What people are getting wrong about money in retirement

This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here.

The Government says we have to save more for our pensions, some of us much more. The Pensions Commission’s latest report, Pensions 2050, out this month, warned particularly about the position of self-employed people if they didn’t set aside more of their income and put it into a pension pot.

Only four per cent of wholly self-employed people have any private provision, and the number is even lower among the young. But the problem is much wider than that, as nearly half of working-age adults, that’s 18 million people, are not saving for a pension at all.

Commenting on this, Torsten Bell, who is minister for Pensions, said: “Britain has got back into the pension saving habit, but the job is only half done with tomorrow’s pensioners still on track to be poorer than today’s. The Commission warns that without action, millions more people could be at risk of becoming reliant on state support in retirement.”

He’s right at one level. But many people understandably feel that they are saving for their pensions with the huge amount they and their employers are paying in national insurance contributions. After all, 35 qualifying years and you get a full state pension. As long as the Government maintains the triple lock – whereby it increases by inflation, average earnings, or 2.5 per cent – many people assume that should be enough to live on. But that is only guaranteed for the life of this Parliament.

Indeed, before he took office, Bell was one of the strongest advocates for ending it. As head of the Resolution Foundation think-tank, he called on the Government to scrap what he described as a “silly system”. He once even called it “rubbish”.

That’s not particularly to get at Bell. Politicians are politicians. It is simply to point out that we cannot assume that, come 2050, there will be a half-decent state pension. The Pensions Commission can’t say that explicitly, but that’s the message it is seeking to get across.

As you might imagine, the private pensions industry sees this as an opportunity. It wants to sell more pension plans. But it is also doing something that is socially useful, the key point being that most people grossly underestimate how much money they will need in retirement. Standard Life has done a lot of research on this, including the way in which parents of adult children are supporting offspring through the famed “Bank of Mum and Dad”.

Nearly two-thirds of parents are doing so. But they can only do this effectively if they have set enough aside for themselves. Standard Life’s basic message is: “retirees say modern retirement lasts longer, costs more and is harder to navigate than expected”. Several themes emerge from their research.

One is that retirement is not just about building a pension pot. As far as the financial side is concerned, it is about shifting from being a saver to a spender. In other words, managing the savings – which may sit in different pots from different employers – so that you don’t run them down too fast, or invest in assets that don’t keep pace with inflation.

There’s the immediate question on retirement about whether to take the 25 per cent element that is tax-free straight away or whether to hold back. The Pensions Commission is worried about this, feeling that too many people take the cash immediately, and Standard Life feels there is a danger here. “Nearly half of this money is spent on large expenses such as cars, holidays or home improvements, raising concerns that some people may be drawing on retirement savings too quickly without fully considering longer-term financial needs,” it notes.

There is a problem, though. One of the reasons why people take the cash is that they worry that a future government will end the 25 per cent tax-free option. After all, this Government has suddenly imposed inheritance tax on pension pots – that comes in next spring.

Both leading candidates to replace Sir Keir Starmer call for higher taxation on savings. Greater Manchester Mayor Andy Burnham is on record as wanting to increase taxes on people’s assets. And former health secretary Wes Streeting wants “a wealth tax that works”. You see the problem: why save more for your retirement when a future government will gun for your savings?

There is an answer to that question. It comes in two stages. The first is to save more and in particular to start tucking away money earlier, as thanks to compound interest, it will grow faster. But savings should be put into a form that is protected from taxation. That means pension pots, which are only taxed when you take the money out and ISAs, where you pay the tax up-front but which grow free of tax thereafter. It is possible that a future government, desperate for cash, will reverse the current legislation on both pensions and ISA savings. But we have to live with that possibility. It is still right to save.

The second is to retain some form of earning capacity. The Government will gun for that too, but it is harder for them to do so given the number of voters who are of working age and in some form of paid-for activity. Even a small income helps if it’s alongside a reasonable pension, and you don’t have to pay national insurance on your earnings. Changes in the structure of the labour market help: working from home, growth of self-employment. And there are health benefits, as carrying on doing some work seems to buffer the transition from work to retirement in a less stressful way.

So yes, Bell, we do need to save more, but even more important than that, we need to think about what sort of retirement we really, really want. And plan for that, whatever the governments of the future throw at us.

Need to know

The health element of this transition between working and retirement is one of the most fascinating and I think under-emphasised elements of the whole debate about pensions.

There’s a problem. There is a lot of evidence that people who carry on working beyond official retirement age are healthier. For example, last year, the Institute for Fiscal Studies (IFS) reported that women who remained in paid work in their early 60s reported both better cognitive functioning and a lower level of physical disability. They also walked faster.

But as with so many economic studies, you have to ask the tricky question: why not the other way round? Could it be that the people who are generally healthier choose to stay in work, whereas those who are slowing down choose to retire? All good economics researchers adjust for this, and the IFS is top-notch. But then, you can understand why it’s tricky to measure this because it’s hard to dig into people’s minds: some of us are “can do” and some are “I’d rather not”.

What we do know is that any sudden change in circumstances – moving house, having children – is stressful. Even what might seem a joyful, positive change, such as getting married, adds stress. And retiring is a very big deal indeed, because it alters social status as well as income.

So does retirement damage health? I did a bit of digging and found that the IFS did a paper on this back in 2012 – its message was indeed that it did.

“It is found,” it concluded, “that retirement significantly increases the risk of being diagnosed with a chronic condition. In particular, it raises the risk of severe cardiovascular disease and cancer. This is also reflected in increased risk factors (for example: BMI, cholesterol and blood pressure) and increased problems in physical activities. Furthermore, retirement worsens self-assessed health and an underlying health stock.”

Gosh, that’s pretty punchy stuff. If it is right, and intuitively I think it is, we really need to think seriously about the whole idea of there being a specific retirement age altogether. Maybe better to tell everyone that you can retire whenever you like, but financially, at least, you are pretty much on your own until, say, you are over 80. Or maybe we need to figure out how to make a gradual, progressive retirement system work better than it does now.

I have no easy answer. I just think the debate is really important and will try and get back into the subject in future.