FTAdviser.com

Advertising

Walking along the street of many cities in the UK, it is really hard not to notice how many old people there are in the country.

Its not just the UK, neighbouring European Union states expect to see a big increase in pensioners in the coming decades, with their being only two people of working age for every person aged 65 or more by 2060. Innovation and advancement in drugs and increasing prosperity have meant that people feel stronger and are living longer.

Living longer can only be great news, when finance is no object. As the ratio of pensioners to working-age people continues to sour, however, its hard not to ask the question, is there enough money to pay for the retirement for today's working population?

The realistic answer is no, because there will be fewer younger people around to pay for the pensions of the retired.

In a 2005 report, the government said the situation could be remedied if taxes were raised, and people were forced to save more as well as work longer, perhaps beyond the age of 65.

Tom McPhail, head of pensions for Bristol-based Hargreaves Lansdown, put the problem down to the overall pension funding being too low.

He said: "For example, a good final salary scheme, which pays out around two-thirds of members' final salaries, requires contribution rates of 20 per cent onwards.

"Currently, most people are paying about 9 per cent to their scheme, so there is not enough funding to shore-up the pension pot.

"With the exception of the public sector, where promises are backed by taxes, dwindling private sector employers are still delivering final salary benefit with the majority opting for money purchase pension with lower contribution rate."

Mr McPhail explained that the problem is further exacerbated by the low average contribution rate to money purchase pensions coupled with 15m of people not having any pension at all.

He pointed out the severing of the link between the state pension and earnings by previous Conservative government did not help the situation.

Mr McPhail said it was the end of the idea that as people grew richer so too would pensioners because pensions rose in line with inflation rather than average earnings.

The decline in occupational pensions, a large chunk of which is final salary, as well as the struggling property market have also been blamed for the pension crisis.

The UK pensioner's contribution is small - about 30 per cent of their working income - in comparison to many neighbouring countries such as France, and Spain, where it is about 70 per cent.

According to the Office for National Statistics data in 2004, the bottom 20 per cent of a retired household had an average gross income in 2002-2003 of £7280. By far the biggest element of that was the state pension.

But despite the inadequacy of the UK basic state pension - which pays an average weekly rate of £90 while the average income is £400 a week - many do not share the view that saving is the key to UK pension problems.

Andy Tully, pension policy manager for Standard Life, warned that although saving is a good move to solve on-going problems, we have to consider the dangers of higher savings and its slow effect on economic growth.

On the issue of people working longer, Mr. Tully said the whole longevity concept is still not fully explored properly therefore it is essential that we keep an open mind.

He said: "We have to plan for the future, however with the many ills that have gripped our society lately such as obesity, it may be possible that people may not live as long as we expect them."

Nonetheless, recent government figures have shown a positive trend in employment of pensioners.

According to an ONS study in 2006, employment rates for both men and women over retirement age rose to new peaks of 9.6 per cent and 11.1 per cent respectively.

Mr. Tully believes solutions to most of these thorny issues can be found through social policies aimed at raising the standard of living for both the employed and the unemployed.

While, Mr McPhail stressed that an upgrade of the existing pension structure was the only way forward.

He said: "The only way out of this pension conundrum is to rapidly move to a single universal form of basic pension that reflect today’s prices - for example, an average weekly rate of £125 to £130.

"This will involve the government spending a lot of money - raised by winding down of its promises to the public sector - to revamp the current basic system, second state pension and pension credits."

Looking to the future, the biggest question is how are pensioners converting their pot into an income that offers full value for money?

Until the 1990s, the only real choice for anyone with a maturing pension plan that was not a final salary scheme was to buy an annuity.

Annuities come in differing shapes and sizes, but the idea behind them is simple. In exchange for your pension fund, an insurance company guaranteed to pay you a regular income for the rest of your life.

According to Hargreaves Lansdown, the vast majority of retiring investors continue to convert their pension savings into an income by buying an annuity.

Mr McPhail, said: "While annuity rates have halved since the early 1990s, so too has the rate of inflation - so the buying power of an annuitant's income has broadly stayed the same.

"Indeed annuity rates have been one of the few beneficiaries of the credit crisis with many rates soaring to a six year high - up 5 per cent this year alone."

He said the huge numbers of baby boomers retiring in the next few years will still look to annuities first and foremost.

But he warned that with recent stock market turbulence, the income certainty that an annuity provides will be increasingly appreciated.

Hargreaves Lansdown said annuities dominance of the retirement market will continue, even though income drawdown has made great strides in becoming an everyday retirement option for some investors.

Mr McPhail said: "Last year, a quarter of all retirement savings were invested in these plans. As drawdown becomes an increasingly commoditised contract, more investors will find this option appealing. Its sales are set to rapidly grow."