There is a slow burning fuse in the world of pensions with an ageing society, inadequate saving compounded by lower investment returns, and an increasingly unsustainable state pension. Alarms are ringing now but by the end of the next decade, millions may have little more than an inadequate state pension to live on. A looming retirement shortfall for people in their 40s and 50s is only ten years’ away while many 60-year-olds are floundering now. Indeed, the hastily introduced The Freedom and Choice reforms in 2015 have left consumers ill-equipped to make fiendishly difficult choices today.
The Pension Policy Institute estimates that there are currently just over 12m people in the UK at state pension age or older and this will rise to just under 16.5m by 2050 while the over 75s are set to increase by 50%, with a consequent rise in numbers facing cognitive decline.
Over the past 20 years, defined benefit pensions where the risk of underperformance lies entirely with the employer, have all but disappeared in the private sector. At the same time as the move from DB to defined contribution, most employers cut their pension contribution levels drastically instead of increasing them to compensate for the transfer. The onus of retirement preparation has also largely switched to the individual. Few are equipped to deal with its complexities.
The most pressing concern in pensions is the contribution shortfall. In the public sector (where DB pensions still predominate) more than one in three employees received contributions of at least 20% from their employer in 2019. Yet, more than 9 in ten private sector employees received less than 12% (of their pensionable earnings) in contributions from their employer with most paying just the legal minimum of 3%.
The only bright spot in the pension firmament is the introduction of auto-enrolment in 2012 has led to millions of workers are now saving for the first time, often in good quality, low charging and large-scale master trusts. Indeed, 77% of the UK workforce are now saving into workplace pensions (up from just 47% in 2012) .
The biggest single factor in pensions
The unanimous verdict, from a straw poll of 14 pension experts from Aegon, Barnett Waddingham, Canada Life, Aviva, Diariada Trustees, First Actuarial, Hymans Robertson, Mercer Interactive Investor, Punter Southall Aspire, the Pensions Management Institute, Irwin Mitchell, Isio and LCP, is that the biggest single problem in pensions is the woefully inadequate low level of contributions.
Data from the biggest pension scheme in the land – NEST, with nine million members shows that as at 2020, each member had amassed within NEST a pension saving of just £1,000. Adrian Kennett, professional trustee at Dalriada Trustees, stresses: “Taking annuity rates at the moment, that would provide a 65-year-old with approximately £30 a year - about one small chocolate bar a week.”
People retiring now by and large have legacy DB pensions but the outlook for the next cohort is abysmal – research from Salisbury Wealth indicates average assets held in workplace pension DC pension pots at retirement is just £5,500 as January 2020.
Financial education is often poor too both in schools and in the workplace leaving 13 million people who are not saving enough to reach the Pension Commission’s target reapplicant unaware of the impending shortfall with a false sense of security that their auto-enrolment contributions are enough.
Running to stand still
Today’s savers are running to stand still. According to actuaries LCP, someone aged 22 enrolling in a pension today on starting salary of £22,437 a year would need to contribute 12% of pay to achieve the same pension as someone contributing 8% a decade ago. (With 2007 expected investment returns (and 2% annual real wage growth on top of inflation): pension pot at age 68: £236,800. With 2017 expected investment returns: pension pot at age 68: £157,700).
Part of the problem is QE - a huge £895bn experiment by the Bank of England which has been a huge dampener on pension yields and interest rates with catastrophic effect for annuities: Charles Cowling, chief actuary at Mercer, shows its deadly affects: “an index-linked pension (including a spouse’s pension) of £1,000pa currently costs as much as £40,000.” He adds: “The combined contribution rate required throughout working life to deliver an index linked pension on half pay would cost is 50% of salary every year.” Clearly, a guaranteed pension is just in the realms of fancy for the future generation.
Opinions vary on the amount need to save for retirement – the Association of Consulting Actuaries has cited 16% of salary.
The legal auto-enrolment minimum contributions 8% (3% from the employee and 5% from the employer) as Matt Calveley, director at Isio, says: “8% simply doesn’t cut it.”
Many retiring now will have some form of DB pension to fall back on but for those in the middle (in their 40s and 50s right now), there is a real risk they simply won’t have enough for their old age.
Other pension problems
There are other problems. A total lack of trust in pensions compounded by sometimes greedy advisers and providers with high charging retail products as well as criminal scammers: £30,857,329 has been reportedly lost to pension scammers since 2017.
No wonder many people prefer property for their retirement hopes.
Gig workers and the self-employed are excluded from auto-enrolment (as are low earners, or those with multiple jobs who do not earn more than £10,000 in any one job). Indeed, nearly 5m people in the UK are self-employed, with one in 10 working-age adults in the gig economy, which is equivalent to 3m workers largely without a pension, according to the University of Hertfordshire.
Tim Middleton, director of policy and external affairs at the Pensions Management Institute, points out to other problems: “Changing work patterns see individuals changing jobs far more frequently. Research suggests that Millennials will have an average of twelve jobs over the course of their working lives."
