Undercover Economist

How can I tell if I’ll have a decent pension?

Last week I mused about whether people in general were saving enough for retirement. (The answer: as far as we can tell, most people are.) This week I have decided to take on a far more important question: am I saving enough for retirement?

Apparently this activity is called “retirement planning”, which strikes me as a silly phrase given the imponderables involved.

Saving for retirement is usually posed as a problem of willpower: foolish, impatient people save too little and doom themselves to an old age devoid of Caribbean cruises. The real problem is not lack of willpower but lack of omniscience.

Hip kid that I am, I started my planning by opening up a spreadsheet. The next steps would have been to project the growth rate of my income, monthly savings, the path of inflation, the return on my growing savings pot, and (eventually) the likely annuity rate on retirement.

That all seemed like hard work, so I shut down the spreadsheet and searched for an online pension calculator instead. These products allow you to type in your basic details and let the computer do the rest. The first British calculator I found, kindly provided by the Department for Work and Pensions, told me that I could collect my state pension when I was 67. This was useful news, but only mildly so, since the DWP did not deign even to guess at what the state pension would be worth in 2040.

Other calculators proved a bit more helpful, but relying on them is a hazardous business, not least because they are often provided by companies trying to sell retirement investments.

Most of them were applying smooth growth rates to judge the growth of my salary and my pension pot. This did at least give me a sense of how much saving is required to produce a certain income, and how much difference early or late retirement might make. I had thought that my hefty regular contribution to my personal pension was likely to be overkill; a retirement calculator informed me that it was nothing of the sort.

But beyond that, those smooth capital-growth curves, so easy for computers to generate, are misleading. Not only do they not incorporate in any realistic way the gyrations of the stock market; more profoundly, they cannot deal with uncertainty over whether I will leap to the top of the corporate ladder in my fifties, be sacked, or be forced to retire because of ill health.

Nor can they tell me when I will die. I have read that the industry rule of thumb is that I should assume I’ll live two years longer than my father did. Happily my father is still alive, and if he wasn’t, I wouldn’t have to plan for any retirement at all. The rule of thumb is utterly useless for most people under the age of 40; which is awkward, since another industry rule of thumb is that you should start planning for retirement in your twenties.

These are not problems of willpower; they are problems of guessing the future in an uncertain world. Insurance, not investment, is what is in short supply. And it matters: research based on surveys of people’s income and consumption suggests that the people who really suffer in retirement do so not because they were spendthrifts but because they were forced to retire sooner than they had expected.

The sensible approach seems to be not to try to foretell the future, but to buy critical illness insurance when it is available on sensible terms, check occasionally with a retirement calculator that you are vaguely on track, and hope for the best.

Most of us manage this, but “retirement planning” just doesn’t come into it.

Also published at ft.com, subscription free.