Women may be achieving equality in many walks of life, but on pension provision, they still lag considerably. On average, a woman’s total pension pot will be about one-fifth that of a man, due to a combination of lower salary, career breaks and missed opportunities.
The Chartered Insurance Institute found in October 2018 that the average pension wealth for women at age 65 is £35,800, one-fifth of a man’s at the same age and a fraction of their financial needs even if they don’t need end of life care. To put this in income terms, a woman’s average pension pot would buy a retirement income of just £1,704, while a man’s would bring £8,520. (https://www.ftadviser.com/pensions/2018/08/07/annuity-rates-set-for-second-successive-year-of-rises/).
These are averages, but even at the higher end, we see poor recognition of the importance of women’s pensions. Even though it is tax efficient for married couples to use both pension allowances every year, particularly given the restrictions on tax relief for high earners, it is not a priority for many.
We look at how different approaches to saving can make a difference to women’s outcomes in retirement. At one end is ‘Jane’, who is risk averse and uses lower risk options for the majority of her savings pot. She goes back to work part-time after her two children are born and saves 10% of her salary. In this scenario, with portfolio growth of 3% per annum, she runs out of money just 3 years into her retirement.
At the other end of the spectrum is ‘Angela’ who returns to work full time after her two children are born, saves 20% of her salary and achieves an investment return of 6% per annum. She manages to achieve a secure income in retirement and her pot should last for her full life expectancy of 89.*
When contemplating retirement income, there are a number of key variables. First, it matters how much goes in the pot. This seems self-evident, but there was a time when pension schemes were based on final salary at retirement. Companies have largely abandoned these schemes as they were costly to run and now it is all about contribution levels.
The pension gap is often exacerbated due to women tending to earn less. The gender pay gap for the year to April 2018 for full-time workers was 8.6%. This is down from 9.1% in the previous year, but still represents a sizeable difference. Pension contributions from employers are usually based on a percentage of salary, so this matters for overall pension savings.
Also problematic is that more women than men tend to work part-time after having children. This not only means they are paid less, but it can also stall their career progression. By the time a first child reaches 20, mothers earn almost a third less, on average, than similarly educated fathers, according to February 2018 research from the Institute for Fiscal Studies (IFS) undertaken for the Joseph Rowntree Foundation.
Even if women do return to work full time after having children, they may see a reduction to their pension contributions during their maternity leave. This can dent their overall pension pot. Contributions will only be paid as a percentage of annual salary, which can be lower during maternity leave, depending on the firm’s maternity policies.
Any gap or fall in contributions can have an important compounding effect. If a woman loses, say, £10,000 in contributions and does not make it up, this could equate to a circa £43,000 loss (assuming a growth rate of 5%) in their final pot 30 years later.
There are lessons to be learned here. The first is to keep contributions as high as possible for as long as possible. That means starting early and keeping contributions going through maternity leave or other career breaks. This may mean contributing to a wife’s pension pot during these breaks for married couples. This can also be a tax efficient way to approach it and seeking financial advice regarding this matter is recommended.
The benefits of starting to save early should not be underestimated. Recent research from Fidelity shows how this can make a difference. It showed that Investor A invests £1,000 a year into the stock market from the age of 18 and keeps doing so for the next 20 years. By the time they reach 38, and based on an annual return of 5%, their investment would be worth £34,719. If they were to make no further contributions, but their investments continued to grow at 5% return each year, by the time they reach 65, their investment would have grown to £129,623.
In contrast, Investor B doesn’t start investing until they are 38. Even if they invest the same £1,000 a year and achieve a 5% per annum return, they can’t catch up. At 65, Investor B’s portfolio is worth £57,403, less than half of investor A’s. Starting early is vital for women if their earnings are likely to become less predictable later in life.
Another variable is investment risk. Women are often reluctant investors – outside their pension, just one fifth of women have any investment portfolio at all, compared with 33% of men (http://www.mhpc.com/wp-content/uploads/2018/07/Women-investing_what-are-the-hurdles.pdf). 52% of women prefer to look at low risk investments despite being aware they will receive lower returns, compared with just 36% of men. Just 0.7% of women prefer taking a higher risk with their savings to gain from better returns in the long-run.
This is a problem, particularly given lower contribution rates. A monthly contribution of £1,000 over 30 years, growing at 6% per annum gives an overall pot of £1,004,515. The same contribution over the same time period growing at 3% per annum gives a pot of £582,737. Investors are almost halving their retirement income. The reality is that no matter how scary it feels to watch the capital value of a pension pot bounce around, this is a long-term investment. Contributions are often made monthly, so even if the capital value is falling, those contributions are being invested at a lower level. This should help smooth volatility over time.
There is no magic formula to improving women’s retirement outcomes. It should improve as the gender pay gap closes and auto-enrolment rates rise. However, it won’t happen by accident. It is important to recognise the role that contribution levels and investment growth play in building a pension pot over time.
*Case study assumptions
Jane and Angela starting salary - £32,680
Jane and Angela start work and pension contributions aged 25
Salary increases – 4%
After returning from maternity leave
Part-time – 50% of salary prior to going on leave
Full-time – 100% of salary prior to going on leave
Maternity pay calculation – paid for 39 weeks. 6 weeks at 90% of weekly salary; £145.18 for 33 weeks; 13 weeks unpaid.
Pension calculations: Full time – 50% of final salary each year, inflation-linked at 2.5%. Part-time – 100% of final salary each year, inflation-linked at 2.5%
‘Annuity rates set for second successive year of rises’ - FT Adviser, 7th August 2018
‘Women Investing: What are the hurdles?’ – MHP, 17th July 2018
Institute for Fiscal Studies (IFS) undertaken for the Joseph Rowntree Foundation – 5th February 2018
The Chartered Insurance Institute’s (CII) ‘Insuring Women’s Futures’– 24th October 2018
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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.