Rising costs of retirement income not necessarily all bad news

Rising inflation and its effect on the price of goods and services required to provide each of the three standards – minimum, moderate and comfortable – saw the cost of each rise considerably, said the tracker, which published its fourth-quarter data for 2022 on March 9. 

The minimum standard saw the biggest rise, where food and energy prices make up a more significant portion of the lifestyle. Yet the moderate standard still saw an increase in cost of 12 per cent, or £2,500, while comfortable increased by £3,700, or 11 per cent.

On face value, this will appear disastrous for the individual saver. However, defined contribution pension saving proved resilient during 2022, despite the volatility in the investment markets.

If inflation comes down as quickly as is expected and growth fails to materialise, questions will be asked about how we solve the economic malaise facing the UK

Richard Carter, Quilter Cheviot

The tracker suggests that on average, DC members can expect a higher standard of living in retirement than at the beginning of the year – even allowing for current levels of inflation.

Not all doom and gloom

The reason savers are expected to have a higher income is as a result of an increase in future expected returns, which come with no guarantee and may never happen. But while current fund values may not look very promising, future expectations have improved, even if most individual savers are not aware of this.

Individual savers will understandably be nervous about what the future may bring when looking at their own fund values, because returns in 2022 were poor, particularly for older members with higher allocations to bond assets.

Some effects of inflation will be offset by the 10 per cent increase to the state pension due in April — particularly for the oldest of savers, for whom the state pension makes up a greater part of their retirement income. 

Even allowing for the effects of inflation, the youngest of the tracker’s sample savers will be better off. The oldest will have a a higher retirement income, but will be expected to have a lower standard of living. This is because in 2022, it was the 50-year-old sample saver who suffered most, despite having an expectation of the highest retirement income at the start of the year. 

The 40-year-old saver overtook this position in 2022, and the 30-year-old saver is expected to achieve a similar income. Both these individuals suffered smaller falls in their existing fund values and can therefore expect greater benefit from future returns.

In reality, many DC savers may have been startled by the volatility in the market, compounded by the cost of living crisis. This may have led them to have reduced their savings, or even opted out of their scheme.

This reinforces the importance of not only communication, but engagement on the individual’s part, to better understand the context of their investment performance.

Rebalancing the index

The Aon UK DC Pension Tracker graph shows a marked fall at the start of the third quarter of 2022 – from 76.9 to 63.5 – as a result of taking account of the updated PLSA retirement living standards.

Over the fourth quarter, the index rose to 66.9, primarily driven by increases in expected returns when the savers reach retirement, meaning their fund values are expected to produce a higher income in retirement than at the previous quarter end. 

“If we ignore changes to the future return assumptions, the tracker would still have risen over the quarter as a result of positive investment returns,” though that increase would have been limited to 64.1, the authors of the report said. 

“This all suggests that once again our sample savers are, on average, expected to have a higher standard of living in retirement than was expected at the end of the previous quarter, albeit lower than if the living standards had not been updated.”

By the end of 2022, the markets may not have become as bloody as feared earlier in the year. But there are still plenty of bumps in the road that may influence the position of the Aon tracker at the end of this month.

Not out of the woods, yet

The gross domestic product figures released on March 10 show that the economy grew in January – it was up 0.3 per cent – while the previous quarter was flat. This means the UK continues to teeter on the brink of recession and many people will have already found life challenging enough this winter.

It remains a challenging environment and central banks will not be drawn on when the time might be right to cut interest rates. 

“Inflation is proving a difficult beast to tame and as such further rate rises may be required,” said Quilter Cheviot head of fixed interest research Richard Carter. 

As an increasing number of people will reach the LTA limit, change is needed to ensure that those who do the right thing and save for their retirement aren’t unduly penalised

Dean Butler, Standard Life

“Ultimately, this is going to weigh on the economy, and the Bank of England continues to have a tough job of balancing its job of getting inflation down without tipping the economy into an even worse recession.”

Backbench Conservative MPs who are hoping for something to stimulate the economy and boost growth from next week’s Budget are likely to be disappointed, said Carter. 

“The chancellor has made it clear that slow and steady is the best way to bring down inflation and get the economy moving again,” he said. 

“However, if inflation comes down as quickly as is expected and growth fails to materialise, questions will be asked about how we solve the economic malaise facing the UK.”

Reform needs to make pensions simpler

It would appear that calls for reform of some of the pensions tax allowances, such as the money purchase annual allowance (MPAA) may have been heard by the Chancellor. 

The MPPA has recently been cited as a disincentive to encouraging older workers back into the workplace.

There is little consensus on the impact it will have on encouraging older workers and debate as to whether poor health or financial security has kept them at home. 

The lifetime allowance clearly does disincentivise some workers – particularly NHS doctors – from returning to work. Even though the LTA limit of just over £1mn does not provide a gateway to riches, but an annuity of just above the PLSA’s comfortable standard of living for a single person, or just under for a couple. 

“In the long-run, however, this is an allowance that really isn’t fit for purpose,” said Standard Life managing director for customer retail Dean Butler.

“As an increasing number of people will reach the [LTA] limit, change is needed to ensure that those who do the right thing and save for their retirement aren’t unduly penalised.”

Just 12 months ago, the LTA was frozen until 2026. But whispers from Westminster suggest Wednesday’s Budget may be a show of the Chancellor’s largesse – at least for pensioners, a key demographic of grass roots Conservative support.    

Those in their mid-fifties may see the state pension age rise, but the triple lock was retained last year. Auto-enrolment is set to expand, but Butler, like many commentators, would like to see minimum contributions increased to 12 per cent to give pension saving a significant boost. 

All the potential changes that could be made by the chancellor only reinforce how complex the pensions system is. 

Recent Standard Life research found that half (50 per cent) of UK consumers already find pensions and retirement information to be overwhelming, and more than two in five (41 per cent) admit that even once they have received it, they do not know what to do with it. 

Butler added: “More than anything, we’d like to see any reform reflect the need to simplify rather than complicate pensions, as this is key to enabling greater engagement with retirement savings and, by extension, improving retirement outcomes.”

Jason Hollands, managing director at wealth manager Evelyn Partners, said that any plans to reform the MPAA and LTA would “be welcome news after the tax raids announced in his autumn statement”.

If the reports are to be believed, said Hollands, the Chancellor would be unlikely to raise allowances while removing tax reliefs. This suggests that pension tax reliefs may have got away with it once again. 

“It would also be unpractical to be able to implement such changes so close to the new tax year,” added Hollands, “as well as politically risky for Hunt to target the tax benefits of private pensions after the significant tax crunch announced at the autumn statement, and on top of the likely acceleration of state pension age increases. “Pension tax reliefs for higher and additional rate tax payers – the proverbial cat with nine lives – look set to survive for now, but their long term survival should not be taken for granted.”