Personal Pension  

Trustee warns replacement ratio calculations are flawed

Trustee warns replacement ratio calculations are flawed

The basis of replacement income ratios produced by the Pension Commission and the Department of Work and Pensions may be flawed, as it fails to take into account changes in the extent of home ownership, according to Pitmans Trustees.

The independent trustee and governance services provider argued that as a result, many of the next generation of retirees, with a background of student debt and who will continue to pay their mortgage or rent their homes in retirement, may not have the income they need to survive.

Replacement income ratios are the percentage of working income needed to maintain the same standard of living in retirement. They range from 80 per cent for lower earners - most of which will come from the state - to 40 per cent for higher earners - little of which will come from the state.

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They are often used by defined contribution pension schemes to measure the adequacy of contribution rates.

Richard Butcher, and independent trustee and managing director of PTL, explained that historically, the cost of living fell around the age of retirement because people paid off their mortgage at around the same time.

“Back in 1981 almost a third of 16-24 year olds owned their own home. Now, just one in 10 of 16-24 year olds are in that position and the trajectory appears to be downwards.

“This implies both that fewer people will own a home when they reach retirement and that those that do will still have a mortgage to pay. The reasons for this are obvious, mostly relating to the growth in house prices relative to average earnings and the accumulation of educational debt, but the impact is frightening.”

Mr Butcher added that from a cost of living perspective, this means that the majority of future retirees will still be paying rent or a mortgage and so will need a higher replacement ratio to maintain their standard of living.

“This significant change in many peoples’ living situations is not taken into account in the replacement ratio as it stands and we urge the DWP and Pension Commission to review their calculations.”

Earlier this month, members of the Tax Incentivised Savings Association’s industry working group stated that the auto-enrolment pension contribution target of 8 per cent by 2018 is still insufficient, with a longer-term goal of 12 to 15 per cent needed to ensure people have an adequate replacement ratio in retirement.