Pensions for us, ask Generation why
The idea that young people should not necessarily be saving in pensions is gaining ground. John Lappin investigates
Employers know this too - they are fully aware that for many young people pension is amongst the least attractive benefits they offer, despite its high cost. When it comes to engaging and attracting emerging talent, alternatives that address young peoples’ more pressing needs and desires are considerably more valued.
Some even challenge whether young people should actually be in pensions. As explained in greater detail in an earlier feature in the magazine, Cass Business School Pensions Institute director Dr David Blake says that in an ideal world people should not be saving in a pension until they are 35. In essence, Blake argues they can’t afford it now, and so they should leave until later in life, when they can. To quote one of two recent reports from the Institute: “It is not optimal for individuals to start contributing to a pension plan until several years into their career. This is because individuals’ incomes are initially low and they are better off consuming their incomes rather than saving from them.”
Unsurprisingly, Blake’s views about the under 35s have provoked a lot of argument among corporate advisers and pension experts, many of whom have spent careers convincing people to save in a pension from the earliest stage possible.
Some come close to outright condemnation. First Actuarial business development director Henry Tapper says: “There is no way that you can build up an adequate replacement ratio for your income by starting at 35 or 40. No way. In a DC environment, the contributions you make in your 20s and 30s are the most important you can make because they have the most opportunity for growth and arguments surrounding debt cut very little ice. Net disposable income is still there in your 20s and 30s, but we have a whole lot of lifestyle choices to make.
“But to give people the impression, that by not contributing to a pension, they are doing something that is somehow financially okay is grossly irresponsible.”
Tapper also believes that concerns about debt can be overblown. “There is a bit of a problem with disposable income, but it is a problem at all stages in life. You need to save throughout your lifetime. The liability you incur, when you stop working is so enormous, so you simply can’t leave 20 years of working life out of that without pension strategy.”
Scottish Widows head of pensions market development Ian Naismith agrees that by and large the debt argument is a false one, except in extreme circumstances. “We don’t see short-term debt as something that should prevent pension savings. It’s important that individuals get into the habit of saving for retirement, and this can be done even when running some debt, such as a loan for a car,” he says.
“However, if debts are out of control or are a particular worry for the individual, it may be sensible to give them priority over pension savings. Obviously if there’s an employer contribution that’s dependent on the individual paying in too that gives extra weight to the importance of the pension.”
Master Adviser IFA Roy McLoughlin, who regularly advises on GPPs, says: “I find it a preposterous argument, because it ignores the effect of tax relief on premiums and more importantly, any adviser will tell you that the basics of the cost of delay, prove that someone who starts a pension in their early working life will have a significantly higher pension pot when they retire.”
Other advisers concur. 80 Twenty Consultancy managing director Neil Welbury says: “This is a perennial argument. But pensions are about as good as it gets, for a good slice of the population. We only deal with HNWs whether in their 20s, 30s or 40s. Fifty per cent tax relief is available now, plus carry forward, making a decent sized contribution. From a tax planning perspective, if you are earning £110,000 a year, make a £10,000 a year contribution, you get your personal allowance back. Human beings are not disciplined, and it makes you disciplined. There is a reason that they don’t let you access the money before 55, which is that you probably would do. Isas are extremely good, but if people are strapped for cash, they are likely to raid the pot. If the aim is to achieve a decent income in retirement few people will be disciplined enough to achieve that. Anything above basic rate it is a no brainer. On 20 per cent it is closer call, but even so, if you do the numbers, I would err on the side of a pension.”
Paradigm Pensions managing partner Steve Bee says the notion of people not saving early in life makes no sense, especially when an employer’s contribution is going to be available.
“That is a bad choice because you give up your employer’s money. If you don’t take your 3 per cent, there is no other way your employer can give you that money and stay legal. And they are the generation who are going to need it.”
To be fair to Blake, he accepts that employer contributions change the argument, and he also accepts that the model he creates to justify not saving requires individuals to be perfectly rational at all times, which he completely accepts they are not. That is why he does not criticise the government’s policy of auto-enrolment for 22-year-olds - because they would in reality fail to carry out the flip side of the strategy required of his ’perfect rational investor’, namely putting 35 per cent of income into a pension in their 50s.
Instead, his argument is an academic one, based on what the absolute best strategy an individual should follow to achieve the best pension outcome over their entire lifetime. In that light, his controversial comments should be treated as a basis for discussion, and do reflect trends that underlie what people might do in future. And corporate advisers are increasingly looking at ways of segmenting employees to give employers better bang for their benefits buck.
But Source Pensions director Clare Mulligan says employers must be very careful in managing between different generations, for example offering an Isa to a younger group of employees but a pension to an older group. She warns this could exacerbate intergenerational tensions in the workforce. Employers also need to be very aware of complying with age discrimination legislation as much as for gender and race and different offerings could fall foul. They also shouldn’t underestimate the benefits of a pension for staff retention. But she says the biggest issue remains the fact that not starting now could leave people without enough benefits.
