Four pension pitfalls and how to tackle them

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In this episode, Kyle and colleague Craig Rickman focus on interactive investor’s market-leading Great British Retirement Survey. Kyle and Craig home in on four of the key findings and discuss ways in which these issues could be addressed. The topics covered include lack of confidence in the pensions system, lack of financial knowledge, pension gaps for women, divorcees and the self-employed, and low pension values.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to On The Money, a weekly investment bite-sized show that aims to help you make the most out of your savings and investments.

In this episode, we’re going to focus on interactive investor’s market-leading Great British Retirement Survey, which is based on the answers from 9,000 people across the UK.

It’s been going for a number of years now. It was first launched in 2019, and we’ve published a very comprehensive report, which I’ll include a link to within the podcast description.

Joining me to discuss some of the key findings and what could be done to improve the culture and education around pensions is Craig Rickman, personal finance editor at interactive investor.

Craig, great to have you back on the podcast for the second week running.

Craig Rickman: Yeah. Thank you. Great to be back on.

Kyle Caldwell: So, Craig, you’ve been part of a team that’s put a lot of time and effort into compiling the report this year. Given that we try and keep this podcast to around 20 to 30 minutes, I think it’s best that we summarise four of the main findings and then talk through how each could be addressed in order to improve people’s financial position and financial resilience.

So, Craig, let’s kick off with the finding that there’s a lack of confidence in the pension system. So, the survey found that frequent changes to pension rules and taxes are undermining trust in the pension system. Just to give some examples of that, one in four respondents said that they [would] feel empowered to save more into [a] pension if the rules stop changing, and one in three millennials said this was also a key concern of theirs.

Craig, how can the situation improve? What needs to happen for people to have more confidence in the pension system?

Craig Rickman: Well, I think that this lands at the feet of the government, really. As you said, there’ve been lots of changes, particularly to pension tax, in recent years. Last year is a really good example. So, in April 2024, the lifetime allowance, which was a sort of ceiling on how much your pension could be worth before you were hit with some pretty hefty tax charges, was officially scrapped, and so savers would have reacted to that and changed their behaviour as a result.

Then, six months later, we had the proposal to bring pensions into the scope of inheritance tax from April 2027.

So, this constant changing of the goalposts risks disincentivising savers, and that’s clear from some of the results of the survey.

The first task for the government is to try and deliver some consistency to the pension tax framework. We’re already seeing another example of the potential pitfalls of not doing that at the moment in the lead-up to this year’s Autumn Budget. The rumor mill is running wild yet again through fear of changes to pension tax, notably around the tax-free lump sum, but also upfront tax relief as well. And so savers are concerned that the rules are going to change…and it’s going to make them less likely to want to engage with their pensions. So, that’s really the first port of call for the government.

I think we should also note that one of the main reasons that people choose pensions is because of the tax advantages. That’s why they choose them over other vehicles. If they’re gradually eroded, then naturally, it’s going to put people off using them. The tax advantages don’t just encourage people to save, but they encourage people to save more than what they perhaps would have done before.

So, that’s one for the government. What we’d really like to see is some commitment to leave the pension tax system alone for the time being. I mean, that’s the private pension space, [but] the state pension as well. We know there’s a lot going on with that. There’s a newly launched review on the state pension age, and we appreciate that that could change.

But the sooner that we get the outcome of this, the better. Because, again, if people don’t know when they’re going to receive their state pension or if it’s unclear when they’re going to receive it, that can affect how they engage with their retirement plans as well. So, yeah, this is something that we’re urging the government to do.

Kyle Caldwell: Changes to the pension system and speculation that there may be potential changes, particularly in the lead-up to a Budget, just dents confidence. I mean, ultimately, if you invest in a pension, you invest in it for your financial future in later life, and it’s a long-term horizon that you need to adopt. Yes, in terms of policies, there’s a lot of short termism going around and the constant shift in the goalposts, I find it deeply unhelpful.

Whatever your political persuasion is, the Labour Party have backed themselves into a corner by saying that they’re not going to raise income tax, VAT or national insurance on working people. And that’s why there are lots of rumours, and why they may be looking at potential changes to the pension system because they need to balance the books.

