How Can Pensioners Around the World Protect Their Savings and Reduce Inflation Effects?

Can people afford to retire? For those old enough to ask this question, the answer is more likely to be: Not for today.

High inflation is nibbling away the real value of savings for many people around the world, as the continuous rise in interest rates in many countries has led to a repricing of bonds and stocks. Thus, the amount of assets that many future retirees are hoping to live off has dramatically shrunk, a result critics have long predicted, especially when populations age and the number of workers falls.

Retirees and national pension institutions will come under great pressure—a problem experts have called the “pension time-bomb.”

So, how to save “savings”?

 

Protect Your Retirement Income

Most people likely consider inflation in the short term when they go to the grocery store or when they fill up their vehicle with fuel. However, the issue is far beyond this; inflation is affecting not only goods in the grocery shop but also your retirement savings.

Retirees or those who are about to finish their career are often advised to shift their assets into bonds and get out of stocks as they prepare to be off in order to protect their savings from large stock market corrections.

“Life-cycle” pension funds typically make up 90-100% of the shares during the younger years of the retirees, a strategy aimed at capturing the higher returns that listed equities tend to generate over long periods. But with less than a month to go, 2022 looks set to be the worst year ever for bonds to lose some value.

Those who are about to hang up their boots have lost 17% of their value since January.

The upshot is that a year ago, a 65-year-old who had saved, for example, $2.5 million for his retirement, investing 80% in government bonds and 20% in stocks, would typically have made an income of $100,000.

However, the collapse in asset prices meant that pot had fizzled to about $2.1m in 12 short months, allowing him to draw down nominal annual payments of just $83,000.

Meanwhile, the resurgence of inflation has nibbled away another 10% of that income, leaving the old man with only $75,000, and the deflation is not over yet. So, poverty could very quickly become a reality for millions around the world.

How to avoid that?

Hamza Guenouni, the researcher at Kent University, answered this question during his interview with Al-Estiklal and said: “While retirees can’t directly protect their savings from inflation rate, there are ways to at least minimize the shadow it casts over their retirement, like reducing housing costs like moving from a larger home to a smaller one to reduce the property taxes paid per month, also homeowners insurance, and maintenance.

“Retirees should try to make sure they can get sources of income that are associated with cost of living adjustments as some income streams will automatically increase due to inflation while others will be stagnant. Thus, retirees should move away from fixed-income sources of income,” he added.

Hamza continued: “Another important point pensioners should think of is calculating their retirement needs as early as possible. By factoring inflation into what they will need, it’s easier to plan for when to leave work and what type of lifestyle they will be able to afford when considering price increases.”

The most important thing is “balancing stock investments with more conservative options, such as bonds, as they are more predictable and tend to provide stable returns,” according to Guenouni.

 

Covid-19 and Retirement

After Covid-19 and with many people around the world experiencing working from home, many workers turned to early retirement. In the United States, for instance, the Federal Reserve Board in St. Louis estimates that the number of retirees reached 3.3 million in October 2021, meaning that more than half of Americans over the age of 55 retired from their jobs, an increase of 48% compared to 2019.

According to The Economist, there appears to be a similar pattern across the Organization for Economic Co-operation and Development club (OECD) of mostly rich countries.

Survey data indicates that some recent retirees are considering returning to work. But those who don’t, or can’t, may face tougher years than they expected. However, individuals are not the only ones who are affected by inflation, but governments also are among the victims and will bear the burden of the adjustment through social security and national insurance schemes, “and part of it will be borne by a creature that is becoming ever rarer: the defined-benefit (DB) pension plan,” according to The Economist.

Many of those who think about retirement today spent a large part of their lives working during the golden age of DB plans, when companies or employers in the public sector, such as schools, agreed to pay workers an annuity after they stopped working.

Total retirement assets in America today are about $40 trillion, of which $17 trillion is held in such schemes. The typical DB payment is 2% of a worker’s final salary multiplied by years of service.

So a teacher who worked for 40 years, for example, and who retired when his salary was $80,000 a year, would earn $64,000 a year for the rest of his life. The business owner, then, will bear all the investment risks that the retiree may face.

 

Pension Schemes

But as life expectancy has risen in recent decades, an aging population has increased pressure on interest rates. It is gradually becoming clear to companies and public sector agencies what DB pension plans are for workers and how difficult it will be for employers to keep their promises.

From the 1980s, the private sector started to re-adjust its offerings of such plans: The employees’ share in DB schemes in America fell from nearly “two-fifths at its peak to just a fifth by 2008. Then the strain of the financial crisis prompted many firms to reclassify DB plans as defined-contribution schemes, where workers simply contribute a set amount to the pot with no guarantee of what they get back after retirement,” as reported by The Economist.

Workers in public sectors, however, had less success in reducing their exposure to these lavish pension offers.

Around $13trn of America’s DB assets are managed by local and federal governments. Many of the biggest DB schemes and some of the biggest pension funds are run today by public institutions, “such as the California Public Employees’ Retirement System (CalPERS) and the Ontario Teachers’ Pension Plan (OTPP), and have assets worth hundreds of billions of dollars,” mentioned The Economist. The portfolios of many schemes may suffer more when many more of their members will be ready to ask for their money.