Personal debt is a significant blindspot in the method used for determining 'adequate' retirement incomes, research suggests, as data from overseas show indebtedness will play an increasingly important role in retirees' needs.
Adequacy is often measured through the use of replacement rates, which are defined as the ratio of retirement income to income while working.
A report from the Organisation for Economic Cooperation and Development last year warned people on low incomes, the self-employed, single people and those aged 55-64 all had at least a 50 per cent chance of missing their replacement rate.
They’re right to highlight instances of consumer debt… It’s something we should take into account when we talk about adequacy
Tim Gosling, NAPF
A recent briefing note from the Pensions Policy Institute and JPMorgan Asset Management, entitled ‘Measuring adequacy under the new pension flexibilities’, said while replacement rates could be a useful indicator of savers' ability to provide for themselves in retirement, freedom and choice has brought its efficacy into question.
It states: “Replacement rates have been brought into question by the removal of constraints to how individuals can access their defined contribution savings.”
Chris Curry, director of the PPI, said: “Replacement rate calculations… don’t take into account the levels of debt people have. This is something that when people start thinking about retirement, they need to take account of, especially where they’ve taken out debt knowing they’ll be able to repay it [with their pension savings].”
The PPI also points to the potentially deleterious effect of personal debt on consumers’ incomes in retirement, giving the example of Australia, where in 1994-95 around 80 per cent of the population aged 55-64 owned their own home, of whom 10 per cent had a mortgage.
By 2009-10, 82 per cent owned a home, but 30 per cent had mortgages. One implication of this figure was that increased savings in a liberalised DC environment led to people accruing higher levels of debt on the basis they could repay it using their pension pot.
Useful benchmark
Curry added, however, that the replacement rate calculation was useful “as a benchmark to help us ask ourselves, ‘are enough resources being dedicated to retirement?’”.
Tim Gosling, DC policy lead at the National Association of Pension Funds, said: “[The PPI is] right to highlight instances of consumer debt… It’s something we should take into account when we talk about adequacy.”
However, he added: “There’s a notion that pension freedoms have changed everything, and in one respect they have. But they haven’t changed what people want; they want an income and a sense of certainty in their retirement.”
Jamie Jenkins, head of pensions strategy at provider Standard Life, said: “The one thing freedom and choice doesn’t solve is that there’s been a prolonged period of undersaving. It doesn’t in itself increase the size of the pot people have available.”
Jenkins added the replacement rate offered a good target, “but people may have other savings or forms of income. We shouldn’t look at pensions in isolation”.
But he said the introduction of freedom and choice could ultimately improve adequacy.
“It offers flexibility to look at adequacy in a number of ways,” he said. “Adequacy might be a stable income for life – for some it might be bridging the gap between retirement and the state pension.”
