A challenging couple of decades for pensions

The UK’s pensions landscape has dramatically evolved over the past 20 years. Policy changes, technology, and the economy have all significantly impacted the way that people are preparing for retirement. However, retirement outcomes have not necessarily improved, and in some cases have actually worsened. We explore what’s happened over the past two decades since the first Scottish Widows Retirement Report was published, and what savers might expect in future. 

How has pensions policy changed over the past 20 years? 

Auto enrolment

One of the biggest changes to come about in the past 20 years is the introduction of automatic enrolment. Initially launched in 2012, it’s been a game changer for workplace pensions, bringing 10 million more workers into a pension scheme and ensuring they are saving at least the minimum for retirement. Saving amounts that employees automatically contribute to their pension pot have risen from just 2% at launch, to 8% in 2018.

However, there have been no significant policy changes since it was introduced more than a decade ago. One of the changes that would be beneficial would be to take the statutory level of retirement saving from 8% to 12%, with strong guidance that those who could be saving 15% do so. This would help workers to save more realistically for a good standard of living in retirement. 

Pension Freedoms

Introduced in 2015, Pensions Freedoms gave people more flexibility over their pensions savings. However, the pensions industry needs to be wary about encouraging people to dip into their pension pots before they reach retirement. Though we recognise that this can be tempting when savers are feeling the impact of rising costs, more needs to be done to give people the tools and understanding to manage their own pensions effectively. 

State Pension and triple lock

The State Pension increased by 8.5% this year in line with the triple lock rule, increasing the amount from £10,629 to £11,502 per year. The State Pension is critical for keeping people on track for at least a minimum lifestyle in retirement, with 75% of retirees saying that it helps to pay for essentials, such as food and utilities. However, many people who expect to rely on the state pension when they come to retire are concerned about changes to it, with 12% of people believing it will not be available at all when they come to retire.

What’s working well when it comes to retirement savings?

Reforms have led to real improvements over the last 20 years in how many people are now saving for retirement, and how much they’re able to save. The introduction of automatic enrolment has resulted in millions more saving for retirement, with 70% more people saving into a pension since it was introduced.

In total, more than 22.5 million employees are now contributing to a pension. We’ve also seen a 51% increase in real average pension wealth for those aged 50-64 since 2008, and a 36% reduction in the gender pension gap for those aged 50-64 since 2008.

However, while automatic enrolment has boosted participation, there are still some significant gaps. Savings rates are still too low for millions, and without further effort, many will have a much lower standard of living in retirement than they would expect. Others will rely much more heavily on the state than might be necessary.

Challenges facing the UK pensions industry today:

Some of the challenges facing the UK are making it harder and more complex for people who have already retired, or who are saving for their future retirement.

Rising costs 

During the last two years, costs have risen which has put added pressure on household finances.  Inflation has since dropped to the Bank Of England target of 2%, and this issue seems to be abating.

However, prices today are still higher and, as a result, day to day costs for those who have already retired (or are about to) have increased. People are now advised that they need an income of £14,400 per year for a single person to have even a minimum lifestyle in retirement – an increase of 13% compared to last year. 

Housing costs have also increased, with private rents going up by 15% since 2020. Wages, in contrast, have been stagnant since 2007, according to the Resolution Foundation. 

These rising costs mean that fewer people are on track for a minimum lifestyle in retirement, with 8% more of the population projected to have a minimum or less than minimum lifestyle compared to last year, and a 5% decline in people expected to have a comfortable lifestyle.

* % increase to the 2024 PLSA standards based on 2023 data, compared to previous PLSA standards based on 2022 data.

Longer lifespan

Life expectancy has increased in the past 20 years, with men expected to live three years longer and woman expected to live two years longer. Therefore pension pots need to stretch that bit further – but people are also working to an older age too, with state pension age now 66 compared to 65 20 years ago.  However, people have become more accepting about having to work later in life, with 23% of future retirees expecting to work longer than they would have liked. 

