Back when the national retirement age was first set, life expectancy was 72 and retirement was expected to be a few years of well earned rest. Now, it can last a third of our lives - and the figure is still rising. According to a study in the medical journal, Lancet, half of all babies born since the year 2000 in rich nations can expect to reach the age of 100.
The baby boom
For many developed nations, the challenge of an ageing population is made more acute by the ‘baby boomers'. This generation started at the end of the Second World War when soldiers returned home to a grateful nation and an environment of renewed optimism. Over the next 20 years, the economy and the birth rate both rose dramatically.
It is self-evident that the baby boomer generation has been at the heart of some of the most profound changes in our society and in the wider economy over the past fifty years. Developments as diverse as credit-cards and the contraceptive pill moulded the experiences of the generation that would give rise to the phenomenon of the teenager! However, the important change for the nation's finances started in the 1970s, when the boomers were ready to buy a home. At the time, these cost an average of £5,000. This was slightly more than two times the national income, which meant they were quite affordable.
House prices then rose over the decade, so when it was time for the boomers to upgrade to a family home, the price was around four times the average income (around £32,500). However, this was still affordable, as crucially, household savings rates had also risen.
The following generations
Today, the average family home costs £325,000, which is over ten times the average income. As a result, the baby boomers have become the richest generation this country has ever produced. Unfortunately, this has also meant that following generations have had to pay much more for their homes, so they've had to go more heavily into debt.
Even the baby boomers themselves are now facing challenges. Many will not want to use their savings purely to generate an income (which would have been the case with previous generations) as they need to preserve their capital for their children or grandchildren.
Understanding the power of demographics
Of course, the baby boomers are just one example of the influence that demographics can have over every economy on the planet. Put simply, the younger your working population, the more of the future you consume today through debt. As a society, we have to hope that when we arrive at that future, there's enough money left to pay for the retirement of the ageing population. This is a challenge that is likely to be faced by countries around the world over the next 20 to 30 years.
Closer to home, Standard & Poor's gave a good example of the problems that the UK must deal with. In 2006, they suggested that gilts would reach junk status within 30 years if nothing was done to face the challenge of the generation gap. It's chastening to think that this prediction was made before we had to face the fallout from the financial crisis.
Searching for a solution
So what's the solution for the UK? One option could be to incentivise people through the tax system. Instead of asking people to pay tax on their earnings when they have to work in retirement, we could make it tax free. We could also incentivise people to opt out of the state pension system through tax allowances, rather than forcing them to have their incomes means-tested.
In addition, we could look at using the skills that the baby boom generation have built up over the last 40 years. Their expertise and experience could be invested in a programme of mentoring and apprenticeship. This could help future generations face the challenges of the generation gap, rather than being overwhelmed by them.
Further insights
Visit iView to hear Steven Andrew, manager of the M&G Income Multi Asset Fund, talk more about the challenges of the generation gap and discuss some innovative solutions.
For Financial Advisers only. Not for onward distribution. No other persons should rely on the information contained in this article. House price and affordability calculations: Department for Communities and Local Government, Office for National Statistics, M&G calculations. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The company's registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776.
