Saving for a pension is seen as a sensible thing to do. But is it really not a giant waste of money?
Take a typical renter who retires at 61 after becoming, for all intents and purposes, unemployable.
If he has little savings, he might get over £300 from the taxpayer each week in the form of pension credits, housing benefit to cover his rent in full, and council tax benefit.
The exact amount will depend on his circumstances, such as whether working-age adults live with him, whether he has disabilities, and how much his rent is.
Now take a 61-year-old renter who has saved a £100,000 pension pot, who could take a private income from it of around £100 per week.
According to the Pension Service and the Government's online calculator, Benefits Adviser, his benefits are going to be reduced by precisely the amount he could receive in private pension income. His local council says that the pension pot will also be taken into account when calculating other benefits.
His total potential weekly income, including private pension and benefits, will also then be just over £300. In other words, until he's 65, his £100,000 savings have amounted to nothing.
The insanity continues post 65
Many younger people will face a higher state retirement age, but someone today in their early 60s will start receiving the state pension at 65.
At this point, the benefits situation changes.
A 65-year-old renter with no private pension might get a total income in benefits of around £330 per week from £310. (Remember, the actual amounts vary considerably depending on your situation.)
A 65-year-old who has saved a £100,000 pension pot will get a total income from state benefits and the private pension of perhaps £355 per week – or just £25 more per week than someone relying wholly on benefits.
In other words, he's getting just £1,300 more per year, despite his large pot.
The tax situation will undoubtedly change again in following years but, at that rate, he's going to have to live until he's nearly one-and-a-half centuries old before he has got his money's worth from his pot, compared to if he just relied on benefits.
By this point, inflation might have made his private savings worthless.
Smaller and larger retirement pots
Most people save much less than £100,000 in pensions.
A 65-year-old who has saved £40,000 might typically take £10,000 as a lump sum, to pay off debts and go on holiday.
That's the 25% of his pension pot that he's allowed to take up front, tax free – which is a fantastic benefit of pensions.
With the remaining £30,000 he might get around £35 per week in private income to top up his benefits.
However, his benefits are reduced by about £30 per week precisely because he's getting that private income. So he'll only really be £5 per week better off compared to someone who didn't bother saving for retirement at all.
Such a retiree might have to live close to two centuries before he'll have been able to get back his £30,000 retirement pot.
The person on benefits, on the other hand, has already spent the money in his youth that he should have saved in a pension, and therefore got full use out of it.
Someone who has managed to build up a £1 million pension pot might take “just” 29 years to get his money back, but this could be 11 years longer than he should expect to live.
Is property the way out?
On the surface, using property as your pension appears to offer a good way out of the conundrum. Your home is not taken into account when calculating the amount of pension credits you receive.
You can also turn it into cash whenever you need to by downsizing or through equity release plans.
However, as shown above, the taxpayer pays the rent of many retirees. One of the big benefits of being a homeowner is that you escape paying rent after a few decades; our renter on state benefits has managed that without the high cost of buying a home. He also has very few home maintenance costs compared to a homeowner.
Before retiring onto state benefits, he could potentially have paid less in rent and related costs than some people buying did in mortgage and maintenance costs.
Retired homeowner benefits
In my tests using Benefits adviser, anyone who owns their home outright will receive exactly the same benefits, minus housing benefit, putting them in the same situation.
The benefits system makes a mockery of my recent article that tries to estimate at what price buying a house is worth it compared to renting. (Read when When should you stop renting and buy?)
[SPOTLIGHT]You pay the high cost of buying so that you can eventually get out of paying rent, only to find that someone who didn't pay that high price gets out of paying rent at retirement anyway.
Consider morals and political risk, too
I'm sure most people agree that it's right that we take responsibility for ourselves if we can afford to. It's also reckless and ill-advised to just rely on the Government to pay us similar benefits in future.
Auto-enrolment will certainly help, although the system would surely work better and more fairly if most people were forced to save for their own futures.
But these are questions for voters and the Government, not us here.
What we have to do is decide how to save.
Shift away from pensions
If you rely on benefits supporting you, you're taking a big risk. But the same can be said of relying too much on private pensions.
Pensions are so inflexible. When you put your money in, you can't take it out until you retire, and you can only do that in the way the Government of the day says you can.
But there are no wonder cures.
Share ISAs and other savings currently have the advantage that you can spend your money whenever you like and for whatever reason you like. However, those savings will impact your benefits in pretty much the same way as having a private pension.
Buying a home comes with high costs in the early years as well as ongoing maintenance, and a renter on benefits is likely to have his rent paid for him in retirement anyway.
However, while buying might fail to pay off for you as well as you might expect, it will for your heirs. Plus you have security in not relying on handouts, and no landlord to kick you out with three months' notice.
What do you think? Are pensions fatally flawed? How are you saving for your retirement? Let us know your thoughts in the comment box below.
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