Who is going to pay for your retirement?

In today’s issue:

• The money for retirement must come from somewhere
• Demographics undermine all retirement schemes
• There is only one way to pay for retirement left

We all want to retire. But the money has got to come from somewhere. Whether it’s future taxpayers or a buyer for your property and stocks, someone needs to pay up. And I’m beginning to wonder who it’ll be…

It all began when the Kaiser created the state pension. The German taxpayer would fund people’s retirement.

But ageing populations and changing demographics made an affordable state pension unaffordable for governments. And so our pension today no longer covers the cost of living, let alone a decent retirement.

Many used to believe their employer would pay for their golden years. After a lifetime of work, the company practically owes it to their workers. And defined benefit pension plans were the way to deliver.

But it turns out that companies are not so good at investing their employees’ pension assets. They can over promise and under-deliver.

Besides, people no longer tend to spend a career in the same industry, let alone with the same company. The result is a mess.

In the end, the financial burden of company pensions became too great too. Defined benefit schemes became a millstone around the neck of British business. In some cases, they even caused companies to go bust.

And so we’ve transitioned to contribution-based pensions. You get out what you pay into your own pension pot. With a fund to manage the assets and try and generate a return in the meantime.

But will it be enough? Or does this new system suffer from exactly the same weakness as all the others did?

Where will the money come from?

What’s striking is that each transmogrification of the retirement system hasn’t changed the underlying maths. The money must still come from somewhere. Someone must still pay up for every pound retirees receive.

Do you plan to rely on the government to pay for your retirement? You might want to think otherwise. The government itself is in such a precarious financial position that it almost sent pension funds bust in 2022.

Longer term, there just aren’t enough young taxpayers to fund government-based retirement schemes. The inflows and outflows don’t match.

In the US, which keeps the accounts of these obligations separate from the government budget via their social security trust fund, the balance of that fund is dwindling. Within a few years, it will run dry.

Then any cash going to the American version of the state pension will have to come straight from the taxpayer. And, given the social security trust fund is crashing, that is going to mean a sudden dramatic increase in government spending.

Will taxpayers foot the bill? Or will the US government borrow even more? Its Congressional Budget Office is already warning about a Liz Truss-style bond market meltdown…

The problem is demographic. There just aren’t enough young taxpayers to fund the government’s pension system anymore. Not anywhere in the West. That’s why we’ve transitioned to alternative models.

So perhaps you’re hoping the stock market will pay for your retirement?

Then I’ve got news for you. Well, the Telegraph does. It reported that research from Goldman Sachs “found final salary schemes are selling almost as many British stocks as other pension funds are buying.” In other words, retirees are withdrawing as much from the stock market as young people are paying in.

The challenge is no different to the government’s pension problems. If you want to sell your investments to pay for retirement, you need to find a buyer. Just as there’s a lack of taxpayers, there’s a lack of investors to buy the assets that retirees are selling.

While paying your taxes to fund pensions is compulsory, investing in the stock market is not.

Perhaps you’re hoping to retire on your property wealth. But there are a few threats to this method too.

Firstly, where are you going to live? Won’t the price of that property have risen alongside the one you are going to sell?

If a lot of other retirees plan on selling their property to pay for retirements too, what will this do to the price of property in the UK?

And if demographic projections are right, properties will be getting sold to an ever smaller cohort of buyers. More supply, less demand… you know what’ll happen to prices.

Perhaps most importantly of all, what about those who did not build enough property wealth to retire on? Will they let you realise those gains on your home tax free? I wouldn’t bet my retirement on it.

There is only one way to pay for retirement

What makes long-term retirement plan projections work is investment returns. US pension funds like to presume returns around 7% to make their financial obligations look achievable. Back in the 90s, they assumed more than 8%.

The idea is simple. By contributing to a pension fund (and its fees) each month, your savings can be invested in stock markets and other asset classes. These generate a return. And so your pension pot can grow of its own accord.

Then, when you retire, it will have grown large enough to fund your retirement.

Unfortunately, the returns don’t always live up to the projections. And they’ve been declining steadily. A 6% projected return is now more realistic according to a report by Pew Charitable Trusts. And over the course of a few decades, that gap adds up.

But a bigger pot also means that younger generations will have to pay up even more to pay for your retirement. They’ll have to buy even more assets that you plan to sell. The underlying maths has not changed.

Buy and hope is not a retirement plan

To me, it just doesn’t pass the pub test. Punting the nation’s retirement assets on something as fickle as the stock market is mad. It can go through decades of underperformance.

Besides, the risks right now are unusually high. We have record amounts of government debt, dangerously high deficits, unusual demographics, high valuations on stocks and plenty more reasons to believe the market won’t deliver.

Not that the pension funds have failed to collect their fees, of course. It is, after all, your fault that your investments failed to perform as well as their marketing materials promised. Investing is risky, didn’t you know?

The coming disappointment we both foresee is why John Butler, our investment director, decided to launch Southbank Wealth Advantage. It aims to generate the returns you need to offset the treadmill of demographics, inflation, taxes and all the other headwinds you face.

Find out how, here.

Until next time,

Nick Hubble
Editor, Fortune & Freedom