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The state we’re in

I am 28 and do not have a pension plan. Is it sensible for me to start saving towards a pension or should I just rely on the state?

The UK operates a three-tier pension system which comprises the basic state pension, the state second pension and personal provision provided through an employer-sponsored scheme or private pension.

The basic state pension is £90.70 a week for individuals or £145.05 for married couples where the wife has little or no personal entitlement. The objective of this approach is to provide pensioners with a minimum state-provided pension, sufficient merely to prevent poverty, supplemented by an earnings-related state top-up pension for employed people only and, finally, an occupational or private pension. This strategy has transferred a great deal of responsibility for provision from the state on to the employer and individual.

Even though the basic state pension is considered to be among the least generous in the developed world, a combination of an ageing population, increased life expectancy and declining fertility rates means that the UK state pension system is experiencing significant strain and is unlikely to remain viable in the long run. We have also seen a decline in personal provision over the last decade as a result of the closure of most defined-benefit schemes, reduced contribution rates to money-purchase schemes and a general apathy by individuals towards saving for their future via private pension plans.

Research by the Pensions Commission suggested that the individual is not responding to this challenge and that at least 75 per cent of all defined-contribution scheme members have insufficient contribution rates and nine million people may be saving too little for retirement.

Further research carried out by the Association of British Insurers suggests that a huge savings gap of £27bn currently exists.

The Government is aware of these problems and has proposed to introduce a new scheme called personal accounts in April 2012.

All employers who do not offer their staff an appropriate pension will be obligated to enrol their staff automatically into personal accounts.

These proposals fall short of compulsion because it will be possible for individuals to opt out of these schemes should they wish to do so.

Whether this happens will depend on a number of factors, primarily around the individual’s attitude towards saving for retirement versus spending to support their current lifestyle.

An added complication is that there are certain means-tested benefits to assist pensioners whose income falls below certain minimum levels. Everyone over age 60 is entitled to a minimum income of £124.05 (single people) or £189.35 (couples) in 2008/09. This is known as the guarantee credit.

However, because the guarantee credit is means-tested, some people who have been prudent enough to make some private provision will not benefit at all from it. This will often discourage saving by low income workers, as can be seen from these examples:

  • John is single, 66 years old and receives the full basic state pension but has no other income or savings. He gains £33.35 from the guarantee credit (£124.05 less £90.70).

  • Jim is also single, 67 years old and has built up a small personal pension fund of £30,000, enough to provide him with an income of £30 a week on top of the full basic state pension. He therefore gains only £3.35 from the guarantee credit (£124.05 less £90.70 less £30).

    Whether you should save for your retirement is therefore not as simple a decision as it may seem at first glance, as there are a number of groups who could lose out, particularly as the threshold for savings credit diverges from the basic state pension. These include:

  • People who rent their home in retirement and who might qualify for bousing benefit as well as council tax benefit.

  • Self-employed people, particularly those on low earnings, who cannot join the state second pensions. For them, the first part of any savings will suffer 100 per cent offset against pension credit.

  • Anyone who starts saving in their 50s, having done little before then and perhaps with a broken working pattern.

    Assuming that you do not feel that you are likely to fit into any of the above three categories, then my recommendation would be a resounding yes, you should start saving towards your retirement as soon as possible.

    Patrick Murphy is director of wealth management at Thinc

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