We can't afford to retire

Posted on: 12 June 2009 by Gareth Hargreaves

If the recession, the banking crisis and rising unemployment aren't bad enough news try this: you can't afford to retire.

retirement optionsThere are a whole raft of problems here:

  • We're not saving nearly enough
  • The money we do save isn't performing as well as we hoped or expected
  • We are living longer and that means more years of retirement to support from savings over a given working life
  • Those expecting to rely on state benefits are not going to escape this demographic time bomb

Putting It Away

We weren't saving enough even before the recession arrived, and it is becoming increasingly clear that the downturn has driven a coach and horses through our attempts to provide for our retirement. According to a survey from HSBC, 14% of us have been forced to stop saving for retirement, 19% are using savings to pay off debts and 11% have had to defer retiring altogether.

It also found that just a quarter of Britons felt fully prepared for retirement, more than half had received no financial education whatsoever and only 5% knew about the requirement to buy an annuity.

However, those who think they have provided for themselves shouldn't become complacent.

Keen Investors

Those who followed all the advice from independent financial advisers and shovelled their savings into shares early in their working life have little, if anything, to show for it in the last decade and a half.

Share prices are back where they were in 1997 and for most of us, dividend payments have been largely swallowed by the excessive fees and overheads charged on investment funds, with-profits policies and personal pensions. That is 12 years in which you haven't a penny more than those who stuffed money into the mattress. Still, at least you are saving, and that is important.

Occupational Pensioners 

Those about to retire with a good final salary pension may feel they are doing okay. However, in a little-publicised and sneaky piece of legislation in 2008, the legal minimum for annual inflation uprating was cut to 2.5% rather than the 5% it used to be.

So while payments will match inflation up to 2.5%, if prices rise to, say, 3.8% in a given year you will still only get 2.5% more. That rule is affects contributions made after April this year. That may not sound much of a difference, but it really adds up the younger you are, the longer you live and the higher inflation is.

For those farther from retirement, there is even more to worry about. The defined benefit scheme, in which your pension is guaranteed as a fraction of your final salary, is an endangered beast.

Even the most financially stable employers are switching to defined contribution schemes for new employees, in which the investment risk of share and bond prices is shouldered by you, not them.

In the last week, three major employer schemes have been cut. BP is ending its final salary scheme for new employees, Barclays is taking the more radical step of ending it for 18,000 existing employees, while Morrisons is moving to an average salary scheme in which payments will inevitably be lower. The supermarket group is requiring a 3% contribution from staff where none had previously been made.

Don't Forget The Fund Holidays

While you may have thought this is because of poor investment returns, it should not be forgotten that if employers had not taken huge pension fund holidays, in effect stopping contributions when investment returns were better than expected in the 1980s and 1990s, they would not be in such a poor state now.

HMRC figures show that £18 billion of such holidays were taken in the 1990s alone. That amounts to failing to fix the roof while the sun was shining.

While any occupational scheme remains valuable because of the contribution made by your employer, it is probably not the gold-plated scheme it used to be.

Hard-pressed employers are contributing less, as a recent investigation by Money Mail showed. It calculated that a typical final salary scheme would be worth twice as much as a defined contribution scheme over a working life.

Annuity Rates Gloom

For those retiring on a personal or defined contribution pension, there is the additional headache of annuity rates.

These are the returns you get for surrendering your pension pot to an insurance company, something that has to be done by the time you are 75. Annuities are bags of mainly government bonds, churning out cash every year from interest payments.

However, as interest rates have fallen, so too have annuity rates, meaning you need to have a much bigger pension pot to get the same income.

Government Retirement Accounts

From 2012 new government retirement accounts are being introduced for those who currently don't have occupational pensions.

Contributions will be 8% of salary. The employee will pay 4%, the employer 3% and tax relief will provide 1%.

That is great for those who don't have any pension savings, but it is poorer than almost all final salary schemes and many pay-as-you go schemes, where employers alone often contribute 8%.

Those Slow To Act

Those who haven't bothered to start saving aren't looking so pretty either. Relying on the state pension may seem OK now, with pensions uprated in line with inflation and an earnings-related element. But the entire benefit system is becoming less affordable as we peer into the future.

This is especially so now the government looks likely to be shouldering $2 trillion in national debt by 2014 from the recession and the cost of bank rescues.

Just as an individual funding their own retirement has to balance the transfer of savings from working years to those of retirement, the state has to balance what it can reap from those in work for those who have retired. The government doesn't invest the money, but transfers it directly via National Insurance from taxpayers to state pension recipients.

However, the falling birth rate and extended longevity is giving each taxpayer a larger number of retired people to support and there could  come a point when they will cry "enough".

The demographics to show this are quite stark. A 65-year-old man can now expect to live until the age of 82 and a woman to 85. That is an increase life expectancy of four and three years respectively for a given 65-year-old since 1982. By 2010, the number of retired Britons in the UK will exceed the number of children.

The Economics Of Pensions

The basic fact remains that no pension scheme, of whatever kind, in any economy, can protect pensioners against such demographic effects. Ultimately, pensioners cannot compete with the working population and win.

The reason is that a given amount of savings, an annuity or a promised state or company pension is fixed in cash terms and is vulnerable to inflation.

People working or in business business can change the 'real resources' so if the burden of occupational pensions or taxes gets too high, they will eventually rebalance matters in their favour through wage and price increases.

We are already seeing that effect, through watering down of occupational pensions.

The 2005 Turner report already suggested retirement ages should go up by a year to 66 in 2030, to 67 in 2040 and 68 in 2050. Given current investment returns and increasing longevity, 2030 may not be soon enough.

Wait For Longer Before Retiring

However, the good news is that such projections are merely that: projecting today's situation into the future. It is quite possible that any or all of these variables may shift in the future.

After a long period of underperformance, it really is quite likely that the stock market will produce better returns over the next decade. We are also starting to see an upsurge in births, which could eventually help the demographic imbalance.

With increased pressure on the NHS, a rise in obesity, alcohol intake and sedentary lifestyles it is also unlikely that longevity can continue to expand at the same rate.

And if in the end we all have to work a little longer, that may not matter so much. The main thing is to make sure that whatever we do is enjoyable and fulfilling, as well as earning a penny or two.  

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