How are pensions affected by wealth inequality?

Wealth inequality in the UK is broad and varied. It affects what people earn today, and also what they’ll earn from their pension in retirement.

There are lots of ways to look at wealth disparity, such as the difference in wealth between age, gender and ethnicity.

In this article, we highlight some of the causes of wealth inequality and the measures you can take to best position yourself to receive a good retirement income. However, we fully acknowledge that these are complex topics and we don’t have all the answers. A larger effort from industry and government is required to eliminate these inequalities for good.

How your age affects your future pension income

In the 1960s, the most common company pension was the defined benefit scheme. Also known as the ‘final salary pension’, these schemes were considered generous as the amount paid out during retirement was calculated based on the number of years an employee worked at the company and their salary during that time.

But defined benefit pensions were expensive for companies to run. And after the UK Government introduced the Social Security Act in 1986, which relaxed workplace pension rules, the 1990s saw companies shift towards much more affordable defined contribution pension schemes (which most people pay into today via workplace and personal pensions).

In most cases, the change saved companies a lot of money, but resulted in most employees receiving less into their pension each year.

Not every employee was affected. Often people over a certain age were allowed to keep their defined benefit pension, while younger and new employees weren’t.

In less than a decade, the burden of most people’s pension contributions was moved from the employer to the employee. Today, just over 1 million people are actively contributing to a Defined Benefit pension - down from 8 million people in the 1960s.

The below chart shows the expected annual retirement income of two people retiring at 65, who both earned an average salary of £30,000 for 45 years. The only difference is that one had a defined benefit pension and the other had a defined contribution pension while they were working.(1)

The difference is stark. After working for 45 years, the person with the defined contribution pension could receive £12,700 less each year. And that’s after contributing 4% of their income into their pension as a gross contribution for 45 years, which the other person didn’t have to do.

Even if the person with the defined contribution pension contributed 10% of their income into their pension each year, they’d still receive £300 less than the person with the defined benefit pension.

So what’s this got to do with wealth inequality?

Generations that worked through the 1960s, 70s, and 80s (the Silent Generation and the Baby Boomers) are much more likely to have had defined benefit pensions, and therefore retire with a good pension income. But younger generations that entered the workforce since the 1990s (Gen X, Millennials and Gen Z) are likely to retire with less than a quarter of that income.

Is the wealth gap widening between the generations? The pension gap along with the rise of house prices and student fees certainly isn’t helping.

What you can do about it

Don’t let the generational wealth gap put you off from making the most of your pension.

Defined benefit pensions are a rare find, these days. But some companies do still offer them, particularly in the public sector. But if you’re more interested in following a career path where companies are more likely to offer defined contribution pensions, consider following these tips:

1. Start paying into your pension early. The earlier you start, the more quickly your money is likely to grow in real terms, thanks to compound interest.
2. Pay in as much as you can afford. The more you pay in now, the more your pension pot is likely to be worth when you retire.
3. Pay in lump sums if and when you can. Occasionally, you might receive money from a pay rise or inheritance. By paying that money into your pension, you’ll be helping future you.
4. Find an employer that has a generous pension scheme. Not all defined contribution pensions are the same. Employers are required to contribute at least 3% of your qualifying earnings, but some employers pay much more.
5. Adjust your contributions if you go on maternity or paternity leave. If your monthly income decreases, consider increasing the percentage of your income you pay into your pension so you don’t fall behind.

Despite defined contribution pensions being less generous than their predecessors, it’s still possible to retire with a healthy pension income. See our article, How you could build a million pound pension.

How your gender affects your future pension income

Women in full-time work are paid 7.4% less than men, on average. And when it comes to pensions, the difference is even more pronounced - we analysed our own customer data in March 2021, and found that the average pension pot for women was around 40% less than men.

For both income and pensions, the gap widens as people get older. And there seems to be a range of factors at play.

If you’re paid less, you’re likely to save less. Thanks to the introduction of Auto-Enrolment in 2012, more people are paying into a pension. But the amount people are able to contribute is dependent on what’s left over after other essential costs. While women might not be immediately affected by paying less into their pension, their long-term finances are likely to suffer as they’ll receive a smaller retirement income. And this can impact more than just finances, but their freedom of independence too.

Historically, women have been more likely to take time out of work to raise children. Traditional gender roles and few companies offering adequate paternity leave have likely contributed to this. While there have been positive developments in parental leave, a mother’s earnings will drop during the months they’re at home. With the added financial pressure of caring for a child, women are therefore much less likely to be able to keep their pension contributions at the same level during this period.

Returning to work after maternity leave can also limit a woman’s earning potential. Some may find they’ve been overlooked for a promotion, or learn that their colleagues’ salaries have increased while theirs hasn’t. And while some women may look for a more flexible or part-time working arrangement, most employers aren’t set up for this, limiting the options available for mothers heading back to work.

