FOOL'S EYE VIEW
When Saving Just Isn't Worth It

By Cliff D'Arcy
December 4, 2003

Along with house prices, interest rates and consumer debt, the debate about pensions is one of the four big money issues in Britain today. Saving for retirement is one of the core financial goals that we promote here at the Fool.

In some ways, it's not important whether you use a pension or an ISA to save for retirement - the choice is yours. With pensions:

• You get tax relief on your contributions, which boosts your payments by between 28% and 67%
• Your pot isn't taxed, although you do lose a slice of your dividend income to the taxman
• Your pension income is subject to income tax.

With ISAs:

• You don't get tax relief on your contributions
• Your pot isn't taxed, although you will no longer be able to claim the 10% dividend tax credit after 6 April 2004
• Any income or capital withdrawn isn't taxed.

However, the whole issue of saving for retirement has been thrust into the spotlight again, this time by the revelation that, for some workers, pensions could almost be a waste of time.

A report from actuaries (mathematical experts) at Mercer Human Resources has revealed that a couple retiring today would need to amass a considerable sum to be completely free of means testing throughout their lives. Based on a couple aged 65 (male) and 62 (female), Mercer concluded that the pair would need capital of £180,000 between them in order not to qualify for any means-tested benefits.

However, if a couple failed to save anything at all, the value of what they would get from the state (from their basic state pensions, Pension Credit, Housing Benefit and Council Tax Benefit) would be far less than £180,000, so it still makes sense to keep saving.

To build up a fund of this size over thirty years would require monthly contributions of:

• £220 if the fund grows at 5% a year after charges
• £154 at 7%
• £105 at 9%.

£105 a month isn't beyond the reach of most workers, but £220 would be a stretch for many families. After all, it's more than a tenth of the average income before deductions.

Anyway, as I see it, the problem isn't really about saving, it's about the increasing use of means testing to target benefits to the less well off. (According to a recent estimate, 25 million people are entitled to at least one means-tested benefit at present.)

For example, the introduction of the Pension Credit in October has made pension planning even harder, especially for those on modest incomes. Around three-quarters of pensioners should be entitled to this new means-tested benefit, and about 2.3 million are already claiming it. However, many will find that their savings will reduce their entitlement to means-tested state benefits, leaving them no better off than those who have failed to save. Thus, the government has been criticised for creating yet another disincentive to save.

What's more, means testing is often absurd and unfair - a good example being the way savings are treated when calculating their entitlement to the Pension Credit. Without rhyme or reason, the government has assumed that pensioners earn £1 a week for every £500 of savings they have. That equates to an interest rate of 10.4%, which is about three times actual savings rates. Although the first £6,000 of savings is excluded from this means test, I view this bizarre interest calculation as an utter disgrace.

It's worth mentioning that the Association of British Insurers recently claimed that a staggering four out of five workers will fall into the 'means testing trap' fifty years from now!

However, my personal view is that saving for retirement is a no-brainer: I'd much have control of my money than place my fate in the hands of any government! What's more, powerful trends in the UK population will lead to far less pension money to go round in the future, which means many of us will have to get by on less.

I think anyone on a reasonable income who makes a conscious decision not to save for retirement is taking a big risk. In, say, thirty years' time, there will be millions more pensioners than there are today, being supported by a smaller workforce. This means that there will be a vast number of people hoping to claim one or more of the various benefits on offer - and the government's pension pot is by no means a bottomless one!

Of course, at the far ends of the income range, the approach to saving is obvious: for the low paid, saving a reasonable proportion of their income is usually not an option, whereas it should be a doddle for high earners. It's those people on average incomes who face a difficult decision about whether to save or splurge. These workers need to determine whether it is in their 'economic interest' to save at all.

Nevertheless, Britain seems to be turning its back on saving, because the savings ratio has halved to under 5% of household income over the last six years.

To summarise: I think the simplest answer is: if you can afford to save, you should always do so - unless you have expensive debts that you should pay off first.

More: Visit our Pensions centre and discussion board | More Money For Older People | The New Pension Credit.