In my view, any government should be trying to encourage more people to take responsibility and take control of their financial future, and to consider how much they’re investing into a pension and then work out whether the amount they’re actually investing is going to be enough to give them what they need and [allow them to] do what they want in retirement.

I also think, Craig, that what doesn’t help is that there’s been a constant game of musical chairs with the pension minister post since Steve Webb stepped down in 2015.

I was looking before we came on the podcast and there’s been eight different pension ministers, and I think that’s deeply unhelpful. Maybe it’s viewed as a bit of a junior position within governments and a stepping stone to potentially other things.

As I’ve mentioned, investing in a pension is a long-term game, and with pension policy, the same long-term mindset should be adopted.

Now, the next finding that we’re going to cover from our survey is a lack of financial knowledge. There’s lots to unpack here.

Our Great British Retirement Survey found that only one in 15 (7%) said that they received sufficient financial education in school. We also found that two-thirds said that they’d have liked more financial education in school. Our survey also revealed that older workers risk making poor retirement decisions due to their lack of financial knowledge.

So, Craig, how can the lack of financial knowledge be addressed?

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Craig Rickman: Well, the first thing to say on that is that this is something that the government has recognised and is seeking to help with in some shape or form, with its targeted support regime, which will be available to providers, from April year.

This will allow pension providers to sort of guide people towards suitable financial products and decisions. So, that’s a good thing. But beyond that, there’s obviously a lot more that can be done.

If you [think about] going to the roots of it, financial education in schools, trying to expand that, and broaden it to include things around pensions, so how pensions work, how the state pension works, how tax relief works, and scams as well.

We know that’s still a big problem. So, better financial education could have a big impact, but that will only support future savers.

The other part is what to do about it now. So, obviously, targeted support is one element, and we’ll have to see what happens with that. The other is, wake-up packs.

These are currently sent to people age 50 and, essentially, they’re designed to give people a bit of a jolt, really, and say that your retirement will be approaching at some point in the next however many years.

So, for those who are 50 at the moment, they'll be receiving their state pension at age 67, but we know that some people may want to retire before that. So, it’s designed to give them a bit of a jolt to engage with their pension savings and get themselves in a position in later life where they can retire on their own terms.

But they’re sent to those age 50, and while that gives people some time to make a difference to later life, giving them some extra time would be beneficial. There’s a huge difference between saving and engaging with your pension over 17 years compared to 27 years, for instance, if the wake-up packs were sent to people at age 40. I think that could make a big difference.

The other thing is to try and get away from financial jargon. I think the industry has made some big improvements on this over the years, but there’s still a long way to go. People who haven’t been as familiar with their finances as others may find it difficult to try and pick apart what the terms mean. So, to try and simplify it and make [the language] easier to understand for people, will make a big difference.

That’s obviously something that isn’t just on the government. It’s on providers like us as well, interactive investor, and that’s something that we’re trying to do.

Kyle Caldwell: I completely agree. I’d love to see financial education adopted in all secondary schools. Obviously, not just investment, but all the key personal finance topics as well.

Some topics are a bit too far away to think about. Obviously, when you leave school, you’re not going to instantly buy a house. It’s going to take time to build a pot of money for a house deposit.

But concepts like compounding, it can really help to know [about that before] you leave school. You can get credit cards quite quickly and quite easily. I think it’s an important concept to learn how debts can accumulate and how they can grow over time. A lot of people find that out to their cost later on without knowing that that’s going to happen.

Craig Rickman: Yeah. Well, that actually happened to me when I was 18. It was something that I wrote about a couple of years ago. I got a call from my bank which said, ‘Would you like a credit card?’ and I said yes.

Fast forward six months and I’d racked up a level of debt that was unmanageable for me. I was still studying, and I was doing a bit of part-time work, but that was barely covering the interest. In the end, my parents had to bail me out, and I had to pay them back. They didn’t just let me totally off the hook, [and] it was an important lesson to learn.

