Stagnant incomes, rising wealth inherited later in life, and the relative poverty of defined contribution schemes compared with older defined benefit schemes are all factors that threaten the sustainability of retirement income, according to speakers at the Pensions and Lifetime Savings Association’s annual conference.
Torsten Bell, chief executive of the Resolution Foundation, drew on data from the Office for National Statistics, showing wages had only just returned to the levels seen before the 2008 financial crash at the time the Covid-19 pandemic struck.
“That pay squeeze was happening at the same time as we ramped up pension contributions because of the successful policy of auto-enrolment,” he said.
“The effect of that is people’s take-home pay, if they were auto-enrolled and they were on average earnings over that phase, has actually been even worse.”
We’re going to have a lot of people with modest DC pots in years to come who won’t be able to afford to retire, who’ll be working longer than they want to. It’s very hard to see what we can do about that
Steve Webb, LCP
Mr Bell said this highlighted the tension that exists between the desires to increase pension contributions and the need to increase incomes. “Every time we manage to successfully increase pension contributions we are decreasing short-term living standards.”
The result of this is a “big divergence” between pensioners and working-age people in disposable household income.
“We’ve seen 30 per cent growth [between 1994 and 2018] for the pensioner population, whereas it was nearer five per cent growth for the working-age population. And all of that broadly disappeared in the early stage of this crisis for the working-age population,” he noted.
Meanwhile, household wealth has experienced a considerable and consistent rise — more than doubling since the 1980s.
“The danger, that I don’t think we talk enough about in the context of pensions, is that for lots of people their quality of life in retirement won’t actually be determined by the size of their pension saving in their lifetime. It’ll depend on how lucky or unlucky they are on the size of their inheritance… it’s fulfilling much more of the function that we’ve traditionally thought of as pensions providing,” Mr Bell explained.
Smaller DC contributions make state pension more important
This phenomenon is compounded by the failure of auto-enrolment to attain the same level of contributions seen in older DB schemes — in part due to these concerns about the impact on disposable incomes.
Mr Bell drew on data from the ONS Occupational Pension Schemes Survey in 2014, which showed that, while DB schemes attracted contribution rates of 5.2 per cent from members, 15.8 per cent from employers and a total of 20.9 per cent, the equivalent figures for DC schemes were 1.8 per cent, 2.9 per cent and 4.7 per cent, respectively.
LCP partner Steve Webb said that this combination of factors make having the state pension especially important, cautioning against any move to “turn the taps off” in response to the lockdown-induced economic crisis.
“The role of the state pension is going to be crucial in the coming years for young people,” he said.
“If we say we’ve got a golden generation coming up to retirement, free university education, they own their own homes, big DB pensions, and they’ve grown 30 per cent relative to the working population, therefore we should switch the taps off and switch spending towards the young.
“Young people desperately need… a damn good state pension, because if they worked outside the public sector they aren’t going to get much else.”
Stalled progress on auto-enrolment will only exacerbate the need for a strong state pension, Sir Steve continued.
“Already, the government had got pretty wimpish. We had a very sensible, incremental report — extend auto-enrolment to 18 year olds, apply percentages to all of your earnings, not the bit above £6,000,” he said.
“Even before Covid it wasn’t going to be until 2025 [before] we saw action. That seems to be on hold.
“We’re going to have a lot of people with modest DC pots in years to come who won’t be able to afford to retire, who’ll be working longer than they want to. It’s very hard to see what we can do about that.”
Pensions ‘used to’ negative interest rates
Both Sir Steve and Mr Bell agreed that the prospect of negative interest rates is not uniquely of concern to pension funds.
“We’ve already had them; we’ve had them for years. The fact that nominal rates would go negative is just more of the same. We’ve been getting used to negative real interest rates for a while now,” Sir Steve said.
“The fact that a particular interest rate goes slightly more negative isn’t really a problem, the problem is nobody is making any money on anything,” Mr Bell added.
The threat posed by negative interest rates is a general one, and it is individual savers, not the funds themselves, that will be hardest hit, Sir Steve concluded.
Calls for govt to rethink auto-enrolment contributions
On the go: Wealth manager Quilter is urging the government to allow low earners who opt out of auto-enrolment to still receive their employer pension contributions.
“If you’ve got a DC pot the capital sum has gone down, now you’re going to get even lower rates of return. One of the concerns we’ve got, particularly with longer retirements, is the sustainability of income for individuals.
“The world of pensions is used to negative real rates. It’s the individual savers who are having to struggle with smaller pots, having to last for longer, with lower interest rates.”
