Saving for retirement – starting at birth

Tony Stenning |10-Jun-2016

As funding retirement becomes increasingly expensive, BlackRock’s EMEA head of retirement planning, Tony Stenning, explores whether saving from birth could be the answer.


The Challenge

Funding retirement—whether through a state pension or privately—is increasingly expensive. Traditional defined benefit plans are financially stressed, as workforce demographics tip toward a more balanced ratio of younger to older workers.

Moreover, within defined contribution (DC) plans, the later anyone begins to save, the more expensive their retirement becomes because the ‘buying power’ of invested savings to generate retirement income declines as the worker ages. A pound invested at age 50 is worth less than one invested at age 30 because it has less time to generate investment returns. Even beginning to save in one’s early 20s—which too few people do—is often not enough to ensure a secure retirement.

A Solution

Instead of waiting until a person begins to work to save for retirement, let’s take the radical step of beginning to save for retirement—at birth!

Call it ‘compulsion’ but with a twist. As with a compulsory scheme, everyone would be included. Unlike such a scheme, the participants are not mandated to save part of their pay checks. Instead, the government would ‘give’ every newborn child a modest sum in lieu of their future pension. Allowed to compound up over 65 years, this modest sum could not only solve the government’s funding crisis; it could also create a sovereign wealth fund to finance infrastructure and other vitally important long-term, capital intensive projects.

To underpin the argument we divide future retirees into four groups:

  • Current pensioners who are well off (relatively), many of whom will leave behind a legacy, probably a house.
  • The 40 to 50 year-olds who are in DC schemes and have not saved enough will take those assets as inheritance and use them to fund their own retirements.
  • The 20 and 30 year-olds who have enough time to save for retirement but will not get much when their parents die.
  • The newborns, where we could direct taxpayers’ money to pre-fund future pensions and provide a universal pension for all.

People in the first three groups arguably have some means of meeting their retirement needs, if imperfectly. This solution won’t affect them. But it could help address—and maybe even close—the gaps between the sums needed to fund the nation’s fiscal obligations and the government’s ability to pay for them.

It could help address the gaps between the sums needed to fund the nation’s fiscal obligations and the government’s ability to pay for them

Conditions and Assumptions: Although past performance of stock markets is not necessarily a guide to future returns, we believe this solution could work, based on the following assumptions:

  • Average dividend rate is assumed to be 3.3%, which is the 20-year FTSE 100 average through December 31st, 2015.1
  • Inflation is targeted at 2%.
  • The current state pension level for retirees is £7,500 per year.
  • To match the £7,500 level, a lump sum of £2,000 invested at birth would need to compound at 7.55% for 65 years to produce an annual pension comparable to the current state level.
  • Assume a drawdown rate of 3.3% per year from the lump sum—i.e., a drawdown rate equivalent to the dividend rate.

The 7.55% return on this initial £2,000 contribution at birth could be considered a conservative return, based on 20-year historical FTSE 100 market returns of 6.4% (ending Dec. 31st, 2015), plus the 3.3% dividend rate over the same period, less 2% for inflation—or 7.7% overall. What’s more, this higher return (7.7% v. 7.55% vs.) does not include any further potential upside from investing in very long-term assets over 30, 40, 50 year periods.2

We believe the return on investment assumed above could be achieved through a combination of more traditional equity investments and by taking advantage of the investors’ decades-long investment horizon to secure the liquidity premium offered by long-term infrastructure investment. The money could be pooled to create a sovereign wealth fund after only 10 years (at which time the fund would hold around £25bn) to invest in badly needed infrastructure and other projects. The new system could also enable pay-as-you-go state pensions to themselves be retired.

If the government were to make, in lieu of any future pension, a one-time contribution of £2,000 to every baby at birth (of which 800,000 are born annually in the UK), the cost to the Treasury would be £1.6 billion3 per year. Compare that to the current cost of nearly £110 billion for pay-as-you-go pensions! The resulting annual retirement income produced from this sum should exceed the new State triple locked pension, and at a fraction of the cost.4

Clearly this is a potential long-term solution and transition would not be easy. However it could solve the unfunded pension systems that are becoming cripplingly costly as populations age.

Tony Stenning
Managing Director, Head of Retirement for EMEA
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1 Source: Bloomberg, as of 4/14/2016. This material is provided for educational purposes only and should not be construed as research. The information on this website is not a complete analysis of the global retirement landscape. The opinions expressed herein are as of 02/16 and are subject to change at any time due to changes in the market, the economic or regulatory environment or for other reasons. The material does not constitute investment, legal, tax or other advice and is not to be relied on in making an investment or other decision. The information and opinions contained herein are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, but are not necessarily all inclusive and are not guaranteed as to accuracy or completeness. No part of this material may be reproduced, stored in any retrieval system or transmitted in any form or by any means, electronic, mechanical, recording or otherwise, without the prior written consent of BlackRock. This publication is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
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