But it’s something that if I’d had the correct education at school or just better education around finances at school, it’s something that could have been avoided.

I guess it’s something that would have happened to a lot of other people, and it could have been more severe. I mean, I managed to catch it fairly early, but it could have been worse.

That really does illustrate the importance of people having a good grip because with credit cards and the level of interest rates that are charged, debt can snowball really quickly. So, yeah, I couldn't agree more with that point.

Kyle Caldwell: Another thought I had, Craig, in terms of improving financial education is related to when you have a child.

I remember when our first was born, and we were given a bag that had some vouchers in. It was things like getting a couple of quid off nappies. They were obviously gratefully received, but I remember thinking when I got that bag that it would be great if there was some information in there regarding how to save and invest for the child because that’s a real key thing for a new parent to consider.

Obviously not in the first couple of weeks when you’re suffering sleep deprivation, but at some point down the line in the first year or years, I think it’s important, if you can, to save for your child’s financial future and to make some investment decisions regarding that.

I think there should be more education around the importance of using the stocks and shares Junior ISA version as opposed to the cash Junior ISA. I've not looked at the latest stats, but the last time I covered it, there was a greater proportion choosing the cash version of the Junior ISA, which to me shows that it must just be a lack of awareness that over an 18-year time period, as the history books show, the likelihood is that your investment returns are going to beat cash.

Craig Rickman: Yes. I think you’ve touched on something really important there because when you have a child, that’s one of the most important times to review your finances, isn’t it? Not just looking out for saving and investing for their future, but making sure that you’ve got enough financial protection should anything happen to you, as well. So, education around that point is so important.

Kyle Caldwell: We’re now going to move on to the third finding that we’re going to cover from our survey, which is the pension gaps for women and divorcees.

Of the around 9,000 people surveyed, women expect to have saved £150,000 on average when they get to retirement compared to £250,000 for men. Divorced respondents expect just £75,000 on average by retirement, and that’s compared to £350,000 for married respondents.

Craig, what can be done to try and narrow these very large gaps?

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Craig Rickman: I think part of the answer lies in the auto-enrolment framework. What we know is that women typically take more time off work to have children, to care for elderly parents, sometimes both at the same time.

So, auto enrolment, which is the workplace pension initiative launched in 2012, seems like one of the best ways to address it. Something that we could do is reduce the auto-enrolment earnings trigger from £10,000 to £4,000. At the moment, if you earn less than £10,000, you’re not automatically enrolled into the pension scheme. Some companies may still do it, but under the rules, they don’t have to.

So, if that was decreased to £4,000, then that would support mainly part-time workers, which, if women are looking after the children, which is typically what happens; I know there’s been a bit of a shift around that culturally, but that is still what happens most of the time; and working part time, that would enable them to build pension wealth or have a better opportunity of building pension wealth while they take time out of the workplace. So, that’s something that could help.

Kyle Caldwell: As you mentioned, Craig, as women often take time out of the workplace in their 30s and 40s to care for young children or parents, this has a huge knock-on impact on pension wealth later.

So, they’re contributing less, and then they’re going to struggle to catch up to men because of investment compounding. They’re missing out on the investment gains as well as not putting the same amount of contributions in at the same time. It’s a double whammy.

Also, the fact is that women tend to earn less on average than men, which also contributes to the pension gender pay gap. We talk a lot about compounding on this podcast, so that’s how investment returns generate future gains and snowball over time.

So, if you’re contributing less in your 20s and 30s, compounding isn’t working as much for you as it is for people who are continually putting money into their pension and continuing to work throughout that period.

Craig, our research also found that there’s a very big gap between the self-employed. Could you talk through this and what could be done to address this gap?

Craig Rickman: Pension participation among self-employed workers has been reducing for some time or it’s certainly a lot lower than it was in, say, the late 1990s.

In the late 1990s, around half of self-employed workers actively contributed to a pension, and since then it’s fallen to about a fifth. That’s a big drop. One thing we should mention is that you don’t have to save into a pension for retirement, there are other ways to do it.

