Uncovering a household’s saving journey to retirement

How much should I save for retirement? It’s a question anyone planning for their future will face, particularly as modelling from Phoenix Group’s longevity think tank, Phoenix Insights, shows as many as 18 million people in the UK are not on track for the retirement income they want.

There have been a number of helpful standards adopted by the pensions industry and policy makers for understanding saving adequacy. These recommend a target level of saving that’s right for a broad number of people and tend to be based either on calculating how much of people’s working income they will need to live on in retirement (as recommended by the Pensions Commission) or a typical households’ consumption needs in retirement (such as the PLSA’s Retirement Living Standards).

These targets can be an effective way of communicating a savings goal, but for many they will be wide of the mark as they don’t allow for the enormous differences between the financial lives of different people in different circumstances at different times of life.

When we include factors such as gender, childcare responsibilities, housing costs, age and consumption habits, we start to realise how a broad-brush approach to measuring savings adequacy can work on average but might be less effective at an individual level.

Phoenix Insights, in collaboration with Nest Insight, is exploring the financial circumstances experienced by different households as they journey to retirement to offer a more nuanced definition of ‘retirement saving adequacy’.

The interim findings reveal some of the factors that can most affect people’s ability to save for retirement.

Age

Age is a good predictor of people’s income throughout their life, and consequently their capacity to save.

However, we found that when factoring in individual characteristics and circumstances alongside age, such as sex and having children, there are noticeable differences in individuals’ income levels.

For example, having children is associated with higher incomes for men, while for women, it is associated with much lower income in their 20s and 30s.

Affordability pressures

Different experiences of day-to-day spending, such as bills and mortgage costs, also illustrate the complexities of circumstances that households, even within the same age-income group, can find themselves in.

Our analysis found someone aged between 33 and 40 with a monthly employment income in the range of £833 to £1,150 faces around a 14% chance of being behind on rent or mortgage payments today.

These are groups who would currently be automatically enrolled into a workplace pension, and are not among the lowest earners, but for them questions about their financial priorities at retirement age might feel less urgent than paying bills today.

Worryingly, over 10% of middle earners in their mid-40s are behind on rent or mortgage payments in a typical month.

This can create challenges around the trade-offs between present-day and future priorities, and the affordability of putting aside income into long-term savings.

Housing

While there are many factors that affect the way households prioritise present day costs versus future retirement income, perhaps the most critical of these is housing.

Phoenix Insights modelling suggests close to 11 million people are likely to face ongoing rental costs in retirement – and the share of those expecting to rent is generally higher among younger age groups, likely reflecting the difficulties they have getting on the property ladder.

There are huge inequalities in who is able to save for a deposit, but provided it is achievable it can pay to prioritise saving towards a house.

Additional housing costs can create a significant drain on retirement income and need to be considered alongside retirement planning. However, despite the role that owning a home can play in retirement, saving benchmarks tend not to factor this in.

Changing priorities

I began with the question many ask around how much people need to save for retirement.

The truth is, it depends. These aren’t easy questions and individuals face a lot of competing priorities and decisions. But there is strong evidence for a contextual approach to saving adequacy benchmarks that factor in people’s consumption and spending power, which can change during their working lives.

Current adequacy standards tend to focus on pension saving and pension income. We feel there is a gap to develop a richer model that takes into account these differences in people’s financial lives. This should allow for better targeting of nudges and other interventions that can help people make the right choices at the right times.

The Financial Conduct Authority and the government are currently reviewing how we can close the advice gap, including enabling people to better access more targeted forms of support from providers.

Helping savers make better decisions about their long-term finances is one of the biggest challenges pension providers face, and an adequacy model that allows for the many differences in people’s lives could be a valuable tool for those in the accumulation phase to consider.

Age, sex, periods of non-earning, divorce, childcare responsibility and saving towards a house are just some of many circumstances and characteristics that represent the present-day reality of households in the UK.

By uncovering which factors make the biggest difference to someone’s optimal savings rate, we can hope to improve our understanding of adequacy standards and consider what is the ‘right’ level of retirement savings for individual households. We hope that these will complement existing benchmarks already in place.

Patrick Thomson is head of research and policy at Phoenix Insights, Phoenix Group’s longevity think tank