Auto-enrolmentJun 25 2021

Tisa: 8% pension contributions 'simply not enough' for a comfortable retirement 

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Tisa: 8% pension contributions 'simply not enough' for a comfortable retirement 
Credit: Anna Shvets via Pexels

A recent study by Which? surveyed more than 6,800 real retirees to establish clear minimum pension pot requirements for an essential, comfortable or luxurious standard of retirement.

This is vital research and a valuable indicator for individual contributors and households looking to secure a comfortable future. 

However, several factors have the potential to complicate this picture.

For one, according to studies conducted by Tisa, the tax free cash allowance is nearly always withdrawn and often earmarked for big ticket purchases, resulting in some households failing to save enough to reach a comfortable standard of retirement despite contributing what they believe to be sufficient funds over their working lives.

Saving enough?

Although the introduction of Auto Enrolment (AE) in 2012 has led to record numbers of employees contributing to their workplace scheme, challenges remain.

It is essential that they must now save enough, or they risk creating an inadequate retirement pot.

And for these to be sufficient, we need to understand the additional financial pressures retirees will almost certainly encounter at, during and towards the end of the course of their retirement. 

The new Which? research concludes that couples will typically need net income of £26,000 and singles £19,000 a year for a comfortable retirement.

However, when additional factors such as raising a family, caring for elderly relatives, consistent increases in life expectancy and inflation proofing are considered, annuity income can be as much as halved.

Importantly, the fund value required for a household to achieve a comfortable retirement through an annuity is £265,420. This is based on the purchase of a level annuity with 50 per cent spouses guarantee.

Upon first death, the surviving spouse would experience a significant drop in income through the household loss of basic state pension and 50 per cent of the annuity. 

Were the annuity to provide indexation and 100 spouses pension, the fund value required would need to be circa £400,000.

Although the introduction of Auto Enrolment (AE) in 2012 has led to record numbers of employees contributing to their workplace scheme, challenges remain.

Tisa’s modelling for a median earning household journey based* on AE starting at 18 and contributions based on full salary indicates that a contribution level of 12 per cent would broadly achieve this.

However, life journeys can vary enormously, and it is therefore vital that retirees are equipped to understand the impact that life events might have on pension saving and, subsequently, their retirement outcomes.

Tisa's modelling is based on an optimistic baseline, as it presumes that the mid 2020 proposals have already been implemented in full, although we do not currently have a firm date in legislation.

It also assumes that no tax free cash is taken and is used for annuity purchase. As mentioned above, tax free cash is nearly always taken and if this not used for retirement purposes, contribution levels of over 12 per cent would be required. 

Future challenges

Half (50 per cent) of people who accessed their pension pots for the first time in 2019/2020 did not seek any advice or guidance.

A portion of tax free cash could be set aside to help cover the need for later life care should it arise, though our own research has found retirees tend, understandably, to avoid consideration of this stage of retirement.

This could be mitigated to a degree by guidance and advice provided at the point of pension access and through retirement, which could ensure tax free cash is not considered as a windfall, as it is currently by many. If, fortunately, money is not needed for care, then it could form part of the inheritance.

When we consider other generational differences, such as homeownership, the picture becomes even less clear.

The 12 per cent figure is just about adequate for those who reach retirement without mortgage payments or rental costs. But homeownership is being reached later in life for many, meaning they will continue to pay mortgage repayments in retirement, and fewer overall will ever own a home. 

Recent statistics suggest a third of millennials will be lifetime renters and we expect this figure to be even higher for Generation Z.

Half (50 per cent) of people who accessed their pension pots for the first time in 2019/2020 did not seek any advice or guidance.

Lifetime renters will face higher living costs in retirement, as well as having no property equity to deploy when needed.

They therefore need to be saving more than the 12 per cent to accrue a pot large enough to sustain a decent retirement.

Tisa’s research shows that a lifetime renting household can expect to run out of private pension savings 12 years before a household who own their property at retirement.

Being prepared

For the next generation, we therefore need to make sure they begin to save early, from the very beginning of their workplace lives. 

Luckily, Gen Z have a long time to save. If we begin to implement changes this decade, the youngest workers will be able to commence their pension saving from 18 and will have around 40 years of compound interest to gain.

This gives Gen Z a real opportunity to reach retirement with the pension pot they need. The longer we defer these decisions, the greater the likelihood more generations will approach retirement with inadequate savings. Overall, people tend to underestimate their life expectancy and do not place much importance on later life costs. 

Pension inadequacy does not need to be a reality. We need to ensure AE remains relevant against a constantly changing backdrop of working patterns, personal wealth and tax. This is the task that Tisa, pension funds and legislators must undertake as a matter of urgency.

 

*The household journey includes one adult taking time out to raise two children and finishing work at 60 to carry out caring responsibilities. The other adult has 40 years of AE contributions. Basic assumptions include an annual 2.5 per cent salary increases, annual 5 per cent investment growth with figures discounted back to today’s terms. 

Renny Biggins is head of retirement at TISA