Financial security in retirement: a generational gap

There is a truism prevalent that older people own most of the wealth, and younger people have little, presented as if it were a new social injustice. Perhaps it was always thus. In UK law, a child under 18 cannot inherit money other than through a trust run by adults, and anyone under 16 cannot take a full-time job. Children depend on their parents or guardians to house, feed and clothe them. Child poverty is a scourge for some, but it is really parent poverty. Many parents lack the money to make decent provision for their children. Past generations started poor and gradually saved or made money to give them greater financial security in old age. 

There are some recent trends that show the younger generation is struggling more in their efforts to become financially independent. Fewer buy their first home in their 20s or even early 30s. Many have large debts from the change of system of student finance, which requires the student to borrow to pay the fees and living costs.

It was a reasonable assumption by previous generations that they would reach retirement owning their own home with the mortgage paid off. They would have a pension paid by their past employer as well as the State retirement pension. They might also have some savings to let them go on a cruise, buy a new car or give something to their grandchildren. Many young people today do not think they will be able to do that. Many do not even expect to afford a home of their own. 

How did many of the now retired Baby Boomer generation end up financially secure? Why the pessimism amongst the young about doing so well? Do enough young people understand that in a usual long life there is time to save, time to make money out of owning a property, time to set up a business?  All these can lead to a comfortable old age. Will families get together to talk through how the different members can reach financial security by helping each other? 

Much of previous wealth creation was supported by judicious borrowing to buy property and other assets, and sensible steady saving of modest amounts which, with the passage of time and the wonders of compound interest, became important sums.

Many young people today think there is a barrier to wealth creation if they are not going to inherit a nest egg from richer parents. Many do not have a concept that we all have balance sheets as well as income accounts. The day to day focus is on trying to ensure their monthly outgoings for life's necessities and pleasures do not exceed their income. Some set themselves targets to save, while others prefer to maintain a lifestyle. Many are forced to turn to consumer debt with the vulnerability to ensuing financial difficulties. 

The income account is a fancy name for paying their wages into their bank account, then drawing it out to pay the mortgage, credit card and food bills. Dickens’ Mr Micawber was an early prudent financial adviser, who told people to spend a little less than their income for happiness. If they spent more than they earned he warned them of a life of misery. Excessive borrowing can lead to bankruptcy, ruling out easy employment and entrepreneurial opportunities. Borrowing can take the waiting out of wanting, but it can also give you a crisis when the lender wants the money back, or the rate environment shifts up. The recent pressure from higher mortgage payments as interest rates rose from a more benign environment highlights this dilemma.

However, the current generation do understand the need to put aside a small portion of their income for future use, where possible, many saving for a deposit for first home purchase. They may join a pension scheme to start saving for an income in retirement. Some may take out a regular savings plan, perhaps linked to a tax-free ISA account, to build up a rainy-day fund. But unless there is the comfort of a large income, these are useful adjuncts but they are not going to make you wealthy any time soon. They are schemes for the patient, which can end up with a good sum in 40 years time but not in 4. 

Older people who have saved for retirement, saved for a rainy day, and bought a home of their own show what can be done by ‘playing the long game’. They may well have a balance sheet with assets worth more than £500,000: a home with mortgage paid off worth say £250,000, a pension pot worth at least the same, and then some additional savings. Retirees in this position can spend the income from the pension and other savings while living rent free in their own home. They can buy an annuity with the pension pot and get a guaranteed additional pension payment each month. It creates flexibility: making assumptions on life expectancy can free up some of the capital in their later years. They can trade down to a smaller property and free some more money.

Young people also have a balance sheet. Too many today have one main item on it, a large student loan. Some do take out a mortgage which permits them to own a decent asset in the form of their own home. Many of the current generation borrow to start or grow a business, hoping that they will be able to repay the loan from growing revenues and end up with a valuable asset. The financial press is awash with ‘start up’ news and fund raising opportunities. However, one of the biggest impediments to financial flexibility is the student loan. In effect, it imposes a ‘graduate tax’. This is now centre stage in the political debate, with the government looking at ways to ease the financial strain. Without some amendment, aspirations to create the financial security of a previous generation are severely restricted.

About the author 

Lord Redwood has been a long-standing member of the EPIC Investment Partners Advisory Board.

Lord Redwood is a well-known commentator on governments and economies, with long experience of investment markets. Trained as an analyst at Robert Flemings, he moved to N.M. Rothschilds where he became a Manager and Director of pension and charitable funds and Head of Equity Research. He was seconded to become Head of the Downing Street Policy unit before chairing a large, quoted UK industrial business. He served as an MP and a government Minister.

In 2007 he set up Pan Asset with a colleague, an investment management business that pioneered active/passive funds and models in the UK. Following the sale of the business to Charles Stanley, a quoted investment manager in the City, he became their Global Chief Strategist advising on non-UK markets and economies. He also ran a demonstration fund for the FT, writing articles about it and illustrating the use that can be made of ETFs in portfolios.

He is now an adviser to EPIC, providing insights into the big investment issues of the day from the debt and spending problems of the major governments to the green and digital revolutions which have so much impact on equity markets. He is a Distinguished Fellow of All Souls College, Oxford, where he helps with their Endowment investments and gives occasional lectures on modern economics and politics.