Why You Need To Save More Than 8% A Year

Cliff D'Arcy

By

Cliff D'Arcy

Published in Investing on 3 May 2011

The new NEST pension scheme isn't bold enough.

It's a fairly well-known fact that the UK faces a potential 'pensions time-bomb'.

A rocky retirement

For example, the mass closure of final-salary pension schemes has taken away guaranteed pensions from millions of private-sector workers.

Similarly, government cutbacks could lead to reduced pension payouts for up to six million public-sector workers.

Hence, the Department for Work and Pensions estimates that at least seven million working-age adults are currently under-saving for retirement.

The nation's NEST egg

In order to tackle the problem of under-saving for retirement, the government is to introduce NEST, the National Employment Savings Trust.

To be launched in 2012, NEST is designed to provide a simple, low-cost pension plan for almost all workers. In effect, NEST is a compulsory, workplace-based pension plan for everyone (except for workers who opt out or already belong to superior pension schemes).

One of the benefits of NEST is that it provides workers with a single pension pot to which they can contribute despite moving from employer to employer. Initially, only large employers will be required to offer NEST to their workers, with smaller employers joining later on.

Initially, contribution levels to NEST will start out low, but will increase over time until the minimum contribution level will hit 8% of earnings by 2017. This will consist of a 3% employer contribution, 4% employee contribution, plus 1% tax relief from HM Revenue & Customs.

Another plus is that NEST will operate on low margins, with long-term costs estimated at 0.3% of a pot's value.

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The big problem 

In theory, NEST is supposed to enhance existing pension provision by introducing minimum standards for workplace-based pensions. However, the scheme came under attack today from the Association of Consulting Actuaries (ACA) (pdf).

The actuarial trade body has warned that the NEST contribution of 8% will not be enough to provide adequately for life after work. Indeed, the ACA argues that, for millions of low-paid workers, NEST will simply substitute private savings for state benefits.

To build a suitably sized pension pot, the ACA recommends contributions of half a worker's age. Thus, a 30-year-old worker should receive total contributions of 15% of his/her pre-tax salary, while a 50-year-old employee should pay in 25%. Given that few can afford such hefty contributions, this looks to be another unworkable outcome.

Be bold and brave

Thus, the ACA has urged the government to be bolder in its reform of occupational pensions. It recommends that the state provide tax incentives for a 'middle way' between defined-contribution (alias money-purchase) and defined-benefit (final-salary) schemes.

Thus, employers who provide pension schemes which exceed NEST contribution levels, and meet a certain quality threshold, would be given additional tax breaks to help fund these 'NEST-plus' schemes.

Also, the ACA has warned that the launch of NEST could accelerate a 'race to the bottom', with workers losing out as employers shut down generous existing schemes, to be replaced by basic NEST pensions.

Retirement is your problem

The ACA also added that it 'feels that a huge amount of work needs to be done to embed a culture of financial education necessary to underpin a culture of saving.'

To do this would require rebuilding the public's trust in long-term saving; reducing complexity in the State pension system; making it easier for employers to provide support; and encouraging the widest possible participation in retirement saving.

Of course, all participants in pension reform face a huge uphill struggle in convincing these and future generations to move from 'living for today' to 'saving for tomorrow'.

In the meantime, it's up to each and every one of us to take control of our own retirement planning. This need not be via traditional pension schemes, especially as workplace ISAs gain prominence.

In short, improve your retirement prospects, don't wait for widespread pension reform. By saving in a low-cost SIPP (Self-Invested Personal Pension) or tax-free ISA, you can start to build a brighter future today!

 

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Comments

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DIYIncome 04 May 2011 , 8:57am

An article on a very important issue - not only should saving for retirement be a key obejective for all of us - particularly those of us reading Motley Fool (I hesitate to call us Fools, because we are clearly not). In addition, the impact on taxpayers of supporting more people who have not made any provision for retirement is likely to grow substantially in the future.

There are already enough tax incentives to encourage saving.in a pension - even those not in work can save nearly £4k and receive a tax 'refund'. The problem is those who cannot - or who choose not to save.

I'm afraid some degree of compulsion is required - but it is difficult to increase tax further - the only solution is to reduce public expenditure elsewhere (and there is lots of scope) and for formalise the National Insurance system by introducing a real insurance character, using private insurers..

I suspect one of the missing element is also education.- but this needs to be introduced at an early age.

supersol42 04 May 2011 , 2:27pm

If the government comes good on its promise to up the state pension to £140 per week at 2010 levels, and scrap the Pension Credit, then at least it will be true that even the smallest of private pensions is worth having. Certainly, of course, the more the better, subject to a maximum £50K per annum contribution, and the Lifetime Allowance; not a problem for most people.

For all this to work, however, the government really must tie in this massive increase in the state pension with auto-enrolment; as the rules currently stand, the first auto-enrolled people to retire will do so almost immediately, in October next year.

polonium210 04 May 2011 , 5:46pm

There is another problem. I have just taken voluntary redundancy (aka jumping before I get pushed) at the age of 51. So, with a few years to (scheduled) retirement, I find that 25% of essentially nothing (to use the printable version) is essentially nothing.

And I suspect that there are a good few others like me (in our fifties, highly educated, highly skilled and highly under-employed) who will be a burden on the State for years to come.

F958B 04 May 2011 , 6:58pm

The last time I looked, NEST was proposing to invest almost exclusively in cash and bonds, which seem highly unlikely to provide even a half-decent long-term return.
Bonds - over very long periods - have generally offered only very small returns once inflation is factored-in and this generally leaves bonds trailing way behind equities on a "total return" basis, which is what younger investors need.

