While longer lives are good news for most people they are creating a major headache for European governments. People living longer require more health and social care as well as pension payments over a longer period of time. All this has to be paid for and as governments juggle finances to reduce their budget deficits, they are also looking at pension reforms and other ways to boost finance for state pensions and welfare costs. This could potentially include further tax rises to cover the cost of increased longevity.
Over the last 100 years or so, accelerated medical advances along with a heightened awareness of health issues, improved food consumption and living standards has extended life expectancy, not only in Europe but worldwide.
The European Parliament’s study in January this year headed “Demographics, financial crisis & pensions: How to help the system?” highlights some interesting points:
•The population of the European Union as a whole will be slightly larger in 2060 than today but older.
•In 2008 the population was about 495 million. It is estimated to grow to 520 million by 2035 and 506 million by 2060.
•In 2008 half of the population was age 40 or more; in 2060 it will be 48 years or above.
•In 2060 there will be more than twice as many people above 65 than children below 15.
•In 2060 the number of very old people might amount to 80% of the number of children.
•In 2008 the dependency ratio (relationship between the numbers in employment to those too young to work or retired) in Europe equalled 4:1. In 2060 it will be 2:1. In other words there will be around half the number of people paying taxes and social security to fund those in retirement.
Taking Spain as an example, the National Statistics Institute forecasts that the by 2049 the population over the age of 64 will double, representing over 30% of the total population, and the ratio of workers to retirees and minors (aged under 16) will be 10 to nine. The dependency rate will have soared to 89.6% from its current level of 47.8%. Life expectancy at birth is set to reach 84.3 years in males and 89.9 in females in 2048, which is an increase since 2007 of 6.5 and 5.8 years, respectively.
Life expectancy will gradually increase over the years as medical science advances further. People will live even longer and the costs of care for the elderly will increase exponentially. Pensions will have to be paid out for a much longer period of time. When the current pension age was set in the 1940s, people were only expected to live on average around seven years into retirement. Today they can expect to live 20 or 30 years as retirees, which is almost a third of the average lifespan. Governments realise that they have to act now to tackle the situation which means longer working lives and possibly higher taxes to help provide the finances.
The UK, France, Spain, Cyprus, Ireland, Germany, Italy, Greece and the Netherlands have all announced increases or are reviewing both public and state pension ages all with the view to raising them. France proposes to raise the age from 60 to 62 by 2018 and the UK to 66 from 2016, possibly even higher. Spain wants to raise its pension age from 65 to 67. Germany’s pension age rises from 65 to 67 between 2012 and 2029. In some countries there has been public outrage and demonstrations against the reforms – but the blunt fact is that governments can no longer afford their outdated pension systems and everyone will have to pay more to finance their retirements.
As life expectancy lengthens and people spend more years in retirement it is not only state pension schemes that will have to last longer. On a personal level you need to ensure that your wealth will last at least as long as you do. You need to have enough spending power for you to enjoy a comfortable retirement all the way through. Ideally, you should not have to worry about whether you will have enough money to live on in your senior years or a back up sum for emergencies such as health care. You may also wish to leave a sum of money behind for your heirs.
Many retirees move their investments into more ‘safe’ assets, such as a bank deposit account. But with the prospect of 30 years or more to fund in retirement this is unlikely to be the right thing to do. Instead of keeping most of your money in a bank account, which can offer low interest rates, no capital growth and minimal tax mitigation opportunities, you should consider a strategic investment policy designed for capital growth over the longer term and regular income if required. This would often be a portfolio containing a diversified mix of equities, bonds, property and cash designed with the aim of outpacing inflation.
Your wealth needs to keep pace with inflation in order to protect your spending power and financial security through retirement. For example, if your personal rate of inflation runs at 4%-5% it can reduce your wealth by around 37% over a ten year period alone. Even a low rate will have an adverse effect over time. Annual inflation of just 2% would reduce the spending power of €200,000 to €109,100 after 30 years – that’s almost half its value wiped out.
The inflation threat is not clearly visible because it slowly eats away at the capital in your bank – but it can have a serious adverse impact on your wealth.
If governments continue on a course of increasing taxation to help decrease their deficits and fund longevity, your portfolio also needs to include legitimate tax mitigation structures designed to help you pay the least amount of tax possible wherever you live. With many of these arrangements you can combine your tax and investment planning in one exercise, allowing you to tackle the twin threats of tax and inflation at the same time and gain peace of mind about your financial security through retirement.
An experienced wealth and tax management firm like Blevins Franks will advise you on the available opportunities and suggest recommendations based on your specific circumstances, aims and objectives.
By Bill Blevins, Managing Director, Blevins Franks
6th July 2010