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Retirees of the future: Increased worries about income security and growing inequality

by Patricia Buckley, Lester Gunnion
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11 minute read 09 August 2019

Retirees of the future: Increased worries about income security and growing inequality Issues by the Numbers, August 2019

11 minute read 09 August 2019
  • Patricia Buckley
  • Lester Gunnion India
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  • The current state of affairs
  • Rough going ahead
  • Possible solutions could further increase income inequality among...
  • How will the responsibility for retirement funding change?

​Pension funds of major economies are stressed for resources in the face of aging populations and falling birthrates. Policy fixes exist, but some of the most popular will further increase income inequality among retirees. Ensuring retiree income-security is a tightrope walk for governments and current and future retirees alike.

It is not only the workforce of the future that presents challenges to business and policy leaders. With more of the current workforce contemplating their postwork future with increasing trepidation, policy changes by the private and the public sector are critical … and this must happen sooner rather than later.

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Advances in health care, education and nutrition, declining birthrates, and a growing proportion of older adults have put the world economies in uncharted territory—of planning for retiree benefits. With fewer people entering the workforce, the exit of the older adults from the workforce is creating stress in many government retirement plans, particularly in those where retirement payments are funded by current workers (the pay-as-you-go systems). Some of these plans will potentially be in a fund deficit—where taxes coming in will be insufficient to make full and timely payments—in the near term. In other words, the retirement plans will be bankrupt—unless something changes.

Governments have a tough task on hand as there is more than what meets the eye. Although most governments are encouraging businesses to help ensure a financially secure retirement for their workers and are urging citizens to save for their own retirement income security, the reality is that most people depend on national plans for retirement income-security. However, national plans are stressed for funds and to shore up funds, they are pushing governments to increase retirement ages of workers. This worsens the hardships already borne by lower income workers and exacerbates the already increasing income inequality, even in retirement.

To illustrate the precariousness of the situation faced by a growing number of countries, we examine the national pension plans for six countries: The United States, China, Japan, India, Brazil, and the Netherlands.

The current state of affairs

The combined public and private retirement systems of the countries examined in this article cover a wide range of combinations of adequacy and sustainability.1 India ranks low on both factors, providing inadequate benefits and falling into the unsustainable range. Brazil ranks high in adequacy of benefits but ranks even lower than India on the sustainability scale. Japan’s pension system ranks slightly higher than Brazil’s in terms of sustainability, but below average in the adequacy of its benefits. China’s pension is equal to Japan’s in terms of benefits and somewhat higher in terms of sustainability. The United States has slightly higher sustainability and adequacy ranks, but it is the Netherlands that compares very well not only with this group but with the entire group of 34 countries that Mercer included in its study—second only to Denmark.2

As the cornerstone of most retiree security-systems is the public component, we focus our discussion on public financing schemes. For example, in the 24 countries from the Organization for Economic Co-operation and Development (OECD) for which data is available, private pension spending averaged 1.5 percent of GDP in 2013, equal to just 20 percent of the average public spending on retirement benefits.3 A description of the pension plan designs of the countries discussed in this article is shown in figure 1. These countries, with the exception of India, rely on a pay-as-you-go system (payments made by or on behalf of current workers flow to current retirees as a set or defined benefit) and coverage is universal or near universal. In India, workers get the payout from their individual accounts at age 58. The full retirement age for the more standard pension plans ranges from 50 years to 66 years. Benefit formulae generally factor in wages and years of work, and most programs are financed by a combination of employer and employee contributions, with some countries also including general transfers from the government.

A snapshot of government or other mandatory pension plans: The Netherlands offers the best adequacy and sustainability among the countries explored in this article

Another important measure of retiree benefits is the replacement rate. Only India has a flat replacement rate of 87.4 percent across income classes, and while it looks impressive, it is not actually as useful as one might believe because a mere 12 percent of the population is covered by the plan (figure 2). The other five countries have progressive replacement rates, i.e., although high earners will receive higher-value pension amounts, lower earners receive a higher proportion of their prior earnings than their better-paid peers. Of these countries, only the Netherlands has mandatory private plans. With both private and public plans, the country has a flatter distribution of replacement rates, albeit rates in all three earnings groups are almost 100 percent.