So, you can use ISAs. If you’ve built up enough of a business, that’s something you could potentially use as well. You could use buy-to-let properties. So, pensions aren’t the only way to do it. Because of the tax advantages, they’re the most popular way, and for a lot of people, probably the most effective way.

So, it’s still a big concern. You should also note with self-employed workers that they generally have a different set of circumstances than employed workers, or different considerations. So, for example, cash flow tends to be more important. Anecdotally at least, I know of some self-employed workers who prefer to use ISAs because of the accessibility. But, that said, in a lot of cases, they still need to be thinking longer ahead.

Trying to encourage more self-employed workers to engage with pensions is a big task. One of the main things is increasing awareness. There’s a lot of information and a lot of help out there from Pension Wise to the Citizens Advice Bureau and regulated financial advisers too. I think part of the job is to just increase awareness and try and point self-employed workers in the right direction.

The other thing is to try and find a way of expanding auto enrolment to self-employed workers. Now, obviously, there are some practical challenges there. There’s no fixed salary to deduct pension contributions from, that’s the main one, and there’s no workplace to pay the money in.

Self-employed workers tend to have irregular earnings. So, any kind of auto-enrolment system would have to factor those things in. This is an area that the government looked at a few years ago, but nothing further went with it.

But I think it’s the time to revisit it because the risk is if self-employed workers are reaching retirement with insufficient savings, then we could be reaching a real crisis point. Many may wish to continue working, but if they’re doing physical manual jobs, that may not be possible.

Any pension gaps and potential looming pension problems need to be solved, but this is certainly one of the biggest that the government, and perhaps the wider industry too, needs to tackle.

Kyle Caldwell: Our fourth topic, in which I’m pretty sure we’re going to cover auto enrolment further, is based on our survey finding that low pension values are commonplace across the UK.

The survey found that six in 10 pension savers expect to fall short of a moderately comfortable retirement, anticipating pension wealth of less than £300,000. Older workers have the lowest expectations. Two-thirds of those in their early 60s expect pension wealth of less than £300,000 compared with 53% of those in their 20s.

So, Craig, before we talk about what can be done to try and improve the situation, let’s first take a step back.

I think it’s very helpful for listeners to know the ballpark figures for a comfortable retirement. So, Pensions UK, which was formerly called the Pensions and Lifetime Savings Association, publish their pension projections for a minimum, moderate, and comfortable retirement.

Could you talk us through those projections, Craig, and are they a good target to aim for?

Craig Rickman: Sure. So, let’s have a look. Pensions UK crunch these numbers every year, and they look at three different levels of retirement lifestyle. So, minimum, moderate, and comfortable.

And this is the cost in retirement, so this is what you would need after you’ve paid tax. So, this is what you would need going into your bank account. So, the minimum amount that you would need, and this would be a very frugal retirement, let’s say, that’s £13,400 a year. To live a moderate retirement, it’s £31,700, and for a comfortable retirement, it’s £43,900 a year. That’s for a single person.

If you’re in a couple, then clearly, you’d need more than that. So, these figures assume that you would get the full state pension. You can translate those into pot sizes, which is what most people will be aiming for when they set a target.

So, to accumulate enough pension savings for a moderate retirement, you would need somewhere between £330,000 and £490,000. For a comfortable retirement, somewhere between £540,000 and £800,000.

The reason for the wide range there is because of annuity rates, and we know that this is what it’s based on, and we know that those can change over time.

So, are they a good target? I mean, in reality they’re a guide more than anything else.

They’re just a guide to help people think a bit more carefully about the type of lifestyle that they want in retirement. For some people, having £30,000 a year, they’d see that as more than comfortable to live on. Others may need a lot more than that. That will depend on the lifestyle that you want in retirement and will probably also be dictated by how much you’ve been earning during your working years as well because most people will want a smooth-ish transition to retirement.

I think one thing it does illustrate is the importance of getting the full state pension, which is currently just under £12,000.

So, as you can see, that would almost cover off the minimum amount that you would need for retirement. Again, that’s a minimum, or it could take a really big chunk out of the amount of savings that you would need to fund either a moderate or a comfortable retirement.

