David Gow: Plan ahead to save yourself from the ticking pensions time-bomb
With a pensions price tag of up to £750 billion, the rapidly rising number of elderly people will have huge implications. No other force will have such an impact on the shape of public finances, government policy and the NHS.
For the first time ever there will soon be more people in the world aged over 65 than under five. People over 65 don’t generally work or pay anywhere near the level of taxes they did when working. They do, however, receive state pensions and use public services, and many of them will end up in care. The problem is that this all has to be funded.
In the UK, older people entitled to public sector pensions, health services and long-term care will soon outnumber the workforce whose taxes help to finance those benefits.
Public sector pensions are “pay as you go” schemes, in that today’s workers are paying for today’s pensioners. So what happens when there are more pensioners than workers?
The International Monetary Fund warned in April that even a slightly faster than expected increase in life expectancy could impose a huge new financial burden on western economies such as Britain: our ageing population could cost as much as £750bn.
Unless governments enact sweeping changes to age-related public spending, sovereign debt could become unsustainable. Sweeping reforms and culture changes are necessary. The main options are higher retirement ages, higher annual contributions or reduced payouts – and our government is already acting along these lines.
The state pension age is rising for everyone, while big changes are afoot for members of generous public sector final salary schemes. The NHS superannuation scheme, the flagship public sector pension fund, is a prime example.
The NHS is the fifth largest employer in the world, with 1.7 million employees (more than 150,000 of them in Scotland). All of them will be affected by the proposed changes, which will see the vast majority of staff contributing more, retiring later and having their benefits calculated on a less generous – for many – “career average” basis.
Final salary pension schemes, such as the NHS one, were designed for a smaller population with fewer pensioners. The government needs to educate the public to recognise that greater longevity will entail personal sacrifices, such as increased personal savings and a willingness to pay a higher share of medical and long-term care costs.
For those not in the public sector, the government is bringing in automatic enrolment into workplace pensions – beginning in October this year – whereby workers will have to make contributions towards their retirement unless they opt out.
Many commentators believe these changes won’t be sufficient to address the problem, and that further significant action will be necessary. For example, hikes in the retirement age for public sector schemes could soon become commonplace, with bonuses for people working longer.
So these are the changes being foisted on us. But what changes are you making to give yourself the best chance of a comfortable retirement?
Are you happy to stop working later than you planned? Until now, most people expected to work for 40 years, but today’s 20 and 30-somethings can expect to work for more than 50 years. Can you face five decades of work?
People are living longer, but they generally want to cease work at the same age as previous generations. The time to act is now.
Firstly, define when you want to retire, or at least when you want to start phasing in your retirement. Consider how much you will realistically need in retirement and your likely income from all sources, including help from the state (though this shouldn’t be relied upon).
Individual financial planning and monitoring is crucial. Do you know how well your pension savings are performing? If you’re putting in the hard yards by saving regularly, it’s got to be worth checking that you’re getting the best out of it. Sadly, there’s a good chance that much of your hard work in putting money aside could be undone by poor investment performance.
For example, in the 1980s many people began saving into with-profits pension funds, and more than 20 million people still have exposure to with-profits funds. Most of these are performing poorly, so these investors are unlikely to prosper unless they switch to a plan with better prospects.
Think about investment costs too. Evidence suggests that low-cost index trackers beat the majority of actively managed funds over the long term. Despite that, most investors have pension portfolios of managed funds.
Once you’ve built a true picture of your situation and ensured your current savings are working as hard as possible, you can calculate what you need to do between now and your desired retirement date to achieve your objectives.
Many business owners operate cash-flow models to monitor and improve efficiency. You can take this approach to your own cash situation too, with the help of a good financial planner.
Such a model will not only make reasonable assumptions about inflation, investment returns and property growth rates, but will also take into account your expected pension income from a range of sources: the state, occupational and personal pensions and other savings.
You can then factor in any predicted lifestyle that necessitates a certain level of regular and irregular capital expenditure. Imagine a model that shows you can easily maintain your desired lifestyle, or one that shows you’ll run out of money five years into retirement.
Projecting forward in this way, and looking at your financial standing given a range of assumptions, shows where your financial life is heading and puts you in control.
You could decide to put more money away for the future and increase your investment exposure to growth asset classes or have the option of spending and enjoying your money earlier than you’d anticipated.
If you want to live longer and still prosper, take some time to work out how you’re going to do it.
David Gow is a chartered and certified financial planner at Acumen Financial Planning in Edinburgh