By Fiona Tait, Pensions Specialist, Royal London
Cash flow planning
One of the most effective methods used by financial planners to engage savers, particularly those at a younger age, is cash flow planning. In basic terms, this approach can be described as identifying an individual’s current expenditure, projecting it forward to retirement and identifying the level of saving required to provide that equivalent income.
Royal London decided to apply this approach to provide a general but realistic picture of how much the average member should be putting aside for their retirement, at each stage of their life.
Although cash flow planning by its nature is highly individual, this is one of its key strengths as it does help to provide a realistic but general picture. The figure we use is based on the average spending of a UK pensioner in 2015, which according to the recent Pensions Through the Ages research commissioned by Royal London, is £1,084 per month .
Given the choice, most retirees would prefer to maintain their current lifestyle in retirement. They may spend less on work-related items such as commuting, parking and canteen lunches but this will be offset, and in many cases superseded by, the expenses of considerably more leisure time. We have therefore used the current spending figure as a basis for future income needs.
With members still typically retiring at the State Pension Age of 68, this means that many of today’s members are half-way to retirement in their mid-30s now. If we project average pensioner spending to 2050, the estimated monthly income required would be £2,694. (1)
So how much does this cost?
Using current annuity rates and someone in good health, who retires at age 65, it has been calculated that they would require a pension fund of £666,000 to secure that projected income of £2,694 per month.
In order to achieve this, a member who starts saving at age 35 would require to put aside at least £1,086 per month!
Other sources of income
Thankfully this is not the whole story. £1,086 is the contribution amount required if the whole of their retirement income were to be funded by the individual. In actual fact, the majority of scheme members will have at least 2, if not more, other sources of income:
Firstly there is the state pension. The projected figure for the state pension in 2050 is £1,558 per month , around 75% of the amount required in our scenario. However, there is no guarantee that the state pension will exist in its current form in 2050. Indeed 40% of the interviewees in their 30s from the research we commissioned believed that the state pension wouldn’t exist at all.
Secondly, there are workplace pensions. Contribution rates will vary but must eventually conform to a minimum contribution of at least 8% of band earnings, or an acceptable equivalent.
A defined contribution pension scheme based on around 8% contributions is not likely to provide a fund value anywhere near £666,000 , Even if we deduct the 75% to take account of the state pension, the fund required would then be £166,000.
Figures from the Pensions Policy Institute indicate that a median earner who contributes 8% of band earnings throughout their working life, would accumulate a fund of £79,361. A 15% percent contribution on the other hand would produce a fund of £148,801 which is much closer to the shortfall amount of £166,000, once the state pension is taken into account.
If members are confident that they will benefit from the full amount of these two additional layers of funding retirement income, the amount the individual needs to actually save could be considerably less than the £1,086 per month our calculations indicate is required. But for the majority whose working life is more varied any shortfall should, if possible, be identified and action taken.
So what to do?
These figures are only meant to be a guide, as they are based on a hypothetical situation and different, equally valid, assumptions could be used. As there is in reality no such thing as the “average” member; each member will have their own individual needs and wants. But at least they provide a starting point.
I believe that the important thing to note is that all but the lowest paid members will need additional savings if they want to fund a comfortable income in retirement. Saving £100 per month will not do it. 8% of band earnings will not do it.
This is the message we need to get out to members.
1 Research carried out on behalf of Royal London by Harris Interactive UK Ltd, using a bespoke survey with UK individuals across a range of age groups. Additional data was sourced from: the Office of National Statistics (ONS) Family Spending Report; Centre for Economics and Business Research (CeBR).
2 Assumes 2.5% p.a. growth via the triple lock
3 Royal London figures, based on a projected income of £2,674 at age 65 escalating in line with RPI.
4 Source: Pensions Policy Institute “Automatic Enrolment Scenarios post 2017 November 2015
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