In Focus: Retirement Income  

Pension poverty warning as DC models found outdated

Pension poverty warning as DC models found outdated
 Photo by Jordan Benton via Pexels

Britons relying on workplace pensions may end up with significantly less income in retirement than expected and perhaps even in poverty, governance services provider PTL has warned.

Calling it a "catastrophe" in the making, the independent trustee and governance services provider claimed that most workplace pension plans were being built based on defined contribution adequacy models that were outdated and overlooking some "major factors". 

As a result, the managing director of PTL warned that many more members than previously thought are heading toward retirement with inadequate savings.

Richard Butcher stated: “DC adequacy models make assumptions about all sorts of things, including certain lifestyle and social factors.

"But the problem is that many of those assumptions are out of date. As a result, we are over-estimating the levels of adequacy those members will achieve."

He said unless these models were fixed, members would end up with far less money in retirement than the models have given them reason to expect.

Butcher added: "Unless we fix the models, we’ll have many more unhappy members and, far more importantly, more members living below the standards of living to which they aspire - perhaps even in poverty.

"Beyond the human tragedy, this could cause significant damage to the brand of pension saving which has already suffered reputational issues over the years."

According to PTL, the key factors being overlooked include:

  • The decline of home ownership, meaning more people will be paying rent through retirement. All the current models assume no housing costs.
  • The tilting of the inheritance scale: families in the middle of the wealth distribution will inherit less because their parents are having to pay for long-term care.
  • Educational debt: the myth of the graduate premium, in the case of some degrees, imposes a significant break on the ability of those affected to save for their futures.
  • Long-term health costs. Successive governments have ducked this issue, meaning that pension savings will become the de facto funder.
  • Financial fragility. Butcher said while this isn’t a new problem, it is a persistent one, and unless it is fixed, members are likely to opt out, even in response to what many of us would consider a relatively minor financial event.

He added: “While it’s tempting to think employers or the government will step in, at the moment this looks unlikely.

"The impact of Brexit and Covid on some employers has made it impossible for blanket increases in contributions, and the government will need to focus what few resources it has left on growth generation."

There was a glimmer of hope however, Butcher said. As the pension system was becoming "progressively more efficient",  incremental gains can offset the impact of these factors.

Also, while auto-enrolment can help, he said the contribution rate remains too low for it to fix the problems, and cited the need for at least a 12 per cent contribution rate. 

The 12 per cent contribution rate has been put forward by several pension advisers and providers over the past few years.

As reported in FTAdviser last year, research from Aviva found while more people were participating in workplace schemes, there was still a long way to go for people to meet their expected income goals in retirement.

At the time, Laura Stewart-Smith, workplace savings manager at Aviva, said people needed to contribute more than the minimum rate set by government into their auto-enrolment schemes if they want to be able to retire comfortably.

She said: “It’s important that people don’t assume minimum contributions can fund their future, as it is often insufficient to provide the level of retirement income they want."