Unveiling the Flaws in Europe's PAYG Pension Model

In Europe today, the majority of public pension systems operate under a pay-as-you-go (PAYG) model. This entails using the current social contributions made by each worker to cover the pensions of present retirees. When first introduced, this system was innovative, but it has always operated on the assumption that the number of workers is greater than the number of pensioners. But what happens if this ratio is reversed? This question is pivotal, as a simple Google search for 'EU Pension Crisis' quickly highlights potential long-term concerns.

For example, a search result citing the EU political report of 11 Mar 2023 states that: "Europe will have 35 million fewer workers by 2050 and almost 50 million more pensioners. The population aged sixty and above will comprise approximately one-third of the total, and according to the OECD's projections, pension expenses are poised to consume an unsustainable 12 percent of GDPs”. While the specific metrics might be subject to debate, the ramifications of a reduced number of contributors to a collective system could escalate into a significant predicament.

For instance, in April 2023, French President Macron enacted a law to increase the state pension age from 62 to 64. Following the implementation of the changes, protesters mobilized in various forms, culminating in widespread mass demonstrations. President Macron contended that these reforms were crucial to avert the collapse of the pension system and to address a 13.5-billion-euro deficit.

Similarly, following three consecutive international bailouts spanning from 2010 to 2015, Greece found itself in a challenging predicament as it grappled with the economic implications of these agreements. As part of the bailout stipulations, the Greek government was compelled to implement a series of pension cuts, a decision that significantly impacted the country's pensioners. These austerity measures triggered a wave of protests among pensioners who were deeply affected by the reduced financial support. In the face of mounting opposition and societal upheaval, the Greek government was compelled to reevaluate its approach. In the subsequent years, recognizing the social and political implications of the pension cuts, adjustments were made to strike a balance between meeting international obligations and addressing the pressing concerns of its citizens.

Modern history shows us that the PAYG (pay-as-you-go) pension model has become a persistently contentious matter; one that short-term coalitions seem reluctant to address head-on. In certain cases, there are even those who might try to take advantage of the model´s flaws for their own gain.

In his annual chairman’s letter for this year, Larry Fink of BlackRock expressed that “The world faces a ‘silent crisis’ when it comes to retirement. You rarely hear about it in the news media. It’s not part of the political dialogue in most countries. And corporate leaders rarely discuss it - not in public, anyway.” He added: “It doesn’t make headlines or attract attention because it’s not immediate. It’s not this year’s - or even next year’s - problem. But it is a crisis. And the longer we delay the conversation about it, the larger the crisis grows.”

Yet, the challenges are significant - lower expected market returns, increased housing and healthcare costs for retirees, and the shifting of retirement risks onto individuals have collectively made it increasingly difficult to provide support for extended periods of longevity. Given that BlackRock stands as the largest asset manager globally, such remarks certainly warrant consideration.

What should hold the utmost importance are the steps individuals can proactively take to secure their long-term well-being. In numerous countries, there are available options within pension pillars 2, 3 and 4, that offer potential for fiscal optimization and tax-efficient utilization during retirement. Crafting a personalized game plan for each individual, whether they're an independent worker or a company director, requires unique considerations and should be approached with appropriate guidance.

As perhaps the greatest investor once said: “Someone is sitting in the shade today because someone planted a tree a long time ago“.

Complimentary Guide to Belgium's Pension System

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