Jon Upton, policy analyst at the Pensions Policy Institute, explores the organisation’s latest research into how people can end up with an inadequate pension – and what can be done about it.
The Pensions Commission is tasked with improving pension adequacy. This may mean that automatic enrolment is reformed to make contribution rates high enough to target an adequate retirement, rather than a baseline minimum. How exactly this will work is yet to be determined, because adequacy itself is hard to define.
There is more than one way for a pension to be inadequate, and this is perhaps most obvious when looking at the subjects of the PPI’s most recent research: people who have low earnings at some point in their careers.
One way for your pension to be inadequate is for it not to let you continue your working life standard of living into retirement. This is the central idea of the ‘replacement rate’ methodology used by the Turner Commission, which expresses your retirement needs as a proportion of your working life income. That is, if you have a high standard of living just before retirement, but then have to ‘downsize’ aspects of your life because your savings aren’t enough, then your pension is considered inadequate. You may not be in poverty, but ideally, you would have saved more during working life to avoid this downsizing.
This kind of inadequacy is a risk for people who had low earnings earlier in life but earn more later. Just before retirement, their lifestyle may be comparable to a lifelong high earner. However, their pension wealth may reflect a mixed earnings history.
This could describe someone who graduated from university but couldn’t find higher-paid work in their field straight away, or someone whose financial position was too unstable in their twenties to be able to save.
The state pension and ‘oversaving’
Continuing your pre-retirement lifestyle is only desirable if you had a good standard of living in working life. For this reason, another kind of inadequacy is to fail to afford even a basic standard of living, regardless of how you lived working life.
Pensions UK’s Retirement Living Standards include a “minimum” level, which is the amount needed to buy everything for a minimal, but complete, retirement that allowed you the freedom to fully participate in society with financial security.
For those with no private pension savings, state income alone may not be enough to reach this standard, which may mean that their retirements are limited by a lack of funds in some way. This is especially true for single retirees, because the state pension is only based on your individual record. This means that couples receive twice as much state pension, but can share living costs, while single people face higher living costs as a proportion of their state income.
Nonetheless, if the state pension is to be the backbone of some retirees’ incomes, then this should be acknowledged: not just to ensure that it is sufficient by itself, but to ensure that people who are on track for this kind of retirement save appropriately. People in this position may find that any private pension saving is actually ‘oversaving’, since working life benefits are lower than the state pension, and any earnings they have may be better spent more immediately.
People in this position may also be at risk of missing out on state pension eligibility: if they did not work in a given year because they were caring for children, or for health or disability reasons, they may miss out on some state pension eligibility if they did not apply for child benefit or universal credit at the time.
The government has recently introduced a way for parents to retroactively gain extra “qualifying years” if they missed out at the time, but no such pathway exists for people who were unable to work. Simplifying the way that the benefits system interacts with the pension system may be especially important for those who depend entirely on the state pension.
Finally, there are two more ways for a pension to appear adequate on paper, but to be at risk of becoming inadequate by the time you retire. Many low earners will retire with pensions that are above the minimum standard of living, and allow them to continue their current lifestyle, but only if they do not have to make rent or mortgage payments. Similarly, many low earners (such as mothers who took a career break) may be on track to have a good retirement, with the caveat that they are dependent on their partner’s pension.
The new Pensions Commission has a decade of data to build on the success of automatic enrolment and “finish the job” by addressing inadequacy. To make this work for low earners and all savers, it is first important to recognise that many retirements are adequate by one measure, but not another.
Jon Upton is a policy analyst at the Pensions Policy Institute.
