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Decisive action is needed to prevent a retirement crisis

Most people aged 30-45 will not have enough money to retire unless the government addresses the intergenerational inequality of the current pensions system, writes Jon Greer, retirement policy expert at Old Mutual Wealth.

After years of slogging away at work, even those who love their jobs have days where they can’t wait for that magical period of retirement. But for a generation of the UK population, daydreams of holidays, rest and relaxation are being clouded by worries about whether they will ever be able to afford not to work.

Last summer, Theresa May promised to build an economy that works “for every one of us”, and the government established an Inclusive Economy Unit. But intergenerational inequality has continued to grow, due to the longterm shift in the pensions landscape.

There is now an entire generation – those aged 30-45, the “in-betweeners” – of people who are at a huge risk of under-saving for retirement. The previous generation has been provided for through a combination of funded pension provision and home ownership, and the generation after was introduced to auto-enrolment from a younger age, which should help to ensure that their income in retirement is at least adequate.

A closer look confirms our suspicions. The ONS recently found that while household incomes have increased for retirees in recent years, non-retired households still have less money, on average, than before the 2008 crash. At the same time, it released data showing overall income inequality had shrunk to levels comparable with the 1980s. This means that the gap between high and low earners has decreased, but the gap between the young and old has widened.

The generation following these in-betweeners has time on its side. Modelling by the Pension Policy Institute in 2015 showed that a median earner would need to contribute between 11 and 14 per cent of their earnings from age 22 to the State Pension age to maintain their living standards. Even then, this isn’t certain – these people only have a two-thirds probability of maintaining their standard of living.

For people who begin contributing later, the PPI says contribution levels to replicate working life living standards could be as high as 27 per cent. The average in-betweener would have been in their 30s when auto-enrolment was introduced, meaning they face a colossal challenge to make up the shortfall. Furthermore, the PPI report shows average employer contribution levels into defined contribution schemes were below four per cent of salary in 2014. While the minimum contribution levels are due to rise in 2018, the scale of the challenge for this generation is clear.

This growing intergenerational inequality has not gone unnoticed. Labour MP Frank Field has launched a select committee review of intergenerational fairness. In its preliminary report, the committee recommended the government undertake a forward-looking assessment of intergenerational income and wealth. Old Mutual Wealth has already embarked on the same process.

We recently conducted research with YouGov to better understand this generation – who they are, what their savings habits are, and how they feel about their retirement. Of the more than 3,000 respondents, almost nine out of 10 agree it is important to save/ invest for the future. But 22 percent save £100 or less per month. Why? After they fork out each month for childcare costs, student debts and rent or mortgage payments, they simply don’t have enough money left at the end of the month. The Bank of England says this trend is set to worsen: it predicts on record as households dig into savings to fuel spending.

Another key element of the problem is that this “in-between” generation keeps putting financial planning on the back burner. On average, those aged 30 said it would take them almost 10 years to start planning. As they moved through their mid-thirties, people began delaying even more.

This planning procrastination has resulted in just 13 per cent of 44- and 45-year-olds reporting to have a plan in place and we believe this is a key contributor to high levels of concern. Over half of the people surveyed feel negatively about their financial future.

The situation these in-betweeners find themselves in is not generally of their own making. The reasons are complex, but things that may have been taken as fairly straightforward by previous generations – owning your own home and building up a funded pension – are much more challenging for this generation.

At the moment we operate a ‘pay as you go’ system for state pensions, meaning the national insurance paid today funds the current generation of retirees. While the system has its merits, society has changed and it’s creating a problem. As society gets greyer, working-age taxpayers face a growing bill to cover the state pension.

Changes to the state pension were introduced, in part, in recognition of this. The package of changes included the triple lock, rising state pension ages and the abolition of the earnings-related part of the state pension. The underlying premise of these three changes was to replace the state pension with a new deal, in which the state pension started later but was of a decent amount, indexed at a reasonable level. The triple lock ensures that the state pension increases each year by either earnings growth, inflation or 2.5 per cent, whichever is highest. The issue with the triple lock is that regardless of what is happening to people’s earnings generally or the state of the economy, the state pension will ‘ratchet’ up by at least 2.5 per cent. This ratchet effect has been key to rectifying the relative decline in the state pension that occurred between the ‘80s to the ‘00s.

However, the scenario has changed again and policy needs to reflect that. There are some options that could ensure the social contract remains in place. For instance, now that the relative decline in the state pension has reversed, the triple lock should be reviewed from 2020 and replaced with an earnings link. In times when earnings fall behind price inflation, an above-earnings increase could kick in until real earnings growth resumes. The government should also consider future policy on universal pensioner benefits. Targeting these benefits more efficiently could help leave something in the pot for younger generations.

Another option for policymakers to consider is increasing auto-enrolment contributions to help this generation make ground more quickly. An agerelated approach to maximum autoenrolment contributions and the use of ‘nudge’ techniques to minimise opt-outs should be considered.

Doing nothing is not an option. If Theresa May wants to build an economy for all of us, she must not forget that a whole generation currently has little hope of escaping work and spending its days of retirement in the sun.

To view all of Old Mutual Wealth’s retirement reports, visit: https://www.oldmutualwealth.co.uk/products-and-investments/pensions/pensions2015/retirement-reports/

Jon Greer is a retirement policy expert at Old Mutual Wealth.

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