Gross pension replacement rates vary across countries (percent of individual earnings)

EXPLORE THE INFOGRAPHIC

Retirees of the future

Rough going ahead

While policymakers can debate as to what portion of retirement income governments should have responsibility for, what is not in debate is that all these programs will face challenges due to aging populations. Although Japan has the most severe imbalance between the size of the working population and the retiree population, all the six economies we are discussing are aging. Even Brazil and India, with their relatively younger populations, will likely face severe demographic headwinds in the future. In the next five years, the ratio of people aged 65 and older to working age population will average just under 30 percent for the OECD countries, but for all these economies that ratio rises rapidly after that (figure 3).

Economies are getting older

With fewer workers to support a growing number of retirees, the pay-as-you-go pension plans are going to get significantly more expensive. Three of the six countries discussed will see their public pension costs rise substantially as a percentage of GDP between now and 2050 (figure 4). India, Japan, and the United States will not see a large relative increase, but each for a different reason. In India, pension coverage is very low, and the country follows a fully-funded model. Therefore, public spending as a percentage of GDP could remain unchanged. Japan has undertaken reforms to rein in costs by changing the indexation scheme for benefits and gradually raising the mandatory contribution-rate from 13.9 percent in 2004 to 18.3 percent in 2017.40

Public pension costs as a percentage of GDP are set to rise substantially for some countries

The United States’ projected increase is not particularly large, but it is not clear how the system will be funded once the current source of public pension funds runs out. There is only one source of funds for the retirement portion of Social Security—the funds payed into the Old-Aged Survivor Insurance (OASI) Trust Fund. Until 2011, this trust fund was still growing relative to costs outlays (benefit payments and administration costs). However, according to the intermediate estimates in the 2019 Annual Report of the Board of Trustees, the OASI trust fund reserves will be depleted in 2034. After this point, only an estimated 77 percent of scheduled benefits would be payable.41 In addition, the United States has another major retirement funding issue. A large group of employees—approximately one-quarter of state and local government employees—are not included in the federal Social Security pension plan, but are covered by state and local plans, many of which are extremely underfunded.42

As for China, the public pension program faces a similar funding-crisis timeline. Public reporting indicates that accumulated pension funds are likely to peak in 2027 before running dry in 2035.43 Despite government support (more on this later in this paragraph), pension funds are likely to be in deficit in 2028 and accumulated deficits are projected to increase to 90 percent of GDP by 2050.44 For now, however, the government can and does make up shortfalls in the various plans. Each of the three two-tiered pension schemes (covering government workers, urban workers, and rural workers; detailed in figure 1) faces funding challenges. The plan for urban workers, for example, is fully funded in principle, but as the retiree population grew, administrators of tier-one funds reached into tier-two funds to make current payments. To add to this, employers fell behind in making their payments. A 2018 survey revealed that only 27 percent of companies paid their entire social security contributions.45 As a result, several individual and notional accounts at the second tier were depleted. Not all hope is lost, though, as the National Social Security Fund will likely be used to make pension payments.

In general, the risk of poverty increases with age, and public pension funds are in a position to influence it to an extent with appropriate budget planning. For example, funds in the Netherlands and Brazil have been instrumental in reducing poverty among those over 65 to very low levels (figure 5). However, in China, the United States, and Japan, the poverty rates of the elderly are high and exceed even that of children, while in India, the poverty rate among those over 65 is roughly on a par with that of children.

Brazil and the Netherlands have lowered their poverty rates for the aged

Possible solutions could further increase income inequality among retiree populations

Shoring up public systems while figuring out how to lower (or at least not raise) retiree poverty-rates is a challenge. The two approaches usually considered are (1) increasing mandatory contributions and (2) raising the full retirement age. Each approach is likely to harm those at the lower end of the income spectrum and contribute to income inequality among those 65 years and older.

Income inequality has been increasing across the globe,46 and raising mandatory contributions will further exacerbate it. The fact that retiree benefits are almost always based on earnings contributes to increased inequality in the retirement phase, especially as the lower-paid workers are also much less likely to have access to private pension plans or to be able to save much toward their own retirement. There is also a substantial urban/rural divide, another type of inequality created in some countries. This is certainly true in India and China, and the state and local pension issues in the United States could also contribute to increase in geographic unevenness.

