Middle class pensioners are doomed!

15m households face a serious income squeeze in retirement.

The prospects for millions of British pensioners in the coming decades are not great, with many facing a drop of up to 60% in their income in retirement.

Plunging incomes

Earlier this year, Chatham House published a report looking at the prospects for future British pensioners, and its conclusions are gloomy at best.

The think tank looked at how we are saving for retirement, and projected retirement incomes all the way up to 2050. And it found that households in the middle income groups - by this definition, those households with incomes of between £18,000 and £44,000 – will see their income plunge by 60% when they pack up work, if they ever do.

Indeed, the think tank believes that 60% of the UK’s population will rely on the State for half of their retirement funding, while the poorest 40% - around 10m households – will be entirely reliant on the State Pension.

The report describes this as a ‘squeeze’ on middle class pensioners. Frankly, I’m not sure the word 'squeezed' quite does it justice!

So why is the situation so dreary?

A modest State Pension

The Chatham House report highlights that the UK has a relatively low level of State Pension provision – back in 2007 a report placed the UK in last place when comparing the pensions on offer from European nations, with the state paying an income equivalent of 17% of average earnings. Even the nation in second last, the Netherlands, offered a State Pension paying nearly double the UK figure, while the average across the rest of Europe stood at 57%.

Things are improving somewhat on that front for many of us, as I explained in State Pension to jump by £40 a week, but they are still pretty mediocre. And if you’re a public sector worker, the situation is far from encouraging. Have a read of Public sector to work longer for worse pensions.

It’s up to you to save

Something else that sets us apart from various other developed nations is that the responsibility for saving for retirement is down to us. I’m not obligated to put money towards my pension each month.

And that’s a big reason, in my view, that so many of us are utterly useless at saving for retirement in our younger years. Why put a couple of hundred quid aside, that you won’t see for decades, when you could buy an iPad?

As a result, most of us leave it too late, and miss out on valuable years of compound interest on our pension savings, even if we are only able to put a few pounds aside each month. Check out How to double your pension for more.

Why things will get worse

The Chatham House report highlights a number of factors that will lead to this extreme squeeze on pension incomes in the coming decades, and it’s difficult to argue with any of them really.

First of all, there is the gradual erosion of defined benefit pension schemes, to see them replaced (if at all) by defined contribution schemes. And while this will inevitably lead to less generous pensions for the recipients, I have some optimism that the Government’s NEST programme, which will oblige employers to provide employees with a defined contribution scheme, will at least mean that everybody benefits from a bit of employer cash in their pension pots, rather than just a select few.

Next on the list of reasons to be fearful is the performance of wealth and pension funds, and their vulnerability to economic shocks. Chatham House believes that poor annuity rates only serve to further discourage people from saving from retirement, and it’s difficult to refute that. Annuity rates have been on a downward trend for some time – according to MGM Advantage, they fell 8% between June 2009 and December 2010 – and that is not exactly going to inspire people to save more.

One potentially troublesome feature that Chatham House did not even mention is the recent ruling by the European Court of Justice, eliminating the use of gender when pricing up financial products. That’s potentially a further disaster for annuities, as we explained in Male pensions could be cut by 13%.

It can be fixed!

Of course, it’s easy to focus on the negatives when looking at pension prospects, particularly as there are plenty of them to focus on. But there are ways to improve the pension sector, suggested by the report, which are not beyond the realms of possibility. Let’s take a look at them.

Government incentives to save: The current tax relief is not doing enough to incentivise saving, so Chatham House wants to see the Government offer matching contributions. I can’t see this happening, particularly with our parlous public finances, but in the form of NEST, there will be an extra incentive for us all to save.

Increasing flexibility: By improving the flexibility of the pension schemes, we may all be more inclined to save. Again, the Government has already taken steps toward this by consulting on the possibility of allowing early access to the money you save.

Guaranteeing annuity rates: The fact that savers are unsure what to expect from their pension when they retire, due to the uncertainty of annuity rates, is undoubtedly a problem. However, I just can’t see how guaranteeing the rates on offer is a feasible answer. Instead, I’d like to see more shorter-term annuity options, things like fixed-term annuities that allow you a little more flexibility than simply signing up to an annuity for life. Have a read of You are making this pension mistake for more.

Reforming the State Pension: Eliminating some of the complexity and introducing a single, flat pension would be a boost to pension planning. And thankfully, that’s exactly what the Government are doing, as I explain in State Pension to jump by £40 a week.

Working for longer: Sadly, this is absolutely inevitable. The simple fact is that we are all living longer, and it’s just not realistic to expect to spend a third of your life in retirement, at the expense of the State. Chatham House’s calculations suggest that if retirement age is moved to 70, then retirement incomes could be 5% higher than in their base-case scenario by 2050. A small improvement, but an improvement all the same.

This is a classic article from March 2011, which has been updated.

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