But I think the thing is to get people thinking about what sort of retirement they want and how much money they will need to be able to do the things they want to do as an individual or a married couple.

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Kyle Caldwell: So, Craig, what could be done to improve the situation? Of course, auto enrolment was introduced around 15 years ago. It’s undoubtedly been a success. I don’t think you could argue against that. Is it now time for a rethink in terms of the amounts that workers put into their pensions and the amount that employers contribute?

At the moment, for those who qualify, every monthly paycheck, employees put in at least 5% and employers put in 3%.

Craig, how much more does this need to go up by to address the risk of people not saving enough for their retirement?

Craig Rickman: As you say, auto enrolment has been a great success in getting more people to save, but the concern now is that people aren’t saving enough if they stick to those minimum amounts that you said, which is between employee/employer 8%.

We should also note that it’s 8% of qualifying earnings as well, which are earnings between just over £6,000 up to the higher-rate tax threshold, which is £50,270.

Some employers will pay based on your full pay. There are different ways of doing it, but under the rules, that’s the minimum amount, and that’s what some employers will adhere to.

So, the thinking is that the minimums need to increase. There are some challenges around that at the moment for both employees and employers. For employers, they’re facing higher tax bills from April with the national insurance changes, the national insurance threshold being reduced and the headline main rate being increased. So, they’re facing stiffer tax bills. To lump them with extra pension contributions for their employees might not be particularly welcome.

For employees, they’re still battling against the rising cost of living. Inflation has come down significantly from the dizzying double-digit heights that we saw a few years ago, but it’s still far higher than the Bank of England’s 2% target. So, prices are still rising a lot faster than we would like.

And so, again, if they were to be paying more into their pensions or paying more into their pensions by law, there is a risk that it could increase the number of people opting out of pensions altogether. So, that balance needs to be struck.

The minimum rates do need to go up, and we think they should go up to 12%, but they should be phased in over a period of time. The government has said that auto-enrolment rates aren’t going to change during this parliament.

But then beyond that, to increase them, so maybe uptick minimum contributions by 1% a year over a period of four years will increase what people are paying into their pensions and boost their future financial security in a way that’s palatable for both, companies and their staff.

Something else that they could do would be to expand auto enrolment to younger people. So, currently, 22 is the minimum age for enrolling into a pension scheme, but it would be helpful if that was lowered to age 18, to encourage more school leavers to save for retirement. The point that you made earlier around investing compounding, the earlier that people can start to save for retirement, the better.

Kyle Caldwell: As well as potentially increasing the minimum contribution for your pension under auto enrolment from the current level of 8% to potentially 12%, for me, financial education as we mentioned earlier on in the podcast, is an important part of the messaging around helping people understand the importance of saving towards their retirement.

If financial education was strengthened, then there would be fewer opt-outs in terms of pensions. Also, people would potentially put more money into their pension if they understood the importance of compounding, how their pension contributions benefit from tax relief, and how employer contributions help to top up what you’re putting into your pension.

So, our Great British Retirement Survey, it’s a sober read. However, we hope that the issues we’ve highlighted and how they could be addressed has provided plenty of food for thought. As I mentioned in the introduction, I’ll provide a link to our report below the episode description.

Craig Rickman: Yeah, and if you unearth anything in the findings that you’d like us to cover in the future, then get in touch by emailing us at OTM@ii.co.uk.

Kyle Caldwell: Well, that’s all we have time for today. My thanks to Craig, and thank you for listening to this episode of On the Money.

If you enjoyed it, please do follow the show in your podcast app, and please spread the word. If you get a chance, please leave a review or a rating in your preferred podcast app too. Those ratings and reviews, they really help to get the podcast into more ears, so if you could spare the time to give us that five-star review, I’d really appreciate it.

We love to hear from you, and you can get in touch by emailing OTM@ii.co.uk. In the meantime, you can find more information and practical pointers on how to get the most out of your investments on the interactive investor website, ii.co.uk, and I'll see you next week.

On The Money is an interactive investor (ii) podcast.