Are you sleepwalking into a pension shortfall?

Under auto-enrolment, millions of workers risk heading for a retirement in which they won’t have enough money to live comfortably. Can pension savers remedy this before it’s too late?

In the imagined future of my retirement, the sun is always shining (there must be a name for this psychological bias/delusion), and I’m always enjoying myself with friends and family, indulging hobbies, travelling, and volunteering. My pension is hopefully going to fund all my retirement dreams – will yours?

As a defined contribution, or DC pension saver, which is what a lot of private sector workers are these days, there was some unwelcome news from the government recently on auto-enrolment contributions, which is the money paid into your pension by you and your employer.

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Under auto-enrolment, companies must enrol into a pension scheme anyone aged between 22 up to the state pension age – currently 66 - and earning more than £10,000 a year. Auto-enrolment pension contributions are currently set at 5% for employees and 3% for employers, so a total of 8% minimum goes into a pension, although you can contribute more. You can also opt out, but people are typically advised not to unless financial hardship demands it.

Many people and organisations, including interactive investor which published a report called ‘Is 12% the new 8%’, have voiced concerns that the current 8% contribution rate is not adequate for a decent retirement. Part of the reason why individuals need to contribute more than 8% to their pension, is that investment returns in the future are likely to be ‘lower for longer’, which means pensions will grow more slowly, so you need to save more to get a decent-sized pension.

This week, the Department for Work and Pensions (DWP) published a response to recommendations made last year by the Work and Pensions committee, which urged the government to say whether it considers “an increase in minimum contributions possible in the foreseeable future”.

In its response, which was published on 23 January, the government acknowledged that “current statutory contributions of 8% on a band of earnings are unlikely to give all individuals the retirement to which they aspire”, but it would not commit to raising the contribution rate.

Are you contributing the bare minimum to your pension?

My concern is that a lot of people will leave their contribution rate at 8% for years, meaning they are at risk of a serious pension shortfall in retirement. The longer you leave it, the less time there is to benefit from investment growth and compounding over time.

Pension engagement, as the industry calls it, is a huge problem. According to the interactive investor 2022Great British Retirement Survey (GBRS),10 years after the introduction of auto-enrolment, one in four people say they know nothing about pensions.

Younger workers in their 20s and 30s might be lulled into a false sense of security when it comes to auto-enrolment minimums. My fear is that some people will assume that the auto-enrolment minimums have been set at the right level for a comfortable retirement, because the government is somehow acting in loco parentis and doing the thinking for them. 

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I understand that suggesting people contribute more to their pensions during a cost-of-living crisis is an unaffordable luxury for some. If you are struggling with rent/mortgage payments, and rising food and energy bills, there is little or no money to spare. So, if you are reading this, and you don’t have the capacity to raise your auto-enrolment contribution now, don’t worry. Return to thinking about your pension when you can.

But for those who can afford to pay a little more into their pension each month, here is why you really should consider contributing more than your 5% minimum under auto-enrolment.

Facing retirement facts

Many people are forced into an early retirement through ill-health or because of caring responsibilities for elderly parents, for example. It is often women who take on caring roles, and they often have smaller pension pots.

According to the ii GBRS, only one in three 55-to-65-year-olds say they work full time, with one in three having cut hours due to health issues or caring responsibilities.

Retiring many years before the state pension age – increasing from 66 to 67 in 2028, and then 67 to 68 between 2044 and 2046 but is likely to increase faster than planned, as reported by my colleague Alice Guy- means you will not have as much annual income as you need.

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Under the pension freedoms, introduced in 2015, private pension pots can be accessed from 55 or 57 from 2028, but this age is likely to rise for workers who are younger.

Money held in a tax-efficient ISA, combined with access to a private pension, can often help keep early retirees afloat financially until they can access their state pension.

Even if you don’t retire early, an 8% contribution may still not be enough to fund the life you want.

Stop sleepwalking: how do I know if I’m saving enough?

Retirement income is generally a mix of the state pension and an individual’s private pension.

It’s pretty much a given that if you have a defined contribution pension, rather than a final salary pension (a defined benefit, or DB pension), it is going to be up to you to help direct your financial future. Educating yourself in ways that will help you manage your own money is a wise investment and thinking about your pension early on is vital.

The Pensions and Lifetime Savings Association (PLSA) publishes extremely helpful statistics to help you think about how much money you will need in retirement, and how big your pension pot needs to be. Look to see if you are on track. If not, you have time to do something about it.