Which will survive the longest: you or your pension pot?
Life expectancy in the UK has increased by 15.5 years for men and 14.4 years for women since 1946, while the average retirement age has remained relatively unchanged. That’s a problem. Will an individual’s final pension pot be large enough to fund their entire retirement?
Today, a 30-year-old man will, on average, live until he is 87. A 30-year old woman will live, on average, until she is 90. The same male has a one in six chance of reaching their 100th birthday, while almost a quarter of females are predicted to live to this landmark age.
Rising life expectancy is obviously a positive, and a key indicator of economic development. But for individuals, there is a growing social issue of just how longer retirements will be funded. Especially the ones that could last for over 30 years. It is vital for everyone to think about how much income you will need when you retire and start saving accordingly.
Self-provision is essential
Pension provider Aegon found that, on average, people would like to enjoy an annual income of £32,000 when they retire. This is more than 13% greater than the current UK median wage of £28,200, and more than double the current average pensioner income of £15,400.
If someone were to retire at 65 and live until they were 90 years old, they would require a final pension pot of £624,750 to be able to pay themselves £32,000 per year (assuming a 2% real return on their investments during retirement).
To accumulate this amount, we estimate that the same person would need to save around £4130 per year for 44 years (assuming they start work at the age of 21 and receive a 5% real return annually).
Taking UK median earnings of £28,2001, this means that an 'average' person would need to contribute close to 15% of their income to their pension in order to save £4130 a year. However, the average total contribution rate (employee plus employer) for private sector pension schemes was just 4% in 2015.
Using this data, we have graphed what we expect an 'average' person’s pension pot (red line) to look like over the accumulation and drawdown periods if they contribute just 4% of their income during their working life. We have then compared this to what they would need to contribute to accumulate a pension pot of £624,750, in order to pay themselves the £32,000 a year in retirement that an average person desires (blue line).
The red line depicts the scenario described above, and shows how at retirement, if the individual pays in just 4% of their salary a year, they can expect their pension pot to grow to £155,500. If they draw an income of £32,000 per year, the pot would run dry after just five years, leaving the individual reliant on the UK state pension after their 71st birthday.
The blue line shows how this average person could solve this problem:
- Increase their contributions to 12.5% of their salary
- Work until they are 69 (more on this later)
As the chart above shows that by making these changes this person is able to comfortably fund their retirement expectations until the age of 90.
Don’t rely on the state pension
If people fail to save enough during their working life, they may end up dependent on the state pension. In the UK, this pays out a maximum of £122.30 per week, assuming you pay National Insurance (NI), for at least 30 years. Making voluntary payments or claiming unemployment benefits also count as qualifying years.
However, the government is growing ever more conscious of its swelling pension liabilities, due to the growing number of retired people relative to those in jobs who support state pension payments through taxation. Since 2011, the government has taken gradual steps to reduce this liability over time, primarily by raising the State Pension age:
Timeline of State Pension age increases:
- 2011 – State Pension age to be equalised at 65 for men and women by 2018 and to rise to 66 by 2020
- 2014 – State Pension age to increase to 67 by 2028
- 2017 – State Pension age to increase to 68 by 2039
What’s more, in order to eliminate the government budget deficit, which is currently estimated to be around 3.5% of Gross Domestic Product (GDP), many researchers believe that the state pension could become means-tested. This could lead to some workers making NI contributions throughout their career, but ending up receiving little or no state support when they retire. This uncertainty over future state provision makes self provision more important than ever.
Working for the man, for longer…
If life expectancy continues to rise, but people remain set on retiring at 65, the average person’s final pension pot will be simply distributed across additional years of retirement. If this is not planned for in advance, the unprepared may find that the annual income that they can sustainably drawdown to be far lower than first expected.
As shown in our example above, staying in the job market for longer will help accumulate a pension pot that is large enough to fund your entire retirement. And there are already signs that this is happening in the UK.
Data from the Office for National Statistics (ONS) — admittedly not that timely — suggests that the average retirement age is starting to creep up. Over the last 20 years, this increased to 64.8 from 63.3 for men and to 62.6 from 60.3 for women.
It may not be a pleasant prospect, but retiring at 69, 70 or even later, may soon become a reality for a large proportion of the UK’s workforce.
This analysis doesn’t factor in life events, such as the sale of property to help fund ones retirement. Neither does it consider the option of taking 25% of your pension as a lump sum tax-free.
However, if the average contribution rate doesn’t start to increase, it is likely that there will be a large proportion of retirees who will be disappointed with the level of income they can expect to receive in retirement, as a result of not paying enough into their pension during their career.
If you think that could outlive your pension pot, you should first consider increasing your pension contributions. If you don’t, you are likely to be forced to work for longer or to re-evaluate the level of income that you can realistically expect to receive upon retirement.
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1 Estimate for the year ending 5 April 2016