Pensions: don’t rely 100% on the government

By David Rumsey

Managing Director

3D Global Financial Services

 

Recent statements by the Minister for Labour and Social Insurance, Antonis Vassiliou, underline why it is a good idea to back up your state and Provident Fund pensions with your own private arrangements.

Mr Vassiliou said on October 25 that the only options for ensuring the viability of the social security fund were to increase social security contribution rates, raise the retirement age, or lengthen the number of years a person must work in order to qualify for the state pension.

Whichever path is chosen, it is clear that to earn a state pension in future, we shall all have to either accept less money in our pockets via higher social insurance rates, or work longer to earn enough years of credit to draw the pension.

These statements reflect the fact that the pensions system in Cyprus, like many others in Europe, is facing serious difficulties, caused by demographic and social changes.

The social insurance contributions made by you today are not put away by the government and saved until you retire. Under the “pay-as-you-go” system used by many countries across Europe, your social insurance payments are spent immediately on today’s pensioners.

This system works fine when the proportion of workers to non-workers is steady. But it works much less well when the proportion of workers is shrinking.

 

Fewer taxpayers funding more pensioners

 

And that is exactly the challenge that Cyprus faces in the coming years.

Couples have fewer children than they did 50 years ago. This means that the proportion of older people drawing pensions is rising, while the proportion of younger people paying taxes is falling.

According to the Ministry of Finance’s Convergence Programme 2005-2009, the proportion of older people (over-65s) will rise from 12% of the population in 2002 to 28% of the population in 2050.

At the same time, the working-age population (those paying the taxes) will fall from 67% of the population in 2002 to 61% of the population in 2050.

“These projected demographic changes would result in the old age dependency ratio rising unfavourably from 17% in 2002 to 46% in 2050,” the Convergence Programme says.

If there is no reform, the government projects a debt/GDP ratio of 250% of GDP, compared with less than 70% today.

This would almost certainly lead to huge tax rises that would cripple the economy.

 

Reform could take too long

 

Over the next few years, therefore, the Cyprus government will try to implement some highly unpopular policies.

If you think back to the introduction of VAT, these policies will take a long time to implement.  

But with pensions, the longer you leave the problem, the worse the public finance situation becomes, and the harsher the measures required to make it better.

For example, if the retirement age remains the same for the next ten years and social insurance rates remain the same, the government is likely to face a deep financial crisis that will make it difficult to meet its pensions commitments.

Under these circumstances, therefore, it would not be wise to rely 100% on the government for all of your income needs in retirement.

But nor is it advisable to rely 100% on Provident Funds. They also face problems, which I plan to revisit in more detail in future articles.

 

The third pillar: personal pensions

 

Faced with these problems, governments in Europe are actively encouraging the “third pillar”, namely personal pensions.

A typical personal pension plan is placed in a fund that invests in a wide range of assets: international stock markets, international bonds, property and commodities like gold or oil. 

These funds operate in a highly competitive market, so have to perform well. The fund managers are constantly assessed for performance against their peers, while independent financial advisers such as 3D Global keep a constant watch on the fund’s fees.

This means that they have to do much better than just keeping pace with inflation.

Good balanced euro funds – that is, funds which invest in a wide range of assets but avoid highly risk assets – have risen by as much as 8% per year in the past 5 years and by 12% in the past 3 years.

This is far better than even the ten-year Cyprus bond, which had an average yield of just 4.3% in early October.

In future articles, I’ll look at how saving can help your tax bill too.

But for the time being, let me leave you with this thought.

Relying on the government alone means that all of your risk is located in one place.

Don’t put all your eggs in one basket.

 

3D Global Financial Services Ltd., www.3dglobal.com , is regulated by the Cyprus Securities and Exchange Commission.