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Pensions: how much should you save?
The vexed question of how much to save for retirement has reared its head once again with a controversial report suggesting that rational investors should not start saving into a pension scheme until after age 35.
The vexed question of how much to save for retirement has reared its head once again with a controversial report from academics at London’s Cass Business School maintaining that rational investors should not start saving into a defined contribution pension scheme until after age 35. Even more controversially they go on to suggest that from the age of 55, you should be saving one third of your salary.
The real problem with saving for retirement – which everyone seems to ignore – is that unless you are an above average earner, or you don’t marry and acquire dependants, most people cannot possibly afford to save for retirement until they have finished educating their children. And even then, parents are often called upon to help with adult offspring’s housing costs.
Impossible to save
A family with one earner and two children on the average wage in London and the south east of around £30,000 a year will be hard pressed to survive, let alone save for retirement. For most families, mortgage repayments, travel costs, basic utilities like gas, electricity, telephone and TV, plus food and education costs such as school uniforms, more than eat up all their disposable income. Unsurprisingly, most have credit card debts or personal loan commitments.
Mortgage repayments on a £120,000 loan, even at today’s low rate averaging around 4%, will eat up some £640 a month out of take home pay of £1,896, plus around £63 a month tax credits and £146 child benefit. There will also be utilities bills, now averaging around £1,200 a year or £100 a month, plus council tax at around £1,200 a year which takes up another £100 a month.
Travel is a major item of expenditure. For example an annual season ticket from Luton to London’s King Cross costs £4,232 or £352 a month – and that doesn’t take into account ongoing tube or bus fares to the office. These basic costs eat up £1,192 a month leaving just £913 a month to pay for food, clothing, running a car, household and life assurance and holidays and Christmas. There is no way the average family can afford to save for retirement.
Pension providers and those with a vested interest constantly remind us that a person needs to save on average around 15% of gross earnings throughout their working life to retire on anything like a decent pension. This is simply out of the question for millions of families – which is why the Cass report suggests that people shouldn’t expect to start saving for a pension until they are in their thirties. Even then it will still be impossible for many families.
The Cass report is simply setting out what we know – that young people save for a deposit on their first home and can’t afford to put money away for a pension. It isn’t until later life – possibly their fifties, when children have grown up and earnings have peaked – that families may be able to afford to save for a pension. But even that is dubious given the massive increases in the cost of further education. And the Cass suggestion that people should save a third of their salary from age 55 is probably unrealistic for most.
‘There is a huge amount of irrational behaviour,’ said Professor David Blake, director of the Pensions Institute at Cass and one of three co-authors of the report. The Cass paper found that to maximise pension saving, ‘surprisingly, it is not optimal for individuals to start contributing to a pension plan until several years into their career. This is because individuals’ incomes are initially low and they are better off consuming their incomes rather than saving from them.’ Clearly paying off debt and saving for the deposit on a home are top priority for most.
According to the Cass report the optimal contribution rate, ‘increases steadily from zero prior to age 35 to around 30% to 35% after age 55.’ But reality does creep in when Blake admits, ‘I doubt that most people would have the willpower to maintain such high contribution rates towards the end of their working lives.’
Few would disagree with the suggested investment strategy advocated by the Cass report which is that 100% of early contributions should be invested in equities (or a diversified growth fund), with bonds being introduced later. It advocates an equity holding of 20% to 50% at retirement, when the bond holdings are sold and ‘phased annuitisation’ should begin.
Not surprisingly there has been considerable criticism of the Cass report from both pension providers and advisers. In an ideal world we would all earn enough to allow us to pay off debts incurred as a student, save for the deposit on a home, finance the high costs of having a family, and save for retirement.
But pension providers and the government seem to ignore the reality – that many millions of families barely survive. Figures from Standard Life in a report, Your Commitments, Your Future, point out that people aged 35 to 44 are under the greatest financial pressure, spending on average £1,208 a month on financial commitments including mortgages, debt and general household bills.
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