Undercover Economist

Maybe our pension worries are overdone

Here’s the conventional wisdom on pensions: you’re a weak-willed and short-sighted fool who isn’t saving enough, and as a result you will spend your retirement in poverty. The US press is loaded with hand-wringing on the subject – largely, although not exclusively, based on “research” from companies who sell pensions and investments. In the UK, the definitive statement was made by Adair Turner’s Pension Commission in 2004: “Most people do not make rational decisions about long-term savings without encouragement and advice.” Ouch.

The sense of impending doom has been deepened by the realisation that both corporate pension schemes and implicit pension promises from governments may have too little cash behind them. That may be true, but it is only indirectly relevant to the question of personal pension saving.

One of the results of this nervousness has been a search for ways to encourage people to save more: tax breaks and enrolment by default, for example.

But look more closely, and it is far from obvious that there is a serious and generalised problem with personal pension saving. It’s hard to say for sure, partly because the future is unknown and partly because it’s hard to say exactly how much money should be in a sensibly funded pension. For example, if someone is making £60,000 a year, what pension income would count as sensible? £75,000 would probably be excessive – but what about medical and long-term care costs? £25,000 a year seems low, but many people get by happily on less.

Yet economists have been gamely making the effort; they look for “consumption smoothing” as a sign of sensible saving. In practice that means that aiming to consume about as much after retirement as before. But even that simple comparison can be misleading. The economist Erik Hurst has recently calculated that while most American households do cut back on spending after retiring, that does not literally mean tightening their belts: the cutbacks mean spending less on commuting and work clothes. Spending on food also falls, but the retirees eat just as well: they simply spend more of their plentiful leisure time cooking at home. Spending on entertainment and donations to charity increase. No sign there of a penurious dotage.

An admired analysis of retirement saving was published in 2006 in the Journal of Political Economy by John Karl Scholz and two colleagues. They concluded that more than 80 per cent of Americans seemed to be on track to retire with enough money in the bank; the remainder were mostly not far short of sensible savings. Another economist, Laurence Kotlikoff, is famous for his calculations that the US government has run up a staggering implicit debt in the form of Medicare and social security promises, but seems sanguine about private saving. Kotlikoff believes that the savings plans that tend to be recommended by the “retirement calculators” on investment company websites recommend saving too much and buying too much insurance. (Kotlikoff is now marketing his own retirement calculator.)

So should we be more relaxed about personal pensions? It’s hard to be sure. Some people do suffer impoverished retirements, but they tend to fall into two categories: those who were poor for most of their lives anyway, and those who unexpectedly lost their jobs or their health in their fifties. In neither case is “more saving” the answer to the problem.

The adequacy of personal pensions in the UK is hard to evaluate. James Banks, a pensions expert at the Institute for Fiscal Studies and University College, London, says that the US calculations haven’t been replicated here, because the necessary data have only recently been collected.

In any case, trying to work out how much to save for retirement is hardly a relaxing problem. The mystery is not that some people fail, but that anybody succeeds.

Also published at ft.com, subscription free.