Money doesn’t buy happiness, the saying goes. Yet a lack of it can certainly have a negative effect on your state of mind. Take poverty among the elderly, for example. Not only is it heartbreaking for those affected, but it also undermines others’ confidence in their own retirement provisions – and with that, their overall well-being.
Pensions matter. Still, it is a largely overlooked topic in happiness research. APG colleague Eduard Ponds, along with several researchers, decided to change this. The full study is available on the Netspar website, but I’ve been given permission to share some conclusions here.
So, what did they find? Pensions contribute to happiness, albeit indirectly. Their research shows that funded pension systems contribute to people’s subjective well-being. Not because such a system makes people happy in and of itself, but because it helps provide expected financial security in later life. And that feeling of security is a significant contributor to overall well-being.
The idea that money is set aside for old age inspires more confidence than a purely pay-as-you-go system, where today’s workers fund the pensions of retirees. Due to population aging, with an increasing number of retirees per worker, such systems inevitably come under pressure. Roughly speaking, there are three options: higher contributions, lower benefits, or a later retirement age. Pick your poison. Governments can postpone the issue for a while by increasing national debt, but eventually, a generation will have to pay the bill. And as long as it is unclear how those choices will play out, that uncertainty erodes the sense of security. And that is precisely the crux.
Ironically, it was the desire to avoid uncertainty that led many countries to adopt pay-as-you-go systems after World War II. Countries that had experienced high inflation and financial instability during the interwar period – as well as those with a strong preference for predictability – opted for systems where the government guarantees pensions via pay-as-you-go. Countries with higher risk tolerance and a more stable financial history were more likely to choose funded systems.
In hindsight, taking that risk has paid off. Following the stagflation of the 1970s, inflation and interest rates declined, which in turn boosted bond prices. The value of stocks and real estate, which pension funds increasingly invested in from the 1990s onward, also rose. These developments were good for pension reserves and good for trust. Of course, things could have turned out differently. Consider runaway inflation or a crashing stock market. In that case, a pay-as-you-go system might have offered more financial security. Since no one knows how the economy will evolve, a mix of both systems - like the one we have in the Netherlands - is the wisest option (see, for example, this Netspar paper).
Do pensions cause happiness? An accrued pension pot supports happiness, but of course, it’s not the only factor. Not even the most important one: social relationships and health carry more weight. Eduard Ponds himself is retiring as a professor this June. He is also eligible to retire at APG, but he will continue working part-time. Not because he has to, but because he can. The man is unstoppable. Because retiring is great. But he enjoys thinking about pensions even more.
Charles Kalshoven is an expert strategist at APG.