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.
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."
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.
7 ways to improve your retirement
7 ways to improve your retirement
If, like many Britons, you have failed to save the cash you need to maintain a comfortable standard of living in retirement, one option is to sell your home and downsize to a smaller property, using the money leftover to cover your living costs.
If moving out of the family home is too much of a wrench, however, the good news is that equity release schemes allow you to stay in your house or flat while still using the equity built up in it to provide some extra cash. The downside of the schemes, which work a bit like mortgages, is that you may not have much left to pass on to any children or other relatives.
But that's a small price to pay for a reasonable standard of living. For more information, try Age UK on 0800 169 6565.
Choosing the right annuity can have a significant impact on your retirement income. And as with most pensions, you automatically have what's called an 'open-market option' (OMO), you can scour the market for the highest annuity rate.
It is worth checking what your pension provider is offering first, though, as some companies offer guaranteed rates for existing customers that are likely to beat those available elsewhere. The Pensions Advisory Service on 0300 123 1047 is a good place to get some free advice.
On retirement, most people convert their pension fund into a guaranteed income annuity that pays out the same amount every month for the rest of their lives.
However, you can also choose an increasing annuity that pays out smaller amounts in the first few years but offers larger payments further down the line. This may prove a wise move if the rate of inflation remains at over 2%.
It is now easier to work later in life because the "default retirement age" has been scrapped.
People approaching retirement age and worrying about money can therefore choose to work for a few years longer - potentially transforming their financial situation. Other than the extra income from working, these people can look forward to higher state pensions, and higher annuity rates due to their greater age.
They can also benefit from bigger tax allowances and the fact that they no longer have to pay National Insurance contributions. Check out this nidirect website for more details.
You could get a much better rate with an impaired-life annuity if you have a medical condition that is likely to reduce your life expectancy.
Incredibly, even snoring, which is a common symptom of Sleep Apnoea could have an impact.
According to figures from MGM Advantage, a man with this condition could receive an extra £12,000 retirement income over the course of their retirement - or £571.44 extra money each year. Click here to find out more.
To maximise your retirement income, it is vital to ensure that you are receiving all the benefits to which you are entitled. These include the basic State Pension, and in some cases, the additional State Pension.
If you are on a low income, you could also qualify for the guaranteed element of Pension Credit, while those with some savings may get the savings element of this benefit. For more information about these and other benefits such as the Winter Fuel Payment, click here.
Many older couples rely on the pension income of one person - often the man. Should that person die first, the other person can therefore be left in a difficult position financially.
One way to prevent financial hardship for the surviving person is to take out a joint life annuity that will continue to pay out up to 67% of the original payments to the surviving partner should one of them die.
The disadvantage of this approach, however, is that the rate you receive will be lower. Again, the Pensions Advisory Service on 0845 601 2923 is a useful first port of call if you are unsure what to do.