Sophie Robson at Centre for the Study of Financial Innovation has concerns about the financial future of ‘Generation Y’.
Young people face unique challenges in saving for a pension. They are now largely on their own when it comes to retirement planning. Final salary pension schemes enjoyed by their parents are all but closed to new members, and existing personal pension schemes are confusing. Life expectancies are increasing – and with it, the pension needed to fund a comfortable retirement.
These, combined with a lack of knowledge about pensions, risks creating a ticking time bomb.
Young people now have little option but to start saving for retirement early in their working lives. Just 13% of employers still offer a final salary pension to new employees. Attitudes to employment have changed: employees are likely to change companies (and careers) regularly, so companies no longer have the same responsibilities to their employees.
Sadly, understanding of pensions and access to information lags behind this change. A 2012 report by the CSFI, the London-based financial services think-tank, young people were unsure of how they worked, or in 40% of cases, what type it was. Although the majority recognised the importance of contributing to one, many struggled to find the spare cash to do so, especially as many were still paying off student debt. Others felt that years of government tinkering had left the future of pensions uncertain, inflexible and vulnerable to rising inflation – not to mention confusing. This was putting young people off paying into a pension scheme.
Another survey by Blackrock found that while young people expected to retire on a pension of £30,000 per year, only one in ten were actively saving towards a pension. Given that one in four 21 year olds can now expect to live to 100 – according to recent ONS figures – this would require them to build up a pension pot of at least £600,000, assuming they retired at age 67.
The government has stepped in, announcing changes to the way state pensions are paid. From 2017, pensioners will be given a single, flat-rate payment of £144 per week, rising with inflation. It hopes this will simplify the way the state system works, and cut out uncertainty.
Secondly, auto-enrolment, in force in larger UK companies since October 2012, aims to normalise making regular contributions to a workplace pension scheme – at the moment, just 30% of young people are contributing to one. Anyone over the age of 22 earning at least £8,105 per annum will now be automatically enrolled into a scheme unless they explicitly opt-out. If a sum of money disappears from gross incomes, as with student loan repayments, young people are less likely to see it as a financial burden. However, auto-enrolment risks causing unintended consequences for young people: the amount saved is unlikely to be enough to guarantee a comfortable retirement in itself. The maximum contribution, equivalent to 8% of earnings, will only apply to qualifying earnings from £5,564 to £42,475 in the current tax year. So for an average earner, this would only be equal to £4,200 per year saved.
So young people still need to make other provisions for later life, particularly those on an average salary. This could mean actively contributing to other pension schemes – such as a SIPP, or investing in other savings vehicles, such as tax-efficient ISAs.
However, this is not as easy as it sounds. Another hurdle younger people face is that it is difficult for them to build up assets, compared with their parents at a similar age. The average age for first time house buyers is now 35 (according to research by the Post Office), compared to just 23 in the early 1960s. Stocks and shares remain volatile, with investors being forced to make increasingly sophisticated decisions in order to gain the same yields. At the other end of the spectrum, parents, who are also living longer than their own parents, are eating into inheritances, which would have given their offspring some measure of financial independence in later life.
A growing number of young people, and policy makers, believe the existing pension model is outmoded. A generation which is already weighed down with debt, as a result of student loans and diminishing job prospects, is then being asked to lock away a proportion of their salaries for decades, against a backdrop of increasing economic uncertainty. In the intervening years, they will need to find sufficient funds for necessities such as buying houses, cars and eventually raising a family. These purchases all require large capital expenditure, and they are likely to find it increasingly frustrating when they find that, even though they have built this up in a pension fund, they are unable to access it. There is also the risk that they will have to take on debt to pay for it. Not only this, but in some cases, it may not make sense to save. Means testing – particularly with regard to social care – raises the risk that it might be counterproductive to save.
So the problems are clear, even if the solutions are not. Recent government intervention may go some way to mitigating these problems, but it remains to be seen how pension schemes can evolve to meet the changing needs of Generation Y-ers as they move to the next stages of their lives.
Sophie Robson is the author of the recent CSFI (http://www.csfi.org/) report on young people and personal finance “Generation Y: the (modern) world of personal finance”, and is a regular commentator on issues affecting young people and financial services.