All this can drastically impact women’s income, both today and in the future when they retire.

What you can do about it

The gender pay gap appears to be narrowing, but the rate of change isn’t fast enough to fix itself anytime soon. Here are some tips that both women and men can consider to help them retire with a good pension.

1. Don’t opt out of your workplace pension. Despite the introduction of Auto-Enrolment, it’s still possible to opt out from paying into your pension. But to do so would be to turn down free money. Not only will your employer pay 3% of your qualifying earnings into your pension, the government will usually top up your contributions too in the form of tax relief.
2. Start saving early. This will give your pension more time to grow. And thanks to compounding returns, it should grow by a slightly faster amount each year.
3. Adjust your pension contributions during parental leave. Most people will contribute a percentage of their income each month. But if your income goes down, the amount you pay in will be smaller too. So consider increasing your contribution percentage to keep your contributions at the same level (you can always lower it again when you return to work).
4. Contribute to your partner’s pension. If you or your partner take time off work to raise a child, the other might consider using part of their income to pay into their partner’s pension. This will prevent the person raising the child (traditionally, the mother) from experiencing a severe dip in pension contributions, and later receiving a smaller pension than their partner.
5. Share caring responsibilities. Our Gender Pay Gap Report shows that if men took responsibility for an equal share of unpaid care work, women could increase their pots by more than £106,000, and the gap would be eradicated.
6. Register for Child Benefit if you have children. To receive the full State Pension, you’ll need to have paid National Insurance for 35 years. If you take time off work to raise a child, you can claim National Insurance Credits which will count towards your State Pension entitlement.
7. Combine any old pensions into one. If you’ve had more than one job, you might have more than one pension. And because fees differ so much between providers, you might find yourself paying more than you need. Combining them into one plan could reduce costs, and you’ll find it much easier to manage too.

The pension gap is a big and important topic. For more details, read the PensionBee Gender Pay Gap Report.

How your ethnicity affects your future pension income

Is there a racial wealth gap? According to the Department for Work and Pensions (DWP), pensioners of non-white backgrounds received less income from both occupational pensions and the State Pension than their white counterparts.

Another report from the DWP showed that a higher percentage of people from non-white backgrounds were likely to fall into the lowest income group (earning less than £9,200 per year after housing costs).

It’s harder to put money aside into a pension when you have less income to work with. And if, for example, you need to spend time at home to raise children (perhaps because you can’t afford child care) or an elderly relative, your work opportunities will be limited.

The rate of unemployment is higher amongst ethnic minorities, and those who do work may find their annual income is below the threshold required to qualify for Auto-Enrolment (£10,000 for the year 2020-2021). People earning less than this - perhaps those in part-time work, for example - would need to voluntarily opt-in to their workplace pension scheme. But if you’re not familiar with the UK pension system, or your first language isn’t English, you’re far less likely to be aware of your options.

Finally, to qualify for the State Pension, a person will need to have paid National Insurance for at least 10 years. To receive the full State Pension, they must pay in for 35 years or more. But as many ethnic minorities will be first generation immigrants, they might not have accrued the necessary contributions to qualify.

What you can do about it

The challenges facing people from ethnic minority backgrounds are diverse, but there are a number of things you could try that might help improve your pension situation.

1. Speak to your employer about your pension options. The first step towards a happy retirement is to engage with your pension. If you don’t have one, or you’re not sure, ask your employer directly. If you earn more than £10,000 a year, and are aged over 22, you should have been automatically enrolled into their pension scheme. But your employer should be able to explain all your options.
2. Ask on behalf of a relative. If you live with someone who doesn’t speak English as their first language, you can speak with their employer on their behalf. The employer should be willing to speak with you, with your relative’s permission.
3. Contribute what you can afford. If you’re on a good salary, you might have more disposable income to put towards your pension. But if you’re on a lower income, you’ll need to balance what you can afford to put into your pension with your daily living expenses. The earlier you start, the more your retirement income will be, so don’t delay.
4. Check your National Insurance Contribution record. To receive the State Pension, you’ll need to have paid National Insurance for at least 10 years. To receive the full amount, this rises to 35 years. You can check your status on the Gov.uk website.
5. Apply for National Insurance Credits. If you receive benefits because you’re too ill to work or you’re otherwise unemployed, you might be able to claim National Insurance Credits. These credits will count towards your State Pension entitlement.

(1) Defined contribution income calculated using our pension calculator, assuming employee and employer both contributed 4% of employee income, and pension drawdown was fully used up in equal annual amounts by age 85. Defined benefit income calculated using https://www.which.co.uk/money/pensions-and-retirement/company-pensions/defined-benefit-and-final-salary-pensions-ajvnw4q07rlm

Risk warning As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.