Young people know all too little about how a pension works. A report I wrote in 2012 for City think-tank the CSFI, Generation Y: the (Modern) world of personal finance found a lack of basic pension knowledge amongst young people aged 18-25. In fact, one of the key findings was that more than 40% of those paying into a pension scheme weren’t even sure what type it was.
Even if they did have some knowledge of pensions, they seemed reluctant to contribute to one: many felt that pensions were inflexible, confusing, and faced an uncertain future. Final salary schemes have all but disappeared for new workers, while many inflation-linked pension schemes are vulnerable to changes to the index on which they are based. It seems that other age groups fare little better: the DWP’s recent report Attitudes to Pensions found that only 6% of those in the general population felt they had a good knowledge of pensions, while 28% of women admitted to feeling scared about dealing with pensions. Many of those questioned were even uncertain about what their State Pension age entitlement was.
There is a need for better financial training from an early age to promote confidence, and a need for simpler, more certain, pension products, that will be worthwhile for young people to contribute to into the future.
The first of these needs is sadly lacking for young people today. The CSFI survey found that more than half of those surveyed had not received any formal financial education at school, even though it was clear that many were interested in learning more and taking ownership of their own finances. This indicates that a lack of education may rest at the heart of the pension problem.
Auto-enrolment, which came into force for larger U.K. companies in October 2012, is intended to mitigate the second of these issues by encouraging employees to supplement the state pension with a work-place pension. By compelling employees to make regular payments into a pension scheme, unless they explicitly choose to opt-out, the government is aiming to make contributing to a workplace pension the norm. To date the scheme has been welcomed cautiously, with early evidence suggesting that young people in particular are keen to know more about how the scheme works.
Young people may view auto-enrolment as a good way of circumventing the ’manana’ attitude which can prevail when they think about pensions – if the money disappears from payslips ’automatically’, as with student loan repayments, they are less likely to see it as a financial burden. A concern is that auto-enrolment may cause unintended consequences. A risk is that employees who accept auto-enrolment may think that they are paying enough towards their pension. As some do with the state pension, they may not realise they have a personal responsibility to make additional provision for their retirement. Information is key: my concern is that many young people do not know enough about retirement provision to make good decisions, and in particular there does not seem to be enough access to this information for those at the start of their working lives. Auto-enrolling into a pension scheme does not of itself address this.
There are also concerns about the benefits of the policy. First, only those earning over £8,105 a year are eligible for automatic enrolment – and this earnings ‘trigger’ rises every year. Second, although contribution levels are being staggered initially to minimise the impact it will have on people’s pockets (and those of their employers), it will leave people with less disposable monthly income. Third, saving only at the auto-enrolment minimum levels is unlikely to be sufficient to fund an adequate retirement income since the minimum is only to 8% of a band of earnings (4% from the employer, 3% from the employee and 1% in tax relief) – a point recently acknowledged by the pensions minister Steve Webb.
For those on an average salary to live comfortably in retirement, there is likely to be a need to make additional pension contributions, assuming this is permissible within their scheme rules, or make other provisions towards retirement. It is important for young people to think ahead to retirement, and save towards it, and be aware of the limitations of the auto-enrolment statutory minimums. Young people should not risk being lured into a false sense of security; although this scheme should be useful at the outset of their careers, where many have only a modest starting salary, it may not be sufficient if their salaries rise beyond the current £42,475 limit for earnings considered for contributions. If auto-enrolment is to achieve its purpose, then ways must be found to ensure that young people are aware that personal responsibility remains central to securing a decent retirement income, that the state pension (even after the single-tier reforms) will not be sufficient to live on, and that being enrolled into a pension scheme does not guarantee that your pension scheme will be at all similar to the traditional ‘defined benefit’ schemes available in some workplaces such as the public sector. And it remains the case that, in personal finance, it is dangerous to put all one’s eggs in one basket, and pension contributions should be no different.
The message is clear: auto-enrolment should make a valuable contribution towards retirement planning. However, no-one should think that just because they have not opted out of their employer’s scheme that they are absolved from personal responsibility for providing for their retirement. The state pension and auto-enrolment pension may yet provide a safety net from a retirement spent in poverty, but additional savings and investments may be required to ensure a retirement spent in comfort. The earlier a young person realises this truth the more time the young person will have to accumulate that which is necessary for a comfortable requirement.