03 July 2024
In recent years, we have seen actual and planned changes to the state pension age that will impact millions of people. There is a degree of confusion because the assumption that life expectancy increases generation by generation has been disrupted by the pandemic and, to a lesser extent, the cost of living crisis. So, how should we plan for pensions going forward?
If we look back to the early 1980s, life expectancy for women was 76.81 years and just 70.81 years for men. Fast-forward to those born between 2017 and 2019, and the respective figures were 83.01 years and 79.29 years - all-time highs. Looking at the latest data, for those born between 2020 and 2022, the figures are 82.57 years and 78.57 years, making it very difficult for the government of the day to forecast ahead.
If we look at the figures closely, we know that official projections from the Office for National Statistics (ONS) show that a healthy 55-year-old man today can expect to live to 84 and a woman to 87 - significantly beyond the average age above. We also know that there are 15,000 centenarians in England and Wales as of 2022, which has doubled in the past 20 years. Will it double again in the next 20 years or even before?
Did you know that, according to ONS research, a 55-year-old man today has a 25% chance of reaching 92 and a 4% chance of celebrating their 100th birthday? The equivalent woman has a 25% chance of reaching 95 and a 7% chance of celebrating their 100th birthday.
The flat rate state pension for 2023/24 stood at £10,600. If you were to retire today on an average salary of £35,000, you would need to secure pension assets delivering income of £24,400 per year. For a 66-year-old man today, looking to secure this pension income until aged 100, this would require a fund of around £625,000. This would assume 4% annual investment growth and inflation-linked income at 2%.
As more people are looking to extend their working life, let's assume that you worked until you were 70, at which point you began to draw down £24,400 per year from your pension fund. In this scenario, you would only require a fund of £575,000 to fund this inflation-linked income level until you were 100. A £50,000 saving!
As we move on to funding requirements, it becomes more obvious that the sooner you start, the better your chances of hitting your target pension fund. If we look at a 25-year-old person, they would need total contributions of £4200 a year, or £350 a month, to hit the £625,000 target. This assumes contributions increased by 2% per annum and average investment returns of 4%. But what happens if you start ten years later?
Starting ten years later would require total pension contributions (including tax refunds and employee contributions) of £7500 per annum or £625 a month - nearly double that of a 25-year-old. If you leave it until age 45, this will grow to £14,500 a year or £1200 a month. Leave it any later, and you get the picture. It's going to be costly as a consequence of lost compound investment returns over the longer term.
It's important that your pension assets are reviewed regularly and contributions adjusted when necessary. The days of simply setting up a fixed direct debit, leaving it for 40 years, and expecting to have a fund that will cover even the most basic expenditures in retirement are long gone.
In the context of retirement planning, double-digit inflation may have lasted a relatively short period, but the long-term impact is yet to be felt. An increase of 10% (or 11% at the high) in the cost of living impacts the year of the rise and re-bases the cost of living in the future.
If we look at this from a political perspective, governments can assist with personal pensions where possible, but the state pension is a different story. There is no magic fund, with the state pension paid out of tax receipts at the time. As more people live longer, funding requirements for the state pension will increase, and the state pension age will likely need to rise again. As there are no political votes in increasing the state pension age, this strengthens the temptation to kick the can further and further down the road as somebody else's problem.
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