Do young people need to change their financial priorities?
What’s more important to young people, a pension or a property? According to a recent report by financial services consultancy MRM of 1000 young people aged between 18 and 25, it’s property. Just over 32% of those surveyed said this was their top financial priority. On the other hand, just 7% said the same about a pension. Conversely, 21% were prioritising clearing debts and around 20% were saving for something specific, such as a holiday or a car. But with more and more young people locked out of the property market and lacking the means to save for a deposit, should they be focusing on saving for a pension instead?
Let’s start with property. The great British dream of owning a home clearly still reverberates with many young people today. However, it’s a dream that’s increasingly difficult to realise. In many parts of the UK we have seen huge rises in prices relative to wages in recent years and this in turn has increased the size of deposit most young people need to secure a mortgage. According to The Money Charity, it could take 22 years for a person on an average salary to put aside enough for a deposit (assuming they put away 5% of their salary monthly). That’s a lot of commitment to saving before you can even be sure your mortgage application will be accepted. Saving is no easy task either. In today’s low interest environment, it is even harder to accumulate and grow wealth. These difficulties are compounded even further when you consider one of the more startling findings of the MRM study: half of those 18 – 25 year olds we surveyed are not saving at all simply because they don’t have enough disposable income to do so.
So looking at it this way, if you are on an average income, you face a hard few years of saving before being tied into an expensive mortgage on a property. Of course, if buying a house is an overwhelming desire of yours and you’re prepared to take on some headwinds, that’s fine. However, if you are looking at a prudent investment, it may not be the best option.
Should young people be prioritising pensions? While most defined benefit schemes are now closed to those outside the public sector, defined contributions schemes have made a comeback with the advent of auto enrolment. By the middle of 2017, even the smallest employers will be required to offer a scheme to their employees, complete with contributions, which will rise over time.
Furthermore, the new Lifetime ISA (LISA), which was unveiled in the recent Budget shows the government is beginning to recognise the financial pressures young people are facing. By enabling under 40s to use this to save for either a pension or a mortgage and offering government matched contributions on it, it offers a least a partial solution to the twin dilemmas of whether to save for a pension or a mortgage. However, there is a risk that young people will turn away from auto-enrolment, which is more financially advantageous, in favour of the flexibility of LISA.
There are clear benefits to this, particularly over the long investment horizon which is associated with pensions. First thing to consider is a pension can grow without an employee doing much with it. The employers’ contributions are essentially free money, and saving regularly from an early age (the minimum age for auto enrolment is 22) allows you to build money up through compound interest – interest earned on reinvested money over a period of years. In fact, research agency CLSA found that someone who saves from age 21 to 30 then stops will have a bigger pension than someone who saves from ages 30-70 (£553,000 compared with £534,000).
The difference in the two amounts is £19,000, which is a staggering amount of money – not much less than the average deposit on a mortgage, which has been at around £27,000 for the last few years! So should young people give up their dream of owning their own place and focus on funding a comfortable retirement? Well, it’s not as simple as that. The inflexibility of pensions – the fact that you are unable to access your money for up to 30 years – is also a major turn-off. Equally, constant Government tinkering hasn’t helped, with trust in the future of pensions at an all-time low.
While buying your own place can be a slog, once you are there, whatever happens, you do have a fairly liquid asset. Those looking to sell their property and downsize on retirement in order to release equity will find it a major source of capital and a helpful supplement to a meagre state pension. This could make the difference between a financially comfortable retirement and an uncertain one.
So while it’s up to the individual to decide which route they take to financial freedom, missing out on years of easy free money is certainly not to be sniffed at.
MRM will be hosting a panel debate on its recent Young Money report with the Chartered Institute of Securities and Investments on Wednesday, 6 April from 6:15-7:45pm. For more information, or to come along, please email firstname.lastname@example.org