Not a day goes by without a call from somewhere in the pensions industry for the Government to increase savings rates. This is understandable from a business point of view (more money to manage) and as responsible public policy. On current trends the UK is heading towards a retirement financing crisis in the next 20 years, when the first generation of defined contribution-only savers retire with total incomes less than half their average salary.
Thus there is growing pressure for an increase in default workplace scheme contribution rates. Not just from 3 per cent to 8 per cent in 2019 (as scheduled currently) but beyond that towards the 15 per cent of salary usually seen as necessary over a lifetime of saving to provide an above-half-but-below-three-quarters-of salary-pension.
The difficulty is that greater long-term savings is at odds with the UK’s consumption driven growth model. In a recent column I noted the decline in the UK’s household savings ratio. By Q2 2016 the ratio of household income saved to household net disposable income stood at 5.1 per cent. Low by historical standards, this number is likely to fall further – or at least if the Government’s growth targets are to be met.
UK economic growth in the near term depends on greater household spending, not saving. In a weak investment environment, exacerbated by Brexit uncertainty, it is hard to imagine productivity growth doing the heavy lifting. Indeed, the Office of Budget Responsibility’s March forecast predicted a significant rise in the ratio of households’ gross debt to income through 2020-21.
Looking beyond the aggregate data does not make the challenge appear any smaller. Inter-generational distinctions loom large. Those over the age of 50 own the lion’s share of these assets – property and, yes, pensions. Quantitative easing has only widened the divide between those who own assets and those who do not. In its determination to drive up the price of risk-free assets the Bank of England has driven up the price of all assets.
Take 30-somethings. People in their early-30s are half as wealthy as those now in their 40s were at the same age, according to the Institute for Fiscal Studies. Those born in the early 1980s have an average wealth of £27,000 each, against the £53,000 those born in the 1970s had by the same age.
Today’s 30-something generation has missed out on house price increases since most cannot afford to get a foot on the housing ladder. Likewise on the boost most homeowners with a big mortgage prior to 2008 will have enjoyed from a large fall in interest payments, often sizeable enough to make up for a fall in real earnings.
Similarly, for most 30-somethings (except those in the public sector) the prospect of a guaranteed defined benefit pension is fantasy. Paying for the DB pensions of their parents’ generation is not, however. An enormous amount of money — around £50bn a year — is being ploughed into funded private sector DB schemes to keep them solvent. Every time interest rates fall, these pension schemes swallow more company and taxpayers’ cash. Thirty-somethings, and other working generations too, pay for the promise made to their elders through lower pay, higher prices or lower returns on shares.
For younger generations, low interest rates promise a lower return on long-term savings. With the risk-free rate of return so low, the magic of compounding is attenuated. Savings need to do much more of the heavy lifting – to the tune of a more than 200 per cent rise in contributions just to generate the same income. Indeed, author and commentator John Kay notes that long-term real interest rates just 2 per cent below their historic level mean the additional cost of pension funding corresponds to a 10 per cent fall in income. The drop in interest rates over the past 30 years has been much bigger than that.
It is in this wider macroeconomic context that demands must be placed for a rapid hike in pensions contributions. Those with the smallest projected retirement incomes are those with the fewest assets; those with the biggest pensions tend to have other substantial assets too. Unfortunately, the conundrum is such that the small amount of economic growth there is to be over the next five years depends it seems on less household saving and more spending.
Gregg McClymont is head of retirement savings at Aberdeen Asset Management