A recent exchange on Twitter about the perceived defined contribution pension savings crisis, led to the following response from pensions expert John Ralph: “Long-term solution to UK pensions problems = 1. Work longer; 2. Spend less, save more; 3. Lower retirement income expectations.”
John was obviously restricted to Twitter’s famous limit of 280 characters, therefore, could not expand on his remedy, but on the face of it, no one would disagree with his comments. However, life is not that simple. Let’s look at the impacts in more detail.
- Work longer
Recent research distributed by the National Bureau for Economic Research in the USA maintains that working up to six months longer can be the equivalent of paying an additional 1% contribution into a pension over 30 years. On the other hand, according to a research article published in The Lancet in 2012, by the age of 65 nearly 50% of the population suffer from two or more morbidity conditions, and this is more pronounced in lower socio-economic groups.
To me, this indicates that we must move away from the idea of a fixed retirement age and that government policy should be more focused on the ability to flexibly retire. Those who are unable to work should be looked upon as having retired when they are no longer fit to work, whereas those who can work longer should be encouraged and rewarded to do so.
- Spend less, save more
Again you cannot disagree with the sentiment. But dig deeper and you will see that pensions tie-up money for a long time which reduces consumption. The UK economy is driven by consumer spending; if more is saved economic growth will be less, government tax income from spending (VAT) will reduce and reduced employment means less will be received from income tax and National Insurance contributions than otherwise would be the case. Government spending on benefits will increase, reducing the amount available for infrastructure investment.
There is a counter-argument that more money invested in pensions means more funds available for investment in the UK economy. This could counter the impacts described above if that investment improved infrastructure and productivity in the UK. A diversified investment strategy would by definition mean that a large proportion of the additional savings would not be invested in the UK economy.
At a macro level, therefore, would a dramatic shift in spending and saving deliver the desired result?
- Lower retirement income expectations
This is the point I find most interesting. What income expectations do people have in retirement, and by how much might they be reduced? If they are reduced, at what stage do people say it’s not worth saving into a pension?
Over the years the image and expectations of retirement have changed. It is presented as a world of regular holidays and healthy, active sporty people in their early 70s living as if they were still 35. Is that image a reality for all but the wealthiest 20% of retirees?
It is not retirement income that is the problem. It is retirement spending. To state the obvious, if people spend more than the income they receive they are in trouble.
Before the introduction of pension freedoms it was not uncommon to find people who retired with insufficient pension savings. They took their tax-free cash and purchased an annuity. They carried on spending as if they were still working, and once the tax-free cash had run out they started to build up debts. Often these people turned to equity release to resolve their debt problems.
Pension freedom just makes the whole pension pot available for the same exercise. How many people are spending their pension savings to maintain their working living standards regardless of whether they have saved enough to do so?
In the UK, 83% of household wealth is held in pensions and housing. We should educate people about how retirement income can be funded by using both. If you are renting in retirement, how much more income do you need to meet that rent than if you owned your own home outright? How much do people need to save to realise that income?
This does not look upon housing as an investment or as an alternative to a pension when providing for retirement. It looks upon housing costs as a necessity of retirement spending which has to be paid for in advance of retirement or during retirement. Having acquired a house the owner has an asset that may be able to be used alongside pension savings to get closer to that dream retirement. However this needs the right guidance and advice in preparation for, and during, retirement.
It’s not simple to provide better retirement experiences. A lot needs to be done but solutions go beyond just defined contribution pensions and certainly, in this day and age, housing wealth cannot be ignored.
Bob Champion is chairman of the Later Life Academy
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