Retirement saving – we all know we should be doing it, but are we saving enough?
Last month the Independent Review of Retirement Income concluded that the average worker needs to double their pension contributions.
In the report, Professor David Blake, director of the Pensions Institute at Cass Business School, wrote:
To get a decent-sized pension pot for retirement, it is necessary to make adequate pension contributions – something of the order of 15% of pensionable salary.
The first Momentum UK Household Financial Wellness Index also found that one-fifth of people feel unable to make adequate provisions for retirement. This is part of a wider savings shortfall which we wrote about here.
Average pension contribution: how much are we saving at the moment?
The average worker pays just 4.7% of salary into a pension, with employers making further contributions of just under 4%.
Eventually, under Automatic Enrolment rules, employers will be obliged to make a 3% minimum contribution, and workers a 5% contribution.
However, this doesn't necessarily add up to an 8% overall contribution. Why? Because the figure these percentages are based on ignores the first £5,824 in your salary – along with any earnings over £42,385.
So if we should be aiming for 15% pension contributions, we'll need to effectively double the amounts we're currently setting aside for retirement.
But can we afford to do so?
This set off a lively debate at our offices.
Two members of our content team, who are at different life stages, give their views…
Yes – but it means changing how we think about our income
Mark is married, a homeowner, and recently became a father. He started saving for retirement in his thirties and has both a workplace pension and a SIPP.
On the face of it, doubling your pension contributions seems like a big ask.
To me, though, if retirement is ever going to be a priority in your life, it needs to become one of the top priorities early in your working years.
I only began to realise this after turning 30 and it required a big adjustment. In fact, I'd go so far as to say it requires a totally different way of thinking about your income.
Let's say you are in your early twenties and earning £20,000. You work out what you can afford, keep things frugal and live a £20k lifestyle. Then you get a first promotion and a 20 per cent increase in salary to £24,000. What happens to that extra £2,720 (after tax and NI) more in the bank each year?
For most of us, it simply goes directly into improving our standard of living.
The first problem with that is that pretty soon, your £24k lifestyle feels normal – exactly like your £20k lifestyle did. There's even a term for this. They call it the hedonic treadmill. When your standard of living rises, the initial pleasure quickly wears off and it becomes your new baseline.
In other words, you are unlikely to reach the point where it feels like you're earning enough to make a radical adjustment to your take-home pay – such as putting 15 per cent of your gross pay into your pension.
The other difficulty is that having something taken away (a pension contribution) leads to a far more profound sensation than having something added on (a pay rise). So whatever you earn, it is always going to feel difficult increasing your pension contribution. The fact is, other than peace of mind, there's no immediate reward for doing so. It's a psychologically difficult thing to do.
However, the fact is that a lifestyle based on 15% less than our current salary is undoubtedly possible – and it needs to become our new 'normal'. Simply, we need to think of our income as being 15 per cent less than it currently is, and plan our remaining expenses accordingly – exactly as we would have to do if they raised Income Tax by a further 15 per cent.
It's not easy. It has taken a big psychological leap to put this into practice. For me, the catalyst was getting married and joining up our finances. My wife and I agreed a target for the proportion of our income we want to save and give away each year. So when we're planning our finances, we mentally deduct that amount from our total income along with taxes and NI. What's left becomes the starting point for our budgeting and planning.
We're currently making some adjustments to our finances after the arrival of our son, but both retirement saving and charitable giving will remain priorities. When I was in my twenties, I thought I couldn't afford to save for retirement – but I still managed to afford a car, several drum kits and some travelling! It's all about recognising that pension saving means sacrificing some income now in return for an income later.
No – my generation is facing a retirement crisis
Ruth is single and renting privately. She has recently started a workplace pension in her twenties.
I agree that, generally, people tend to prioritise short term spending over longer term financial security – and when it comes to pensions this needs to change. However, for those who are on low incomes, or (like me) in the early stages of their career, it's easier said than done.
The average salary for 20-24 year olds is £16,400, with 25-29 year olds earning an average of £22,700. The average rent in the UK, excluding London, is £744 per month as of February this year. Only when my rent and bills are paid can I start to think about saving. It's important to have an emergency fund, ideally of at least three months' salary – particularly when you're living in short-term rented accommodation. Most people my age aim to eventually own a home; it makes good financial sense and provides security when you start a family. As house prices continue to rise, so too does the size of deposit we're required to save.
When you're just starting out in your career, there are so many competing priorities for your limited saving power that it seems impossible to meet them all adequately. And that's without taking into account travelling and other experiences, which do little for your financial wellness but help you to develop as a person. It's easy to see why pension saving slips down the list.
Because of compound interest, starting to save into a pension earlier can mean that you end up with more pension for less cash. But it's maddening that the best time to start can also feel like the most difficult.
Of course, difficult things are still worth doing, and some sacrifices are worth making. I think the auto-enrolment rules (which mean you have to opt out of a company pension instead of in) are a step in the right direction.
What do you think?
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