The current pension system was designed for those with uninterrupted long working careers with a single employer. Working patterns have changed but pensions have not, leaving some workers at risk of a financially precarious retirement. In this research we explore key causes of pension insecurity and suggest ways to plan for a more stable retirement.
By This research was carried out by the Pension Gaps Working Party, of which Alexandra Dias is a member, from the Institute and Faculty of Actuaries. It combines quantitative actuarial modelling with a qualitative ethnographic study in collaboration with Ipsos. Our results have been published in two reports: How much could you lose? and A pension system fit for the 21st century.
The pension risk transfer
For decades, the retirement dream was built by working forty years for the same employer. The system did the heavy lifting, ensuring that investments were sound enough to provide a pension until the end of life, the so-called final salary pension. But the risks previously managed by the state and the employers are now borne by individual workers. The replacement of final salary schemes with defined contribution pensions releases employers from the obligation of guaranteeing a pension for life, passing on the risk to the employee. Women, self-employed, and part-time workers are particularly exposed to such risks, but are often unaware of that exposure. Where can people go wrong as they are grappling with their new responsibility? Below are the biggest pension pitfalls that every worker should consider.
How to wreck your pension
- Delay starting to contribute: Auto enrolment in an occupational pension scheme is not compulsory. Commencing pension contributions at age 35 instead of 25 can result in a 40% smaller pension. The belief that there is always time to catch-up is the most expensive assumption in pensions. The miracle of compound interest means that missing contributions in early career has the largest negative impact on the pension. In our twenties, we are often forced into choosing between pension contributions, house deposits, or student debt. Yet the true cost of these trade-offs is rarely self-evident or clearly communicated.
- Take a career break: A career break of six months (e.g. maternity leave) without contributions can reduce a final pension pot by £30,000. Maternity leave is rarely seen as a defining financial event but it can have a significant long-term impact on your retirement security.
- Go part-time: Moving to part-time work (e.g., three days a week) for the second half of a career can reduce the final pension by approximately 25%. Roughly one-fifth of the UK workforce is part-time, and 70% of those workers are women, who often reduce their working hours to accommodate caring responsibilities. The career ceiling faced by part-timers further deepens the gender pension gap. Research from ‘NOW: Pensions’ suggests that for a woman to retire with the same amount as a man, she would need to work an average of 19 years longer.
- Suspend contributions temporarily: Opting out of a pension for just five years, e.g. to pay for school fees, can lead to a more than 10% reduction in the pension. It is important to be aware of the cost of such trade-offs.
- Ignore the match: Many employers match employee’s extra contributions with 1% of the salary. There may be no such thing as a free lunch, but the employer match is ‘free money.’ The value of small adjustments is significant. Contributing just an extra 1% of your salary over a 40-year career can result in a £100,000 difference at retirement.
- Ignore pensions on divorce: Pensions are often the second-largest financial asset in a household after the house, yet actuarial advice is ignored in a staggering 19 out of 20 divorce cases. With male pensions typically 30% larger than those of women, ignoring the distribution of pension contributions on divorce can mean that one party ends up with significantly more retirement income than the other.
How to secure your future
The Pension Gaps Working Party suggests that you take three immediate steps:
- Quantify your gap: Use the PLSA “Retirement Living Standards” to see if your current trajectory aligns with your future needs.
- Audit your life moments: Treat divorce, career breaks, and shifts to part-time work as critical pension moments. For part-time workers, try to negotiate “Full-time Equivalent” contributions with your employer. Continuing to contribute based on your previous full-time salary ensures your future security isn’t penalized for today’s flexibility.
- Engage with guidance: Use Pension Wise to learn the options for taking money from your pension, and don’t avoid engaging with your pension provider.
A new inclusive, flexible, community-based system
Our current pension system was built for an economy that no longer exists. Our research suggests that employers and policy makers can adapt the pension system to meet the needs of 21st-century workers in the following ways:
Inclusion of the self-employed: Implementing an auto-enrolment model for the self-employed that is flexible to varying earnings, integrated with the banking system. Only 18% of the self-employed are saving for retirement, compared with 90% of traditional employees. Our research shows that the self-employed lack easy ways to start saving for a pension. We performed simulations showing that, for an average salary, delaying starting a 3% contribution from age 22 to age 45 can inflict a 60% reduction in the pension.
Life-events auto-flex: Developing default pension schemes that allow contributions to adjust during life events (e.g. parental leave, moving to part-time) to preserve retirement trajectories. In interviews, we found that a fixed level of default contributions will lead to opt-outs and that contribution smoothing or pause features would add extra flexibility.
Universal early savings: Introducing a “UK Child Saver” product from birth to embed a culture of saving and leverage long-term compound interest. Our simulations show how early saving habits are critical but in field interviews we found that there is a lack of pension culture. Our research showed that parents can be a big influence in supporting the next generation to save into a pension.
Community-based resilience: Exploring Collective Defined Contribution schemes and community-driven platforms (similar to “friendly societies”) to move beyond individualised risk and foster collective financial citizenship. Our research found that people feel that they are expected to rely on their individual financial planning, and that the value of community-based solutions and collective resilience is being overlooked.
Communication: Our study revealed financial disconnection with a significant lack of brand visibility and engagement by the participants. Pensions are viewed as “irrelevant”, “overwhelming”, “confusing” and “opaque.” While individuals could easily identify their bank, not even one could name their pension provider.
