The average member of a defined contribution scheme with Ireland’s largest pensionfund provider is on target to retire with a pension of just 17 per cent of the salary, according to figures published last week by Irish Life.
It’s a scary thought but a timely wake-up call to Irish workers who are increasingly members of such defined contribution schemes – where your final pension relies on the amount contributed and the investment performance of that sum.
Many Irish employees still think of pensions as providing a set percentage of their salary in retirement – the classic two-thirds of salary pension for those with 40 years service. However, changing work practices and, more importantly, the increasing difficulties of traditional final salary pension schemes to meet their pension promise to members/employees mean that, for most private-sector employees, this scenario is increasingly irrelevant.
And the move to defined contribution schemes is throwing into stark relief the level of contributions required to have any chance of meeting people’s expectations.
Irish Life analysed company pension schemes that it administers – almost 1,400 across the State with about 38,000 members.
It shows that, on average, people do not start saving towards a pension until they are 37 years of age. Even then, they are putting a maximum of 10.3 per cent of their gross salary into a pension.
They took the average current member – a male (58 per cent of the number surveyed), aged 43, earning €46,000, with six years of contributions to date and a current retirement “pot” of €45,000.
At current projections, this average member can expect a pension pot at retirement (aged 65) of €190,500, giving them an average pension of just €7,900, or17 per cent of their salary.
Including the State pension at today’s rates – assuming it is still universally payable by then as it has it own looming funding crisis – this person can expect total retirement income of €19,900, or about 43 per cent of their working salary.
For those on higher pay – where the proportional benefit of the State pension clearly reduces – the percentage of final salary will clearly be lower. The data suggest that someone with a salary of about €100,000 would receive a pension of just 31 per cent of that.
If you strip out the “average” employer contribution in the survey of 5.7 per cent, the survey findings show employees are putting just 4.6 per cent of their pay into their retirement fund.
At a time when people can expect to live to 80 or beyond, that is a perilously small sum to set aside to fund 15 or more years in retirement. The survey assumes people retire at 65, which most of Irish Life’s current schemes allow. That is likely to increase in line with State pension age over coming years but the shortfall in expectations and reality remains substantial.
And it could be worse. The illustrations are predicated on an annual investment return of 4 per cent. That’s not unreasonable – investment returns in the sector have averaged 5.5 per cent over the past decade – but not guaranteed. Investment returns over the past seven years have averaged just 1.3 per cent annually, for instance, and just 3.1 per cent over the past 14 years.
The Irish Life figures show that if investment growth is two percentage points lower than target, your replacement earnings (pension as a proportion of current salary) will be five percentage points adrift – 12 per cent rather than 17 per cent. The same obviously applies on the upside.
It also assumes that your salary will grow by 2 per cent per annum between now and retirement. As all too many are only too painfully aware, most salaries have not grown at all over the past five years and there is little confidence that 2 per cent per annum is deliverable in the medium term future.
Moreover, the figures make no allowance for the increasingly frequent “raids” by government on pension pots, such as the 0.75 per cent pension levy this year and the lower ongoing levy of 0.15 per cent in the years ahead.
Finally, the projected pension figures make no allowance for a lump sum – something most private pension savers still anticipate on retirement.
On the upside, they assume it will cost more than €24 of pension savings for every €1 of pension. That is determined by annuity rates which, over the past decade, have been hovering at all time lows. That should improve but nobody is brave enough to suggest when or by how much.
Other findings from the survey are also instructive.
While the gender gap is seen as a significant issue in pensions. The Irish Life survey found that men and women could expect roughly the same level of replacement earnings – 17 per cent for men and 16 per cent for women.
However, as the average current salary of women members (€41,000 at 42 years of age) was lower than that of men (€51,400 at 43), their average actual pension would also be noticeably lower – €6,700 a year compared to his €8,700.
The importance of the “default” investment strategy offered is illustrated by the data showing that nearly three-quarters of younger members – and 64 per cent of all members – opt for the default. Get that wrong, and members could lose out significantly.
A very rough guide to customer engagement – people consulting Irish Life’s interactive pensions website or app – found that they contributed substantially more than the average scheme member and thus could expect replacement earnings of closer to 24 per cent, compared to the 17 per cent figure average. Interestingly, they tended to be higher earners.