Conventional wisdom says legacy defined benefit pensions will tide over those retiring in the next few decades while defined contribution pots gradually grow and take their place.
But a recent paper by LCP called The Ski-slope of Doom dispels this myth. While public sector workers continue to benefit from generous DB schemes, those in the public sector will be much worse off.
The report says: “Private sector DB rights at retirement are currently close to their peak and will decline precipitously in the next 25 years, especially for men.
“By contrast, DC rights will grow only very slowly and will replace only a fraction of the loss in DB rights, leaving new retirees in years to come substantially worse off than their counterparts retiring today.”
A hidden decline
This collapse in retirement provision has been missed because most data does not split out the public and private sector pensions. The growth of the public sector in recent decades has increased the number retiring with defined benefit pensions and this masks the rapid decline in income from these benefits in the private sector.
If you strip out the public sector, after peaking in a year or two, private sector male pension income at retirement will decline sharply for the next two decades, falling by around 20%.
At the peak in 2023/24 men can expect a weekly income of £300 which will decline to less than £250 a week by 2045/46.
The gap between men and women will fall because of the collapse in male pension income but also because of the boost to the state pension of the triple lock policy. The report forecasts women currently retire with just under £200 a week which is forecast to rise to just over £200 a week by 2045/46.
Auto-escalation is the answer
The importance of the triple lock to improving the retirement benefits of women illustrates how the state pension can act as a buffer against declining DB pension income.
“Even downgrading the triple lock to a double lock wipes out most of the projected increases in women’s at-retirement incomes for the next 20 years,” says the report. In other words, until DC pots can mature sufficiently to replace DB pensions, the state pension will play a vital role.
This analysis underlines the importance of accelerating the build-up of DC pensions. While the plans to extend auto-enrolment to those at 18 rather than 22 as well as expanding the band of ‘qualifying earnings’ are welcome, they do not go far enough.
The report argues the government should build on auto-enrolment with auto-escalation ensuring that as wages rise, so do contributions – while ensuring there is an opt-out.
I argued in this post that auto-escalation – with opt-outs – should be implemented, irrespective of wage increases. The aim should be to increase contribution levels to 16% from 8% to provide a better chance of generating a decent pension pot. This report underlines the importance of such a policy change.