Retirement Pension Plan
Research in many countries as well as in Malta shows that not only that individuals display low levels of financial literacy but also that financial illiteracy is linked to lack of financial planning and insufficient resources in retirement – given that for many persons, financial security in retirement depends on the State pension.
What explains this low level of retirement preparedness? Why do people do so poorly when it comes to designing and carrying out retirement saving plans?
Research repeatedly shows that there are significant gaps in knowledge about retirement. Moreover, many people are focused on the short term as they plan for retirement; when planning for retirement many people (and professional advisers) limit their focus to investment management; there is significant misunderstanding about potential life spans and their variability.
What constitutes ‘enough’ retirement income? Retirement income adequacy may be defined relative to a standard of minimum needs, such as the poverty rate. Alternatively, it may be defined to represent the level of spending households experienced during working years. Many argue that retirees do not need to replace 100 percent of the pre-retirement income to maintain standards as spending profiles of elderly persons change – for example they would no longer need to invest in their children’s education or pay off the mortgage. Moreover, in Malta’s case significant in-kind benefits are provided by the government to elderly persons – such as health care, community care and long-term care.
Yet people are not only living longer than previous generations but are significantly far healthier and leading much more active lives. Thus, ensuring that an individual has the necessary level of income during retirement demands one’s comprehension of the value of the pension income on retirement and how this compares with the quality of life that person seeks in retirement. This necessitates an understanding of how the pension system works and how saving and investment behaviour during one’s working life can impact, positively or negatively, one’s pension income.
The pension reforms carried out recently in Malta have sought to safeguard that the level of the replacement ratio for the state pension income during retirement would be such that it would provide adequacy and, hence, dignity, during retirement. What this means, of course, is that the income from the State pension alone will, particularly for persons in the lower to middle income categories, definitely not be equal to the income received during employment.
Surveys carried out by the National Statistics Office on behalf of both the 2004 and 2010 pension reform working groups showed that to the majority of households the State pension constituted the foundation of income in retirement. It follows therefore, that persons particularly those who have an income higher than the Maximum Pensionable Income (€17,842 for persons born between 1952 and 1961; and €21,749 for persons born on and after 1962) who during their working life cycle decide that their main income during retirement will derive from the State pension face a gap between the income received during employment and the income they will receive in retirement – a gap, which, unless planned for, is likely to result in a significant impact on their quality of life during retirement.
The reform groups, in both 2010 and more recently in 2015, in the studies they presented to Government, underlined that parametric and systemetic reforms to the pension system architecture alone do not suffice. Two other important reform thrusts were required:
The first is the introduction of a ‘Third Pension’ – that is a voluntary private savings retirement pension scheme that incentivises persons to save to complement their State pension income when they retire. After first recommended for introduction in the White Paper on pensions reform in 2004, the Third Pension Framework was finally introduced in 2014. In November 2015 we saw a number of financial service providers launch the first third pension products.
The second is financial education and literacy. Experience overseas clearly shows that good financial literacy skills enable persons to make better-informed decisions with regard to their short and long-term financial well-being in an increasingly complex financial marketplace. Faced with too much choice, people are likely to make the wrong decision or no decision at all: they will not buy a product or stick with what they already have. As self-responsibility for retirement planning increases, the need to improve levels of financial literacy through financial education becomes increasingly apparent: people will need to know how much and how to invest and they will need to become involved with financial markets in order to build their families’ asset wealth and to manage that wealth during different cycles of their life journey. It so follows, therefore, that it is of paramount importance that when persons save for their retirement they are aware of the investment vehicles they choose, the associated risks, their rights, etc. Knowledge on retirement income and financial literacy is, undoubtedly, a key life skill for current and future generations.
One of the key recommendations presented by the Pension Strategy Group in 2015 is the re-constitution of the Commission for Retirement Income and Financial Literacy. The Government has accepted this recommendation and early in 2016 will formally announce the Commission. At the launch a three year draft entitled ‘The National Strategy for Retirement Income and Financial Literacy: Knowledge, Planning and Action – 2016-2018’ will be launched for public consultation.
David Spiteri Gingell
Chair, 2004 and 2010 Pensions Working Group; and Member 2013 Pension Strategy Group, Malta