Younger generations likely to face lower standard of living at retirement

• Central Bank Research Technical Paper finds that demographic changes have led to a build-up in wealth among older generations, and a decline in rates of return.
• Younger generations therefore face significant challenges in building up sufficient wealth to fund their retirement.
• As a result, future retirees are likely to face progressively lower standards of living at retirement than previous generations.

The Central Bank of Ireland has today (31 August 2022) published a Research Technical Paper, “Wealth Accumulation and Inter-generational Inequality with Inverted Population Pyramids”, authored by Simone Cima. The paper considers the impact of changing population dynamics on the economy and what this means for the ability of younger generations to fund retirement. It finds that in advanced economies, younger people face significant challenges in building enough wealth to fund the same standard of living at retirement as the generations preceding them. 

The paper notes that demographic changes mean many developed economies are transitioning to an inverted population pyramid, with a greater number of older people than younger people. As a result, the labour force is smaller relative to the size of the population, while an increasing amount of wealth is concentrated among older populations. These developments have contributed to a decline in rates of return on wealth, as there is an abundance of wealth relative to the working population.

Lower rates of return mean that it will be increasingly difficult for younger people to build up wealth for retirement through the accumulation of returns. The paper finds that, while younger cohorts might benefit from higher wages compared to previous generations, the negative effect of lower returns means they may not be able to accumulate as much wealth out of their savings as previous generations. With current demographic trends, future retirees will likely face a progressively lower standard of living as a result. This in turn may be exacerbated by the need to fund a longer retirement (due to increased life expectancies) and by potential changes in public policy. With public finances coming under increasing strain from pension provision, younger generations may face higher taxes during their working life and/or reduced income from the State at retirement. 

The paper also considers whether wealth transfers from older to younger generations might offset these developments. This wealth may ultimately be transferred to younger populations. However, longer life expectancies means wealth would be transferred later in life, and, due to lower birth rates, it will transfer to a smaller number of heirs. This, combined with existing wealth inequalities means that wealth transfers may exacerbate both inter-generational and intra-generational inequality.

The paper concludes by considering potential policy measures to address these developments in light of future demographic challenges. Investment in research and development leading to strong technological growth can counteract the decrease in returns due to demographics. Additionally, improved financial education may help to equip households with the skills to invest more widely and therefore to optimise returns on savings and wealth, especially at the lower ends of the wealth distribution. An increase in the pension age, given longer life expectancies, is another potential consideration. 

ENDS 

Notes to Editor

“Wealth Accumulation and Inter-generational Inequality with Inverted Population Pyramids” draws from a number of data sources. The Penn World Table's edition 9.1 provide data on macroeconomic aggregates such as GDP and other national accounts components, the capital stock, employment, productivity, capital share of income, and depreciation data. 

Population data is derived from the UN World Population Prospects 2019. 

These data sources are combined to create a panel dataset comprising 64 countries over a period from 1950-2100.