Mind the gap
Compared to baby boomers, younger savers are at a considerable disadvantage when it comes to making long-term financial provisions.
- Lower pension contributions and rising living costs are creating financial inequalities between young and old
- As older, unemployed citizens outnumber their younger counterparts, the financial stability of the global economy may be undermined
- Governments, employers and financial services companies need to do more to narrow the gap and improve the prospects for younger citizens
Younger people might be physically fitter, but they are failing to keep pace with their older counterparts when it comes to maintaining healthy finances.
Research from the London School of Economics found that, by 2010-2012 in the UK, the median total wealth of households aged 55-64 had grown to £425,000 but had fallen to £60,000 for those aged 25-34. To bridge that gap, young households would have to save £33 every day for three decades—an unlikely prospect for the average 30-year-old.
In fact, when the Intergenerational Foundation (IF), a UK-based research organisation specialising in intergenerational fairness, published its first Europe-wide equality index in March 2016, it found that the financial prospects for young people had fallen to a ten-year low.
A number of factors have conspired to create this intergenerational wealth gap, including rising life expectancy, less generous state and workplace pensions, market falls, high unemployment rates and rising house prices.
Liz Emerson, co-founder of IF, warns that if such factors continue unabated, poverty in retirement is likely to increase. “There are enormous consequences resulting from the younger generation's inability to save,” she says.
Paring back pensions
For the baby-boomer generation, generous defined benefit (DB) occupational pension schemes were the norm. Today, the cost of honouring these DB schemes has become prohibitive for the majority of employers, resulting in cheaper defined contribution (DC) schemes, which see the employee take full responsibility for investment risk.
Pablo Antolín-Nicolás, principal economist and head of the private pensions unit at the OECD, says: “The shift from DB to DC was accompanied by a reduction of contributions—particularly employer contributions. In the world of DB, employer and employee contributed around 20-25%, but now it is around 10%. So it is very difficult to achieve the same level of retirement income.”
Governments, too, have withdrawn from state pension provision. With the ratio of those aged over 65 for every 100 European citizens aged 25-64 projected to grow from 31.6 in 2015 to 61.6 in 2055, the flow of contributions into the state pension systems may buckle under the strain.
Aaron Grech, chief officer at the economics and statistics division of the Central Bank of Malta and research fellow at the London School of Economics, explains: “We’re in an environment of declining state pension provision, where over the next 40 years there will be a decline of between 5% and 15% in replacement rates. The limited amount of financial wealth could raise significant retirement income adequacy issues.”
As Europeans generally enjoy a longer life than some of their counterparts across the globe, this disparity needs to be tackled sooner rather than later, says Patrick Frost, CEO of the Swiss Life Group: “What can we do? Remain silent and wait out the problem? Of course not. Even if it might not be nice to tackle it. We are talking about nothing less than intergenerational solidarity. What we do now will have consequences for people as yet unborn. It would be unjust for us not to act.”
A knowledge exchange
In terms of intergenerational solidarity, older citizens can help their younger counterparts plan and save for the long term.
“While occupational pension provision has declined over time,” explains Dr Grech, “there is evidence that younger generations have tended to show little interest in what there is on offer. If there is one important thing younger generations need to learn from previous generations, it is that pensions matter.”
The IF suggests that older citizens, with help from the government, do more to share their accumulated wealth before they die. Passing money down to the next generation is a practice as old as time, but with rising longevity, younger family members receive inheritances much later in life.
Ms Emerson says: “Governments could encourage greater lifetime giving by helping to make wealth transfers between the generations more fluid, tax efficient and less onerous. IF advocates skipping a generation so wealth transfers occur when most needed, such as when starting a family or buying a first home.”
In addition, Ms Emerson suggests that older generations could accept faster reform to their own pensions and retirement ages “by accepting that taking less for longer themselves could help their children and grandchildren in the long term”.
Governments and employers can also play their part in improving the financial prospects of Generation Y and beyond.
Dr Grech suggests that governments invest in housing projects to help younger citizens manage high property costs, while also creating programmes to improve employment prospects. “It is very important that younger generations get further up the employment market. Governments around Europe need to focus resources on improving access to education and training,” he says.
Ms Emerson points to Norway as a positive example of promoting intergenerational fairness. The Norwegian government uses its Government Pension Fund Global (GPFG), a sovereign wealth fund, to ringfence assets for future generations, thereby improving young people’s financial prospects. "In Norway, the interests of different generations are more fairly balanced,” she notes.
The decline of occupational pension provision does not mean that employers have bypassed their responsibilities to help citizens save for retirement. Valuing a workplace pension scheme and making adequate contributions that incentivise employees to participate are key ways in which employers can improve the financial fortunes of younger workers.
Dr Grech says: “Employers need to give due importance to workplace pensions again. These can be great sorting devices for them to attract employees who want a long-term career and who are more open to training and upskilling.”
Taking the reins
Although the current financial landscape looks challenging for younger savers, there are opportunities for them to take control over their future.
They have the edge over their older counterparts when it comes to technology, and access to knowledge and guidance has never been easier. There is also time for more product innovation from financial services companies.
And while the financial markets are unpredictable, young people can capitalise on falls and use their long-term horizons to build substantial pots.
Add to that a closer partnership between industry, government, employers and citizens, and a more equitable savings environment becomes a real possibility.