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Young people need to work 10 years longer to fund retirement

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Younger generations have been encouraged to save more to make sure they can enjoy a comfortable retirement in the future; but not everybody can afford to put more money into their pension pots.

A joint study by LCP and Interactive Investor found that these groups face two options when it comes to having enough funds in their pots: “Take more risk or work 10 years longer”.

This is because they will either need more time to build up their retirement funds, or generate higher expected investment return over the long term for any given level of contributions.

With a starting salary of £22,437 ($31,000, €26,100) a year and entering into a pension scheme at age 22 with 8% contributions, a young person would have £157,700 by the time they reach 68, based on 2017 expected investment returns; this compares to £236,800 based on 2007 estimates.

The figures are based on the assumptions that the money is invested in a default fund comprising of 60% equities and 40% bonds.

So, to reach the same sum expected by the 2007 outlook, they would either need to retire at 78, or move their funds into 100% equities, LCP and Interactive Investor found.

‘Sensible strategy’

LCP partner Dan Mikulskis said: “Falling investment returns are a challenge for all investors and a common recommendation is to save more to make up. But there are other options, including working for longer or taking more investment risk.

“Millions of young people in particular are currently invested in ‘default funds’ which are designed to be broadly suitable to a wide range of investors. Many of these are designed with an aim to manage risk. Taking more investment risk is always a tricky balance, but by moving more of their pension into growth assets such as equities, younger people could expect a better return and could save themselves having to work well into their seventies.

“At the very least, all investors should be ‘looking under the bonnet’ to find out how their pension fund is being invested and asking the question what the right level of investment risk is for them”.

Becky O’Connor, head of pensions and savings at Interactive Investor, added: “The thought of having to work until almost 80 years old is enough to fill even the most active and ambitious among us with dread.

“It should at least be enough to encourage a closer examination of our pension funds to see if they are working hard enough – so we can eventually stop working. Any small changes made now to boost the growth potential of your pension could save years of graft later on.

“Taking more risk with a pension – your life savings – might sound counter-intuitive, but actually in today’s ‘lower for longer’ growth environment, low interest rates and rising inflation, it is a sensible strategy, provided you are investing for the long term.”

A wider problem

In other news, research by the International Longevity Centre (ILC) and Standard Life, part of Phoenix Group, revealed that younger generations are not the only ones being affected by lower pension savings.

They found that nearly one in three of generation X members – those born between 1965 and 1980 – face financial hardship in retirement due to “inadequate pension savings” and risk of only achieving a “minimum or lower than minimum standard of living”.

The majority (59%) don’t have any additional sources of income, and 60% have a defined contribution (DC) scheme but they are not contributing enough to have a moderate income in retirement.

Around 44% have contribution gaps of at least 10 years – a proportion that rises to 48% for women – 18% are not paying enough; 17% don’t even know how much they are contributing; and only 7% are saving enough to sustain a moderate life style when they stop working.

Just less than a quarter (23%) expect to have other sources of wealth as their main income in retirement, which include: other savings and investments (26%); an inheritance (25%); downsizing or releasing equity from their property (23%); support from a partner or family member (14%); or other property investments (11%).

‘Act fast’

Andy Curran, chief executive of Standard Life, said: “Many Generation Xers don’t have adequate pension savings in place, and sadly face financial vulnerability in retirement. Many entered the job market too late to take full advantage of final salary pensions, yet too early to enjoy the full benefits of initiatives like auto-enrolment, and their retirement income will be stretched as a result.

“To address this, we would encourage employers to consider mid-life MOTs, to help people take stock of their finances and support them with planning for later life. At the same time, we’d also urge Gen Xers to regularly review their annual spending and engage with their finances as early as possible to gain a better understanding of what they’ll need in the future and so being better placed to take the necessary steps to achieve a more comfortable retirement.”

Sophia Dimitriadis, research fellow at ILC and report author, added: “There’s still time to support the retirement prospects of generation X and alter their current trajectory. But with the oldest members of this generation retiring in just over a decade, we will need to act fast.

“The majority of people with DC pension savings are chronically under-saving, and with many Gen Xers too overwhelmed with other priorities – like caring responsibilities and the additional pressures from the pandemic – it is vital that the government builds on the success of auto-enrolment to support people to reach an adequate retirement.

“Increasing minimum pension contributions is clearly vital, but it’s important we include an element of flexibility by allowing people to temporarily pay into their pensions at a lower rate if they are really struggling financially. The government can also introduce a flat-rate 30% tax relief to enhance the pension pots of low earners, many of whom are struggling to afford to save more for retirement.

“In the meantime, we urge Gen Xers to play their part by trying to capitalise on moments where they can afford to save more – such as following a pay rise or a decrease in mortgage payments to increase their pension contributions. They will also need to take stock of their finances, using recent guidance created by the Institute of Actuaries, to see if their current pension contributions will be sufficient for them to lead the lifestyle they want in retirement.”