Saving 12% of Salary from 20s Necessary to Avoid Hardship in Retirement

A recent report on the pensions landscape has highlighted that at present rates of saving, a concerning 46% of the UK population will not have sufficient funds to meet the target income for a comfortable retirement.

Pension provider Scottish Widows’ latest annual report sets £23,000 as the minimum annual income requirement if we are to pass our retirement years enjoyably and without significant financial concerns.

In a bid to tackle the time bomb of an ageing population hitting retirement age over coming decades with little more to rely on than their £155 a week state pension, the UK government began phasing in auto-enrollment from 2012.

Auto-enrollment is legislation that means everyone in the UK over the age of 22 and earning a minimum of £10,000 a year is opted in to having a percentage of their salary automatically put towards their pension savings each week or month. Employers are also obliged to contribute with HMRC topping up savings by adding tax relief to the pot.

At present, auto-enrollment rules mean employees pay 1% of gross pay towards a workplace pension. Because this 1% is taken out before income tax and national insurance, it amounts to 0.8% of take-home pay.

The employer is obliged to make a contribution matching that 1%. Over the 2018/19 tax year contributions go up to 3% from the employee’s pay with the employer contributing 2%. By 2019/20, auto-enrollment will have been fully phased in with 4% coming from the employee and 3% from the employer.

With government tax relief added into the mix, full auto-enrollment will amount to a sum equivalent to 8% of annual pay being added to the individual’s pension pot every year.

Is Auto-Enrolment Working?

Saving 12% of Salary from 20s Necessary to Avoid Hardship in Retirement

It would appear that the answer to the question is both yes and no.

  • Yes: the positive impact of auto-enrolment is that Scottish Widows’ report indicates an increase in the number of people saving sufficiently for a comfortable retirement has risen from 46% to 56% since its introduction. 80% of under 30s are now paying into a workplace pension every month.
  •  …and No: Scottish Widows’ report holds that while 80% of under 30s are paying into a pension, mainly via auto-enrolment, 70% are not saving enough to hit the targets they will need to have a financially secure retirement.Additionally, the research finds that half of the under 30s demographic plan to opt out of auto-enrolment when contribution levels are increased for the 2018/19 tax year, citing unaffordability.

While auto-enrolment is opt-out rather than opt-in, it is not a legal requirement to make contributions and employees can ask to be made exempt of contributions. An official opt-out request that acknowledges understanding of the consequences, such as foregoing employer contributions, must be made in this case.

The pension provider’s calculations indicate that auto-enrolment should be raised to a total of 12% of salary, split between employee and employer contributions and government income tax back top-ups, from the present 2019-onwards 8%.

That’s the figure that will allow everyone to hit retirement with enough in the kitty to meet an annual £23,000 income.

Saving 12% of Salary from 20s Necessary to Avoid Hardship in Retirement

Chart Credit: Scottish Widows

A natural retort would be that a pension provider has a clear vested interest in releasing a report that concludes we’re all going to spend our twilight years eating cold beans on semi-toasted toast unless pension contributions are significantly raised.

The more we invest in our pensions the better for business like Scottish Widows and their peers, so they have an incentive to be somewhat alarmist, right?

However, some simple calculations demonstrate that Scottish Widows is right. The state pension provides a little over £8000 per year so our workplace or private pension pot needs to be able to provide around £15,000 per annum in returns to get to the target £23,000 retirement income.

A final pension pot of £300,000 would be expected to be able to provide an ongoing income of around £15,000 a year, if we suppose an average annual return of 5%. To get to £300,000 over 40 years, again supposing 5% annual returns going back into the pot as compounded returns, around £202 per month would need to be saved.

The average UK Salary is currently £27,195. 8% of that, as per current post-2019 auto-enrolment contributions, is £181 per month and falls short of the calculation above. Anyone who has not started making regular pension contributions by the age of 25, or makes on average less than the national average salary over the course of their working life, would not meet the £23,000 target pension income at retirement.

The Solution

Saving 12% of Salary from 20s Necessary to Avoid Hardship in Retirement

There is little by way of general criticism of the auto-enrolment scheme. Paraphrasing Scottish Widows’ savings expert Catherine Stewart, it may not be the ‘silver bullet’ that secures a comfortable retirement for the whole British population, however it has kick started the savings habit for millions. The conclusion though, has to be that even more needs to be done.

With so many already planning to opt out of auto-enrolment when the higher 8% contributions come into force over the next couple of years, a further rise to 12% has to be considered optimistic. Pushing that through in the foreseeable future would be politically complicated for any government.

At least in the medium term, Personal Responsibility is clearly the most realistic hope.

It’s far less than certain if state pension provisions can realistically be maintained at even their present level into the future. Staying opted in to auto-enrolment is a good start but going that extra mile to set aside that little bit more voluntarily will make a huge difference to being able to enjoy a comfortable retirement.

That could be by upping contributions into the same workplace pension as auto-enrolment contributions, an additional self-invested pension or even other savings products to provide supplemental income in retirement.

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John Adam

John Adam writes about the financial markets and reports on critical news for retail investors. He also consults for venture capitalists in Europe who invest in tech-intensive growth companies.