Ever since employers started moving away from defined benefit (DB) pension promises for their employees there have been challenges to ensure that people have sufficient income when they finally cease remunerated employment. There are many good reasons for the move to a defined contribution (DC) system. Employers benefit from greater control and certainty over their liabilities; employees gain greater freedom over the amount and form of their benefits – particularly since the new freedoms introduced in 2015.
But as with all things in life, compromises are involved. The flip side of the freedoms is that members are required to make choices, and with a subject as complex as financial planning, many find the subject too difficult to master. Default arrangements, initially for contribution levels and investments, have been around for some time and do help in a generic way. Similar tools for the application of savings pots to provide income have been slower in coming. For many, however, these have come too late. Survey after survey reminds us of the consequences – a cohort of workers heading for retirement poverty.
Recognising the importance of the issue, government, employers and the pensions industry are all stepping up their efforts, with the number of aids available to help members now growing. The latest contribution comes from the Pensions and Lifetime Savings Association (PLSA), called “Retirement Living Standards”.
This seeks to address the first and perhaps the most fundamental question in planning a retirement income – just exactly how much income will one need, or want? Without a target, it is impossible to construct an effective plan to get there. The consequences of falling short are serious, but overprovision is also undesirable, as limited resources during the working years need to be spread across a large number of necessary expenditure items. Reliance on guesswork is simply not a viable option.
The PLSA contribution
Enter the PLSA initiative. This sets out a series of simplified illustrative generic living standards in retirement. These are presented in three bands, defined as follows:
- “Minimum” – covers all needs, with some left over for fun
- “Moderate” – provides more financial security and flexibility
- “Comfortable” – provides more financial freedom and some luxuries.
In each case, further detail fleshes out what items are and are not included, categorised under House, Food and Drink, Transport, Holidays and Leisure, Clothing and Personal, and Helping Others. So for example, for a single person, a “minimum” living standard would include such things as an allowance for a £38 weekly food shop, no car, a week and a long weekend holiday in the UK each year, and £460 for clothing and footwear.
A “moderate” standard allowance, by comparison, would include a £46 weekly food shop, a 3-year old car replaced every 10 years, 2 weeks in Europe and a long weekend in the UK, and £750 for clothing and footwear.
Achieving a “comfortable” standard would take one to more dizzying heights including a £56 weekly food shop, a 2-year old car replaced every 5 years, 3 weeks in Europe and £1K to £1.5K for clothing and footwear.
There are different figures for couples, with for example the “comfortable” standard including a £91 weekly food shop, two cars each replaced every 5 years, 3 weeks in Europe and up to £1,500 per person for clothing and footwear.
The required income figures
In each case, an income figure is produced that is deemed necessary to fund that standard, both for a single person and a couple. An individual would deduct their expected State Pension(s) (the figure is available from the Department for Work and Pensions (DWP) website) leaving the balance required to be provided through a workplace pension and/or other savings vehicle.
As with any predictive tool, it uses a number of assumptions. If these are not accurate then the whole project falls. Mindful of this, the authors have involved research from Loughborough University. The headline results are the following required annual incomes for single-person households (figures for couples in brackets):
- Minimum – £10,200 (£15,700)
- Moderate – £20,200 (£29,100)
- Comfortable – £33,000 (£47,500).
These examples can never be more than generic illustrations, but one of their main strengths is the simplicity of their presentation. We know that one of the causes of the lack of member engagement with pensions is an inability to see the bald figures in a personal, practical context. Although perhaps deceptively simple, the retirement income standards should at least give some useful context for many savers.
Once the target required income has been selected, the next step is to identify the contributions likely to be necessary to achieve that. This will never be an exact science, but a useful recent report from the Institute and Faculty of Actuaries (IFoA) puts up some figures for the monthly amounts that might need to be saved in addition to the National Insurance contributions necessary to secure a full State Pension. Based on the PLSA’s income figures above, the IFoA concludes as follows (figures for couples – in aggregate, not for each person – in brackets):
- Minimum – £86 (£0)
- Moderate – £799 (£753)
- Comfortable – £1,755 (£2,128).
Putting this into context, this means that people saving at the minimum level required under automatic enrolment, and with a full National Insurance record, should achieve the ‘minimum’ retirement living standard. Further, someone on average full- time earnings will need to save around a quarter of their income (26%) to be on track to achieve the ‘moderate’ retirement living standard, a figure that more than doubles if the “comfortable” target is required.
Importantly, the report also identifies that the greater cost of living in London requires the PLSA income figures for London residents to be greater, with a corresponding impact on required contributions.
The PLSA’s stated ambition is for the pensions industry to deliver these standards to pension savers, with 90% of active savers belonging to a pension scheme that uses them in member communications by 2025. Provided the figures prove to be robust and that they gel with the public that would be a major step forward from where we are today.
Universal consensus over the figures would help in wider financial planning by the government when setting state benefit levels, and for all employers, including those who still provide a DB offering to their employees. The latter will be able to use them as a guide to the level of benefit that they wish to provide, including assisting with benchmarking their own offering against that of competitors, whether on a DB or another basis. It would also provide a reassuringly familiar backdrop for a range of member communications, such as where an employer wishes to change their offering in the future.
Furthermore, consistency in the message given by schemes will help members. DWP predicts that employees will on average have 11 different jobs over their working lifetime. Changing pension provider each time (and sometimes during employment) will add to the difficulties for a member to plan their retirement income, so anything that brings a level of consistency to the process will be invaluable.
Remember the context – but a good start
Useful though the retirement living standards and the IFoA figures are, it is important to keep them in context. They can only be illustrative and generic. They cannot replace individual advice based on a member’s personal circumstances, which themselves will be incapable of accurate and definitive assessment, particularly several decades in advance.
Furthermore, individuals will still need to consider such things as the age at which they plan to retire, their likely life expectancy, what other uses they may have for their retirement pots, and what other savings they will make.
So, although not of itself capable of resolving retirement income inadequacy, the initiative nevertheless provides an important tool. If it increases the overall level of appreciation of likely needs in retirement, it will be a welcome addition. If that can be achieved, it may encourage individuals to save more than the inadequate minima currently required under the automatic enrolment regulations.
Who knows, it may even help focus input to the forthcoming debate on the suitability of the current pensions tax system – but that is for another day….