Is retirement inevitable and sustainable in modern times?

THE word “retirement” refers to leaving formal employment or stopping all income generating activities.

Legally, retiring refers to your tax status and access to your retirement savings in terms of the post-retirement investment vehicle options available. But have human beings always reached a point in their life where they stop earning an active income?

Historically, we just did not live long enough to even consider the possibility to stop working. In the 18th century life expectancy was only 35 and rose to just above 50 when Alexander Fleming discovered Penicillin in 1928. Consequently, people simply worked as much as they physically could until they died.

In addition, saving was incredibly onerous as economies were dominated by a subsistence lifestyle; Feudal style taxes were paid to maintain the central powers rather than channelled back to the citizens and financial systems for saving were rudimentary at best.

How then did retirement come about and why at age 65?

The age of 65 was well past the life expectancy of the population in the 1880s and therefore a relatively safe bet for the government purse

The person generally credited with “inventing” retirement as we know it, is Chancellor Otto Von Bismarck in 1883, but his objective was mostly to increase his popularity with his people, and to stem the tide of rising Marxism in Europe. He announced that he would pay a pension to any citizen of the age of 65. This was well past the life expectancy of the population in the 1880s and therefore a relatively safe bet for the government purse.

In addition, the industrial revolution had sparked a trend of urbanisation, funnelling people out of rural life and into industrial and business cities.  Scientific motivations were put forward where people were beginning to be classed as less productive due to reduced physical ability of people to work after age 60 – the most notorious being that of the infamous Physician William Osler.

Retirement therefore gained popularity as an economic necessity as people started living longer, unemployment took hold after the 1929 great depression and young men returned from both the First and Second World War seeking jobs. In 1935 Franklin D Roosevelt proposed the Social Security Act where workers had to pay for old-age insurance for their own future.

Retirement became an economically attractive option to push the “elderly” out of work

Retirement had become an economically attractive option to push the “elderly” out of work, making way for new job seekers and leisure was motivated as the reward for years of hard work.

South Africa formally joined the retirement system of employer-based retirement plans with the passing of the Pension Funds Act in 1956. The Defined Benefit scheme was initially the preferred structure. However, though it was great model in boom times, it represented a significant and possibly crippling risk for both employers and employees alike during difficult economic times.

Since the turn of the century, there has been a significant migration to Defined Contribution schemes, where retirement savings are completely separated from the employer, and more responsibility shifted to the employee. The role of the employer has changed from a paternalistic one to that of a supportive facilitator. The employee in turn, is given a more central role in determining their own retirement outcomes necessarily taking more responsibility and risk.

Having both the time and the savings to fund a leisure lifestyle in retirement still is the exception rather than the norm.

Ironically, having both the time and the savings to fund a leisure lifestyle in retirement still is the exception rather than the norm. Currently only 2% of the working population can afford to retire and maintain their current lifestyle and only 10% can afford to stop working (retire) at all. Most people have no choice but to find some other means to create an active income. This is evidenced by the number of retirement fund members cashing in their retirement savings (roughly 80%) to make provisions to create income earning opportunities both pre- and post-retirement.

Fortunately, the nature of work opportunities has evolved from labour-based to knowledge-based jobs. In agrarian-dominated economy’s, a person’s value was based on physical strength. When we were no longer able to labour at our peak, we could not afford to simply stop working. Rather, older people moved to less labour intensive roles such as managing the allocation of resources and labour, and called on to take important decisions for their family or community. They were the elders in the community by virtue of the experience and wisdom required to reach old age, earning the right to take up knowledge-based work, taking on greater responsibility for the well-being of their family or community.

As the level of education of the general population has improved, the opportunity for more knowledge-based functions have increased as mechanisation reduces the demand on our bodies. This affords us more time and energy for problem solving and knowledge-based endeavours, to such an extent that there are serious debates around the nature and future of work itself.

90% of the current working population still cannot afford to stop working

Thus, the factors determining the possibility to stop working have not changed, except we now expect to stop working, retire and live a life of leisure. As suggested, it was the wealthy that could afford to do so – 90% of the current working population still cannot afford to stop working.

The key to retiring is for savings rates to steadily increase to an amount equal to the amount of consumption required when active income stops. That effectively means to delay consumption over one’s working career enough to sustain consumption when one stops working.

If we follow the Pareto principle (the commonly referenced “eighty-twenty” rule), savings rates should reach an equilibrium at about 20%. The Alexander Forbes Pension Index indeed shows that to achieve a 75% income replacement ratio at 65 one would need to save just under 20% over one’s working career of 40 years. Sufficient government policy intervention, such as tax incentives to delay consumption and reduced access to retirement savings, should be able to influence this natural equilibrium level to a more favourable outcome, ie, more people who can afford to retire.

The increased access to retail debt facilities has meant consumption is not being delayed but rather accelerated by spending tomorrow’s income today. Spending on debt has steadily increased and has reached the 80% mark. This is unsustainable, as we saw in the 2008 sub-prime crisis. It is therefore no coincidence that we find 80% of pensions being cashed in. As a result, savings rates have not reached the equilibrium levels required to sustain the retirement system.

To avoid a potential impending retirement crunch, saving needs to be made easy and automatic.

To improve retirement for all we should consider the previous natural state of affairs where an individual only stopped working when they were no longer sufficiently capable to do so.

A possible solution may be to focus on where we are with what we have. The ideal would be to focus on the knowledge, skill and capability of the individual (especially as the nature of work continues to evolve), rather than making age the eligibility criteria to work.

To improve retirement for all we should consider the previous natural state of affairs where an individual only stopped working when they were no longer sufficiently capable to do so. As a secondary objective, we can then focus on getting people in a position where they have enough resources to purchase a life of leisure. The current financial services industry is well set up to achieve the later objective but limited in the former basic conditions for the critical mass.

By Mark Hawes, financial consultant at Alexander Forbes Financial Planning Consultants

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