Expectations vs. Reality: The increasing gap affecting retirement

Retirement is an increasingly expensive business.

Life expectancy and the cost of living for retirees are rising. So what you are expecting to be enough to keep you going when your working days are done is unfortunately not what you are likely to get. Unless you save as much as possible now into a pension, any money worries you are having today could follow you into old age.

Why a pension rather than any other form of investment? Well it’s because of the tax relief, equal to your current rate of tax. It’s kind of like receiving a whopping great bit of extra interest on top – a bonus that you just don’t get from other forms of investment.

Those who have already retired receive on average of 53 per cent of their final salary according to Schroders - an expectation gap of 13 percentage points

Despite the generous tax relief boosting the pension coffers, what people actually receive when they retire falls short of expectations. There is a considerable gap between what UK workers think they need to cover outgoings in retirement and what they actually receive. As a percentage of current salary, those who are over 55 and approaching retirement in the UK think they will need 66 per cent of their annual income to live comfortably in retirement.

In reality, those who have already retired receive on average 53 per cent of their final salary according to Schroders - an expectation gap of 13 percentage points.

If you are a Generation X-er (aged between 37 and 50) or a millennial (18 to 36) your expectations of how much you will need for income as a proportion of your retirement savings is probably falling even more short of reality.

The research shows the gap narrows only for those closer to retirement (ages 51+), with the younger generations underestimating what they need in their final retirement pot by up to 16 per cent. Although it may seem that millennials and generation-Xers have time to make up the difference, the key danger is the loss of valuable time in which they can build up savings, and the positive impact of compounding investment to help achieve a healthy retirement pot.

It’s an even bigger gap when it comes to expectations of how much retirement income is required to cover basic living expenses. Over 55s approaching retirement think that the percentage of their annual income taken up by paying for living expenses will be 38 per cent. In fact, that figure is an eye-popping 15 per cent higher, at 53 per cent of income, the Schroders research found.

If anything, the perception gap between expectations of what will be needed and what’s actually needed could get bigger.

Life expectancy could shoot up faster in the years to come as a result of rapid medical advancements, retirement planning experts are warning. Living to 100 could become unremarkable - and the effects on your existing pension plan would be dramatic.

Rising life expectancy is likely to be problematic for millennials - who are currently the least realistic about what they will need in retirement, according to the Schroders research.

£300,000 is the amount people need in their retirement pot to guarantee a decent old age - the average UK pension pot in 2017 was just £50,000

Ian Browne, pensions expert at Quilter, said: “(Another rise in life expectancy) is likely to come when medical solutions to mental illnesses like dementia arrive, which are currently an increasing reason for death. Figures from the ONS revealed that for those aged 90 years and over, mortality rates for mental and behavioural disorders have more than doubled since 2010 for both males and females.”

So how do you avoid a sense of crushing disappointment when you retire, a time in your life that you should look forward to, rather than dread?

“It’s critical people are realistic about the possibility of living to 100 and plan their finances accordingly. And if you’re a couple, you also need to ensure that if one outlives the other, they aren’t left in poverty as a widow or widower. Trying to figure how much to save is extremely challenging and there is no perfect science. For many people working backward will probably deliver the most accurate picture of how much you need to save.”

Ready for the reality check? £300,000 is the amount that researchers at Aegon report people need in their pot when they retire to guarantee a decent old age - the average pension pot of a UK worker retiring in 2017 was just £50,000 - a sixth of the ideal pot size.

Can you make up the difference? The extent to which you can close the gap will depend on lots of factors, including your age and earnings. Investing well and regularly can make a big difference to your eventual pot.

The message is to invest, invest and invest some more, from as early as possible in working life, topping up any existing pension contributions and if possible setting up new types of pension that allow you to be in full control of your own retirement saving, such as SIPPs. So that when the time comes, your money worries do not relate to not having enough, but to how you get to spend it.