A decade since the financial crisis first emerged, its consequences are still revealing themselves. The subsequent issues have conspired in a hidden squeeze on households, which is hitting those retiring now particularly hard.
Indeed, according to research we at Fidelity have undertaken, those reaching retirement today might have to cope with pension income some 46 per cent lower than could have been expected had they retired immediately before the crisis.
This represents the combined effect of a real-terms fall in wages, lower market gains and greatly reduced returns on annuities over that time.
We modelled the outcome today facing someone who was 10 years away from retirement in 2007. They were earning £45,000 at that point, with a £50,000 pot of pension savings already amassed and contributing an ongoing 12 per cent of their salary.
Their salary was up-rated through the period using an average from Office for National Statistics Annual Survey of Hours and Earnings data and their pension contributions were added to their pot and invested. At the end of the period in 2017, their pot was used to buy an annuity at current market rates.
The results were then compared to the outcome achieved had they experienced the conditions prevalent in the preceding 10-year period, from 1997 to 2007.
The results show that, by all measures, those retiring now have suffered compared to those having done so a decade previously.
|Salary at start of period:||£45,000||£45,000|
|Salary at end of period:||£63,242||£53,220|
|Annualised CPI inflation in period:||2.60%||2.70%|
|Pension pot at start of period:||£50,000||£50,000|
|Pension pot at end of period:||£180,107||£139,110|
|Income from average annuity based on pension pot:||£12,193||£6,607|
|Replacement rate (of pre-retirement income)||19.30%||12.40%|
The earlier cohort enjoyed 3.5 per cent a year pay rises across the period, compared to inflation of 2.6 per cent, making them richer in real terms.
By comparison, those retiring in 2017 have seen their salary grow by just 1.7 per cent a year, versus inflation of 2.7 per cent, making them poorer in real terms. In our scenario, the difference this makes is £43,156 of missed earnings across the decade.
Lower earnings has also meant lower pension contributions. Those retiring this year in our model would have been able to pay in £5,179 less over 10 years compared to the preceding period. This has been compounded by worse market returns as well.
Invested into a portfolio of shares and bonds (60/40 global equity, global bond), those retiring today will have seen their pot grow to £139,110. Had they enjoyed the higher contributions and better growth offered by the 1997-2007 period, their pot would have swelled to £180,107.
The income they can buy
It is no surprise the lower pension pots of those retiring today secure them less income in retirement. But they have suffered even further from lower rates on annuities.
Annuity rates have been a casualty of monetary policy since the crisis, with the Bank of England rate reduction dragging the rates on government bonds down with it.
Additionally, the market for annuities is now smaller following the pension freedoms. Just six companies offer standard annuities today, compared to nine in 2007, reducing competition between providers.
What has all this meant? Back in 2007, the average annuity rate was 6.77 per cent. Applied to the larger pot accumulated in the 1997-2007 period, this would buy £12,193 a year of income.
Those retiring in 2017 would be able to get average annuity rates of 4.75 pe rcent, which would turn their pension pot into an annual income of £6,607 – some 46 per cent less.
An instructive way to express this fall-off in income is by comparing the “replacement rate” represented by the annuity income from each period. This is the percentage of pre-retirement income replaced by income in retirement. In our scenario, those retiring in 2007 would have been able to replace 19.3 per cent of their income. For the 2007-2017 period, this falls to 12.4 per cent.
This all makes grim reading for today’s retirees. But there is cause for optimism.
One positive change in the period since the crisis has been the pension freedoms, which have freed many more people to access their pension pot using drawdown instead of an annuity.
This comes with greater risk but at least provides an alternative to being locked into low paying annuities and gives greater flexibility over how to manage income.
For clients still with some years to go before they retire, makes sure they are aware of the chance to make more of the time available left to save.
Ed Monk is associate director for personal investing at Fidelity International