She adds: “If we don’t get people in the practice of saving by the time they are 35, it is only going to increase this problem. Everyone in the industry has known for the last few decades, there are adequacy issues, shortfall issues, which would be my concern. People would rather not pay into a pension. But if people don’t pay into a pension, then we are creating a bigger problem.”
However, Friends Life head of marketing, corporate benefits, Martin Palmer places himself in the middle way in the argument. He says that if people have whopping great credit card bills, then it really doesn’t make sense to be saving into a pension, and then borrowing more money at high rates of interest.
He doesn’t agree with Tapper’s assessment of the risk of not starting too soon. “It is worth bearing in mind, how far people are from retirement, if they are in their 20s, they are going to be 45 years away, unless they are planning to retire at 60. Maybe they should put their money into something that is more accessible.”
Palmer suggests that the industry has to take the current culture of short-termism into account.
“If we try and force people to save into a pension, I think they will just say no. I think those individuals will want more flexibility.”
But for Palmer it is not just the culture but the economic conditions. He points out that no-one sees pay rises of 7 or 8 per cent these days and suggests that in the past it was easier, initially, to fund a mortgage and then a few years later to start a pension. However he adds: “I am not in the camp where if someone is 20, a pension isn’t the right thing. But I think the key thing is getting them to save, and maybe, then we can get them to put the money into a pension that is better.”
He thinks therefore there could be a role for corporate wrap. However, Palmer says he remains unconvinced by some of the early access arguments.
Jelf head of benefits strategy Steve Herbert concedes that in some circumstances, younger people might want to pay off debt or might want to save in a corporate Isa with help from their employer. But, he says, that is not the reality on the ground. “The argument for that grouping is they are better off using employer contributions to remove debt. But I don’t know of any wrap that A works or B where the option to remove debt is really there. You can put money in an Isa but that tends to be an employee’s money, not an employer’s. If you don’t have debt then save in a pension, if you have debt, you may want to pay it down, but can you utilise the employer’s money?”
However Bee has, arguably, a more radical take for when auto-enrolment becomes the reality.
“Should they be doing it instead of paying off their debts? No. What they need is a pension. But the pension they need, no one has designed yet. That is not because of people in the industry, but the legislation is stuck in the middle of the 20th century.”
Bee argues that current pensions may not be fit for purpose for generation Y. He suggests that we need to design something that is of ’earthly use’ when you are young or middle aged and suggests this could mean revisiting the lifetime Isa by fusing the pension and Isa regime or perhaps adapting some of the features of a SAYE scheme to the pensions environment.
“It would be brilliant to think that people had this duel product it could be one or the other, like Schrodinger’s cat. If it’s a pension, I’m not sure, but the more you put in, the more rights, you build up for the long term. It can be both a savings account and a long-term account. You don’t decide at the beginning.”
Richard Butcher, managing director of Pitmans Trustees believes that even the process of opting out, if people properly consider their finances when doing so, could help spread a savings culture.
He says: “We need to encourage a savings culture and pensions are one way of doing that. There are other liabilities including getting on the property ladder. But it is a question of prioritising, pension savings are part of that long-term journey. They may have more expensive liabilities.
“Hopefully auto-enrolment will cause them to think about it and even if they don’t save for a pension, they will look at other forms of saving. A corporate wealth platform, for example, could then encourage participation.”
However Butcher also believes that the big pension reform will inevitably have a chapter two - and that will be compulsion.
Bee believes that if generation Y fails to engage in large numbers, it will cause a fundamental redesign.
“Loads of people talk about these reforms failing, when millions opt out, but I don’t think it will be the end of the reform. It will be the end of what we call pensions. If generation Y opt out in their millions, they will be spelling the end of the pension product. You can’t have long term pension reform failing. It will not be a judgement on the fact people don’t save, it will be a judgement on the type of saving we call pensions. It might shock the Government needs to allow products that people actually want, rather than ones they have to have. Why shouldn’t we have products that suit every one? You design a system, where you can design your own product. If you want it to be long-term savings, then let it be long-term savings. If you want it to be short-term to fix the roof on your house, then let it.”
Some give this view short shrift however. Tapper says: “Unless we are clear to people that the pension problem is what it is, then people will feel we can opt out of this auto-enrolment and think Isas will look after us. A pension is a pension, a DC savings plan allows you to accumulate wealth and allows you to buy a pension at your choice of retirement age. But what you are buying is an income stream for life until a point at which you die. An Isa is a capital reservoir product - it is great - it has its own purposes and it is a different kind of vehicle. The public need certainty, and there is a danger you are smudging the edges.”
However, it is just possible that public attitudes may be changing already. McLoughlin suggests that many parents are now putting pressure on the younger generation to sort out their pensions and he is seeing that with younger employees signing up to GPPs.
“Paradoxically we are finding that the younger generation are more enthusiastic and knowledgeable about pensions and one of the central reasons for this is that they are being advised by their parents who are either reaching or have reached pensionable age. They say my parents have been badgering me to take out a pension. The baby boomer generation are faced with a lower standard of income with the demise of final salary and they are making sure their children know the cost of not doing anything.”