New research suggests that one in seven people may still be paying off their mortgage aged 70. This could cause big problems for pensions planning, argues Sara Benwell
Long gone are the days when we could view pensions as an issue in isolation.
As we all know, declining DB provision means that for most people, whether they have enough money to retire on is largely dependent on how much they save.
In the new world – contributions are everything.
And how much people are able and prepared to save depends on a variety of factors including (but of course not limited to) how much debt they have, how much they earn and – for many people – where they’ve got to on home ownership.
That means that all these things should matter to anyone who cares about retirement provision, but it is the property problem that pension scheme managers, trustees and HR directors should take particular notice of.
The issues here are twofold. The first problem is affordability of housing. In 1960, the average age of a first-time buyer was 23. Today the average age is 34 across the UK and approaching 40 in London and the South East.
For the pensions industry, this raises a critical question – namely ‘when is the right time to try and get people saving enough?’.
Ideally you want to get people saving as early as possible to make the most of cumulative interest.
But most have accepted that getting a low-earning 22-year old to save huge chunks of their salary into a pension is unrealistic, particularly when you consider the proportion of their earnings that is swallowed by rent and day-to-day living expenses.
Can we really afford to wait until people are 40 before we ask them to make meaningful contributions to their retirement savings
Generally speaking, once someone makes it onto the property ladder, they have more money. It sounds crazy, but out of control rents mean that many people find a mortgage – when they eventually get one – is cheaper or equivalent to the rent they were paying.
On top of this, most people who are renting are also trying to save everything they can for a deposit. Once that’s dealt with, their spare cash goes up.
If people were still getting on the property ladder at 23 this wouldn’t be a problem. But with the average age of first-time buyers climbing steadily – the point at which they stop renting and have more free money to up their pensions contributions keeps moving further away.
And can we really afford to wait until people are 40 before we ask them to make meaningful contributions to their retirement savings? Probably not.
But if we start asking already-stretched young people to start saving earlier, there is a real risk they’ll opt out.
And even if they don’t opt out – it will push the average age of first-time buyers out even further. Which leads to the second problem.
Research from Aegon has found that one in seven people will still be paying of their mortgages at age 70.
A further 42.5 per cent of people think they will still be renting throughout later life.
This fundamentally changes the nature of retirement planning. When we discuss replacement ratios or adequacy, we do so on the assumption that people will need significantly less money than they do in their working lives.
A huge part of this is because we assume they will own their homes – mortgage-free. Removing the need to pay for where one lives makes a massive difference to how much money someone needs.
Pushing homeownership further out means that people will need far bigger pots than we may have thought. And if almost half of people are going to be renting, they will need substantially more money than most of the models are predicting.
The New Zealand superannuation scheme was designed on the assumption that people own their own homes and property purchase is a key part of that.
Several other countries have acknowledged these issues, and are making strides to form closer links between home ownership and pensions provision.
In New Zealand, for example, the KiwiSaver allows you to withdraw some of your savings to put towards a first home.
Some commentators have questioned this strategy, asking whether retirement savings should be used for that purpose alone, but experts have pointed out that the New Zealand superannuation scheme was designed on the assumption that people own their own homes, and therefore that property purchase is a key part of that.
In the US too, savers can withdraw money from their 401ks to invest in a first home.
So what does this mean for the UK pensions industry in general and schemes in particular?
It means that we need to rethink how and when we do auto-escalation.
We need to find ways (in a universe where there is no compulsion) to encourage people to save while they are young. And we can no longer wait till they’re homeowners to ramp up contributions.
For individual schemes, it sheds some light on how communications should be framed too. If we think that many people are spending 22 years saving up for a deposit for a home (usually considered a medium-term goal) we need to consider long-term pensions saving alongside that goal.
Pension scheme managers and trustees also need to seriously think about their at-retirement strategies.
If people are going to be renting throughout retirement or paying off mortgages for 15 years after they stop working - how does this affect their income needs and – specifically – drawdown plans?
The bell curve model of income requirement, where we assume people will need lots of money in the early years, less in the middle, and more at the end when care costs increase starts to look less realistic.
We need to work out how to balance realistic contributions with the need to ensure people are saving enough
Indeed, you could make an argument for some kind of annuity-style product that at the very least covers someone’s rent or mortgage bills.
For HR directors, the key here is holistic financial planning. If we want people to put more into their pension while also trying to get on the property ladder, we need to provide them with financial education and help them save money elsewhere. Dealing with debts, which take up an ever-more alarming slice of people’s take-home pay, is critical here too.
We need to look at someone’s salary holistically, and work out how to balance realistic and achievable contributions with the need to ensure people are saving enough. This will require new thinking, perhaps where escalation is tied to pay rises, or people can dial contributions up or down as required.
In essence, pensions is just one financial responsibility among several critical savings goals - and we need to stop living in the past and treating them in isolation.
Because if we make it a competition between saving for a pension or a a property, it’s not likely to be a battle that pensions will win.