The other avenue to shore up the health of public systems is increasing the age when a person can receive full retirement benefits, but this can leave lower-paid workers worse off than the higher earners. Specifically, lower-paid workers are more likely to have physically demanding jobs and a higher likelihood of poorer health, causing them to take early retirement with smaller pensions. In contrast, the more highly compensated workers may be able to work longer, earning higher-than-full-retirement payouts (in countries that have that feature), as they accrue additional savings and private-pension balances and are able to put off drawing down assets for living expenses.

Besides these two popular solutions is the “means-testing” approach. A means-tested public pension system decides eligibility for pension payments based on income and assets. Retired workers with income and assets above a certain threshold are considered ineligible to receive full pension payments, despite having made contributions to the pension system. Such an approach, if adopted, could bolster state coffers, reduce retiree poverty, and narrow inequality after retirement by redistributing wealth. However, the approach has been criticized for discouraging savings, and transition to such an approach in countries where it does not already exist is likely to be contentious.

How will the responsibility for retirement funding change?

The current economic environment of low investment returns makes it harder for the funds to fulfill their pension obligations. As a result, there is a palpable retreat from defined benefit models to defined contribution models, with the burden of providing for the future shifting from the state and the employer to the worker.47 Defined contribution models are common in developing countries, but workers in developed countries are likely to feel unease at the idea of not being guaranteed a pension.48 Nonetheless, such a shift seems necessary from a financial-sustainability perspective.

Unfortunately, for older workers, it usually means more work and less leisure, a prospect that has been met with consternation. For instance, in the Netherlands, where the pension system is considered one of the best in the world, workers and trade unions were on strike, in June, against further increase in retirement age and proposed cuts to existing benefits.49 In Brazil, reform proposing a longer period of work before pension benefits can be availed has faced fierce opposition for decades.50 In Japan, the existing pension system catalyzes intergenerational conflict while proposed reform is usually met with political opposition. In the United States and China and even in India, existing pension systems are caught between workforce expectations and what can be provided. Amid all of this, the population of workers on the verge of retirement keeps growing … and so does the problem. The employees are increasingly focused on this issue, so too should the employers.

Acknowledgments

Cover art by: Tushar Barman

Endnotes
    1. Monash University, Melbourne Mercer Global Pension Index 2018, October 2018. View in article

    2. Ibid. View in article

    3. OECD iLibrary, “OECD pensions at a glance,” pp. 146–167, accessed July 16, 2019. View in article

    4. The United States Social Security Administration, “Fact sheet,” accessed July 16, 2019. View in article

    5. Congressional Research Service, “How social security benefits are computed: In brief,” May 3, 2019. View in article

    6. The United States Social Security Administration, “Fact sheet.” View in article

    7. The United States Social Security Administration, The 2019 annual report of The board of trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, April 25, 2019. View in article

    8. Organisation for Economic Co-operation and Development, Pensions at a glance 2017: Country profile—China, 2017; Huoyun Zhu and Alan Walker, “Pension system reform in China: Who gets what pensions?,” Wiley Online Library, January 22, 2018. View in article

    9. Organisation for Economic Co-operation and Development, Pensions at a glance 2017: Country profile—China. View in article

    10. Ibid. View in article

    11. The Social Protection Platform, Universal Pension Coverage: People’s Republic of China, accessed July 16, 2019. View in article

    12. Ibid. View in article

    13. Japan Pension Service, “National Pension System,” February 2, 2019. View in article

    14. Ibid. View in article

    15. Ibid. View in article

    16. Ibid; Pension Funds Online, “Pension System in Japan,” February 2, 2019. View in article

    17. Japan Pension Service, “National Pension System.” View in article

    18. Alfie Blincowe, “Understanding the Japanese Pension System part 1/3: What is it and how does it work?,” GaijinPot, August 2, 2018. View in article

    19. All About Japan, “All about pensions in Japan,” March 18, 2019. View in article

    20. Organisation for Economic Co-operation and Development, “Pensions at a glance : How does Japan compare?,” December 5, 2017. View in article

    21. Organisation for Economic Co-operation and Development, Pensions at a glance: Country profile—India, 2017. View in article

