A recent study by Alexander Forbes suggests that today’s average 40 year old will have 30% less funds in retirement than the previous generation due to lower market returns, longevity and lower savings rates relative to income.

The Alexander Forbes Pensions Index, which was launched in April 2012,  indicates how the income a typical person is projected to receive in retirement has changed since January 2002. The index tracks three indices based on three savers and it reflects the impact of market conditions, longevity as well as savings rates across generations.

The three savers were born on 1 January 1972, 1 January 1962 and 1 January 1952. On 1 January 2002, they were 30, 40 and 50 years old respectively and all expected to be on track to have a pension that replaced 75% of their pre-tax salaries when they retired at age 65. This means that for each saver, their index value was 75 on 1 January 2002.

However due to declining market conditions those values have fallen significantly and the 60 year old born in 1952 is now only expected to receive an income of 57% of final salary in retirement while the 40 year old saver is only expected to receive a replacement value of 40% of their final salary.

Michael Prinsloo, Head of Best Practice at Alexander Forbes Research and Product Development says all three savers were invested the same way however the saver born in 1952 has a considerably better index value than the saver born in 1972 due to the fact that the retirement savings landscape has changed.

Prinsloo says the investment outlook today is considerably gloomier than it was ten years ago and younger members are expected to be invested in these less favourable markets for longer. In addition, salary inflation has been high relative to investment returns in recent years. This decreases the index because past savings are proportionately lower relative to the current salary and this effect is amplified over time to retirement when final salaries are expected to be significantly higher for younger members.

For members who are only five years away from retirement an effective drop in expected retirement income of 24% over the last ten years has serious consequences. They only have five years to boost their reduced savings, alternatively they will either have to work longer where possible or seriously reduce their lifestyle in retirement.

Alexander Forbes says although younger members do have time on their side to rectify problems, the index shows that they are sensitive to weaker market conditions and also face two additional challenges: longevity and higher consumption rates.

In terms of longevity the costs of purchasing an annuity in retirement are expected to increase as insurers price for the average member to live longer. At the same time younger people have much higher rates of consumption than the previous generation which not only leaves less money to save but also increases the cost of their lifestyle which they wish to maintain in retirement.

Ultimately younger people need to reconsider the amount they put away for retirement which will need to increase significantly in order to make up the shortfall in market returns. It is also very unlikely that a 40 year old today will be able to afford to retire at age 65, especially if they are expected to live into their 90’s. Prinsloo says this will also require a re-think by employers in terms of contribution rates and retirement ages for younger employees.

 This article first appeared in Mail & Guardian