James Daley: Why are ministers so short-sighted?
Saturday 17 November 2007
How much do you reckon you need to save for retirement? If you're hoping to end up with at least two-thirds of your salary by the time you finish work – which is what most financial advisers believe to be a worthwhile target – then the answer is probably a lot more than you think.
If you finish your working life at 65, on a salary of around £40,000, for example, you'll still need to have saved well over £300,000 to be able to retire on an annual inflation-proof income of around £26,500 – and that assumes that you qualify for a full state pension.
Furthermore, if you're still a long way from retirement, you'll need even more money. With life expectancy continuing to rise, people will need to have ever larger pots of savings if want to retire at the same age their parents did. With the depressingly low savings rates of today, the probable reality is that many people will end up having to either work much longer, or retire on a much more meagre income than they had hoped.
After waking up to this ticking time-bomb a few years ago, the Government decided the only way to get people saving more was to give them some gentle encouragement. Hence, from 2012, every employee over the age of 22 will be automatically enrolled into their company pension scheme – and will have 5 per cent of their gross salary paid into it each month. If their company doesn't offer a scheme, they will be enrolled into a so-called "personal account" – effectively a big private pension plan set up by the Government, to catch all the people whose companies are not generous, or big, enough to offer their own scheme.
As well as the 5 per cent you put in, your employer will be forced to pay at least an additional 3 per cent. And while this 8 per cent a month will not necessarily be enough to provide everyone with two-thirds of their final job's salary – the idea is that many will save more and people will have enough so that they don't have to rely on benefits from the Government.
Although most politicians and analysts have applauded the Government's vision and aims, its grand plan unfortunately sits rather awkwardly with its current system of benefits. Consequently, there are a significant number of people who face the possibility that they could save for many years into personal accounts, and still end up no better off than if they'd never saved a penny and simply claimed "pensions credit" once they reached retirement age.
Mike O'Brien, the pensions minister, admits that he does not know how many people might fall into this trap. Although he insists it will not be many, there are thousands, potentially millions, who will not be able to save in confidence – knowing for certain that every pound they save will go to giving them more money when they reach retirement.
The majority of those affected will be lower earners, but not exclusively. Parents who take long career breaks to bring up their children, for example, may also find that they end up with only a small amount in their private pension pot at retirement – meaning that although they made several years of pension savings, they are still no better off than their next-door neighbour who saved nothing, and qualified for full benefits. A truly perverse system.
O'Brien seems to be counting on employers and the media to make the system work – by persuading the public that they should make the effort to save, because they'll "probably" be better off. This is naive and wishful thinking.
People don't just need to know that they'd be better off saving, they need to know that they'll be significantly better off. Given the choice of keeping an extra 5 per cent of their pay each month, or losing out on a few extra pounds in retirement, there will be no competition. If O'Brien neglects to sort this problem out, Labour's grand redesign of the British pension system is likely to be a complete failure.
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