Pension
IDA members risk financial shock when they retire
Sell your house or significantly reduce your living expenses. This could become a real dilemma for many IDA members when they retire.
These members have paid so little into their pensions that they can expect a significant drop in their income when they leave the labour market, a new analysis conducted by the Labour Movement's Economic Council for IDA concludes.
The analysis compares three groups: a group of people who are eligible for IDA membership, a group with other long-cycle education and a group representing the rest of the population.
The conclusion is that 62 per cent of the IDA group has a coverage ratio of less than 70 per cent, while the same applies to 56 per cent of the group with other long-term educations.
Most pension funds recommend a coverage ratio of 80 per cent, which means that you will continue to receive 80 per cent of your income when you retire. This reflects the fact that most people still have mortgage and car loan expenses, but that they do not need to save up as much as they did in the past.
IDA's chief economist Anders Overvad calls the results of the analysis an eye-opener.
'The reason for conducting this analysis was that we had a suspicion that many IDA members were saving up too much. We have now done a complete U-turn, because when we look at the group of IDA members, many of them are set to experience a significant drop in income.'
You should contribute 16 per cent of your income to your pension
There are two explanations for why the IDA group is set to experience a greater decline in income than other highly educated persons. The first is that they are more likely to work in the private sector and in industries where pension contributions are low.
The second is that they are highly paid and have to contribute more to achieve a good coverage ratio because the Danish state pension accounts for a smaller proportion of their income as pensioners.
IDA recommends that people contribute at least 10 per cent of their income to their pension at any given time and that they contribute 16 per cent on average over their entire working life.
'Looking at this analysis, it seems that there is a belief that a savings rate of 5-10 per cent can ensure a comfortable retirement, but that is far from certain,' says Anders Overvad.
'Ideally, you should aim for 16 per cent, and yes, that is a lot of money, but it also gives you greater flexibility as you approach the end of your working life.'
According to IDA's chief economist, it is not just a question of being able to sweeten your retirement with travel and experiences, but also of having a safety net if necessary.
‘Unfortunately, we are seeing more academics having to stop working because they are suffering from stress or are on long-term sick leave. In that case, you are better off if you have pension assets, and you are not as dependent on whether you have paid off your house or whether it has increased in value since you bought it.’
The elderly in particular have saved up too little
It is particularly the generations who are about to retire who will experience a significant drop in income.
Among 60-66-year-olds in the IDA group, 29 per cent will see their income halved when they retire, while the expectation is that this will apply to 10 per cent of 30-34-year-olds. According to Anders Overvad, this reflects the fact that the pension system has become much more extensive than when the older generations entered the labour market several decades ago.
Although the analysis shows that the IDA group has decent pension savings on averagem this masks large differences, and those with the lowest coverage of less than 50 per cent in particular will not have much to sweeten their retirement.
'Those who experience the largest drop in income have assets of around 700,000 in free funds and roughly the same amount in equity in their homes,' says Chief Economist Anders Overvad.
It is this group in particular that may end up in a difficult dilemma, where they have to consider selling their home.
'They may have to, but it is rarely a good solution. Usually, you live where you do because you like it, and it is no fun having to move. Nor is it certain that you will actually save much, as it is typically more expensive to rent – especially if you have paid off a large part of your house,' explains Anders Overvad.
His advice to IDA members who are due to retire within the next few years and who have not paid enough into their pension is to seek personal financial advice.
'If you have discussed your wishes for your retirement, you are in a much better position. Of course, it is better to do this in your 30s than in your 60s, but better late than never, and perhaps there is an opportunity to invest your free funds or housing assets more wisely,' says Anders Overvad.
New graduates can benefit from compound interest
When you are in your thirties, there are many expenses associated with starting a family and buying a home. Therefore, it comes as no surprise to Chief Economist Anders Overvad that only 31 per cent of 30-34-year-olds contribute more than 15 per cent of their income to their pension, compared to 54 per cent of 60-64-year-olds.
But from a financial point of view, it makes the most sense to contribute to your pension in the early stages of your working life. The longer your money is invested, the more it will grow with compound interest. For example, if you have 500,000 Danish kroner in your pension, with an interest rate of 3 per cent, it will be worth almost 420,000 Danish kroner more over 40 years compared to if it accrues interest over 30 years.
Chief economist Anders Overvad also points out that it will not necessarily be easier to contribute to your pension later in life and thus make up for lost ground.
'It is expensive to have small children, but so is having teenagers. So you have to carefully consider whether you will reach a point in your life where you have the financial means to make up for what you have lost. Priorities are tough, but you have to think about what kind of old age you want.'
And you should not only think about how much to contribute to your pension, but also how to invest it.
Women cheat themselves out of up to DKK 1 million
The analysis also shows that women's pension assets amount to 88 per cent of those of men in the IDA group because they often work in sectors with lower salaries and have more breaks throughout their working lives, partly due to parental leave. However, one low-hanging fruit for many women would be to increase their risk profile, says chief economist Anders Overvad.
'What we know from pension funds is that many people do not consider their risk, and that this is especially true for women. If you compare a man and a woman who are broadly similar and have the same income, the man will typically take a high risk, while the woman will take a medium risk, and this could ultimately cost her up to a million.'
'From a financial point of view, the recommendation is that you should take the highest risk when you have the longest time horizon. Of course, it's a shame that you may incur some large losses along the way, but you can reassure yourself that there will be many years to reap the rewards.'
Chief economist
Anders Overvad
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