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In your 40s? You could face a retirement 'wilderness'

Pension freedom reforms have been great for many recent retirees but won't help those in their 40s and 50s build big retirement pots.


by Michelle McGagh on Mar 24, 2016 at 09:00

In your 40s? You could face a retirement 'wilderness'

Two generations face a retirement ‘wilderness’ as meagre savings force them to fall back on the state or risk their pensions on the stockmarket for longer.

The introduction of pension freedom has been warmly welcomed by today’s over-55s who have been able to access their pension savings as cash, but Becky Tilston-Hales, managing director of fund manager BlackRock, said younger generations faced a very different future.

While older generations of babyboomers are still benefiting from generous defined benefit (DB), or 'final salary', pensions, people in their 40s and younger would only have 'defined contribution' plans which rely on the level of contributions and the investment returns they achieve.

Tilston-Hales said those using the freedoms today ‘have decent DB [pensions] and want to work part-time, and have a phased retirement, and for them the pension pots outside DB are there as a bonus, for holidays or paying off the mortgage, and for non-essential living expenses’.

However, she warned in ‘five or 10 years this will change and [the pensions that were seen as a bonus] will become an essential source of wealth’.

The concern is that those who are relying on their DC pots not to pay for luxuries, but to pay for their entire retirement have not saved enough, even if they were to buy an annuity, and are running out of time to do so.

‘We will have a wilderness period where the pot is not big enough to get a decent annuity income and definitely not big enough to stay in the market [by investing in a drawdown plan]…there will be a period where people look to the state again,’ she said, adding that it is at this point the government will have to think about compulsory pension saving.

Falling back on the state was one unattractive option future retirees would face if they didn't save enough, said Tilston-Hales. Their second choice would be to stay invested in the stock market.

‘There may be a period where people end up in the market because they have to grow their pots,’ she said. ‘They may have to take on market risk for a short period of time [in their retirement].’

Although Tilston-Hales said auto-enrolment would help young workers on the road to saving an adequate sum for retirement she still believed ‘two generations will be hit’, mainly consisting of those in their early 50s and 40s.

However, there is a risk of even younger generations facing the same hardships if they fail to save enough, part of the reason for the government’s plans to introduce lifetime ISAs next year.

‘Auto-enrolment is a positive step and anything that will…engage [young people] like the lifetime ISA is a good thing,’ said Tilston-Hales. ‘But when it comes to contributions they are still so far off compared to DB schemes – they need to be 15% to 20% [of salary to compare to DB provision] and they are way off that.’

However, Tilston-Hales added that lifetime ISAs would only be beneficial as another route to saving if individuals did not ditch their workplace pensions in favour of the ISAs, as they would miss out on employer contributions .

Andrew Tully, retirement expert at Retirement Advantage, a pension adviser, said although lifetime ISAs offered savers flexibility, saving into a workplace pension made more sense financially – particularly when overall auto-enrolment contributions rose to 8% of a person's salary (with 4% from the employee, 3% employer and 1% tax relief from the government).

‘With the lifetime ISA if you pay the maximum £4,000 in a year the government will add £1,000 and you receive the funds tax-free at retirement. If we ignore growth to keep things simple, that is £5,000 tax-free,’ he said.

‘If you work for a company then you will be auto-enrolled into a pension scheme. If you pay £4,000 into the pension scheme, with tax relief and the basic employer contribution you will get £8,000 (assuming 8% total contributions).’

Tully said at retirement, 25% or £2,000 of the fund would be paid tax-free and income tax paid on the rest.

‘Assuming you are a 20% taxpayer, the remaining £6,000 reduces to £4,800, so in total you have £6,800 – much better than £5,000.’

Tully said on a ‘purely financial basis’ pension saving is better ‘however, we can’t ignore the additional flexibility that the [lifetime ISA] offers those under 40, which might outweigh the financial benefit of traditional saving via a pension’.

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