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The Truth about Pensions

On the basis that you have shown interest in property as an investment, and knowing that the major reason for buying property is to ensure financial security in retirement if not sooner, we thought it would be interesting to take a look at one of the main alternatives to property - pensions.

A lot has been written in the press over the past few years about pensions and in our opinion almost all of it has been misguided, misleading or worse. The truth is that despite the convenience and sensationalism of the story, its much more acceptable to blame others for our misfortunes than take responsibility ourselves. We have not been simply ripped off or sold out, the truth is that the average worker in this country has never been able to look forward to anything other than poverty in old age and the reason is simple - you can’t get a pint out of a half pint pot and pensions have never been adequately funded for all but a select few.

The only way to fund a substantial income in retirement using a pension is to pay in a substantial amount of money into it while you are working - but how much? Well that depends (in the past actuaries have made their funding predictions based on a 1% positive yield gap between investment returns and inflation which means real growth of 1% - !) but you can assume a minimum of 15% of earnings for forty years in order to provide 2/3rds of final salary in retirement at age 65. Want to retire earlier? Well fine then for every extra year you need to increase your contributions exponentially (which means by a lot). So how many people do you know who have made this type of sensible provision from the age of 25 at the latest (every year of delay reduces the final pension exponentially, you get the picture)?

This picture of reality, the hard simple facts, begs the question where did we get this impression of a fading pensions Nirvana? All the misunderstanding, myths and lies had to come from somewhere didn’t they? Yes, they did and like all conjuring tricks once you know how they work you can’t believe how simple it all was and the magic of the trick just fades away. So how was it done? Well as usual there is a kernel of truth to support the myth of the golden age of pensions. We all know that civil servants have the best pension’s right? That’s because you and I pay the contributions whatever they are. A civil servant who works faithfully for their masters for forty years can expect about 2/3rds of their final salary as a pension when they retire and they will also get inflation linked increases for the remainder of their lives (couldn’t have them suffer a reduction in their standard of living now, could we?). Of course when they die their spouse will also be entitled to a generous pension for the rest of their lives and just in case they don’t make the forty years of hard labour through illness accident or premature death, they and their families will be taken care of. So it will come as no surprise that very few Civil Servants leave their employers early, they are even apt to complain that they have been put in ‘golden handcuffs’ in simple terms and though they may earn more money in the private sector, their pension cannot be replaced.

Now private industry - even big business could never compete with these arrangements which left them with a dilemma; how to attract workers and appear to compete while keeping their costs under control. During the post war boom big companies like ICI were persuaded by social thinkers of the time that in order to obtain the loyalty of their workers they would need to offer generous pensions similar to the ones enjoyed by civil servants. The problem these companies had was how to fund the schemes on an affordable basis and still be able to offer attractive headline benefits. The solution presented itself in the form of a clever cosmetic facsimile, enter the actuary, that master of the numerical slight of hand. Want to offer your employees generous pensions? Don’t want to pay much for them? No problem sir just leave it all to us!

So how was this financial equivalent to filling a pint pot with one measure taken from a thimble achieved? Simple really, just penalise the early leavers. Early leavers? Who are they we hear you thinking, early leavers are workers who leave their employers early which in pensions talk means before they have completed forty years of service! So that would mean virtually everyone then! That’s right, give that man a cigar, and go straight to the top of the class.

What this all meant was that although you would get your 2/3rds pension if you worked for one of these employers for forty years without a break, if by chance you were to move jobs even once or twice during your career, even if every employer you worked for ran a similar scheme, your final benefits would be devastated - you might get a third of what you would have got if you hadn’t moved. Did workers understand this? Was it all explained to them? Like heck, the whole house of cards depended on workers naively moving jobs blissfully unaware of the dire consequences these moves would have for their future financial security. The only beneficiaries of this process were the relatively tiny group of workers who did stay and for them the system worked fabulously well, after all their fat pensions were being subsidised by the poor suckers who weren’t around to complain about it.

Not surprisingly this dubious situation could not go on although it was not our politicians but their much maligned European counterparts who finally called a halt to the proceedings. In examining our way of doing things these anomalies were exposed and an edict sent out from Europe in the early 80's that things would have to change. What this meant was that in future early leavers would have to have some protection for the value of their pensions, meaning that the value of their pot on transfer could not be frozen as had been the case until then; companies would be forced to re-value the pot every year by the rate of inflation or 5% whichever was the higher. The effect of this ruling was devastating to the companies concerned although they did not realise it at the time. What it meant was that in order to fulfil the obligations of the pension funds the company's contribution would have to sky rocket to levels that would become unaffordable and could even bankrupt the company itself. Ever since that time these companies have been trying to back peddle out of their obligations either by encouraging transfers that are not in past members interests, or by reducing scheme benefits, making them closed to new members or even trying to wind them up altogether.

