In recent years the world of pensions has been characterised by change. A new state pension has replaced the old system for people reaching state pension age since 6 April 2016. Automatic enrolment into workplace pensions began to be introduced in October 2012, and will cover all employers at the new minimum contribution level by 2019. Since April 2015, people have had much great flexibility in how they use their pension saving to fund their retirement, with many more expected to keep the money as capital rather than convert it all into an income. Even more recently, in the last Budget, the Chancellor announced the creation of new tax-advantaged savings vehicle – the Lifetime Isa – designed to increase saving for retirement.
But despite – or maybe because of – all of these changes to the pensions system, it is still very difficult to answer one very obvious question: “How much should I be saving for my retirement?”
The answer to this seemingly easy question will depend on a wide range of different things – most obviously, how much money do you want in retirement? But how much to save in a pension will also depend on what other assets you might have, or expect to have in future, and what you plan to use them for. This will include things such as your house as well as other savings that you might have. And finally, when do you want to start relying on your pension saving? When are you going to stop work, and are you going to stop completely, or perhaps work part-time?
For many people, avoiding a drop in living standards when they stop work seems like a reasonable target when thinking about how much money they might need in retirement. This doesn’t mean fully replacing your salary, as some things are likely to be different. The mortgage might be paid off; you may no longer have to get to work every day. And some of what you need will be provided through the state pension – although the new level of £155.65 is unlikely to go very far for most people. But saving enough so that you could, if you wanted, have a total income of somewhere between one half (for high earners) and three-quarters (for lower earners) of the amount that you earned in work could avoid a significant fall in the quality of life when you retire.
Then, when thinking about how much to save in a pension, the amount that you save when you are automatically
enrolled into your workplace pension scheme – increasing to 8 per cent of “band earnings” by 2019 – might also seem like a good starting point. But are these two things – saving at automatic enrolment levels and maintaining living standards in retirement – consistent?
The answer is, unfortunately, probably not. Someone starting working and saving now, aged 22, working and earning the median earnings for their age and saving at the automatic enrolment minimum for every year until they reach the current projected state pension age of 68, has roughly a 50/50 chance of reaching the target. For a higher earner, the chances are lower, at four in ten. In order to have a three-in-four chance of maintaining living standards in retirement – not guaranteed by any stretch of the imagination – a median earner would need to increase their contribution level to 13 per cent of band earnings, and a higher earner to 14 per cent.
There are some important considerations here. The first is that the minimum contribution level for automatic enrolment is not collected over all earnings – only on “band earnings”. Band earnings are earnings between £5,824 and £42,385 (2015/16), so if you make contributions on all earnings the headline contribution rate is a little lower.
A second consideration is that the size of the contributions required is heavily dependent on what happens to the state pension. The figures cited assume that the new state pension is increased each year by the “triple lock” – that is, the highest out of three variables: growth in prices, earnings, or 2.5 per cent. Although this is the current policy of the government, some are concerned about the affordability of the triple lock. If instead the new state pension was increased each year in line with average earnings growth, both median and high earners would have less than a one in three chance of not suffering a fall in living standards in retirement, and would need to contribute 17 per cent of band earnings to have a three-in-four chance of achieving their target.
Not everyone will work and save continuously for 46 years. Contribution rates would need to be considerably higher for those who have breaks in either earning or saving, or start saving later. For example, someone not starting saving until they are 40 will need to contribute between 25 per cent and 30 per cent of band earnings to have a good chance of not seeing a fall in living standards in retirement if they have no other savings and still plan to stop work at state pension age.
In the real world, of course, 40-year-olds who don’t have any prior pension saving are not going to be able to put one-quarter of what they earn into a pension. This is why automatic enrolment has become such an important savings policy. The earlier you start to save, the less you need to save each year to reach any given target. But, as these figures show, automatic enrolment by itself is not likely to be enough for many people. Either the minimum required contributions will need to be higher, or new ways must be found to persuade people that they ought to be saving more. That is easier said than done.
And any changes that help the younger generations are likely to be too late to help those already halfway through their career with few pension savings. Many will have to look at alternative options to complement the pension saving that they can do. This might be using other assets (downsizing the house, or using equity release), or accepting that retirement isn’t going to be as comfortable as they’d hoped for. But for many, depending on their health, the option of not retiring at state pension age might be one to consider. Delaying retirement for three years can, through a combination of increased saving and less spending, increase income in retirement by 20 per cent each year.
So, as with so many questions, there is not a single, easy answer to how much money you should be putting into a pension. The amount you should save will vary depending on who you are, what you are saving for, and how long you have to save for. The amount is almost certainly higher than many people think. But there are other things that can be done alongside pension saving, such as using other assets or working longer, that can help people save enough for a comfortable income in retirement.