31 October 2019
The Price of Retirement
We are not saving enough.
by Frank O’Nomics
What, for you, would constitute an acceptable retirement? The ability to keep a roof over your head, clothe and feed yourself? Or does some scope to lounge on a sun-kissed beach and visit the theatre feature in your plans? The introduction of auto-enrolment has done much to address the effects of the decline in defined benefit pensions, and has led to a large increase in the number of those saving for their retirement. However, very few are saving enough to ensure even a ‘moderate’ retirement. A report from the Institute and Faculty of Actuaries this week argues that workers on average earnings will need to save over a quarter of their monthly salary, almost £800 per month, if they expect to be able to eat out, go to the theatre and take a foreign holiday when they retire. It will come as no surprise that very few are saving anything like that amount.
The introduction of auto-enrolment took the onus to join an employer’s pension scheme away from the individual and made membership automatic (although employees can still choose to opt out). It was a very successful example of the ‘nudge’ theory of economics, resulting in 10 million workers becoming auto-enrolled, with only 10% opting out. Since April of this year the minimum contributions under the scheme are 8% of earnings; comprised of 4% from the employer, 1% from the government (via tax relief) and 3% from the individual. The IFoA analysis suggests that saving £86 per month, assuming that the state pension continues (currently a maximum of £8,600 per year), could fund a minimum standard of living in retirement, which would include a holiday (in the UK) and £36 to spend on food each week. However, if you envisage a more indulgent lifestyle, with a two-week holiday to Europe and a weekend in the UK each year, together with a more realistic £46 per week on shopping, then you need to save the aforementioned £800. Going further, if you want the lavish retirement currently enjoyed by those lucky baby-boomers who have defined benefit pensions, where three-weeks abroad, beauty treatments and theatre trips are the norm – then you will need to save a whopping £1755 per month.
The obvious question is – what can we do about this? “Save more” is the glib answer, but for most this will not be feasible or acceptable. People either do not have any money to spare, or they are not prepared to forego indulgences such as meals out and holidays now, just so that they can enjoy them in the future. To some extent the government could help by increasing minimum contribution rates further. If individuals could find a further 1-2% and employers were made to do the same it would make a big difference. However, there would be economic consequences. Current retail spending would be likely to decline and, by increasing the costs of employment, many companies could either struggle to survive or would have to cut their work forces.
The government could help further. While it would probably be too expensive to increase the level of tax relief on contributions, it is not unreasonable to argue that the age of auto-enrolment should be reduced to 18 from the current trigger of 22. As a rule of thumb, the sum you need to save into a pension to facilitate a reasonable level of retirement income is around half your age, as a percentage, when you start saving. For those auto-enrolled at 22 the rate this would indicate 11% (so 3% more than the current minimum) but if the starting age was 18 then the additional saving needed by the individual would only be around 1%. The government is considering making these changes but they are unlikely to take effect until the mid-2020s, even if a decision were to be made soon.
The other area for government focus should be the low paid and the self-employed. Those earning less than £10,000 are not auto-enrolled (although their employer cannot refuse if asked). This is particularly relevant to those coming back into the workplace in a part-time capacity, who don’t benefit from any additional payments into their pension pot. Extending auto-enrolment to the low paid may be an administrative problem and will produce only moderate amounts – but those amounts will be valuable to those who need them most. The self-employed are a bigger conundrum, particularly as many so classified earn very little. They can join the National Employment Savings Trust (NEST), a workplace saving scheme set up by the government, but tax advantages provide little solace to those without an employer to generate some contributions.
The solution is much more likely to lie in a change in working patterns. The IFoA study assumes that people will retire at 68. For those who want to continue to fund a more comfortable lifestyle this retirement date will either be delayed, or they will find other, part-time employment after retirement. A study by Fidelity International released this week, showed that around half of UK adults plan to work at least part-time during their retirement, with 45% expecting to work into their 70s, and 9% into their 80s.
A UK government review of auto enrolment in 2017 estimated that 38% of the workforce was under-saving for retirement. This was before the most recent increase (from 5 to 8%) in the minimum contribution rates, but the IFoA study would suggest that this percentage will not have fallen far. Auto-enrolment has done much to encourage savings but it clearly is not enough. The consequences may be that there is far less disposable income to be spent on leisure, many more will become dependent on the state – or that retirement will become a thing of the past.
