First the good news. More Britons than ever before are saving for retirement through a work-based pension scheme: new Office for National Statistics (ONS) data shows 33.5 million people are members of a pension plan at work, a 10% increase on last year. Much less happily, however, many of those pension-scheme members are putting nowhere near enough into their plans to secure a decent standard of living in retirement. The ONS says the average contribution to a defined-contribution pension scheme is just 4% of earnings, including what the employer pays.
Steve Webb, the former pensions minister who now works at pension provider Royal London, describes the 4% as a “shocking figure” that needs to be three or four times higher if savers are to be financially comfortable in old age.
To put the figure into context, the average contribution to a defined-benefit pension scheme, where income is guaranteed to be a set amount in retirement, is 21.2%, according to the ONS. And while the 4% defined-contributions figure is above the 2% minimum set down in law for workplace pensions, that threshold is scheduled to rise in the years ahead. It will increase to 5% in 2018 (including a 2% employer contribution) and then to 8% in 2019 (including 3% from employers).
The data suggests that the auto-enrolment reforms, which began to come into effect in 2011, have had a dramatic effect on pension-scheme membership. The reforms require all employers automatically to enrol their staff into a workplace pension plan, other than those who have specifically opted out. But while this has resulted in many more people joining pension schemes, large numbers are likely to be disappointed by their eventual retirement incomes unless they increase their contributions.
“It is quite clear that mass membership of pension schemes through automatic enrolment is just the start of a very long journey,” warns Webb. While the new minimum contribution rates will make some difference, current levels aren’t sufficiently high to guarantee people will save enough for their later years.
How much to put away
Financial advisers say very few people are saving as much as they should in private pension plans. As a very rough rule of thumb, they suggest the ideal contribution rate for your pension is half your age at the time you begin saving. So a 30-year-old should aim to save 15% of their earnings each year for the rest of their working lives.
Such amounts can sound intimidating, but not all of the money has to come out of your own pocket. Pension contributions get income tax relief, which reduces the cost of each £100 paid in to £80 for a basic-rate taxpayer and to £60 for a higher-rate taxpayer. And if you’re a member of a workplace scheme, you’ll qualify for a contribution from your employer.
Nevertheless, not everyone is in a position to achieve their ideal contribution rates. But the important thing is to save as much as you can afford – and to raise your pension contributions over time if your disposable income increases. Private pension providers are duty-bound to give you an annual update on your progress, which should include a projection of the pension income you’re on target to meet. You should use these updates to inform your savings strategy.
Finally, if you are saving larger sums, make sure you don’t fall foul of the maximum limits on pension savings. For most people, the limit on annual pension contributions is £30,000, while there are punitive tax charges to pay if your total pension savings rise above a certain amount – this lifetime allowance is currently £1m. This allowance applies to the total of all the personal and workplace pensions you have, but excludes your state pension.