Young people will have to take greater responsibility for their retirement, but pension providers may actually be discouraging them, writes Alex Clifford.
*Winning ifs Young Business Writer of the Year 2012 entry*
To many young people, getting old seems to be one of those impossible things, like an alien spaceship landing in their back gardens. But across the developed world, it is true that the probability of us living into old age is continually increasing. According to a report from the Department for Work and Pensions, one in six of us should expect to live to reach our hundredth birthday. In the face of such statistics it is clear that young generations need to start thinking about the ramifications of longevity.
A demographic crunch is underway in the UK, in 2008 the Office for National Statistics announced that there are now more people of pensionable age than under-16s, for the first time ever. This means that there will be less people of working age to support an ever-growing number of pensioners. To cope with these shifts the UK government will change the definitions of who counts as a pensioner – there are currently plans to increase the pension age to 66 between 2018 and 2020, 67 between 2034 and 2036, and 68 between 2044 and 2046. But does that go far enough? Given that the state pension already costs 10% of the UK government’s total annual budget, will the government be able to afford the state pension to everyone for several decades?
Employers are less likely to fund pensions in the future as well. Defined Benefit (DB) schemes, where employees pay into a pension scheme and receive a guaranteed income in retirement, are closing to younger members. Shell was the last FTSE 100 company to offer a universal DB scheme to its employees, and this closed a matter of weeks ago.
What this means is that the state may have to be less benevolent to future pensioners, whilst employers are also offering less generous schemes. Therefore the cost of pensions is going to fall firmly on the shoulders of the individual.
Although this is already largely the case today, it could be argued that many baby boomers approaching retirement, have had an easy ride. They have benefited from several decades of benign economic conditions – stock market gains on the back of a growing economy, room to climb the corporate ladder and a tripling of house prices. Many baby-boomers face a reasonable retirement with a state pension, Defined Benefit pensions and home equity in the bank. However tomorrow, where there will be greater constraints on the government purse and less generous pension schemes from employers, the impetus will shift ever-more towards individual responsibility.
So with this maelstrom of gloomy news, it would seem that now is the time for young people to consider pensions. If young people don’t want to be working into their 70s and potentially longer, they should start tucking money away now. Indeed, Einstein is reported to have said “compound interest is the most powerful force in the universe”. If young people can capitalise on several decades of compounding interest on their investments, then they should expect a much earlier retirement than those who don’t.
But there are certainly limitations to this goal. To begin with, do young people really have enough disposable income to pay into a pension? With the desire for many to get onto the housing ladder, pay off student loans and start families, pensions are likely to be further down the list of priorities. And perhaps a more fundamental question is whether pension schemes are the best way of planning for retirement. In the UK, pensions are a relatively poor investment even before managers take hefty annual fees. A report by RSA, an insurance group, noted that the average annual pension of £16,080 is reduced to £9,900 due to management fees and the effect of lost compound interest. The public has little trust in pensions and rightly so, it would seem.
“After more than 20 years within the financial services sector I have yet to find a product that ticks all the boxes when it comes to retirement planning,” says Andy Caddick, Head of European Operations at IFA International, an independent financial advice firm.
“The industry needs to wake up to the fact that there is more than one way to provide retirement income. Pensions might be going the same way as the dinosaurs, and maybe one question we should be asking is: are our pension funds being managed by dinosaurs?”
If retirement products were to be tailored more appropriately to the individual, managed better, and less overpriced, then they would become more attractive and the impending pensions crisis could therefore be avoided. Young people could recognise the real benefits of investing earlier in their lives and plan ahead. But given the current state of affairs it would seem that only the most financially savvy can take advantage of worthwhile retirement products. Therein lies the problem, nobody wants to invest into something which will only make their fund manager rich.
Whilst it is true that those who plan for their longevity will be better off than those who don’t, the current lack of saving would suggest something much more severe. It is pointing towards the pensions industry itself as responsible for a future pensions crisis – as the industry’s poor returns will have discouraged young people from saving and ultimately paying the costs of their longevity. This would lead to socially and politically unpalatable scenario.
As life expectancy increases, the stakes become higher, and the responsibility shifts more so towards the individual. Now, there is an opportunity in the marketplace for retirement products which will profit from decades of compound growth and low fees. If these products see the light of day, then young people should look forward to a better future.