Private savings for retirement: a complement to state pensions

Reform of state pension systems is one of the issues that are currently stirring up most debate in developed countries. One of the methods frequently proposed to reduce pressure on state pension systems is by complementing retirement funding via private savings. In fact, private pension plans already play an important role in channelling retirement savings in many countries.

But private savings are still quite negligible in Spain compared with its peers. The financial accounts for Q3 2016 indicate that pension and insurance plans, specific instruments to save for retirement, accounted for 18% of all household financial assets compared with 34% for the euro area as a whole. The proportion of investment funds and shares, however, was 10 pp higher in Spain (36% vs. 26%). In any case the still preferred way to save money, both in Spain and the euro area, is via deposits (see the chart).

Housing and property in general also makes up a large proportion of Spanish household assets. The proportion of households that own their main residence is 83% in Spain, notably higher than the 61% observed in the euro area and almost double Germany’s 44%. If we add other property owned, such as second homes, then the proportion of Spanish households that own property rises to 87%.1

One possibly surprising fact is that the percentage of Spanish households with a pension or insurance plan remained almost unchanged between 2005 and 2014. In fact, it declined slightly from 29% to 26%. This is certainly due to the economic crisis (for instance, there is a notable reduction in the percentage of households with pension plans where the reference person is self-employed). Given the economic recovery and low interest rates since 2014, it is very likely that this trend has now reversed.

As in other countries, the propensity to take out a pension plan tends to increase with age. In Spain, 31% of households where the reference person is 35-44 years old have a pension or insurance plan, while this percentage rises to almost 40% from 45 up to 65. In general, people tend to start late and save little, limiting the complementary contribution that can be made by private savings for retirement. Delaying the start of saving for retirement actually has a significant cost, as it fails to take advantage of the multiplier effect of compound interest. This can be illustrated by a simple example. Contributions of EUR 3,000 per year (increasing 2% each year, approximately in line with inflation) for 40 years with an average annual return of 5% (achievable if part of the savings portfolio is invested in equity) would provide a retirement capital of EUR 507,355. On the other hand, if the decision was taken to make larger contributions but starting later, the outcome would clearly be inferior: contributions equivalent to EUR 6,000 per year as of today (also increasing by 2% each year), starting within 20 years and for 20 years, would become EUR 364,270.

It is particularly important to plan early for retirement in the current low interest rate environment. A longer timeframe means that a larger proportion of savings can be invested in assets that offer a better long-term combination of expected yield and risk, such as equity.

The area of economics that studies how people act, known as behavioural economics,2 identifies three conducts that influence the decisions made by individuals and can explain this lack of discipline in saving. First, we tend to delay decisions with no short-term benefit but which are nevertheless difficult or unpleasant to take. This behaviour is known as procrastination. It has also been shown that, in many cases, we underestimate the importance of good planning for the future, known as myopia or a short-sighted attitude. Finally, academic literature has demonstrated that a lot of decisions are taken through inertia and that we often find it difficult to change our pattern of behaviour. Procrastination, myopia and inertia are three human traits that, applied to long-term savings, help us to understand why, in many cases, we take too long to start saving for our retirement and why we save too little once we do start.

Most countries offer tax breaks to encourage people to take out private pension plans, such as discounting contributions from the income tax base (up to a limit), thereby delaying the payment of tax on this portion of income and its interest until it is paid out in retirement. But some countries have gone further and have opted to implement a mandatory or quasi mandatory private pension system that imposes a minimum obligatory contribution. A more flexible alternative that helps to improve discipline in saving but without forcing people is automatic enrolment. In such systems, companies must sign up workers with a pension fund when they join. Employees then have the chance to modify their level of contribution and even leave the fund. These automatic plans were implemented, for instance, in the US, UK, Italy and New Zealand with an overall positive impact on the household savings rate. Another advantage of automatic enrolment is that, as a reform, it is politically more attractive to impose than making contributions compulsory.

Another increasingly important tool to encourage people to plan properly for their retirement are financial education programmes. In the past few years, the major international institutions such as the IMF, OECD and G-20 have all stressed their importance, as well as warning about the low level of financial awareness among large segments of the population in the advanced countries. One such programme is the Financial Education Plan (Plan de Educación Financiera) set up in Spain in 2008 under the leadership of the National Securities Market Commission (CNMV) and the Bank of Spain to enhance the population’s financial literacy levels, providing the basic knowledge and tools required so that people can manage their finances in a responsible and informed way.

In short, given the pressure that state pension systems are under, private plans are likely to become much more important as a complementary source of income in retirement. Measures such as tax breaks, automatic enrolment in company pension plans and financial education can all help to raise awareness of people’s need to plan properly for retirement in line with their own priorities and needs.

Mathieu Fort

Financial Markets Unit, Strategic Planning and Research Department, CaixaBank

1. European Central Bank (2016), «Eurosystem Household Finance and Consumption Survey».

2. See Benartzi, S. and Thaler, R. H. (2013), «Behavioral Economics and the Retirement Savings Crisis», Science Magazine, Vol. 339.