The problem: A new client is looking at pension saving. What size of defined contribution fund will be needed to secure a comfortable income in retirement?
The solution: A report by the Intergenerational Foundation entitled ‘Are Government Pensions Unfair on Younger Generations?’ includes a host of data on pension saving.
Based on 2011 figures, it has annualised the National Minimum Wage to £12,646 per annum.
It then calculated it would take a fund of just over £250,000 to provide a pension of this amount (with no spouses or escalation).
If you asked the public about the minimum wage, the consensus would no doubt be that it is good to have one, but most would not like to live on it. But few people will have a £250,000 fund so will have to live on less than the minimum wage in retirement.
For most, the state pension will kick in at the State Pension Age, and will mean a lower fund is required. Let’s assume the state pension of £107.45 per week for 52 weeks for a male aged 65 (I have disregarded any Serps or S2P benefit, but have used a couple of variables – I think the point is valid even if you extrapolate upwards).
If we use an annualised minimum wage of £12,646 then the above figures are at worst nearly half this amount and at best,a bit over half.
So it is still necessary to have a private fund in excess of £120,000 to get to the minimum wage level.
When looking at pension saving, people tend to focus on the size of the fund rather than the conversion rate (annuity or drawdown rate). A pension fund of £100,000 sounds a lot, but an income of £5,000 per annum does not sound quite as much.
A recent study by BlackRock suggested that 31 per cent of 25-34 year-olds expect to retire on a pension of more than £30,000 per annum.
So a 25-year-old retiring at 65 would need to save £4,950 per annum (which, with 5 per cent per annum growth, would give a fund large enough to provide such an income). If they waited 10 years, the amount needed to be saved would double to £9,000 per annum.
Part two of the retirement equation is longevity. In a recent report by the Institute of Fiscal Studies, nearly three-fifths of individuals aged between 50 and 64 have never thought how long they will be in retirement and, therefore, how long they will need an income. Perhaps more frightening, only 9 per cent of men and 10 per cent of women aged 30-60 say they expect to live to at least 90, when the current longevity statistics suggest that it is likely to be nearer to 18 per cent and 29 per cent respectively.
Finally, the Department for Work and Pensions’ latest survey on retirement saving, ‘Attitudes to pensions: the 2012 survey’, shows that many people find pensions too complex. Almost two-thirds do not feel they know enough about pensions to decide with confidence how to save for retirement. Two-fifths of respondents with a private pension do not know what their income will be in retirement, increasing to four-fifths for those without a private pension.
A real education process is needed around pension and retirement. People must not underestimate the amount they will need to live on, and must save accordingly. If not, then a level of income they would not accept during their working career could well become the norm in retirement.
Mike Morrison is head of platform marketing at AJ Bell