Pay more or face a poorer old age

Published on Saturday 23 February 2008 16:38

Millions of us need to increase pension contributions due to longer lives...

ALARM bells will soon begin ringing for millions of savers who could shortly be told that because we are all living longer their pensions are not worth what they thought they were.

Three million savers in company money purchase and group personal person schemes, as well as those saving for retirement via 17 million personal pension policies, will have to increase the amount they save for retirement by up to 6% or risk being left with a big shortfall.

In coming months, the watchdog responsible for laying down the rules by which these pensions are calculated will embark on a major review of the assumptions pension companies must use when setting premiums and sending out annual valuation statements.

The Board for Actuarial Standards is expected to demand more draconian assumptions to allow for our ever- increasing life expectancy.

This will make pensions more expensive, cutting the numbers we see on our annual statements. But most of these savers, unlike final salary scheme members, will have no employer to make good the shortfall. Individuals will have to significantly boost savings themselves or be much poorer in retirement.

A huge chunk of the working population will be hit. Gary Shaughnessy, managing director of Prudential's pensions business, pointed out that from next year more employees will rely on money purchase schemes than final salary pensions, even when public sector workers are included.

He said: "The onus is on the individual to make good any shortfall. But the truth is we are already saving nothing like enough.

"The average pension pot is dismally low at 25,000 to last for an entire retirement. A typical man retiring today at 60 is going to live for another 25 years. That 25,000 isn't going to go very far at all.

"Our savings ratio is at a 47-year low. The sooner you start saving the easier it becomes, and also provides greater protection against market volatility."

Any changes to assumptions will also throw into disarray Government plans for a pension for all via the new Personal Accounts. These are based on an 8% of salary contribution, which will look increasingly inadequate. Anyone on below average wages who expects to be very modestly paid for the rest of their life should take advice before starting a pension. They could sacrifice more through lost benefits in retirement than they gain.

Working out how much we each need is not an easy task, given there are at least eight different indices measuring our life expectancy, and coming up with different answers. To date, the pensions industry has relied on data lying midway between the most pessimistic and most optimistic view. For example, it bets a man retiring today at 65, born in 1943, will live until 71. By contrast, a baby boy today, retiring at 68 in 2076, will live to beyond 88.

However, it now looks like the industry will be forced to increase these expectations by two years.

In other words, today's retiree will make it to 73, and today's baby past 90. Women live longer still and a 60-year-old retiree today might live to 87, and a new baby to nearly 94.

Scottish Widows head of pensions Ian Naismith said: "The pensions regulator believes the speed of medical advances and improvements in our health and fitness will feed through to greater life expectancy than we have been planning for. If money purchase and personal pensions are forced to use similar assumptions it could push the cost of a pension up by 5% to 6% a year."

So how much should you be saving? Few schemes outside the old final salary arrangements, which promised two-thirds of your final year's wages, any longer set firm targets. The size of the new-style money purchase, group personal and personal pensions will depend on how much you pay in, investment performance, charges and annuity rates at retirement.

Against this background, most individuals and employers merely contribute what they can, and in most cases it already isn't enough.

Douglas Anderson, a partner at actuaries Hymans Robertson, said: "Most are targeted on employers' ability to pay, and it is important for employees to recognise this. There are a few better ones targeting a pension based on half a final salary. But the reality is there is a far larger number targeting much lower levels of pension. It is up to employees to realise this and make up any shortfall."

Naismith added: "At the top end, a combined employer's and employee's 12% contribution should provide an 'adequate' pension, but most will fall a long way short of the old final salary schemes."

These levels of contribution should be put into the context that many employers are paying well over 20% of salary on their own to fund staff pensions, with employees saving between 5% and 10% on top.

As a very rough rule of thumb, you need to save half your age (as a percentage of earnings) when you begin saving, and the sooner you begin the better. For example, a woman saving 500 monthly from 31 could retire at 60 with a pension pot of 26,715.

If she instead saved 1,000 monthly from 46, she makes the same 15,000 contribution, but only gets 19,971.

But bear in mind that a 100,000 lump sum will currently buy an annuity of less than 5,000 annually without any inflation-proofing. So her 19,951 is far from a fortune.

Early start not enough on its own

SCOTTISH & Newcastle commercial assistant Stephanie McPherson has already been saving into a pension for seven years, thanks to mum and dad, who took out a policy on her behalf with Standard Life when she was 15, writes Teresa Hunter.

Stephanie, now 22, says: "They were worried there would be no state pension by the time I retired, so they wanted me to start saving for retirement at the first opportunity. When I started work I just kept paying in what they had. "

They began making a 15.60 monthly contribution with Standard Life, which grosses up to 20 with tax relief. Commendable though their efforts were, this will not provide Stephanie with an adequate pension.

These contributions would produce a lump sum of 88,780 when she retires in 2054 at 68. This would buy her an annual income of 3,500 at today's annuity rates.

Stephanie, of Edinburgh, only recently began working for Scottish & Newcastle as a commercial assistant, and although she has not yet joined the pension scheme, she probably will. Either way, she needs to significantly increase her savings.

Standard Life's Andrew Tully adds: "She's done the right thing starting young, but if she wants to retire on half her earnings she'll need a lump sum of 450,000. She needs to be putting 260 aside until retirement."

Plans for the future

Employees with company money purchase pensions should ask staff reps to maintain a constant dialogue with the employer about increasing his contribution. If your scheme looks like falling behind ask him to increase what he is paying.

All employees are sent an annual statement detailing the pension they should receive at retirement. Read this carefully. The information is adjusted for inflation, so it tells you in today's terms what your pension will be worth at retirement.

Consider a salary sacrifice arrangements, which can save an employer national insurance contributions, which he may use to boost your pension.

Make sure your pension provides some index-linking: 25 years of inflation will bite into your income.

Keep an eye on your state pension, and if necessary fill gaps in your National Insurance contributions.

When setting up your pension, arrange for contributions to increase annually. Standard Life's pensions manager Andrew Tully says: "Set them up to increase on the day you get your annual salary raise. This way you don't notice losing money you've never had."