Average earners targeting a “gold standard” pension of two-thirds pre-retirement income will need to work to age 77 at statutory minimum contribution levels, a new report has projected, underscoring the key role default levels will play as auto-enrolment matures.
Auto-enrolment will bring 10m UK savers into occupational pension schemes by 2018, as hundreds of thousands of small and micro employers fall within the scope of the legislation over the coming months.
So far the policy has been heralded as a great success: the National Audit Office reported in November that in August 2015, 5.4m people had been enrolled, with a much lower rate of opt-outs than anticipated – between 8 per cent and 14 per cent, compared with the 28 per cent initially assumed.
People might reasonably think, 'The government chose 8 per cent, chose age 22, set the state pension – surely they did all of those things so that I would get a decent retirement'
Steve Webb, Royal London
But a study by the Tax Incentivised Savings Association last year suggested that by 2035, people will be worse off in retirement than the previous generation, a prediction echoed in the nation’s retirement expectations. Nearly three quarters (71 per cent) of UK employees expect to be worse off than their parents in old age, according to research by consultancy Willis Towers Watson.
The gold standard
Average earners contributing statutory minimums under auto-enrolment legislation will have to work into their 70s to generate the two-thirds replacement ratio benchmarked in 2004 by the Turner Commission, states a new report from mutual insurer Royal London entitled ‘The Death of Retirement’.
To additionally secure inflation protection and survivor benefits – labelled the “gold standard” in the report – average earners will need to work until they are 77.
Savers targeting a “silver standard”, half of their pre-retirement income with protections, will have to work until they are just over 71.
For higher earners, the goal of achieving a 67 per cent of pre-retirement income in a pension is “effectively unattainable” at defaulted levels; this group will need to work until their mid-80s to reach an inflation-protected income at such a level.
Contribution rates
Steve Webb, policy director at Royal London and author of the report, said many people being auto-enrolled find themselves defaulted by the government at a particular level.
“[People] might reasonably think, ‘The government chose 8 per cent, the government chose age 22, the government set the state pension – surely they did all of those things so that I would get a decent retirement’,” said Webb. “It’s pretty shocking that is basically unattainable unless [savers] do something about it.”
Webb said default levels must continue to rise from 8 per cent in 2019 using auto-escalation to gradually raise contribution rates in line with pay increase, rather than hiking up entry rates and risking mass opt-outs.
Many savers today will be “miles short” of the pension and quality of life enjoyed by their parents, Webb added, as the decline of defined benefit salary-related arrangements – structured on much higher levels of both employee and sponsor contributions – ramps up.
“We’re not saying everyone who retires today is filthy rich,” said Webb. “But plenty of people retiring now had access to salary-related pensions, long service, plus a state pension, which gets you to this gold standard.”
Squeezed middle
Hugh Nolan, chief actuary at consultancy JLT Employee Benefits, said middle income earners will be worst hit by the transition into defined contribution. “It’s one of those squeezed middle stories – people paying a bit in will get less than they expect,” he said.
Nolan said a higher rate of contributions could be made available on a flexible opt-in basis, maintaining statutory minimums as a backstop level. “[It would be] opt-in with the opportunity to drop back down, rather than having to opt-out,” said Nolan.
Ben Franklin, head of economics of an ageing society at thinktank the International Longevity Centre, said debates on the policy’s evolution over the coming year, particularly around auto-escalation, will be critical to its future development.
“In terms of getting people saving, [auto-enrolment] has been a mighty success,” he said. “But that was always the first part. The second part of the challenge is obviously to get people saving enough to make their pension pots worthwhile.”
