11th October 2011
Whatever was intended fell victim to the law of unintended consequences. And there was a transfer of wealth from the middling and less well off to the insurance companies, investment funds, and City firms whose executives rewarded themselves with bonuses for doing not much on top of generous salaries – often retaining gold-plated pensions for themselves. Last month, The Financial Times quoted a Money Management magazine study which found that pension savers could lose as much as 39% of their nest-eggs in charges and fees.
This is not true universally, admittedly, but only a minority can claim their retirement provision if they stopped working today is better than it would have been for the same person a generation earlier in 1986. And that's before going into the thorny issue of the age at which someone makes their farewell to the world of work.
What went wrong?
Last week The Guardian reported that private pensions were worth nearly one-third less than for someone of the same age who had put away the same amount of money over their working lifetime than just three years ago before the Lehman Brothers crash. Figures cited from accountants PricewaterhouseCoopers show someone with a private pension pot of £300,000 could get an £18,500 a year pension against £22,500 three years ago. And that assumes the pension plan itself has not fallen in value – many with an equity element have lost up to 20 per cent this year alone.
Most commentators blame all this on the "pensions crisis" – we're living too long, saving too little while investment markets go south in tandem with annuity values.
But why did a pension scheme that was once envied in Europe and North American turn into a "crisis"? Substituting the word "choice" for "crisis", however, can be illuminating. For as Big Bang, with its new ways for the City, produced a number of choices, what has happened to pensions reflects choices by those in a position to choose, but leading to routes labelled "inevitable" by the media and politicians.
Big Bang – Small Pension Funds
City Big Bang brought an emphasis on short termism as investment banks took over from staid merchant banks and partner-run stockbrokers.
Firms were encouraged to promote shareholder value above the needs of other stakeholders including employees. Stock price gains determined boardroom bonuses. A prime way of ensuring higher share prices was taking a "contributions holiday" after declaring that the pension pot was fully or more than fully funded.
These "savings" were often distributed to shareholders via special dividend payments – again a way of ensuring a strong share price and higher executive remuneration. But when markets turned down after 1999, the funds had no reserves to call upon. And Gordon Brown's pensions raid which came into force in 1998, diminished the level of income funds could expect from equities by removing tax relief on dividend payments.
This led many into abandoning equities for safer bonds, dealing a blow to the shares market which still remains. It was, after all, pension funds which had created the "cult of the equity" back in the 1950s. Now, what remains of them buy gilts on virtually invisible yields – this RBS report sets out the long term bear case for equities.
At the same time, financial engineering encouraged by a post Big Bang City of London encouraged management buy-outs and private equity. Once a company changed ownership and control in this way, the first target was the pension fund. Could it be raided? Yes was generally the answer.
The next step was to save more money by closing funds at first to new entrants and then, in some cases, to existing members. Again, this was applauded by commentators, few of whom had to worry about their own retirement incomes. After all, they enjoyed twice as much tax relief on their contributions as the basic rate taxpayers who worked for them.
Crisis or self-inflicted choice?
Other countries face similar demographic and investment difficulties. And they manage to pay better pensions.
In late 2008, consultancy Aon reported that UK state pension provision was the worst in Europe with an average 17% of salary paid – compared with 34% in the Netherlands (the second worst) and more than 50% elsewhere. There are obviously other factors involved such as alternatives to pensions and the amounts paid in contributions and taxes.
But the clear advantage of state compared with private pensions lies in the absence of investment risk – they are also cheaper to run. The UK personal pension market turns pension buyers into unwilling investment managers. It works for a minority – some even view their Self Invested Personal Pension (SIPP) as a hobby. However the majority don't want to know. And even those who are savvy about investing face the annuity dilemma on retirement where rates depend on interest levels and a series of internal charges, which are not revealed.
For most of those involved in pensions, the only solution is to suggest retirement income buyers lock even more away into pension plans – this at a time of fast rising prices and earnings which are stagnant at best. Some hopes are pinned on Auto Enrolment, a scheme which makes opting in (and collecting an employer contribution) the default position. It starts with the largest companies in twelve months' time. Respected pensions commentator Ros Altmann believes it won't work, however.
Will the maths add up? A fund growing by 5% a year will only hand 3.5% to members after costs.
Pensions have to be paid for. But how?
It is universally agreed th
at pensions cannot be conjured out of thin air. But state provision is generally lower cost – and it removes the downside risk factors.
Personal pensions protagonists argue that higher state pensions equate to higher taxation. Probably true. But auto enrolment is intended to have a measure of compulsion due to automatic opting in. If the amount paid into personal pensions went to taxation, would those on average incomes be worse off in retirement?
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