04 Aug 2022

A generational pension fund from birth reduces poverty in old age

A SAFE White Paper shows how the German pension system can adapt to demographic change with investments in the global capital market

Although people may earn very different amounts over the course of their working lives: poverty in old age can be avoided. According to a White Paper by the Leibniz Institute for Financial Research SAFE, one possible solution to this demographic problem is a generational pension fund from birth in addition to statutory pension insurance. Accordingly, the state invests a one-time amount of 5,000 euros in the global capital markets for each newborn child. This generational pension may be significantly higher than the average pension paid today. For this, it requires a consistent investment strategy, low administrative expenses, reinvestment of profits, and payment as a lifelong monthly pension at the earliest of 63 years.

“Our calculations show that, despite the associated fluctuations in value, global investment enables a secure pension above the poverty line from age 63. Thus, it fulfills set goals of pension policy as stated in the current coalition agreement,” says Raimond Maurer, Professor of Investment, Portfolio Management and Pension Finance at Goethe University, SAFE Researcher and, together with Prof. Dr. Hans-Peter Schwintowski of Humboldt University Berlin, one of the paper’s two authors. “Reinvestment of realized returns and capital market gains, long investment maturities, and a broad diversification and mix of retirement portfolios counteract old-age poverty, no matter what individuals’ personal work histories look like.”

Figure: Pension assets from age 63 (after inflation) with an investment of 5,000 euros from birth

(Management costs: 0,2% p.a. of fund assets) Mixed portfolio 1: 30% global shares (MSCI-World), 60% German government bonds (REXP), 10% open-ended real estate funds Mixed portfolio 2: 70% global shares (MSCI-World), 20% German government bonds (REXP), 10% open-ended real estate funds Lifecycle portfolio: 100% shares; from age 55, reduction of share quota by 5% annually in open-ended real estate funds and bonds.

The figure shows the final value of various investment strategies for an investment of 5,000 euros between 2010 and 2021 after 63 years: According to the value progression of the lifecycle portfolio (green), a 63-year-old person would have accumulated almost 700,000 euros of final wealth in 2010.

The two researchers use different risk scenarios and investment strategies to model pension outcomes from birth. For realistic incorporation of investment risks and past performance on stock, bond, and real estate markets into the sample calculations, the researchers observe the development of the global MSCI World index. It tracks the price performance of 1,513 stocks from 23 industrialized countries. The paper analyzes the period between 1948 and 2021, including crises, varying inflation, and interest rate levels.

Accordingly, if 5,000 euros had been invested from birth to age 63 in a lifecycle fund with a declining share of stocks in old age, this would result in total assets of 169,000 euros in the worst case, adjusted for inflation, or a monthly supplementary pension of 760 euros, a significantly higher amount than the current basic income level in old age of around 450 euros. In a medium scenario, 5,000 euros invested initially would grow to a total sum of 270,942 euros by the age of 63. With this investment strategy, an inflation-adjusted monthly pension of more than 1,200 euros can be financed – and thus even more than today’s average level of 950 euros from statutory pension insurance. In the best case, individuals can obtain a maturity benefit of over 700,000 euros or a monthly pension of more than 3,000 euros. However, the results are 80 percent worse if the savings process does not start until the age of majority and the 5,000 euros are invested conservatively, mainly in interest-bearing securities. Additional simulation calculations with 500,000 possible scenarios over the next 70 years show that the results are robust when the future development in the stock, interest, and real estate markets and the development of life expectancy is uncertain.

The proposal stipulates that an independent public entity administers the funds while they cannot include mortgages, be inherited, or transferred before retirement. The generated income of interest, dividends, and appreciation in the capital investment is initially tax-free. Only at retirement age, an individual tax rate does apply to pension payments, depending on the personal asset and income situation. As a result of our German progressive tax system, the tax burden is vaster the higher the additional pensions drawn from the statutory pension scheme, the company pension scheme, or a private pension plan. With a one-time payment of 5,000 euros for all newborns, the state does not only save the later expenses for the basic old-age pension, but it can also count on considerable revenues from the downstream taxation of the supplementary pensions. “With the ten billion euros that are in the coalition agreement of the current federal government, the state can build the capital stock for all newborns in the next two to three years,” says Raimond Maurer.

Download the SAFE White Paper No. 90

Scientific Contact

Prof. Dr. Raimond Maurer

SAFE Fellow