30 October 2019
In this blog, the IFoA’s Stephen Hyams talks about a new report designed to help people understand how their level of pensions savings will impact lifestyles in later life.
In a world of defined contribution (DC) pensions, how much do you need to save each year to provide a decent retirement income? There are plenty of online tools to help answer that question, but unfortunately many people don’t use them. Recent research commissioned by the IFoA revealed that 48% of respondents say they are not confident that they are saving enough for their retirement, so there is clearly a need for further assistance.
44% of respondents believe rules of thumb, or savings guidelines, would be a helpful tool for retirement planning and pension saving. The good news is that the IFoA’s new report ‘Savings Goals for Retirement’ aims to provide exactly that.
We need more than one Savings Goal because not everyone shares the same view about what constitutes a decent retirement income. Fortunately, the Pension & Lifetime Savings Association has come to the rescue here by publishing its Retirement Living Standards (RLS), based on consumer research. You can now decide if you wish to aim for the “minimum”, “moderate” or “comfortable” retirement lifestyle.
Savings Goal 1
Our first Savings Goal is that you can expect to achieve the “minimum” RLS of £10,200 if you and your employer pay the 8% contributions specified under Automatic Enrolment (AE), and you have a full National Insurance record, meaning you will receive a full State Pension when you retire. 70% of respondents to the IFoA research said they contribute the bare minimum into their pension; I suspect in many cases this means they are on target for the “minimum RLS”.
Savings Goal 2
For those who aspire to the “moderate” RLS of £20,200, our second Savings Goal tells them this requires a contribution of around one quarter (26%) of average full-time earnings, currently about £800 per month. Very few people are saving at that level, and so there is a danger many will not achieve the retirement income they aspire to.
Savings Goal 3
If you want to achieve the “comfortable” RLS of £33,000, our third Savings Goal says you need to put aside more than twice the amount needed for “moderate”.
The Retirement Living Standards are higher for those living in London, but London salaries will help to meet the correspondingly higher contribution requirements.
Well that is the bad news out of the way, so let’s see what can be done to help. Firstly, household costs are normally shared and the RLS for a household is only around one and a half times that for a single person. For the “moderate” RLS, this additional retirement income is provided by a second person’s State pension, so that the Savings Goal remains at around 25%, or £800 per month. So, the cost can be shared between the household, potentially making it much more affordable.
Secondly, employers will contribute towards the total cost. For example, in a household of two both earning £30,000, a total of £800 per month would be achieved if each person contributed 8% of salary fully matched by their employers. While currently not many employers are so generous, Savings Goals have the potential to encourage a new norm of higher employer contributions.
Another factor that warrants further exploration is the inefficiency of the individual DC market, especially once people reach retirement. The cost of individually purchased annuities is typically around 15-20% more than the bulk terms typically available to defined benefit pension schemes, while drawdown products lack the pooling of investment and mortality risks that would make DC pension provision more affordable and predictable. The growth of master trusts and potential introduction of Collective Defined Contribution Schemes can hopefully address these issues.
Further good news is hopefully on the way, although probably not for quite a few years at least. Very low interest rates are a major reason for the high cost of pension provision, and an increase in long-term interest rates of 2% say, from the current 1% to 3%, might reduce our Savings Goals by around 30%.
The IFoA’s Savings Goals can help stimulate debate within the pension industry, policymakers and employers, with a view to helping far more people achieve a decent retirement income.