Having dealt with Civil Servants and big private companies there is still one further category left to consider, all the workers who aren’t civil servants and don’t work for big companies; what about them? For a long time there has been an old age pension based on a meagre amount equivalent to less than what is needed to stay above the poverty line. There are also means tested supplementary benefits which can be claimed by those old people who qualify in line with our country's commitment to the principles of a welfare society. In other societies these poor old people along with the sick and mentally ill are left to fend for themselves but in the UK we rightly look after them and the cost is met from taxation. In the 70's the then Labour government decided to supplement the old age pension by an earnings related pension, offering up to an extra 20% of earnings paid for out of national insurance contributions (no investment of the contributions, just money in, money out which means today’s workers pay the pensions of today’s pensioners. Of course with an increasing number of old people coming from the baby boom generation it doesn’t take a genius or an actuary to do the math). While this was great in principal, because it offered guaranteed extra earnings on an index linked basis, it still had to be funded and it turned out to be unaffordable, having to be watered down before anyone actually took the full benefits!

Until now we have been considering pension arrangements which share one fundamental thing in common, they are totally paternalistic in their principles. By this we mean that we don’t have any choice or say so, they are provided for us by our employers or the government and we merely participate for good or bad. It may seem condescending to treat us this way, it may seem unfair but as yet we haven’t looked at what we do when left to our own devices. For those of us responsible enough to take an interest in our future financial security there has always been ways in which we can save money by means of a pension. In the case of the employee already in a final salary scheme it has been possible to make additional voluntary contributions and in the case of the self employed or those whose employers don’t offer pensions it has been possible to start a personal scheme of their own. Of course these schemes do not offer guarantees, their worth is determined by how much is put in, how much the contributions grow by and how much the scheme charges.

The incentive to take out these schemes has always been there in the form of tax relief on contributions and on gains, making pensions a tax effective long term savings vehicle. (Of course it is true that Gordon Brown in his enthusiasm for stealth taxes chose to put a stamp duty tax on pensions, despite the obvious under funding he couldn’t resist it) Notwithstanding these benefits, we have failed to take up these schemes in droves and where we have taken them up the amount we put in is so pitiful we may as well not have bothered.

It is not surprising that left to their own devices most people don’t do much, if anything, about pensions; after all it’s a no demand market place, and who do you know who wakes up in the morning, stretches and says “today I’m going to sort out my pension” - most people don’t understand the need for a pension and are unaware of the problem until its too late; you can’t go shopping for something you don’t know is there! In the main those people who have taken out these types of arrangements have been sold them by salespeople. Not surprisingly the insurance companies who marketed these schemes made sure they charged a fortune which resulted in the cancelling out of the tax relief benefits and relatively poor value and poor returns. The reaction to this situation was to regulate the industry, get rid of almost all the salespeople and leave us with better value schemes which no-one knows anything about because there are no salespeople left to tell us. (Even the remaining salespeople are not likely to tell us unless we ask as they are forbidden from cold calling and earn hardly any commission when they sell a pension these days anyway, so little that they often have to charge an additional fee). Even the few people who take up personal pensions of their own accord and fund them to the max are likely to be disappointed. After all in the main they are regulated collective investments, which means stocks and shares, gilts or cash, not exactly first choice vehicles if you want control over your financial destiny.

So returning to our theme, what is the real truth about pensions? That apart from civil servants and a small group of big company employees, the average worker in this country never had much of a pension anyway, that in the past we have been mislead and treated like children not responsible enough to make our own decisions, that left to our own devices we don’t make sensible provisions anyway.

Is there a solution to this mess? Should we all give up on the future and live for today? Should the Government force us to save for our retirements? This last suggestion would certainly be in line with the current policy of removing personal freedom wherever it is still found. No, none of these things will work; in the long run it is only through good communication and education that this issue will be solved. What people are entitled to is the clean simple facts and the means by which they can make their own decisions in their own way. How do we achieve this? Simple really, instead of teaching meaningless out dated academic subjects in our schools to the exclusion of everything which might be useful in later life, we should put pensions and personal finance on the curriculum. Oh, and whilst we’re at it we can also include relationship building and the art of communication as well. Instead of constantly fighting human nature or ignoring it, we need to face the facts, confront the conflicts of interest that are stopping us move forward, and deal with them before they become so embedded in the next generation its too late.

For this Nirvana to be achieved we would need to attract quality people on a committed basis to become teachers in the first place. In order to do this we would need to elevate the status of the teaching profession and pay them a decent wage so they want to carry on doing the job. Please forgive the rant, we know its only day dreaming. What we have suggested could never happen as things stand today, our leaders are well meaning but lack the resolve to lead, our system of Government encourages the status quo and the principals of compromise above the achievement of any goal no matter how beneficial the change may be. We always end up with a camel, never a horse and sometimes we could be forgiven for thinking we are part of a twitching body with no head to guide it.

Yours sincerely

Choices Acquisitions and Investments
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