Will you be hit by the pensions crisis?
We can’t talk enough about the pension’s crisis. Most people aren’t saving enough for the life they are going to want and something has to be done about it. We cover the big questions: why is there a problem, how much we really need to be saving and will the state pension even exist when you retire?
What you should remember from this episode
Tom McPhail is a pensions industry expert who used to be the Head of Policy at Hargreaves Lansdown and now works for a finance consultancy firm called Lang Cat. You can find him here on Twitter here and his podcast Financial Services Unplugged (Spotify).
He says you should be really engaged with your pension because it’ll probably be the most valuable thing you own, along with your property.
As a society we’re living longer but we’re not saving enough to afford these longer lives/retirements.
The UK started its auto enrolment pension system about 20 years ago. This was because pension schemes were getting worse (as people were living longer and businesses wanted to reduce their pension liabilities) and the government needed to increase participation (opt in).
The auto enrolment scheme made pensions opt out which largely worked - about 10% of people opt out.
Pensioner poverty has dropped in the last 20 years. There are of course still lots of pensioners in poverty (and the numbers have sadly gone back up a bit again in recent years because of the cost of living crisis) but since the 2010s, Tom says we’ve made big in-roads into pensioner poverty.
Tom also thinks auto enrolment might get us out of the pension hole of people not saving enough (along with economic growth) - but only in the long term. This is because young people in their 20s will be auto enrolled for 40ish years, so they will benefit hugely from compounding but what about people who are in their 40s or 50s now? They haven’t had the benefit of compounding for their entire careers, nor will they enjoy the generous defined benefit pension schemes of older generations. So Tom is expecting a big pension problem for these people in particular, in the medium term - the next 10 to 30 years or so.
Here in the UK, our pension saving level is about 6% - 8% (of people’s gross income) but Tom says you need to be at about 20% to have a really good pension. 15% is still very good, and Australia is marvelled at for its 12% from auto enrolment. Basically, we’ve still got a way to go.
The state pension has worked historically, says Tom, but it’s looking increasingly difficult to sustain because of demographic factors like our ageing population. That’s why the government keeps increasing the state pension age.
Immigration can help in the short or medium term (by adding more people of working age) but Tom says studies show that immigrants take on the birth rate and lifestyles of their new nation so it doesn’t fix the problem, it just pushes the can down the road.
Declining home ownership is another big problem in the making. About 78% of UK people today own their homes outright in retirement, but this will drop to about 60% in less than 20 years. This means lots more people will have to pay much more to live (because they’ll have to pay rent) which roughly doubles the amount of money someone needs in retirement. This is why it’s good (if not critical) to aim to own your home outright by retirement.
There is also a gender pensions gap. Women’s pensions are substantially lower than men’s, largely because of historical working patterns. Although the picture is improving, women will generally end up with smaller pots than men for the foreseeable because they still take more career breaks to raise children.
Tom suggests couples treat their retirement savings as a couple rather than individually as there are benefits, like tax efficiency.
Only 16% of self-employed people contribute to their pension which is quite scary because there are 5 million self employed people in the UK (and growing).
More than 50% of retirees rely on the state pension for at least 50% of their income.
The proportion of state spending devoted to pensions, social care and health care is going to need to increase markedly because of our ageing population. How will we pay for it?
Tom wonders if we should start putting some state money into a national wealth fund now so that in 30 or 40 years’ time it could deliver income which pays for the state pension (or a good chunk of it) - like you see in Norway.
Politicians stick to the narrative that everyone pays into the state pension and everyone will get paid out of it when they retire because it would be toxic not to - but will it really be like that in 30 years? Is it sustainable?
Auto enrolment came out of a window of opportunity in the early 2000s. Labour had a big majority and faced a disorganised opposition (not unlike today, at the time of writing). They commissioned a review which suggested doing auto enrolment - and then they went out and did it, so fair play to them. The government got consensus across the parties, unions, companies etc. - and Tom thinks we need to do something seismic like that again now to increase what we’re saving.
Tom thinks the number of pensions we have (every time you join a new company, you get put into a new one!) makes it difficult to feel ownership which is one reason why nearly 90% of UK people stick in their default pension fund(s). We just don’t engage with it as a society.
The pensions industry can help the UK’s growth, Tom argues. Pension schemes have a few trillion pounds in their pocket, so MPs are now beginning to say some of that pile of cash should be invested into things which will stimulate growth in the UK, like startups (in theory).
Tom often refers to two countries he thinks have done good things with pensions - Canada and Australia. One of their defining characteristics is they have very few pension schemes - like a few dozen or so in Australia - whereas we have 27,000 defined contribution schemes in the UK. 27,000! Tom asks if we can move to fewer, better run pension schemes? Australia have also means tested their state pension which is intriguing.
Tom’s pension tips for individuals:
Join your workplace pension if you haven’t already.
See how much more you can put into your workplace pension with your employer because some employers will match or even double match what you put in.
Some will also do salary sacrifice which saves you National Insurance.
If you’re self employed - make a plan for your retirement, whether it’s with ISAs, LISAs, pensions, some combination etc.
Check out a pension calculator and the PLSA for living standards. Then you can start to build a plan. The simple act of framing what you want feels a whole lot better than not knowing. That is an hour well spent.
But remember, inflation will have a huge impact on your retirment (and the numbers in your plan), which is why you want to use an inflation calculator. If you’re looking at today’s numbers, for instance, remember the buying power of those pounds has roughly halved in the last 30 years.
Typically, wage and investment growth runs slightly ahead of inflation.
People often struggle to switch from a saving mindset in life to spending in retirement.
The famous Trinity study suggested you can draw 4% of your capital and that should see you through retirement. Tom says that rule of thumb is a good starting point but you still need to figure out what works for you because it obviously doesn’t have any nuance or personalisation in it.
For most people getting a financial advisor to navigate the retirement planning phase is a good idea because that’s when things gets particularly complicated.
