Young people are facing more financial strain than older generations, in an environment with low returns, soaring house prices and skyrocketing inflation, which is making it that much harder to save.
The near extinction of the very generous defined benefit (DB) pensions has also caused more problems, as the market has shifted towards the more modest defined contribution (DC) plans, meaning younger people will face a less lucrative retirement compared to older cohorts.
According to Tom Selby, head of retirement policy at AJ Bell, with house prices hitting records high nearly every other month, many are prioritising saving to get on the housing ladder first, with retirement temporarily benched as a financial priority.
Despite the implementation of auto-enrolment in 2012, several industry players have noted that the minimum contributions guaranteed under the scheme will not nearly be enough to provide sustainable income in retirement, again forcing younger savers to find alternative ways to fund their later life needs.
Recently, International Adviser reported that people outside of London have £1trn ($1.3trn, €1.2trn) more in property wealth than in their pensions, with many looking to access it to reach some financial security at the end of their working lives.
IA reached out to industry players in order to understand the reality of this potential generational retirement gap and to what degree it will impact younger savers.
Steve Webb, partner at LCP, said: “There is no doubt that future generations of retirees will face a tough combination of circumstances. They will generally have much smaller DB pensions, but most will not yet have built up DC pots of equivalent value.
“Those who reach retirement having paid off their mortgage can tap into their housing wealth but need to take careful advice before doing so. For those who are able to do so, keeping in paid work for longer, even on a part-time basis, is one of the best ways to improve your eventual retirement finances.”
Kate Smith, head of pensions at Aegon, noted that there is a specific generation left in retirement limbo, as they have not been able to enjoy DB benefits but also started working before auto-enrolment was introduced.
“Generation X – those born between 1965 and 1980 – working in the private sector, could be hit the hardest,” she said. “This is the generation which sits between the shift from DB to DC provision, so they may have little or no DB benefits and won’t be able to optimise the benefits from auto-enrolment, as it only started from 2012, when many of this cohort would have been well into their working lives.
“Individuals may be led into having a false sense of security, that contributing at the minimum auto-enrolment level will provide an adequate retirement income, as this is the level set by the government.
“Furthermore, others may look to their parents’ generation, many of whom are receiving generous DB pensions, and falsely conclude that they too may expect to experience a similar retirement income, even if they have little or no DB pension. We have found in our consumer research that often expectations don’t meet reality.”
‘Prospective’ wealth gap
But what contributed to such a retirement wealth gap?
According to David White, managing director at QB Partners, it is the fact that DC schemes do not carry the same liabilities as their DB counterparts, making them more attractive to employers.
He said: “Younger people, who don’t have access to DB schemes, are unlikely to have the same inflation-adjusted level of wealth when they retire, leading to a prospective wealth gap between the current retiring and retired generation and subsequent generations of retirees. The younger generation can consider using alternative ways of saving for retirement, but this isn’t on its own going to replace this gap.
“However, the retirement savings landscape is changing for a number of different reasons. Staying on DB pensions, many companies have changed their pension scheme from a DB to a DC basis, primarily due to the cost of having to reserve for defined pension liabilities. This can be demonstrated by the decline in the number of defined benefit pensions over the years.
“Decreasing lifetime allowance thresholds have made it less attractive, from a tax point of view, for savers to use pensions for retirement planning. The current lifetime allowance of £1,073,100 may provide an income in retirement of £40,000-50,000 per annum, depending upon a number of variables such as retirement age and investment growth assumptions, which will not be sufficient for many high earning individuals.”
Although there is little that can be done to change the current retirement backdrop, what can savers do to mitigate their income levels in later life?
AJ Bell’s Selby said: “There is little point in younger savers lamenting the situation; DB pensions are not coming back, and house prices are out of our control. The key is to set a sensible budget based on your priorities and financial circumstances, decide your financial goals – both now and in the future – and then save and invest your money in the most tax efficient way possible.
“For many people this might be a combination of products – an Isa for short-to-medium term savings, a Lisa for a first home and a pension for retirement, for example. A good adviser can also help you review your savings against your goals and, where necessary, help you make adjustments so you stay on track.”
Aegon’s Smith agrees, as talking to an adviser can make sure people stay on track based on what goals they may have for retirement.
She added: “While some advocate rules of thumb around how much you should save for retirement, ideally this is something you’d discuss with an adviser. Much depends on your aspirations for later life, your income while working, what the state will provide and any extra your employer may contribute.
“An adviser will also be able to advise on how best to invest bearing in mind your savings horizon and attitude to risk. While accessing housing wealth may offer a solution to some, it’s unlikely to provide the whole answer and those some way off retiring shouldn’t be relying on this as a core plank of retirement planning.”
QB Partner’s White added that there are other ways young savers can turn to in a bid to grow their savings.
“A general investment account (GIA) can benefit from tax deferral/gross roll up on the underlying assets on a buy and hold basis,” he said. “Once savings have been accrued, an offshore portfolio bond can be used to provide tax efficient income through the tax deferred 5% annual withdrawals.
“New technology is driving more accessible ways of saving and managing money, such as banking apps, investment dealing apps and online pension services such as Pension Bee and this trend will continue.
“Ironically, due to the capital gains and inheritance tax benefits of UK pension savings, together with the fact that pension income is taxed as earned income, it can be argued that drawing an income from a pension should be left until after some of the alternative retirement savings options have been utilised.”