This could lead to 27 million small pots by 2035 according to NOW: Pensions/ Pensions Policy Institute research, many lost and forgotten. Kate Smith, head of pensions at Aegon: explains: workers will not “have a full picture of what they’ve saved or whether they are on track for retirement.” As a result of auto-enrolment, the number of small frozen pension pots are growing exponentially. Smith adds: “ these tend to not be cost efficient to administer.” Dashboards will unite lost pensions savings with their rightful owners are not expected to launch until 2023.
Hilary Salt, partner, First Actuarial, flags social care: “Whilst it’s not an explicit pensions problem, the continuing confusion and political dithering about the costs of long-term care make it difficult for anyone to plan their retirement spending.”
Complex pension rules also deter engagement as Kay Ingram, public policy director, LEBC Group explains: “We have three different regimes: -DC, DB and the State scheme and each has its own unique set of rules, some of which like the Money Purchase Annual Allowance, GMP Equalisation and the Annual allowance trap for DB members act as a disincentive to save and confuse the member.”
At retirement
At the other end of scale, the ‘at retirement’ market is totally dysfunctional. Rebecca O’Connor, head of pensions and savings at Interactive Investor sums up: “The decisions faced by those at retirement are perplexing and stressful because of the sheer weight of responsibility - no one wants to get their choice wrong at this point as it could affect the rest of their lives.” Indeed, Martin Willis, partner at Barnett Waddingham warns: “Selecting the wrong annuity could waste 25% of the fund – to put that another way, the member could waste 10 years’ worth of contributions."
According to LCP, poor pension choices at retirement under the pension freedoms cost savers £2bn. Around 550,000 people between April 2015 and March 2020 withdrew their pension savings, moving them to a bank account, losing out on both investment growth and inflation protection.
One-in-four people aged 55-64 are not even aware of the retirement choices on offer and none sound ideal as O’Connor points out: “Annuities offer an insulting amount for a lifetime of work and yet the alternative of managing drawdown for yourself seems risky, particularly for those who fear cognitive decline as well as running out of money.”
Retirees left to their own devices may face huge, unforeseen but often avoidable tax bills. In particular, experts would like to see the MPAA increase to £10,000 especially in the wake of the pandemic which has seen many older workers lose their jobs years before their state pension will commence.
The free government backed Pensionwise appointments are useful for the over 50s and the £500 advice allowance but both are insufficiently publicised. Financial advice is beyond the means of most people. Chris Noon, partner, Hymans Robertson, notes: “At around 2%, wealthy individuals are paying too much in advice and investment charges while less wealthy individuals (pension assets below £200k) are finding it increasingly difficult to even access advice.”
No wonder, despite the complexities, Financial Conduct Authority data revealed that 64% of DC pots accessed in 2019/20 were unadvised.
Many workplace pensions schemes don’t yet offer all the freedom choices and at retirement people often move from good value workplace pensions to expensive retail products where a 1% annual management charge not uncommon. Martin Willis, partner at Barnett Waddingham, explains: “If we compare this with a typical Workplace DC charge of around 0.35% then the increased charges over the period on which the member may draw income may equate to around two years’ worth of extra income.”
Solutions
One new initiative introduced in 2021 are investment pathways aimed at providing customers who are not receiving advice with better retirement outcomes when: moving all or part of their pension savings into drawdown. O’Connor believes: “this can be a possible solution to people just taking their entire pots as cash at the beginning of retirement and seeing their pot eroded by inflation.
More guidance is needed throughout a person’s life – and higher contributions – employers’ auto-enrolment contributions should at least achieve parity with employees on contributions: a 5% plus 5% match would be a good start but eventually AE should double to 16%. The recommendation from the 2017 auto-enrolment review should also be implemented without delay. These will bring down the minimum age to 18 from 22 and possibly remove the maximum age.
On the global scale The Mercer CFA Institute index for 2020 places the UK 15th in its ranking of the world’s pension systems: a mid-place ranking but as this article points out is a huge room for improvement in all areas of retirement planning, particularly on contribution rates, reform of Freedom and Choice and even trust in pensions, providers and advisers.
Pensions are not in crisis today but without reform, their creaking foundations may collapse tomorrow. The next generation could face the unpleasant Hobson’s choice of working until they drop or facing a life of penury in retirement without change today.
About the author: Stephanie Hawthorne
Financial journalist Stephanie Hawthorne is an honours law graduate of King’s College, London. Winner of numerous prizes for her writing, Stephanie has been a financial journalist for over three decades. She began her career as a researcher/marketing specialist for a national financial independent adviser and subsequently a leading life office, moving on to Financial Times’ Money Management where she was deputy editor. Her former editorships include Pensions World and Counsel: Journal of the Bar of England and Wales.
She has contributed articles to The Independent, The Times, Sunday Times, The Sunday Telegraph, The Observer and The Mail on Sunday, the Financial Times and the ’I’ Newspaper.
She also writes on property and legal issues both for consumer and professional magazines.