prudence invests $100 a month from age 18 to 38 and then stops saving altogether. She achieves an average of 5 percent annual growth for the 20 years she invests, and her fund continues to grow at 5 percent for the next 27 years until she retires at 65.

Extravaganza fritters away her money on frocks and handbags, saving nothing until she is 38.

Then she starts saving $100 a month – until she, too, is 65. Extravaganza also achieves 5 percent a year during the 27 years she is investing.

At 18, both had nothing. When Prudence reaches 38, she has pension savings of $41,000. Extravaganza has zilch.

Now, here is the point of the tale: At age 65, Prudence has $145,795. Extravaganza has just $68,219.

So Prudence has more than twice as much at retirement as Extravaganza, even though Prudence set aside a total of only $24,000, while Extravaganza invested $32,400.

The explanation is that Prudence invested for 20 years before Extravaganza got going and those early dollars had another 27 years to grow in the sensible sister’s fund.

This is not the sort of thing they teach at school – but perhaps it should be. If it was, bankers might not be able to joke that compound interest is earned by people who understand it – and paid by people who do not.

I apologise for what may have seemed a counsel of despair at the start of this article and congratulate everyone who has got this far. You have already taken the first step to avoid having to work until you drop.

The only practical alternative is to take an active interest in serious saving, and the sooner we start, the better. Most people spend their lives working for money but regular saving and investment – even of seemingly small amounts – is a way to make money work for you.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial stance.

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