Saving for retirement—when perseverance pays

Gordon Brown used to talk about “prudence with a purpose.” It’s not a bad definition of pension saving. Achieving that purpose—a decent retirement income—has long been an uphill struggle outside the old cocoon of final salary schemes. However good returns from investments have been, falling annuity rates have made it ever harder to secure worthwhile income from contributions made into pension pots. This is a quest where perseverance is essential.

The case for regular pension saving remains intact, not least since employers chip in as well—at a minimum, 3 per cent of a band of earnings (between £6,136 and £50,000 in 2019-20). Many big firms match much higher staff contribution rates on all their pensionable pay. The earlier you start, the longer returns can compound. Saving every month smooths the ride, making it easier to cope with turbulence when markets fall as well as rise. Fiscal incentives through income tax relief have become less generous and more complicated, but are still worthwhile.

Even with these advantages, pension saving on the scale that’s necessary is tough. Looking over the long-term, accumulating enough funds for a comfortable—if not lavish—retirement will remain a hard slog. That’s for reasons that are both disheartening and heartening.

The disheartening reason is that in an era of low growth, asset returns will also tend to be low. For most of the post-war period average economic growth was 2.75 per cent a year. Since 2008, it has averaged just 1.3 per cent. Asset prices were nonetheless buoyed by the Bank of England’s (BoE) ultra-loose monetary policy—but that has been stretched to a limit.

If anything, growth in the 2020s could be slower. Potential output will rise at a meagre annual rate of 1.1 per cent over the next three years according to the BoE. Sluggishness is likely to persist. GDP growth springs from two sources: more people at work and higher productivity in what they do. Even with net inflows of migrants, employment is unlikely to grow much as baby boomers leave the workforce. Any recovery in productivity growth, dismal for the past decade, is unlikely to make up for the missing workers—especially as Brexit hurts the economy.

Both in principle and in practice, pension savers can seek higher returns in foreign markets. But other advanced economies are also experiencing downward drags on growth owing to dwindling contributions from employment and productivity. Especially since the financial crisis, China has been making an outsized contribution to global growth. But even before the coronavirus epidemic struck Chinese growth was slowing, in part because of its own rapidly ageing population. Emerging economies are generally riskier places in which to invest because of poor corporate governance and weak political institutions.

The heartening reason why retirement saving will be tough is rising life expectancy. In recent years gains have slowed. But looking decades ahead the trend increase seems likely to continue owing to medical progress and adoption of healthier lifestyles. The Office for National Statistics projects almost an extra year every decade over the next 40 years for 65-year-olds.

As people live longer, so the goal of pension saving must change. Self-evidently, it is harder to build a pot that can finance 25 years on average than one that suffices for 20 years (currently roughly the remaining life expectancy at 65). Living longer must mean working longer, too. Indeed, for many it may make more sense to invest in skills so they can carry on working into their 70s, rather than to put ever more into a nest-egg. Prudence requires not just a purpose but being realistic.