Lower growth forecasts mean smaller pensions for millions

Is your pension set to suffer because of out-of-date forecasts?

The Government’s automatic enrolment scheme has done a remarkable job in spurring more people into saving into a pension.

New figures from the Office for National Statistics show that back when it was introduced in 2012, less than 50% of employees had a workplace pension.

The situation is dramatically different today, however, with nearly eight in 10 (78%) staff paying into a workplace pension.

While participation has levelled off ‒ 2020 was the first year in which there have been unchanged levels of participation since the scheme was launched ‒ this is nonetheless a real boon to the state of our pension preparation in the UK.

There are worries still though over the amount we are saving, with a new study suggesting that the calculations used to design the automatic enrolment scheme may be out of date to the point that it’s threatening the quality of the retirement ahead for millions.

Speak to a specialist at Key about your retirement options

A comfortable retirement

A new report from pension platform Interactive Investor and consultancy LCP suggests that lower growth forecasts for equity and bond markets could have a significant impact on the pension pots of more than 10 million people paying into defined contribution schemes.

Currently, the minimum contribution for automatic enrolment workplace pension schemes comes to 8% of your earnings. That 8% comes from a combination of you, your employer, and tax relief from the Government.

The idea with that 8% figure is that if you save that much for a lengthy period, then with the growth from the assets your pension is invested in, you’ll end up with a respectable pension pot. It won’t be so big that you’ll enjoy a life of luxury when you retire, but as a minimum, it should mean you aren’t counting the pennies.

The trouble is, the calculations behind that thinking are starting to look awfully out of date.

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Underperforming investments

The 8% figure was worked out based on the expected rate of return from various types of investments. 

But over recent years, the actual rate of return from equities, Government bonds and corporate bonds has been in steady decline. 

For example, assumptions from the financial regulators on the real rates of return from Government bonds have dropped from 1.9% in 2007 to 0.8% in 2012 and then -0.5% in 2017.

Meanwhile, corporate bond returns have fallen from 2.8% to 0.3% over the same period, and equities performance has dropped from 5.4% to 4%.

Bringing those together into a typical portfolio, made up of 60% equities, 20% corporate bonds and 20% Government bonds, means an overall return dropping from 4.2% in 2007 to 2.4% in 2017.

And that decline in performance can make a huge impact on the size of your eventual pension pot, and therefore the sort of life you can afford in retirement.

We are talking about thousands of pounds here, life-changing sums. 

For example, a typical worker on average pay who puts 8% into their pension from the age of 22 could expect a pension pot of around £85,000 based on growth assumptions in 2017.

But based on the assumptions from 2007, that pot would instead be £131,000 ‒ a massive £46,000 extra.

The reality is that we are now in what the firms describe as a “lower for longer” growth world, where more modest rates of growth are the norm.

And there is a danger that some workers, used to the more optimistic forecasts of the past, won’t act to boost their pension pots.

Speak to a specialist at Key about your retirement options

What can you do about it?

So if our existing pension contributions aren’t going to stretch as far as we hoped, what action can we take now to ensure we have a better standard of life in retirement?

Let’s start with the obvious. If your existing level of contributions isn’t enough, then you will have to think about increasing those contributions.

Some of that may come from your own pocket, while you may find that your employer is also more generous than the minimum levels set out by the workplace pension scheme rules, meaning that your boss will put a little more in too.

Equally, you’ll need to look at where that pot is being invested, and how well it’s performing.

You may find that your prospects are better served by switching where that cash is being placed ‒ sticking with a default fund run by the workplace pension provider, for example, may not really meet your needs, and you’ll be better served by considering one of the rival funds.

Ultimately, engagement is key here.

Simply noticing the money disappear from your pay packet each month isn’t really going to be enough ‒ there’s no guarantee that, even if you do get a steady return on your contributions, the eventual size of your pot will be enough to provide for you in your later years.

How to get a State Pensions forecast

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