Pensions set to be a quarter of what current pensioners get

A perfect storm is coming for pensions, which will leave millions of working people facing extreme financial hardship in retirement. A new report has highlighted that changes to pensions mean millions could end up with a pension worth a quarter of the sum they would have earned from a traditional final salary pension.

The report, put together by the Centre for Economics and Business Research for Saga, found that the days of defined benefit pension - with guaranteed monthly payouts - are fast-disappearing in the private sector. Instead, people earn defined contribution pensions, into which you and your boss pay a fixed sum, to leave you with a pot of money at retirement. The total number of people in these DC pensions is set to overtake the total number in DB schemes by 2018.

Contribution crisis

This wouldn't automatically mean people retire on a pittance, as long as they contributed enough to their DC pensions. Unfortunately, the report found that millions of people are paying too little into their pensions. The average employee contribution to a DC scheme is 1.7% - around a third of the average they put away in a DB scheme. The employer, meanwhile, is paying a small fraction of what they would have to plough into a DB scheme.

Nici Audhlam-Gardiner, managing director of Saga Investment Services, points out: "For those earning £25,000 over a 25-year period with salary increases around 2.5% each year and making today's typical DB contributions they will have contributed close to £180,000. But those on a typical DC contribution rate their total would be just £40,000."

"These losses are even greater when considered against the returns on investment associated with a pension. The result is the DB pension-holder would have a pensions pot five times greater in value than the DC pension-holder."

Underestimate

At the same time Cebr warns that many individuals are probably underestimating the amount of savings that they need to fund their desired lifestyle in retirement. The report took the example of a healthy 65-year-old who had built up a pension pot and decided to buy an inflation-linked annuity to guarantee an income for life. A £150,000 pot would only be able to buy an income of £4,700 in the first year.

To make matters worse, Audhlam-Gardiner said: "We know that not enough people are planning – a recent Saga report revealed that only 30% had begun a retirement plan with only 3% saying their plan was definitely on track."

This means millions will need to fall back on their state pension. The problem here is that there are absolutely no guarantees when it comes to state support. There are already plans to hike the state pension age - and there's no knowing how far and how fast that will go. For younger people, there's even the risk that by the time they retire there will be no state pension to speak of. A survey of MPs at the end of last year found that one in six think it will have died out within 30 years - or will be small it does very little to alleviate poverty.

The only hope we have, therefore, is that we realise how much more we need to do early enough in our career to do something about it, or millions of people could suddenly find themselves working far after in life than they ever expected to.