Pension contribution rates will need to be increased to stop people being forced to work and save until their 70s or 80s. Action must be taken now, writes Rebecca Shahoud
At a glance
• People may be forced to work until their 80s to fund decent retirement
• Those in their mid-thirties upwards will be worst affected
• Start saving younger and contribute more, says industry
The idea that individuals may have to work until their 70s and even 80s to receive a decent retirement is incredibly daunting.
Royal London's The death of retirement report found that contribution rates would need to be increased to achieve adequate pensions.
Punter Southall Aspire managing director Alan Morahan says the industry has known this all along and agrees that contributions need to be higher.
"The notion that 8% contributions aren't enough is one that we're familiar with. The government didn't want to make it too painful for employers or employees at first, so they started at a modest level. But I don't believe any of us really believe it will stop at 8%," he says.
While it is no shock to the industry that 8% contribution levels are not enough, it is more than likely this is being overlooked by savers themselves.
Hogan Lovells counsel Nicola Rondel says: "I think the population are getting very mixed messages about pensions at the moment. On one hand people are being told ‘you can take your benefits at 55', and on the other hand, in this report, ‘you're being told you are going to have to work until your 70s'."
Receiving mixed messages only adds to people's confusion at a time when it is hard to keep up with pension reform.
Morahan thinks one issue is that the public still does not understand the difference between defined benefit (DB) and defined contribution schemes, and also how the pensions landscape has changed over the years.
He says: "With a DB scheme an employer never really said to an employee, ‘We'll pay 15% if you pay 5%', for example. They just said they would pay a set final salary, so people didn't really have a true concept of how much their pension was costing them, and how many of the employees were in a good position. That's just how things were back then."
Morahan believes the public conception of the amount of interest or growth that 8% will accrue is "way in excess" of what is possible.
This is not helped when most employers err on the side of caution when it comes to taking on investment risk in the pension scheme, which dampens the growth that could be achieved.
Saving for longer
Eversheds senior associate Tim Smith says the idea that some people could end up having to save until their mid-80s is more shocking, especially given that most of the key findings in the report assume that people are saving from the age of 22.
According to the report, the estimated retirement age for an average worker earning £27,600 per year would have to save until they were 77 if they wanted to live on 67% of their pre-retirement income. An individual on twice the average wage would have to work until they were 85 to get 67%, assuming they started auto-enrolment (AE) from the age of 22.
Smith says: "Obviously with AE in the future, we will all be auto-enrolled at 22, but there's a generation of people that haven't."
This middle generation - people in their mid-thirties upwards who have yet to start saving - is the group that will be most badly affected, he warns.
"It [raises] big questions. There are people who may be working until their mid-80s, which raises a big social question, as well as creating issues for employers."
He says employers are now starting to look at what they might have to do if their employees stay working past the state retirement age simply because they cannot afford to leave. This creates further problems, such as older employees no longer being motivated or companies unable to bring in new talent.
"Employers want their staff to have dignified exits. That was something the old default retirement age allowed for," says Smith.
Employers will almost certainly come under pressure to contribute more to pensions as members are encouraged to do the same, says Rondel. This comes at a time when employers are also under pressure to increase their workers' salaries.
"Employers are already starting to feel the effect of AE and at the moment the contribution levels are very low, but if they have to make contributions then it does go against the impact of pay rises. It's requires a balancing between having the money now and later," she says.
So what can be done to alleviate the problem?
Smith believes that people should start saving as soon as they start work. "I struggle to see why it starts at 22. It should be the first day of work, so it becomes a habit that people get into. People won't be earning huge amounts at that time, but it can only help."
Morahan thinks that auto-escalation whereby contributions are increased with salary would prove popular. However, it may not be easy to introduce on top of all the other changes to the pensions system.
Smith urges policymakers to start tackling this dilemma now: "The main message for me is that it needs to be something that policy-makers need to be thinking about now in order to avoid storing up a problem for 10 or 15 years' time."
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