Put any group of pension experts in a room together and before too long they will be talking about the so-called 'forgotten generation' of 30 to 40-year-olds, a group of people who have typically saved woefully little for retirement.
Many in this age group were too late to join generous final salary schemes, and they are now too late to enjoy the benefits of auto-enrolment, which will require higher pension contributions to be paid over several decades to produce a meaningful pension.
In fact, a 35-year-old today would have to save £660,000 into a pension plan to have any hope of matching the standard of living enjoyed by current pensioners, who spend £1,183 a month on average, according to research by insurer Royal London.
The scary thing is that people in their 30s have so far managed to accumulate a median pension fund of just £14,000.
PENSION HOLY GRAIL
Broadly, actuaries calculate that contributions of 14-16 per cent of salary are required throughout a person's career, starting at the age of 22, to achieve the holy grail target of a pension income equal to two-thirds of pre-retirement income.
However, few people save at this level for most of their working lives, let alone from such a tender age, and any delay or gaps are hugely detrimental.
We asked consulting actuary firm Hymans Robertson to estimate the impact of delaying pension saving. It found that a 35-year-old would on average have to pay twice as much as a 22-year-old to have a two-thirds chance of saving the same amount.
For example, to generate a pension of two-thirds of pre-retirement income, a 35-year-old would need to put away 18 per cent of their salary, while a 22-year-old would need to save just 9 per cent, assuming both earn £15,000 and will retire at 65.
If they earn £60,000 and plan to retire at 68, a 35-year-old would need to squirrel away 24 per cent, compared with 13 per cent for a 22-year-old.
Such calculations are based on many assumptions about investment returns, inflation rates and the impact of the state pension. The 14-16 per cent figure used by actuaries, for example, is based on the assumption that pension investments return 3 per cent a year.
Of course, actual returns could be lower or higher, while the compounding of a departure of even a fraction of a percentage point from that 3 per cent figure over a long period will make a huge difference to the eventual pot.
The good news is that employees in this forgotten 30-something age group still have time to save for an adequate pension. However, they may find it easier to get a grip on the problem by focusing on simply saving a sum to fund a reasonably comfortable retirement.
The temptation is to use spreadsheets full of factors such as 'contribution rates' and 'replacement incomes'. However, the variables can be so mind-boggling that people are simply put off saving altogether.
For the sake of clarity, let's assume an income of £1,000 a month in retirement would keep the wolves from the door.
On the basis that the state currently provides a pension of about £8,000 - assuming you have paid sufficient national insurance contributions - you would require an additional £4,000 a year of income at retirement at the state pension age.
Typically, a pension pot of £100,000 will provide around £4,000 a year of inflation-linked income from the state pension age (assuming it will have risen to age 70), a somewhat smaller payout than today's annuity rates imply.
However, for a person willing to take a degree of investment risk in retirement, it isn't unreasonable to assume an average 5 per cent annual return.
The table to the right (click to enlarge) assumes 5 per cent growth net of charges and 2 per cent inflation, and that contributions increase each year in line with inflation. As you can see, the cash sum that must be saved each year rises in line with the starting age.
However, if you are 35 and can afford to save around £2,120 a year (£177 a month), you may yet be able to accumulate enough for a comfortable retirement.
RISK AND REWARD
These growth assumptions are consistent with investing in a basket of diversified growth assets such as equities, property, infrastructure and credit risk bonds. That means putting your capital at risk over the short term to generate slightly better returns over the long term.
You can see the power of compound interest at work. The annual contributions required over the 30-year period from age 40 to retirement at age 70 are double those needed over the 48-year period from age 22 to age 70.
'If the saver wasn't prepared to take this level of short-term risk and invested mainly in safe, cash-related investments, a growth rate equal to inflation would be appropriate, which would hike the contributions up as shown [in the table to the right],' says retirement expert Alan Higham at Pensionschamp.com, who crunched the data for us.
'Because there is no real growth, the impact of starting earlier isn't as exaggerated. At age 40 the contribution is only 37 per cent bigger over the 30-year period than over the 48-year period.'
'Research suggests people find it difficult to start contributing to a pension in their 20s and 30s, but it does not actually become that much easier in their 40s,' adds Higham.
'It's important to get into a saving habit as soon as possible, even if you cannot afford to contribute the ideal amount. It is much easier to increase a contribution later in life - for example, as your pay increases - than it is to suddenly start saving.'
Higham adds that investors can make the job of saving for retirement easier for themselves by taking the maximum contribution on offer from their employers.
The good news is that employers have been raising their contribution rates over the past few years. In many cases, they are paying far more than the minimum required to comply with the government's auto-enrolment rules.
According to data from consultant Towers Watson, in businesses where employers are paying flat contributions, these have now risen to an average of 9.8 per cent of salary from employer and employee contributions combined.
But employees would be even more foolish to turn their backs on pension schemes where their employer agrees to match staff contributions, as these contribute a total of 16.1 per cent of salary on average.
Of this, 5 per cent is the employer's core contribution and a further 5 per cent typically comes from the promise to match.
Your employer may offer you the option of joining a scheme where your contributions rise annually by a set increment, commonly 1 per cent a year. This is known as auto-escalation, and it is generally a good idea, as the rises are usually timed to coincide with annual pay rises, so you don't miss the money diverted.
You cannot rely entirely on a basic auto-enrolment workplace pension scheme to provide a decent retirement income.
Even when the minimum contribution for auto-enrolment workplace schemes rises to 8 per cent from October 2018, this will be inadequate. It could prove so meagre that today's workers will be forced to work into their late 70s, according to research by Royal London.
Money Observer's well-heeled readers might take note that when Hymans Robertson surveyed more than 500,000 private sector employees participating in company pension schemes, it found that the group that currently faces the biggest savings shortfalls in retirement is the 'squeezed middle' of 40 per cent taxpayers.
The firm's research shows that less than a third of earners in the 20 and 40 per cent tax bands are likely to achieve acceptable levels of pension income through the defined contribution schemes they participate in.
A higher proportion of lower earners are likely to achieve an acceptable pension income, largely because the state pension will provide a large proportion of their income needs.
Higher earners are also likely to achieve acceptable retirement incomes, primarily because they have the potential to save more.
The lack of major changes to pension tax relief in the 2016 Budget is likely to be a postponement rather than a full-blown retreat, so higher-rate taxpayers would be well advised to make the most of current tax breaks - they are unlikely to be around for long.
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