The number of under-30s saving enough for retirement has increased from 30% to 39% in the past year, likely due to automatic enrolment in Workplace Pensions, according to Scottish Widows.
That’s good news, but still leaves 61% of young adults saving too little, or nothing at all, for later life.
To find solutions to this issue, it is important that we understand why young people are not saving enough, so that we can offer ways to improve their financial outlook.
Naturally, while many of us are young at heart, the years of 18-30s holidays are likely to be behind you. Nevertheless, this information could be useful to pass on to your children, or even grandchildren.
The reasons behind the savings drought
1. Exclusion from Workplace Pensions
Automatic Enrolment means that anyone who is:
- A UK resident
- Between 21-years old and State Pension Age
- Earning over £10,000 per year from a single employer
will be included in a workplace pension, which is subject to minimum, monthly employer and employee contributions, of 2% for employers and 3% for employees, which will increase in April 2019 to 5% employee and 3% employer contributions.
However, those who do not meet these criteria often have no pension provisions. This can include people with multiple jobs, those on zero-hour contracts, contractors and the self-employed.
Retirement expert at Scottish Widows, Robert Cochran, said: “It’s encouraging that more young people are saving enough for a decent retirement and auto-enrolment has played a really important part. However, auto-enrolment was designed as a safety net for a country facing a pensions crisis.
“Some of the hardest working and most financially vulnerable members of society are slipping through the auto-enrolment net because of minimum earnings thresholds. This unfairly impacts multi-jobbers, who could be working the equivalent of full-time hours, yet without the financial benefit of having a single employer.”
The solution: anyone who is aged 16 and over, earning a minimum of £6,032, can request to be enrolled in their employers’ Workplace Pension scheme. Their pensions will attract the same benefits as those who are automatically enrolled, including employer contributions and tax relief. Remember that’s effectively ‘free money’.
For contractors and the self-employed, other types of pension are available. Of course, they will not benefit from employer contributions, but pensions are tax-efficient, and the tax relief makes them a sensible way of saving for later life.
2. Relying on minimum contributions
For young adults who are enrolled in a Workplace Pension, complacency is a big danger.
For the 2018/19 tax year, the minimum contributions stand at 3% for employees and 2% for employers. In April 2019, this will increase to 5% employee and 3% employer. If young adults assume that those contributions will be sufficient, they are likely to face the shock realisation that they don’t have enough money to support their retirement. Unfortunately, by the time this becomes apparent, it may be too late to change the outcome significantly.
As an example, the average salary for full-time employees is £31,720 (Source: Office for National Statistics(ONS)). The minimum contributions, based on qualifying earnings between £6,032 and £46,350, will mean that:
- In the 2018/19 tax year, employers will contribute £81, and employees £107.03, including tax relief, per month
- From April 2019, employers will contribute £22, and employees £107.03, including tax relief, per month.
Someone putting away those minimum amounts might believe that they are on track, and over 40 years, you could build a retirement fund of £196,000 (Based on calculations from NEST Pensions Calculator, which assumes an average return of 2.5% per year, net of charges and fees.) Forecasts are for reference and should not be considered an indicator of future performance.
That sounds like a lot of money.
Unfortunately, it’s not enough.
If that fund were turned into a sustainable income, for example by buying an Annuity, it would potentially be able to secure approximately £8,700 per year (Figures from NEST. Based on an estimated inflation rate of 2.5% and 0.2% interest rate, single policy, taken from the age of 65). Even in conjunction with the State Pension, it is unlikely that will be enough to support the desired retirement lifestyle of a current under-30.
Worse still, that’s without any provision to pass that fund onto a spouse or beneficiary on death and does not leave any flexibility to take a lump sum from the fund, if needed. Of course, it is possible to take a lump sum and arrange a joint policy which will continue to pay your spouse after death, but that will affect the amount you receive each year.
The solution: Calculate how much is needed for a comfortable retirement and begin working toward that goal from a young age. It is possible to voluntarily increase employee contributions, although employers are unlikely to match it.
It may also be worth considering making lump sum contributions when possible. This includes receiving inheritance or financial gifts.
3. Underestimating the importance of retirement savings
Some young adults may simply not regard retirement saving as a priority. There are four root causes of this:
- They feel they are too young to start preparing now
- They can’t afford it
- They don’t trust pensions
- They would rather put their spare money toward more short-term goals, such as buying a house or starting a family
For the first group of people, retirement might seem like it is so far into the future that they will have plenty of time to think about savings in later life. However, when they reach a stage in life where planning for life after work becomes a priority, they will wish that they had started saving earlier to give themselves a head start.
Those who are saving for lifetime events in the order which they happen may find that some goals need more time than others. While it is sensible to prioritise buying a home, it may be worth ensuring that some money is being put aside for retirement at the same time, even if it is only small amounts. Remember, every month you’re not in a Workplace Pension is a missed opportunity to gain ‘free money’ in employer contributions and tax relief.
It is important to use the right product for your needs.
Prior to making any decisions, you must understand your goals and whether they are short-term or long-term aims. Following this, you will need to analyse your budget and allocate it in sensible proportion to those needs.
For example, when retirement planning is a priority, you are likely to be putting money into a pension. That means making the most of your Workplace Pension and maximising your contributions.
When working toward buying a property, you may turn to a Lifetime ISA (Individual Saving Account). This is a tax-efficient account into which you can deposit up to £4,000 per year. A government bonus equal to 25% of the year’s deposits is also added each year, boosting the amount saved.
Lifetime ISAs can be opened by anyone aged 18-39 and contributions can be made until the account holder turns 50. These accounts are available in both Cash and Stocks & Shares.
Withdrawals can be made from a Lifetime ISA to pay for the deposit on a first home, and to be used as a retirement income once the account holder reaches the age of 60, without incurring penalties. All other withdrawals will be subject to a 25% penalty, which will mean that you get back less than your original deposit.
It is possible to transfer your Lifetime ISA balance to a Lifetime ISA with another provider without losing your government bonus or paying a 25% penalty. To do this, you will need to contact both providers and instruct them to carry out the transfer on your behalf. Transferring your Lifetime ISA balance to another type of ISA will result in a 25% penalty charge.
If you are primarily planning to buy a house, your Lifetime ISA may receive most of your savings. However, by enrolling in a Workplace Pension you can ensure that you are putting some money aside for later life at the same time.
If you decide to save into a Lifetime ISA instead of enrolling in, or contributing to a
qualifying scheme, occupational pension scheme, or personal pension scheme, your future and current means-tested benefits may be affected and you will lose access to the benefits of workplace pension, which include, employer contributions and tax relief.
We all want the best for those we love, and with the State Pension feeling increasingly out of reach, starting to save for later life is becoming more and more of a priority. If someone you know is likely to be struggling with savings, now is the time to talk to them, or potentially have them engage with a financial planner or adviser for more guidance. For more information and advice, get in touch with us.