There are almost six million people in the UK who have no retirement savings whatsoever, according to Scottish Widow’s 2013 Workplace Pensions Report. This means one fifth of the UK workforce is relying on the state to cover all accommodation, utilities and subsistence costs for as long as they live after calling time on employment.
Did these people make a decision to live on £140 a week or has the UK sleepwalked into a pension crisis – and, if so, how do we get out of it?
The first problem lies in the number itself: the Office for National Statistics’ (ONS) classification of the UK workforce. The second is what we class as retirement savings and why so many are disengaged from them.
Firstly, the ONS classes the UK workforce as employed people aged from 16 to 64. But in August, the Department for Work & Pensions (DWP) announced there had been an increase of nearly two million workers in the 50 to 64 age bracket over the last 15 years. It is fair to say there would have been a significant, if undocumented, increase in older workers too and this is vital to averting the crisis.
“When we talk about retirement, we look at a date, at a fixed point in time,” says Malcolm McLean, consultant at Barnett Waddingham, “but it is not so much a date as a process. We have to accept it is not just about finishing work completely, we may have to go on in some form.”
This might come as an unwelcome shock to some as the environment created over the past 50 years, for Baby Boomers at least, has been a very different scenario.
“We have an old-fashioned approach to retirement,” says Tim Banks, managing director in the pension strategies group at fund manager AllianceBernstein. “The system we have was built for the idea of converting income into a pension, through the defined benefit (DB) structure, and this cannot happen anymore.”
There are few who would dispute that the era of the DB system is over. Most of the handful of schemes that remain open to existing employees have long-ago closed their doors to new entrants. Even with new ideas being floated this month by the DWP, designed to lighten the burden on employers, it seems unlikely any company will take on such financial risk.
But this does not spell financial ruin for workers on defined contribution (DC) contracts; all it requires is better planning.
Mr McLean applauded auto-enrolment, but warned there remained little foresight into what the system hopes to achieve and contribution levels remain a concern.
The regulatory minimum 3 per cent will barely scratch the surface, experts warn, but recommendations vary. “Until consumers reach their 50s, the main challenge is to put enough aside for retirement,” says Ian Naismith, pensions expert at Scottish Widows. “We recommend a minimum of 12 per cent of income, but to fund the kind of lifestyles people aspire to will take much more.”
Contributing half a member’s age, which can combine the employer’s input, should ensure sufficient retirement income, says Mr McLean.
Tom McPhail, head of pension research at financial advisers Hargreaves Lansdown, says automatic contribution rises as salaries increase would be a good way of narrowing the income gap after retirement.
Both Mr McPhail and Mr McLean are in the growing number of believers in having a range of savings products available to employees, rather than relying on one pension pot.
“Pensions have tax benefits, but so do many company share schemes, and ISAs are simple and easily accessible. The main thing is to be saving – the vehicle is a secondary issue – though, if an employer offers a pension, it’s usually worth joining for the company’s contribution,” says Scottish Widows’ Mr Naismith.
The main thing is to be saving – the vehicle is a secondary issue – though, if an employer offers a pension, it’s usually worth joining for the company’s contribution
A lesson from New Zealand, where auto-enrolment was launched earlier than in the UK, comes from failing to set an end-destination and a route to get there.
David Iverson, head of asset allocation at NZ Super Fund, says: “You need to know what your liabilities are before considering how they will be funded. The actuarial profession is essential at this step in DB plans, but what about DC? Rarely are such projections made by or on behalf of others.”
In this regard, the first real attempt to leave behind the “hit-and-hope” strategies of early-DC provision was the creation of target-date funds (TDFs), which have spread rapidly across the industry. These funds gradually reduce the risk in a member’s fund as they approach a pre-defined retirement date in order to prevent any “shocks”. They also tackle head-on one of the major issues the pension industry has had to grapple with – lack of member investment knowledge.
“For decades we have treated DC members as potential self-directed investors, trying to ‘educate’ them until they can choose their own funds,” says Nigel Aston, head of UK DC at fund manager State Street Global Advisers. “This has proved futile. Better and more holistic defaults are the answer.”
He believes the unpredictability of many default funds, before the advent of TDFs, has disincentivised members from saving more. “In short, we should be designing products that leave the member free to concentrate on saving, while we do the investing,” he says.
These funds are not fool proof, however. Many argue that they are too homogenous and lead investors into thinking they have been built with their specific circumstances in mind. In reality, the cohort they are in may bridge ten or more years.
“The funds cannot take into account the individual’s ability to work or pay in longer to the scheme and they fail to appreciate that some people can afford to carry risk at a later stage,” says AllianceBernstein’s Mr Banks. “Annuities are a type of insurance that you don’t need on your 65th birthday. You should be considering it later in life. Until then, you can draw-down income, but keep saving and investing.”
Mr McPhail says the usual small pot sizes used to purchase annuities made the market inefficient, but warns that individuals with little financial knowledge should seek advice on drawing down.
This is the point of revolution for many in the industry to change our thinking of investing “to” retirement to investing “through” retirement.
By using a range of saving plans, tax benefits and envisaging fluidity through a working life, rather than aiming for a cut-off point when the market might be out of sync with your personal needs, there may be a better chance to be comfortable in old age.
And there is hope. An initiative in some of London’s most underprivileged boroughs has begun the fight-back. RedStart, from pension consultants Redington, teaches the basics of financial planning to schoolchildren who will grow up outside the paternalistic DB pension environment.
“Generations of young people will be responsible for making decisions about their retirement provision – how much money will be required in retirement, how to achieve this through adequate pension contributions, when to make those contributions and so on,” says RedStart co-founder Freddie Ewer. “Educating our young people in financial literacy is not a luxury, but an imperative,” he says.
The challenge is to convince workers that there is no cliff edge to aim for and no short cuts to financial security. The pension revolution starts here.
