Targets for retirement income can help individuals improve outcomes for retirement. Paul Waters looks at how such an approach can work
Every year millions of people across the country set personal targets for their future goals. Whether it's finding a new job, travelling the world or getting more exercise, these personal ambitions and lifestyle changes will now be set in people's minds as a target they wish to achieve.
The reason for this is straightforward. Targets are tangible. They are easy to understand. And they drive real changes in behaviour, which is why they are so important as a tool in improving retirement outcomes in defined contribution (DC).
The government and the pensions industry have long recognised undersaving for retirement as an issue. Auto-enrolment has been a huge success in getting meaningful numbers of people to start saving for retirement but it is exactly that, just a start. The challenge is vast. Analysis of around 500,000 DC members in the UK, that we undertook, shows that two out of three are unlikely to have an adequate income in retirement (as defined by Pensions Commission replacement rates targets).
What difference does a target make?
Many would argue the issue is affordability, and little else matters. Affordability is a relevant factor clearly, but our research has found that savings rates do not increase materially as income increases. Based on our data, people who earn £60,000 save less than 2% more than those earning half that amount.
Working with focus groups, the overwhelming feedback is that people do recognise the need to save for retirement and it is important to them. Yet they don't save particularly more as income increases. We have seen that behaviour changes when a target is set. The crucial difference is that targets give people context. Consider the information on a typical DC benefit statement. You might see how much is being paid into the plan; how much is saved already; how much might be saved in total at retirement; and how much this could be worth as a pension.
This is all very relevant, but so what? Is this good, bad, about enough?
Now consider the same communication but with a target - where you can tell an individual their target pension for a modest retirement is £7,500 and they are on track for a pension of £7,000. A traffic light system can be used to make this even clearer.
One man's modest is another man's extravagant
Setting the target in the first place, and managing the subjectivity and communication challenge around how you label them, is an area that requires careful thought.
If we take the target first of all, there are good precedents here. For example, there is the replacement case methodology based on updated versions of the Pensions Commission research on retirement adequacy amounts. This is the approach we use at Hymans Robertson and has the advantage of recognising the differences in lifestyle and spending patterns pre and post retirement based on income.
In Australia they use a basket of goods approach, with a flat income target against each level - from basic, to modest, to comfortable.
Such an approach will be easier for higher earners to meet, naturally. This is where having different targets to reflect lifestyle expectations comes in. The Pensions and Lifetime Savings Association (PLSA) has been working with Loughborough University to determine what they think a sensible target model should be. It will be fascinating to see the results which are expected later this year.
Ultimately, targets need to be relevant and easy to understand whatever the underlying methodology. We know the vast majority of people are not saving enough. We know that using a target gives people the context needed to better understand their pension requirements and make decisions. And we know we can communicate this clearly in a way that people engage with.
Most DC pensions are forecast to be below the targets. By adopting them as standard across the UK, the overwhelming direction given will be to save more. Five portions of fruit and vegetables aren't actually enough, but they are more than most eat today and so encourage positive behaviour.
As people become more familiar with the targets and far more engaged with their pension saving, they will start to think more about what is right for them and what to do.
So, provided the targets are in a sensible range the most essential thing is for the whole industry to get behind them.
We look forward to helping the industry adopt targets more broadly across 2019.
Paul Waters is a partner at Hymans Robertson
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