Employees will have to work beyond the age at which they are physically capable if they rely on auto-enrolment contribution rates for a decent retirement income says Steve Webb, Director of policy, Royal London
The $64,000 question when it comes to pension saving is always ‘How much is enough?’ In a world of defined contribution pensions where nothing is guaranteed, it can be hard for both workers and firms to know what level of contributions will deliver the sort of retirement income that workers would want.
A possible benchmark could be the default rates set by the Government for automatic enrolment into workplace pensions.
The mandatory rate of contributions for employer and employee combined will rise from the current 2 per cent of qualifying earnings to 5 per cent in April 2018 and 8 per cent in April 2019. So it would seem reasonable to ask whether someone who saves at this 8 per cent level – and builds up a full state pension – could expect to retire with a decent standard of living.
The short answer, based on research published recently by Royal London, is a resounding ‘No’.
The research looked at two possible benchmarks that individuals might wish to attain in retirement. One is a level of total pension income – including state pension – of around two-thirds of pre-retirement gross income. Once you have taken account of the fact that pensioners do not have to pay National Insurance or pension contributions out of their income, and the fact that most retired people will have paid off any mortgage, an income of two-thirds of pre-retirement level would allow most people to maintain their pre-retirement standard of living pretty comfortably.
A more modest ‘silver standard’ benchmark might be to attain at least half of your pre-retirement level of income. While this probably would result in a drop in your standard of living at retirement, it would probably also be manageable, esp-ecially taking into account other lower outgoings in retirement such as travel-to-work costs.
The Royal London research found that if you contribute into a pension only at the minimum statutory level of 8 per cent of qualifying earnings from the age of 22, you would have to work into your 70s to get to the kind of ‘gold standard’ income that some recently retired people enjoyed – especially those who benefited from defined benefit pension provision.
The exact date at which you could stop working depends on whether you want a pension with attractive extras, like protection against inflation and provision for a surviving spouse. But the main message is the same. Simply contributing at the legal minimum level means you will have to work well past traditional retirement ages – and, for many people, past the age where you are physically capable of doing so – to replicate the best pensions of the present generation.
Of course, for a lot of people the situation is worse than this. We know that millions of people do not start saving for a pension while in their 20s. For a large number, being automatically enrolled in their 30s or even 40s will be their first
experience of pension scheme membership. Not surprisingly, the research found that these ‘late starters’ would face working through their 70s and beyond to achieve the standard of living that their parents may be enjoying now.
Furthermore, many women will find that the odds are stacked even further against them. The fact that women are more likely to take career breaks and to return from such a break to work part-time means they have to work even more years to recover the damage that has been done to their DC pension pot.
But this research is more of a call to action than a counsel of despair. It is certainly true that contributing at the bare minimum level throughout your working life will leave you with some unpalatable choices in later life. But it is also true that higher rates of employer and employee contributions can make a decent retirement attainable at much more acceptable ages.
The challenge is for employers to have a realistic dialogue with their workers about what kind of retirement they want and to plan accordingly. It is simply not enough to rely on the contribution rates set by the Government.