We constantly hear that the UK population is not saving enough for retirement, but is this true for all generations?
Despite the media furore about struggling defined contribution (DC) pension schemes, we are rather more optimistic about savers' futures. Here's why.
Are baby boomers' DC savings about to go bust?
DC pots are small relative to typical defined benefit (DB) pensions. However, the baby boomers retiring in the next few years are still very much Generation DB. The Department for Work and Pensions projects that in the next 10 years, less than 10% of new retirees will have a DC pot alone, and about 30% will have just a DB pension. 40-50% will have both.
The Institute for Fiscal Studies estimated that in 2010-11, only 12% of 55-59 year olds had more than 50% of their non-housing assets in DC pensions, whereas 56% had less than 20%. These predictions didn’t even include state pension pay-outs. And, while DC balances have risen since then, so have the values of DB pensions.
Our own research found that those between the ages 55 and 65 typically under-estimated the multiple sources of income they have at their disposal, from state pension and buy-to-let properties, to forgotten DB pensions. Many were pleasantly surprised that they were not far off their goals. This group of savers identified about £25,000 per year as largely sufficient to live off for a household of two, a target which was manageable for many through state pensions and final salary schemes.
So is running out DC savings the primary concern for those retiring soon? We don’t think so. For the majority retiring in the next 5-10 years, their DC pots are not large enough to make a difference, when compared with their inflation-linked state or DB pensions, with a median value for those 55-65 of under £30,000. And from a behavioural perspective, the concerns about individuals spending their retirement savings too quickly are largely overblown, as all evidence suggests that most people are quite prudent in retirement and, if anything, underspend.
A stitch in time saves nine
For those currently in their early 50s, or younger, the situation changes, as DB provisions dwindle. The Intergenerational Commission estimates that for those born in 1970s the average income from DC pension will overtake that of DB, while the state pension will still account for more than half of average retirement income.
As people live longer, and retire later, focussing on contributions in earlier years may help to bridge the retirement income gap. From a policy perspective, the Pensions and Lifetime Savings Association (PLSA) recommends increasing minimum DC contribution levels to at least 12% of qualifying earnings. And on a more personal level, increasing awareness should help target the many who say that they are not sure they have enough in savings to retire. Initiatives such as Pensions Dashboard or Retirement Income Targets will give DC savers an at-a-glance view of their savings — as well as tangible targets. Focus on a wider financial wellbeing may help members assess their total saving needs, so that they can balance these immediate priorities with long-term retirement planning.
So – although the group of upcoming retirees are largely ‘off the hook’, there is a way to go to secure future generations a comfortable life after work. As we move towards new retirement models, what does this mean for DC investments and how should DC assets be used in retirement? Watch this space for future blogs which tackle these questions!
Mark blogging about the pensions generation game reminded me of a couple of Brucie bonuses that investors should be on the lookout for: the diversification bonus and the rebalancing bonus. Although they're often confused, they're very different prizes.