PPI PENSIONS POLICY INSTITUTE PPI Policy Seminar What level of pension contribution is needed to obtain an adequate retirement income? Association of British Insurers 22 October 2013
PPI PENSIONS POLICY INSTITUTE What level of pension contribution is needed to obtain an adequate retirement income? Chris Curry, PPI Director Pensions Policy Institute 22 October 2013 www.pensionspolicyinstitute.org.uk
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What level of pension PPI contribution is needed to PENSIONS POLICY INSTITUTE obtain an adequate retirement income? • Adequacy of retirement income • How often could minimum contributions result in an adequate retirement income? • What contribution rate would be necessary to achieve an adequate retirement income? • Is there an adequacy gap? 4
PPI Adequacy of PENSIONS POLICY INSTITUTE retirement income • Adequacy can be defined as to what extent individuals have a retirement income that: • allows them to fulfil basic needs • allows them to replicate their pre- retirement living standards • Replacement rates are a useful measure if the second definition is peferred 5
PPI Adequacy and PENSIONS POLICY INSTITUTE automatic enrolment • Automatic enrolment into workplace pensions fully rolled out by 2018 • Employees likely to be enrolled into a DC pension • Different factors affect retirement income from DC pensions: • Contribution level and their persistency • Investment returns • Charges 6
What level of pension PPI contribution is needed to PENSIONS POLICY INSTITUTE obtain an adequate retirement income? • Adequacy of retirement income • How often could minimum contributions result in an adequate retirement income? • What contribution rate would be necessary to achieve an adequate retirement income? • Is there an adequacy gap? 7
Retirement income from private PPI PENSIONS POLICY INSTITUTE and state pensions is uncertain Probability of retirement incomes from state and private pensions at SPA for a median earner that starts saving at age 22, retires at SPA and follows a traditional lifestyle investment approach, if contributing at 8% of band earnings
The probability of achieving the PPI PENSIONS POLICY INSTITUTE target replacement income varies by earnings level Probability of achieving the target replacement income with income from private and state pensions for different individuals, if starting to save at age 22, retire at SPA follow a traditional lifestyle investment approach and contributing at the minimum total 8% of band earnings
Adequacy is much harder to achieve PPI PENSIONS POLICY INSTITUTE if the single-tier state pension is not triple locked but earnings linked Probability of achieving the target replacement income for different individuals with income from private and state pensions, if they start saving at age 22, retire at SPA, follow a traditional lifestyle investment approach and contribute at 8% of band earnings, under different indexation rules for the single-tier state pension 70% 63% Triple locked Earnings linked 60% 49% 50% 40% 40% 36% 30% 28% 30% 20% 10% 0% Lower earner Median earner Higher earner
What level of pension PPI contribution is needed to PENSIONS POLICY INSTITUTE obtain an adequate retirement income? • Adequacy of retirement income • How often could minimum contributions result in an adequate retirement income? • What contribution rate would be necessary to achieve an adequate retirement income? • Is there an adequacy gap? 11
The required contribution rate PPI for a good chance of reaching a PENSIONS POLICY INSTITUTE target replacement income increases with earnings Contribution rates needed for different individuals to reach a 66% or 75% probability of achieving their target replacement income, if they start saving at age 22, retire at SPA and follow a traditional lifestyle investment approach. Single-tier state pension triple locked 16% Two-thirds Three-quarters 14% Total contribution rate (% of band earnings) 14% 13% 12% 12% 11% 11% 10% 9% 8% 6% 4% 2% 0% Lower earner Median earner Higher earner
PPI Lower indexation of the state PENSIONS POLICY INSTITUTE pension increases the required contribution rate Contribution rates needed for different individuals to reach a 66% or 75% probability of achieving their target replacement income, if they start saving at age 22, retire at SPA and follow a traditional lifestyle investment approach. Single-tier state pension earnings linked Two-thirds Three-quarters 18% 17% 17% Total contribution rate (% of band earnings) 16% 15% 15% 14% 14% 13% 12% 10% 8% 6% 4% 2% 0% Lower earner Median earner Higher earner
Different factors affect the PPI PENSIONS POLICY INSTITUTE minimum contribution rate to have an adequate retirement income Single-tier triple locked Single-tier earnings linked Probability of Investment AMC: 0.5% AMC: AMC: 0.5% AMC: achieving the approach 1% 1% target replacement income Two-thirds Traditional 11% 12% 14% 16% lifestyle First 12% 14% 16% 17% alternative Second 10% 12% 14% 15% alternative
Different factors affect the PPI PENSIONS POLICY INSTITUTE minimum contribution rate to have an adequate retirement income Single-tier triple locked Single-tier earnings linked Probability of Investment AMC: 0.5% AMC: AMC: 0.5% AMC: achieving the approach 1% 1% target replacement income Two-thirds Traditional 11% 12% 14% 16% lifestyle First 12% 14% 16% 17% alternative Second 10% 12% 14% 15% alternative
Different factors affect the PPI PENSIONS POLICY INSTITUTE minimum contribution rate to have an adequate retirement income Single-tier triple locked Single-tier earnings linked Probability of Investment AMC: 0.5% AMC: AMC: 0.5% AMC: achieving the approach 1% 1% target replacement income Two-thirds Traditional 11% 12% 14% 16% lifestyle First 12% 14% 16% 17% alternative Second 10% 12% 14% 15% alternative
Different factors affect the PPI PENSIONS POLICY INSTITUTE minimum contribution rate to have an adequate retirement income Single-tier triple locked Single-tier earnings linked Probability of Investment AMC: 0.5% AMC: AMC: 0.5% AMC: achieving the approach 1% 1% target replacement income Two-thirds Traditional 11% 12% 14% 16% lifestyle First 12% 14% 16% 17% alternative Second 10% 12% 14% 15% alternative
Different contribution patterns affect the necessary contribution PPI PENSIONS POLICY INSTITUTE rate to have a two-thirds chance of achieving a target replacement income Contribution rates needed for a median earner to reach a 66% probability of achieving their target replacement income with income from private and state pensions, if they follow a lifestyle investment approach, under different contribution scenarios and mechanisms to uprate the single-tier state pension Single-tier triple locked Single-tier earnings linked 30% Total contribution rate (% of band earnings) 27% 25% 23% 20% 18% 14% 14% 15% 13% 11% 9% 10% 5% 0% Baseline (starts saving at age Career break (starts saving at Starts saving at age 40; retires Starts saving at age 22; retires 22; retires at SPA) age 22; retires at SPA) at SPA two years after SPA
What level of pension PPI contribution is needed to PENSIONS POLICY INSTITUTE obtain an adequate retirement income? • Adequacy of retirement income • How often could minimum contributions result in an adequate retirement income? • What contribution rate would be necessary to achieve an adequate retirement income? • Is there an adequacy gap? 19
PPI Is there an adequacy PENSIONS POLICY INSTITUTE gap? • Many individuals may need to contribute more than the legal minimum and a number of strategies could be considered • Information and advice • Incentives • Increasing minimum contribution rates • Auto-escalation • Compulsion? • Other types of wealth • Working longer 20
PPI PENSIONS POLICY INSTITUTE Issues for discussion • Will saving at the legal minimum be enough to have an adequate retirement income? • What should the minimum contribution be, taking into account the variations in earnings, the impact of starting to save later in life, taking career breaks or working longer? • What can individuals and the Government do to increase savings into workplace pensions? 21
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