    22. Ibid. View in article

    23. National Portal of India, “National Pension System,” accessed July 16, 2019. View in article

    24. Ibid. View in article

    25. Yogima Sharma, “Finance ministry seeks labour ministry help to fund proposed hike in minimum EPS pension,” Economic Times, February 6, 2019; Paisabazaar, “Employees’ Pension Scheme (EPS): Eligibility, calculation & formula,” May 23, 2019. View in article

    26. Organisation for Economic Co-operation and Development, Pensions at a glance: Country profile—India. View in article

    27. Sharma, “Finance ministry seeks labour ministry help to fund proposed hike in minimum EPS pension” ; Paisabazaar, “Employees’ Pension Scheme (EPS). View in article

    28. Organisation for Economic Co-operation and Development, Pensions at a glance 2017: Country profile—Brazil, 2017. View in article

    29. Ibid. View in article

    30. Ibid. View in article

    31. Aureo Dias Mesquita, “The case for pension reform in Brazil: An unequal and exhausted retirement system on the verge of collapse,” Wilson Center, May 29, 2018. View in article

    32. Organisation for Economic Co-operation and Development, “Pensions at a glance,” December 5, 2017. View in article

    33. Mesquita, “The case for pension reform in Brazil.” View in article

    34. Ibid. View in article

    35. Organisation for Economic Co-operation and Development, “Pensions at a glance.” View in article

    36. Organisation for Economic Co-operation and Development, “OECD policy memo: Pension reform in Brazil,” April 2017. View in article

    37. Sociale Verzekeringsbank, “AOW pension,”accessed July 15, 2019; IamExpat, “Pensions & retirement age in the Netherlands,” accessed July 15, 2019; Expatica, “The Dutch pension system,” March 21, 2019. View in article

    38. Ibid. View in article

    39. Ibid. View in article

    40. Sharma, “Finance ministry seeks labour ministry help to fund proposed hike in minimum EPS pension”; Paisabazaar, “Employees’ Pension Scheme (EPS)”; Organisation for Economic Co-operation and Development, “Pensions at a glance : How does Japan compare?.” View in article

    41. The United States Social Security Administration, The 2019 annual report of The board of trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds. View in article

    42. The Pew Charitable Trusts, “‘Lost decade’ casts a post-recession shadow on state finances,” June 4, 2019. View in article

    43. Gao Baiyu, “China’s pension system is out of pocket,” Caixin, April 19, 2019; Zheng Bingwen, China Pension Actuarial Report 2019–2050, China Labor and Social Security Publishing, April 2019. View in article

    44. Baiyu, “China’s pension system is out of pocket”; Economist, “Paying for the grey,” April 5, 2014. View in article

    45. Caixin, “China’s dilemma: Lower tax burden or bigger pension hole,” November 20, 2018. View in article

    46. For some examples, see Sonali Jain-Chandra et al., “Inequality in China: Trends, drivers and policy remedies,” IMF working paper, June 5, 2018; Kaja Bonesmo Fredriksen, “Income inequality in the European Union,” OECD working paper, April 16, 2012; Daniel Bachman, Income inequality in the United States: What do we know and what does it mean?, Deloitte Insights, July 12, 2017. View in article

    47. John Authers and Brooke Fox, “Legacy of Lehman Brothers is a global pensions mess,” Financial Times, September 24, 2018. View in article

    48. Ibid. View in article

    49. Chris Flood, “Clock ticks louder as Netherlands’ pension crisis intensifies,” Financial Times, June 1, 2019. View in article

    50. BBC News, “Bolsonaro proposes pension overhaul for Brazil,” February 20, 2019. View in article

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Patricia, Deloitte Services LP, is the managing director for Economics with responsibility for contributing to Deloitte’s Eminence Practice with a focus on economic policy. She regularly briefs members of Deloitte’s executive leadership team on changes to the US economic outlook and is responsible for the US chapter of Deloitte’s quarterly Global Economic Outlook and produces “Issues by the Numbers,” a data-driven examination of important economic policy issues.

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Lester Gunnion is an economist and manager in the Research & Insights team. He contributes to the United States Economic Forecast and maintains a current-quarter nowcast model for the US economy. Gunnion provides frequent macroeconomic briefings to senior firm leaders and publishes research spanning economic trends and sectors in the United States and the global economy. Earlier in his career at Deloitte, he covered the economies of Russia, South Africa, Singapore, Thailand, and Vietnam.

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