Type of pension

Generous Final Salary pension schemes are being replaced by defined contribution schemes, which place greater responsibility on the individual to contribute to and manage their pension pot (bolstered by contributions from their employer). The proportion of employees with occupational defined benefits fell from 46% in 1997 to 28% in 2001. All this means that savers today need to take more responsibility over their long-term savings much earlier.

*Source: Office for National Statistics – Annual Survey of Hours and Earnings (ASHE)

Individual responsibility

Individual responsibility has become more important in preparing for retirement. At the same time, it is not clear that individuals are taking on the mantle of this responsibility. The double whammy of the advice gap and limited engagement with retirement preparation means that more than a third of people are currently at risk of not being able to meet their basic needs in retirement.

As a result, retirement outlooks are generally getting worse with retirees of both the near and distant future facing a much tougher time than the retirees of today. This is exacerbated by people not saving enough, not engaging enough with their pensions early enough, a greater gap between wage growth and big costs like housing, as well as pay and pension inequality.

How can we improve pensions outcomes?

20 years on, the huge issue that we’re facing is that people still don’t understand how much money they’ll need in retirement. Based on current savings behaviour, over a third (38%) of people are at risk of falling short of even a minimum lifestyle in retirement. 

Retirees of the future are facing a much tougher time than retirees today, with the next generation set to retire (Gen X) looking like they may be the worst off group, having missed out on generous Defined Benefit schemes, but being a bit too late for Auto Enrolment. 

So what can we do to address these issues?

1. Expanding auto enrolment policy

As well as boosting the auto enrolment rate from 8% to 12% (or 15% if possible), examining age and earning thresholds could help more people to save for retirement earlier. Parliament has instructed Government to reduce the age at which employers enrol workers into a pension scheme from the age of 22 to the age of 18. They have also instructed that all employers calculate pension contributions without first deducting the lower earnings limit from their salary.

Enacting these changes will increase the pot size of the average 18 year old by £46k in today’s money. We urge the Government to implement these changes as quickly as employers are able to make the necessary changes in payroll systems. 

In addition to adequacy, we also have a challenge in relation to coverage. At present low-paid workers, part-time workers, multi-jobbers and the self-employed are excluded from Auto Enrolment. We believe that the £10k earnings threshold at which workers are auto enrolled be abolished, but that workers on low levels of earnings should be able to opt out of the employee contribution, whist still benefiting from an employer contribution towards their retirement. 

This is on the premise that no-one should be too poor to receive a contribution from their employer towards their retirement.

2. Pensions savings for the Self-employed and part-time workers

Part-time and self-employed workers are more likely to face worse retirement outcomes than full-time workers; 41% of part-time employees are not on track for even a minimum lifestyle in retirement (compared to 25% of full-time employees). 

There are over 4 million self-employed workers in the UK who are currently excluded from Auto Enrolment, and whilst the auto enrolment ecosystem designed for employees wouldn’t be applicable for self-employed workers, an equivalent system designed specifically for the self-employed would help boost their retirement savings.  

3. Investment growth

Whilst the starting point for adequate retirement outcomes is the amount of money that is saved, a second key ingredient is the amount of investment growth. 

Recent decades have seen a race to the bottom on price, which employers and those who advise them have selected pension schemes and providers based on what is known as the Annual Management Charge. This is normally expressed as a percentage of the assets in someone’s pension pot. 

Whilst high charges could have a detrimental impact on the growth of a pension pot over time, if charges are too low, certain types of investment have to be excluded and that could mean that the pension pot grows more slowly.

4. Housing provision 

It’s not just income that matters in retirement -  It’s also expenditure. The shortage of homes means that both house prices and rents are rising faster than wages. Meanwhile, an increasing number of people will be renting through retirement, or paying down mortgages which run into old age. 

If this continues, people will need to save a very large proportion of their salary to cover significantly higher living costs in retirement and there will be a sharp rise in the level of housing benefit paid to retirees. 

To help address this, more homes are urgently needed. These could come from building new houses, as well as looking at the way in which the existing housing stock is used. 

More also needs to be done to help younger people save for a first deposit, as an integral part of their long-term savings and retirement strategy. However owning a home won’t be right, or possible, for everyone. And so the UK needs more, affordable social housing.