Retirement roulette: The perils of inadequate knowledge in planning

Last week I attended a pension seminar organised by APS through the Malta Sustainability Forum. The seminar’s theme was “Confronting pension inequity – unmasking the silent struggle”. One of the main discussion points centred around the importance of financial capability to bridge income earned in employment and income from the state pension. The Malta PAYG pension system, as I discussed in previous articles, is designed to secure dignity in retirement – also achieved through benefits in kind provided by the state, including but not limited to free health, medicines, transport, and so on.

The PAYG is not designed to provide a pension income close to income earned in employment concerning persons with an employment package over the maximum pensionable income (MPI) – the threshold on which the 2/3rds pensions are calculated. For persons born in and after 1962, the MPI is €26,831. Assuming that one meets all the parametric criteria, the maximum pension a person is entitled to is €17,887. What the above means is that for a person whose salary was €30,000 before retirement, on retirement if they are dependent solely on the state pension, their income will fall to a potential maximum of €17,887, which can be less if a person has gaps in their 40-year contribution accumulation period or did not pay the maximum contribution on 10 years over the 40 years. This means at midnight of a person reaching their retirement date; their income falls to 60% (6% less of the social contract of the 2/3rds social security contribution) of what they earned while in employment. This impact on income during retirement widens the higher the salary compared to the MPI.

Bridging the gap between income earned during employment and the state pension is a matter of self-responsibilisation. To incentivise persons to plan for retirement, the government introduced voluntary private pensions (VPP) and voluntary occupational retirement pensions to be offered by employers to their employees. The incentive relating to VPPs are a tax credit of a maximum of €750 on a maximum contribution of €3,000 annually and a tax-free lump sum of 30% of the accumulated nest egg through the VPP. This monetary incentive is designed to overcome behavioural heuristics of myopia and inertia when planning for retirement.

All of the above assumes that one has a clear understanding of what their state pension income shall be so that a person can take the right steps to bridge the gap, partially or fully, between the pension income and income earned during employment and thus embark on retirement planning including investing in a VPP. Yet, is this case?

Ġemma, the government’s financial capability education platform, in March 2021, surveyed persons born in or after 1962. The survey aimed to identify the extent of their knowledge of how the state pension system works and their ability to make informed decisions regarding their retirement generally and the state pension specifically. The results of this survey attracted no attention. This is unfortunate. The results of this population cohort’s knowledge of how the state pension works and thus how it relates specifically to them, is disquieting. The following are some of the results of the survey (https://gemma.gov.mt/wp-content/uploads/2021/06/Final-110621-GEMMA-Survey-on-Pensions.pdf):

• 37% of males and 45% of females stated that they are not knowledgeable about the amount of social security they pay;
• Only 37% of males and 26% of females answered correctly that they pay a 10% contribution if employed;
• 61% of the respondents could not indicate the maximum pension income on which the 2/3rds pension income is calculated;
• None of the respondents was able to indicate that the MPI in their regard and that their pension income would increase on an indexation formula of 70% wage inflation: 30% retail inflation;
• 17% of the respondents only answered correctly concerning the number of social security contributions they will pay in a given year;
• Only 9% answered correctly to the question concerning the minimum number of contributions to be paid to qualify for a contributory pension;
• 37% of the respondents answered that they are unaware of how their pension income will be effected if they only paid 25 out of the 40 contributions accumulation period;
• Only 49% of the respondents stated their statutory retirement age is 65 years;
• 59% said they do not know how their state pension will be calculated;
• 86% said they do not know what a “crediting of a contribution” means concerning their pension;
• 82% stated they are unaware of a credit entitlement for child-rearing; and
• Only 12% stated that they know that they could benefit a credit entitlement for higher and further education.

This research strongly suggests that a significant proportion of persons born in or after 1962 are basing their retirement planning, if at all, on the wrong understanding of how the pension system works concerning them and the state pension income they are likely to receive. What this research unequivocally shows is that sustained financial capability education is imperative for persons to achieve their goals for a desired quality of life during retirement.