Planning for retirement was a relatively straightforward affair when today’s pensioners were still in the workplace. But the rules have changed – and if you don’t keep up, you risk losing out.
In the past, retirement would usually start at state pension age and likely last for a matter of years, rather than decades. It would be funded largely by final salary schemes and the state pension.
Things have changed dramatically in recent years. What does retirement mean today, and how can savers prepare accordingly?
How retirement is changing
Rising life expectancy means today’s workers need to generate sufficient pension savings for a retirement lasting two or three decades or more. At the same time, responsibility for saving for retirement has shifted emphatically towards the individual. This process accelerated with the so-called ‘pension freedoms’ of 2015, which brought more flexibility and choice but also greater complexity.
The most significant change in retirement provision in recent years is the decline of defined benefit (DB, or final salary) schemes, according to Fiona Tait, technical director at Intelligent Pensions. DB schemes provided guaranteed payouts linked to salary. However, most of today’s pension scheme members are in defined contribution (DC) schemes, where the outcome depends on investment performance, charges and the amount paid in.
“Currently around three-quarters of retirement income comes from private sector defined benefits schemes, whereas nearly two-thirds of ongoing contributions are to DC schemes,” Tait points out.
This means that while many current retirees are entitled to at least some proportion of a guaranteed income stream, it’s a different story for the pensioners of tomorrow.
Moving the pension goalposts
Two changes taking place in 2028 will further raise the stakes. First, the state pension age for men and women, currently 66, will begin gradually increasing to 67 between 2026 and 2028.
This won’t affect those with enough pension savings to be able to choose their retirement date. But it will have a much bigger impact on people with more modest pension pots, for whom the state pension age remains highly relevant. The average retirement age for men is 65.2, according to the Pensions Policy Institute, while the average retirement age for women has increased from 60.6 in 1995 to 64.3 in 2020.
“The higher state pension age could lead to many of those currently in their 40s or 50s having to work for longer,” notes Anna Murdock, head of wealth planning at wealth manager, JM Finn. “They may feel they have to continue working to maintain their standard of living until the state pension kicks in.”
The national minimum pension age (NMPA) will also increase in 2028, from 55 to 57. This is the point at which you can begin accessing your private retirement savings, so it affects those hoping to retire early or begin reducing their work commitments. However, very few people use the NMPA as a retirement target, so this increase is likely to have considerably less impact than the change in the state pension age.
The retirement savings gap
While the pensions backdrop continues to change, one thing remains the same: too few people are adequately prepared for retirement.
A third of ‘Generation Xers’ - those currently aged between around 42 and 57 – are at high risk of retiring with ‘minimal’ incomes, according to the International Longevity Centre UK.
A report by the Social Market Foundation warned in February that more than two-thirds of 50-64 year olds in the UK don’t know how much they’ll need for retirement.
Those currently in their 40s and 50s are also members of the ‘sandwich generation’, often helping elderly parents with later life care while also supporting adult children with rising living costs.
“For many, retirement is mainly going to be dictated by affordability, and savings rates are largely inadequate to support a comfortable retirement,” Tait warns. “Being able to retire earlier than the state pension age will often be unsupportable and they will have to wait until age 67, or later.”
People saving for retirement now are more likely than previous generations to have multiple workplace pensions, private pensions and non-pension savings such as ISAs. While their pension income will depend on variables such as investment returns, they also have more flexibility and choice in how and when they retire. But that flexibility demands a proactive approach.
Taking control
The level of savings needed for a comfortable retirement clearly varies between individuals. However, the Pensions and Lifetime Savings Association (PLSA) has proposed a set of National Retirement Income Targets to give people an idea of how much to save.
For example, an individual living in a single household outside London would require a pension pot of £440,000 for a ‘moderate’ income in retirement and £966,000 to be ‘comfortable’. The PLSA believes an ongoing savings rate of 12% is required to provide a ‘modest’ retirement income.
But although the pensions landscape is often complex, there are some fairly simple steps that savers can take to boost their retirement savings.
Start early and save often. Once you get into the habit of regularly saving even modest amounts into a pension and/or ISA, you can let compounding work its magic. This is the snowball effect that occurs when the returns from your investments are reinvested to generate their own growth. “The best tip I can give is to start saving as early as possible and base your lifestyle around what is left, rather than trying to reduce what you are already spending,” suggests Tait.
Second, use your workplace pension. If you’re in your employer’s scheme, it likely matches your contributions or at least contributes a percentage of the amount you pay in. You’ll also be getting tax relief on your contributions at your marginal income tax rate. “To illustrate the point, should you be a higher rate taxpayer and wish to make a £10,000 contribution to your pension plan, it could cost you as little as £6,000 net and you will benefit from £4,000 tax relief,” Murdock explains.
And maximise your tax allowances. The best way to boost retirement funds is to fully use all the tax allowances and exemptions available to you, according to Tom Munro, owner of Falkirk-based Tom Munro Financial Solutions. “For example, maximising ISA contributions each year will accumulate tax-free over time, providing a tax-free income stream later.”
Retirement is a long-term process and attitudes change relatively slowly.
“Most people in their 40s and 50s base their expectations for retirement, if they think about it at all, on the experience of their parents, without realising how much longer they are likely to live or appreciating the impact of the DB to DC shift,” Tait points out.
Those able to build up substantial private savings will have the choice of when and how they wish to retire – but they are likely to be in the minority.
