Every employer now has a pension scheme. Thanks to auto-enrolment, which was introduced in 2012, we are told there are now nine million new pension savers.
However, this is not entirely correct. Some of the nine million will have pension rights deriving from previous employers or some may have made their own private pension arrangements which they may have terminated, or continued in addition to their new auto-enrolment pension. .
The base auto-enrolment contribution was 2% of band earnings from 2012 to April 2018. From April 2018 contributions increased to 5% and will increase again next April to 8% of band earnings. I write about base contributions because there are permitted variations as to how the contributions are calculated so that they roughly equate to the 8% of band earnings. Band earnings are broadly the equivalent to the earnings used for employee National Insurance (NI) contributions.
In a way, to get such a large number of people to save for their old age, is a radical change. Like all radical changes this will have a ripple effect on other sectors of the finance industry. Before looking at what this may mean for the later life lending market we need to understand what the changes mean in practice.
Conventional retirement planning takes an accumulated pension fund, pays the tax-free cash sum to the individual – usually 25% – and uses the balance to either purchase an annuity or establish an income drawdown investment account. Royal London estimates that £260k is required to retire with an income of two-thirds of the average earnings of £27k, inclusive of the State pension. If the retiree is going to rent in retirement they will need £445k.
The above calculations assume that an individual needs less to live on in retirement than they do whilst working. They are no longer saving for retirement, commuting costs no longer have to be paid, the mortgage has been paid off and the children have left home. Royal London also assumes the fund will be used to purchase an indexed-linked annuity to make up the shortfall.
Depending on your personal views, you may come up with reasons why more or less may be required for retirement. Take someone who is retiring today. How much would they have accumulated in their auto-enrolment account? As a guide if they were on £30k a year until April 2018 only £500 a year would be added to their pension pot. This would increase to £1,250 in this tax year and £2k a year thereafter.
As £30k is higher than full-time average earnings many will have less, particular those who have not worked full-time in their final years of working. It is therefore obvious that auto-enrolment contributions will not deliver anything like the numbers quoted by Royal London.
Some of the nine million will have pension entitlements from previous employments or personal provision. This should mitigate their shortfall. But many will have no other pension entitlements, have large gaps in their pension accrual or just not saved enough.
The Pensions Policy Institute estimates that, by 2024, 75% of those retiring will have a defined contribution pension pot of less than £40k in 2014 terms. From then on the level of auto-enrolment contributions is not going to grow that amount very rapidly. In the meantime, because those retiring will have smaller defined benefit pensions on average, the amount of income for new retirees from that source will decline.
What the above ignores is that roughly three in four retirees own their own house. If you look at the reasons people access equity release the above observations mean that housing wealth will be a continuing source of retirement income be that through downsizing, or accessing equity through a mortgage.
What will change is that more people will have a moderate amount of pension savings. Small pension savings will continue to be withdrawn as lump sums. Moderate pension savings can be used for income for a period but not a lifetime, or for a small base income. Moderate in today’s terms is between £25k and £75k.
This gives a problem. Specialist pension and investment advisers will be unable to give advice on mortgage options. On the other hand specialist mortgage advisers are unable to provide advice on pension and investment options. Yet from the above a rapidly growing number of people retiring will have a need for holistic planning and advice covering their pension savings and housing wealth.
But, the numbers who can manage such a client on their own are few in number. For those very reasons, the potential growth in those who will need to combine both in their retirement plan may be a reason to consider becoming a holistic retirement income adviser.
Bob Champion is chairman of the Later Life Academy (LLA)