Between the closure of DB pensions and low auto-enrolment contribution rates there’s a lost pensions generation facing poverty in retirement, argues Sara Benwell
There’s a crisis brewing, one that will sweep through the middle classes and leave huge swathes of the population in poverty at retirement.
In fact, I’m so sure we’re on course to catastrophe, that I’m even willing to predict when we’ll start to see it happen.
In 2040 – 2050, the people who were too late for defined benefit and too early for auto-enrolment will start retiring. Many of these people won’t have saved into a pension scheme for the first ten years of their working lives, and will have spent the next decade contributing a paltry 3%.
According to Columbia Threadneedle research, Britain is the worst at retirement saving in the world. This is backed up by Pensions Policy Institute research which showed average saving rates of just 6% (with many people saving significantly less). This isn’t great for anyone – but it’s catastrophic for those on a middle income.
We’ve finally had confirmation that auto-enrolment contributions will go up, albeit more slowly than initially planned. Rates will now shift from 2% to 5% of band earnings in October 2018, followed by a rise to 8% in 2019. And 8% of band earnings actually equates to a contribution rate more like 6.3% of total earnings for someone on the average wage.
This is far too little, far too late.
They’re almost guaranteed to see their quality of life deteriorate”
For someone who joined employment in the early 2000s at a company with a closed DB scheme, that’s a possible 19 years of working before reaching a savings rate of just over 6%. And we already know that this isn’t nearly enough – even for someone who starts saving in their early 20s.
The PPI’s Future Book calculates that even if a median earner contributes 8% of band salary every year from the age of 22, they only have a 50% chance of maintaining their standard of living in retirement. For someone who starts at 45, the loss of cumulative interest means they’re almost guaranteed to see their quality of life deteriorate in retirement.
Don’t forget the benefits
Of course, private pensions saving is not the whole retirement story.
There is some good news in the form of government benefits and concessions for pensioners. The latest available ONS data for the 2014-15 tax year shows that, on average, retired households received a total of £11,227 a year in cash benefits from the state, including £8,954 from the state pension and £2,273 in additional benefits such as housing benefit and attendance allowance.
The other major piece of the jigsaw of financial support received by pensioners is made up of benefits in kind such as healthcare and travel subsidies. According to ONS figures, benefits in kind are worth £6,274 each year to the average pensioner.
But many of these benefits are not guaranteed. And more than half of pensioners would have to make significant alterations to their lifestyles if it wasn’t for the range of benefits, discounts and concessions they currently receive, according to new research and analysis by Prudential
And for the middle-earners – even if the state benefits stay high - they are nowhere near enough.
Unlike lower earners – who will get a reasonable replacement rates from the state pension – and high earners – who are likely to have significant savings elsewhere – these middle-earners will be faced with a significantly lower income throughout retirement than they were used to in their working lives.
The small business problem
That’s a pretty bleak picture, but in many ways it’s a best case scenario for this cohort of Brits. Six out of ten private sector workers in the UK are employed by small businesses, many of which have not yet been through auto-enrolment.
That means that SME employees won’t even be getting the cumulative interest on saving a 3% for the last few years.
Not to mention the self-employed who may have no pension provision whatsoever.
With house prices stratospheric in some parts of the country there is also a concern that fewer people will go into retirement without owning their own homes.
This is when things start to get really hairy. Trying to live on a replacement ratio of 30% might be a brutal shock to the system, but it’s nothing compared to realising that you can no longer afford the rent in your 60s.
It’s nothing compared to realising that you can no longer afford the rent in your 60s”
It could cause a shock to the Treasury too, if the government suddenly finds itself having to house big chunks of the retired population.
Even those who have taken the home ownership plunge will not be out of the woods. The Aviva Real Retirement report found that one-third of homeowners over 45 with a mortgage do not expect to pay it off before the age of 65, so we could see people defaulting.
Too little, too late
Clearly nobody wants massive pensioner poverty, but that’s where we’re heading if something doesn’t change. Most likely – that will have to be contribution rates.
Getting people to work into their 80s is unrealistic for many, and I seriously doubt the government wants to increase state benefits to cope with the housing situation, so we need to get people saving more and quickly.
That means that people need to be saving 12-15% throughout their working lives as quickly as possible. Brits who have been working for 20 years already need to be saving substantially more.
But we need to achieve all of this without opt-out rates going through the roof.
The way I see it we have two options – auto-escalation – or compulsion. Whichever we choose – we need to choose fast.