Covid jobs crisis threatens young people's pensions
The rise in the youth unemployment rate caused by the coronavirus pandemic is terrible news for Britain’s young adults – and could have a lifelong impact on their financial security, wiping out a large portion of their pension benefits.
Figures prepared exclusively for Guardian Money reveal how only a few years outside the workforce can have a dramatic effect on a person’s chances of building up a pension. Contributions in the early years of someone’s working life are crucial in generating a satisfactory sum to live on in retirement.
The investment platform Interactive Investor looked at the prospects for a young adult beginning their working life at the age of 21, on a typical income for someone in the 20- to 29-year-old age group, which is currently £24,750 a year.
They assumed the person is auto enrolled into the government’s basic pension scheme, where the individual pays in 5% of their pay and their company chips in another 3%.
The final outcome, assuming the person works a full 47 years until the new state pension age of 68 (another hardship for today’s young, coming in 2044), does not make for happy reading. Interactive Investor projects that the person’s pension pot will be just below £184,000.
However, if the same young adult is out of work between the ages of 21 and 25, and only then starts saving through their workplace pension, their likely pension pot shrinks to just under £157,000, a loss of 15% even though their working life is only 9% shorter.
Becky O’Connor of Interactive Investor said: “When they find a job, these young workers will have some making up to do on pension contributions. It would be wise, if it’s possible to do so, to pay in more than the minimum auto-enrolment contribution of 8% to help build these reserves back up.
“For those young people who are earning, now is the time to take advantage of any savings made through living at home with parents, not going out and travelling less, and to put any surplus into your pension.”
One alternative for young adults is to open a lifetime Isa.
Prudent sentiments – but a tall order for any young person who faces having to pay rent and commuting costs while saving to put down a deposit to buy a house. How are they supposed to save into a pension, too?
One alternative for young adults is to open a lifetime Isa, also known as a Lisa. This lets you save up to £4,000 a year with a government bonus of 25% of everything you save, up to £1,000 a year. The money can be used to buy a first property or be put towards retirement from the age of 60. You have to open one before you are 40.
Savers have the potential to earn a total of £32,000 in bonuses if they pay in the maximum £128,000 over 32 years from the age of 18. Accounts can be held in cash or stocks and shares.
A big drawback for many is that you have to use all of the money you have saved to buy your first home or wait until the age of 60 to unlock it. However, as the pandemic swept the country, the government reduced the early exit penalty for people whose incomes had been hit by Covid-19.
Interest rates are low, unfortunately. Newcastle building society and Skipton building society only pay 0.35% interest on their lifetime Isas, compared with 1% earlier this year. You can also open a lifetime Isa that invests in shares rather than leaving the money on deposit. Providers include AJ Bell and Hargreaves Lansdown.
The government bonus makes lifetime Isas appear very attractive. But savvy young savers should first check if their company has an additional voluntary contribution (AVC) scheme. Some of these can be very attractive – you can be sure that in some offices, virtually everyone in their 50s is pouring money from their salary into their AVC, while those in their 20s have not registered how beneficial it can be.
Every time you put money into a pension scheme, you get tax relief. If you ask your payroll department to put an extra £100 a month into your company pension scheme, you only see £80 deducted from your take-home pay, or £60 if you happen to be a higher-rate taxpayer. On top of that, your company may partially match any contributions you make into an AVC.