A decade ago, bonds looked cheap compared to equities.
Nowadays it is equities that look cheap compared to bonds.

Still, if highly allocated to bonds, NEST will be a great way for a government to obtain cheap (and compulsory) funding for the deficit, eh?

MK22 04 May 2011 , 7:37pm

Ahh F958B, you are getting muddled over the use of low cost for NEST. It is low cost to the Government..........

edwardmk 04 May 2011 , 8:59pm

So let me get this straight. Everyone saves in a government scheme. Meanwhile the government does it's best to destroy the value of the money saved by clipping the coinage ( sorry.. quantative easing'. After a lifetime of savings, if the pot manages to grow, the next Gordon Brown can raid the pot to pay for Government overspending, under the auspices of a 'Windfall profits Tax' on big business. Hundreds of thousands of people find the promises made to them are not kept. The retirement they planned for is destroyed. They are told they should not complain. The government needs the money for essential services to everyone who was not 'lucky' enough to be able to save. Remember they also have a statutory duty to pay the pensions they promised to civil servants who've worked hard on our behalf, and are so stressed they need to take early retirement at 55. Even worse, they may decide to do without a pot, and just run the scheme and hope to pay out of current taxation. Ponzi scheme comes to mind for me also.

jmwg 04 May 2011 , 11:44pm

Without in any way wishing to be rude to Polonium210, you can't retire at 51. You have only just gone past the half way point of your working life, as you say you are highly educated, experienced and probably have enormous amounts to contribute - you can expect to live for another 35 years (on average if you have made it to 51 - and you are male). This should be the start of another (hopefully prosperous) great adventure..

Promenader 05 May 2011 , 9:14am

Polonium's "early retirement" sounds like luxury to me - has Polonium negotiated an early pension to obviate the need for claiming state benefit, or is he complaining about the inadequacy of a lump sum withdrawal?

You frequently hear cases on Money Box, Panorama etc where 50+ year old unemployed people fall into poverty because they fall through the welfare net (wife working part-time disqualifies them from benefits etc)

In my own case, I left a "voluntary organisation" just over a year ago. This job - of 20 years - was non-pensionable. I was disqualified from the ESA benefit almost immediately (because of the health tests being phased in by the government).

I do have savings (but no pension) and when my non means-tested benefit is withdrawn shortly I will be living solely on my savings.

Of course if I cannot get another job I really will end up a burden on the state - once I have been stripped of my savings, denied the assistance into work constantly trumpeted by IDS, and denied any possibility of a private pension.

matchmade 05 May 2011 , 11:56am

The ACA figures are ludicrous: it is incredibly difficult to save 15%, let alone 25% of pre-tax salary. How realistic are they about how much people *really* need to live off in retirement? One hears figures like 50% of final salary bandied about, but this seems far too high for me: £10-12,000 p.a., assuming the mortgage is paid off, is plenty, and you don't need to save anything like 25% of salary to reach that.

F958B's point that NEST will be invested in cash and bonds, if true, is well made: why would a 21 year old want to invest in bonds, let alone cash, for a pension they may not draw down until 50 years later?

I'm amused by the nochalant way in which businesses are expected to provide these NEST pensions for free - do all the administration, add 3% "contribution", etc, just out of the goodness of their heart. As usual, business people are seen as cash cows to pay for everything. Any sensible business person will just respond by cancelling pay rises for at least a year to help pay for NEST. If they don't do this, NEST will simply depress profits, meaning the business cannot invest in new products, or take on new staff - it's a straight attack on the bottom line. And I thought the Government was meant to be encouraging business!

Zugersee 09 May 2011 , 5:19am

The biggest problem with this kind of "save for your retirement" kind of stuff is that, even if you start off at 20 years old and put your money away properly, and you save more than 9% and you make a 9% return, it still relies on the idea of compound growth for you to obtain a liveable income.

Therefore over a working life of 35-45 years (depending on where you come from and your poverty level etc) you may have spent the first two and a half decades accumulating properly, but the killer is in the last decade when the non-linear equation really starts to give you some 'pant grabbing' returns.

Now, if for example, you were born in 1951, and you decided to retire in 2006 at the age of 55, well, you'd gone through your accumulation phase already, and hopefully you were in preservation mode prior to the shitstorm that hit our markets.

INstead, let's say that you were deciding to retire at 65 and thought you'd get another 10 years of accumulation under your belt, you've essentially lost a heap of your principal, and you also don't have the 'last decade' of compounding returns to supercharge your investment.

Hence, unfortunately, you've worked hard all your life, even put in another 10 years.... and I daresay you'll be worse off....

Pretty awful in my opinion.

chat01 14 May 2011 , 10:09pm

The problem with pension savings is that the government can change the rules at the last moment e.g. 30 years ago you may have planned to retire at 52 next year. Unfortunately no matter what steps you took to ensure that your pension pot was big enough the government has since decided that you will not be allowed to touch it until you are 55! Who knows what other changes they might decide to unilaterally declare in the meantime. And as was pointed out by Zugersee if you are paying into a defined contribution scheme your pension outcome can be massively impacted by general market events. Defined benefit schemes based on average salary rather than final with slightly reduced benefits from final salary schemes should be able to smooth out the variations provided there are no contribution holidays or tax raids. This would provide the sort of guarantee to workers that would possibly make the restrictions worthwhile. Otherwise probably best to stick to ISAs intially, at least you can get your money out when you decide and we are always told that you shouldn't let the tax tail wag the dog (and let's face it some defined contribution pension schemes have been real dogs).

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