Pension gap

Parents of children currently going through the education system may consider that the reported several thousand former Equitable Life policyholders having had their pension cut by up to half, as the result of new tax codes, is unlikely to affect them. But it has thrown into sharp relief the plight of those relying on relatively modest savings for their retirement incomes.

Actually, the problem is likely to be short-lived, since once the codes are corrected – apparently everyone has been put on an “emergency” footing because of a change of administrator – the tax will be corrected, including (presumably) sorting out any over charge.

But this made us think about the level of savings that people have and what might happen in years to come, if they do not save enough for their retirement.

According to recent data from the Association of British Insurers, almost one third of those currently in work save nothing towards a pension. A further one in seven do not save enough; in fact fewer than half of all those at work currently save enough towards their retirement.

The ‘shortfall’ identified by the ABI is based on research indicating that while roughly four out of ten people want to have a retirement income of between a half and three quarters of their current level of income to retire in comfort, only a quarter expected to do so, based on current saving levels. Yet more than half of all respondents said they expect their pension (including state benefits) to be their main source of income in retirement. A third expect to rely on inheritance, property or their partner’s income in retirement.

Actually, the belief that even as much as 75% of ‘final earnings’ will prove an acceptable retirement income could be outdated. With people retiring in far better health than a generation ago, it is not just that people live longer, but that they expect to be more active in the early years of retirement that creates the need for income. If you have more leisure time, you could well spend more, not less, than before; so having a generous income to pay for all your leisure activities could be important. Not to mention the need to have spare income to help the next generation cope with the demands of modern life!

From 2012, a new compulsory pension scheme will be set up for anyone who is not in an ‘acceptable’ company scheme, to which employers will contribute 3%, employees 4% and the government 1% (although there is an opt-out for employees). However, this will only apply to earnings between a minimum (currently set at £5,035) and a maximum (currently set at £33,540), so the maximum effective contribution will be 8% of £28,505, or just over £2,280 a year.

At the top end of this scale, this represents a contribution rate of just less than 6.8%; but for someone on £45,000 a year, for example, it only represents about 5% of total income. Such low contribution rates are unlikely to provide anything like a reasonable retirement income (except for someone starting very young and always increasing their contributions in line with wage rises).

Making personal provision for retirement will not just continue to be important; it is likely to rise to the top of many people’s financial planning agenda. As we get closer to the time when we are no longer tied to work, disposable income becomes more, rather than less, important.

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