State pension shock: how you can make up the shortfall

There are real concerns among younger people that the state pension will be gone by the time they reach retirement. Katie Binns investigates how they can make up the difference.

Reading through interactive investor’s annual Great British Retirement Survey, a striking statistic jumps out: only 34% of 24- to 29-year-olds expect to receive the full state pension, compared to 54% of 30- to 35-year-olds and 64% of 42- to 47-year-olds.

Dig deeper into the survey and younger participants worry that they won’t be able to save enough in their private or workplace pension, especially if they are prioritising saving for a home. Of those currently renting, 70% believe their pension is unlikely to be enough to cover their rent and living expenses when they stop working. 

There’s lots to indicate that the standard model of getting on the property ladder, saving into a pension, paying off your mortgage and picking up your state pension as you skip into later life isn’t relevant for younger people. People in their mid-30s to mid-40s are three times more likely to rent than 20 years ago, first-time buyers are older than ever, while many young homeowners have been caught up in the cladding scandal or experienced the extra (and eye-watering) costs of new builds or shared ownership.

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Nearly two-thirds of retired respondents with adult children in the survey said they had diverted some of their retirement savings into property deposits. “The best advice I can give kids today is ‘choose your parents well!’” says property analyst Henry Pryor. 

He thinks home ownership will eventually happen for younger people - but only if you have family inheritance and maybe later in life. “While it will be impossible for many young people to buy, given that most people who own homes have kids, and will one day sell up, their children will get a windfall and like as not will be able to buy a home - who wouldn’t buy a home if they could?”

The main takeaway from the Great British Retirement Survey for younger people is to get savvy about what is going to work for their personal circumstances. If you know you’ll inherit a family home much later in life (and you take the gamble that it won’t be eaten up by possible care costs for your parents) you may prefer to forgo the toil of saving for a house deposit and associated buying costs and instead maximise pension contributions.

First up, if younger people really don’t expect to eventually receive a state pension, how much more do they need to save to try to make up the difference? 

The new state pension is £9,339 a year. If you optimistically imagine you’ll live for 20 years after retirement the state pension is worth £187,000. 

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According to interactive investor, a pension pot of £350,000 will give you £11,000 a year private pension that keeps pace with inflation to age 90, on top of anything you receive from the state pension. That means saving £350 a month, including employer and employee contributions and tax relief from age 22, assuming a 3% rate of investment growth. That means roughly 14% of the typical £30,000 salary.

If you’re saving an extra £187,000 on top of this to make up for a discontinued state pension, you’ll need to save an extra £200 a month into your pension, or £550 a month, again from the age of 22, assuming a 3% rate of investment growth. 

“The state pension is valuable. Trying to make up for it would mean sacrificing even more now for the future. If it gives you peace of mind that you could cope with a diminished state pension, you might consider that it is worth it,” says Becky O’Connor, head of pensions and savings at interactive investor.

Be heartened to know the impact of making even the smallest of increases to your pension contributions. For example, if you earn £30,000 a year and get a 1% pay rise, rather than have an extra £20 in your pay packet, increase your pension contribution from 8% to 9% and end up with an impressive £20,928 extra in your pension pot by the time you retire. This kind of minimal effort from time to time over your working life can be a meaningful boost to your pension.

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Also make the most of ISAs. These are a source of tax-free income that can bridge the gap between stopping or reducing your working hours and accessing a pension. Cash ISAs currently pay very little return but are handy for keeping a reserve of money for rainy days, or perhaps while you decide how to invest. A stocks and shares ISA has the advantage over a pension of being accessible at any age, which is why many people have both. 

ii’s How to invest podcast discusses the different ways to invest for retirement, including workplace pensions, SIPPs (self-invested personal pensions) and ISAs.