Why it is important to start pensions early

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Why it is important to start pensions early
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Young savers and the self employed saw the largest proportional increases in financial vulnerability during the pandemic, rising by more than 40 percent, according to the Financial Conduct Authority.

Since young people are now more likely to be much less comfortable retiring than their parents, it is important to start preparing for retirement sooner rather than later. 

Advice firm Purely Pensions has warned that savers in their 20s could lose more than £21,000 at retirement if they put off making contributions to their pensions for the first five years of working. 

Matthew Amesbury, head of Pensions Advice at the firm, says the pandemic has delayed young people starting to save for retirement since more young people are seeking ways of maximising take home pay.

He said this meant many stopped pensions contributions, which would result in them missing out "massively on the benefits of compounding interest and long-term growth’’. 

Pandemic effect

Earlier this year, a survey by workplace savings provider Cushon found concerns about saving for retirement reduced by 20 per cent in May compared with the same period last year, while 75 per cent said the coronavirus made them realise having accessible savings was 'equally important' to having a pension. 

Some 41 per cent of those surveyed would like to see their employers implement a ‘pension redirect arrangement’ which would mean money is redirected into a separate pot to cover immediate and medium-term financial priorities.

In terms of a generational divide, a New York Life Survey in July surveyed 2,200 adults across three generations of working-age people. It found that millennials feel the most confident of all 3 generations about their retirement prospects.

The financial individualism and insecurity of defined contribution schemes comes at a cost to the young.

For instance, 68 per cent of Millennials are confident they’ll retire when they planned versus 62 per cent of Generation X. 

In fact, in 2019, according to a study by Insider and Morning Consult, only 50 per cent of this generation had a retirement account and only 36 percent were actively saving according to a study by Insider and Morning Consult. 

Looking to the future of pensions, the recent shift in Europe, North America and parts of Asia to move from defined benefit to defined contribution plans puts the burden of creating and executing the pension strategy on the individual.

This includes weathering market shocks and making sure their pension pot lasts as long as they do.

The shift from the paternalism of company pensions that provide fixed benefits to the financial individualism and insecurity of defined contribution schemes comes at a cost to the young. 

Since the data shows the majority of young people are not good at managing the risk of retirement savings on their own, they can often underestimate the financial risk of growing old and how inflation can erode savings.

This can lead people to not saving enough and making poor income choices at retirement. 

Options

However, other ways that countries have tried to mitigate these problems, such as implementing state pension ages and increasing pension information to young people isn’t tackling the biggest retirement risk which is longevity. 

One option could be collective retirement schemes, which pool individuals’ pension pots so that investment and longevity risk is shouldered by the group.

This has been trialled in the Netherlands and Canada, where the governments recognise the potential for collective investments to produce better outcomes than individual plans. 

There will be greater pressure on schemes to make responsible investments.

However, this is not without problems. How are schemes to ensure poor investment returns are shared fairly between young and older members? 

Another prediction for the future of pensions is that there will be greater pressure on schemes to make responsible investments.

According to a recent survey by Share Action, 84 per cent of pension scheme members say they would prefer a pension that uses investments to encourage companies to be more responsible. 

Some 68 per cent of 25-34 year olds say it is important for people to use their money for the good of society and the wider world. 

Some of the UK’s largest pension providers have committed by 2050 to be "net zero" or neutral on carbon emissions from their main pension portfolios but this is a pace seen as too slow by many climate campaigners. 

However, it is a start and something that will need to be factored into the savings conversations we need to have now to help encourage younger people to start saving.

Saksha Menezes is interning with FTAdviser