It was 1908 when the UK Government first took an active role in pension provision. A state pension of 5 shillings a week was awarded to males who reached the age of 70. But before you start marveling and blowing fanfares at such magnanimity, the life expectancy of the common man was apparently somewhere in the region of age 47. It was a token gesture attainable only by the privileged few and those with ‘special mightiness’. Prior to this some groups of people were already receiving retirement pensions. These were civil servants, policemen, nurses and the like, plus a few company pension schemes set up by the more enlightened industrialists. Pension provision really took off in earnest after the Second World War. Even then it was less of a concern for universal welfare than a defence against a real and widespread admiration for communism, in a messed-up post-war world. This period proved to be a golden age for pensions. The 1948 National Insurance act provided state pensions for all, age 60 for women, 65 for men. There was a corresponding growth in occupational pensions. These were gold-plated final salary schemes provided as part of the benefits package; juicy temptations to attract and retain the right people. Who wouldn’t want to retire at 50 and have a long and well-funded retirement? A tasty carrot. But with carrots come sticks. They could also be used to control and dismiss those disinclined to tow the company line. Yes, they were wonderful, but also open to abuse. Robert Maxwell? You get my drift.
But there was a problem. People stopped dying and started to live longer – too long. And now, pension provision is in a right mess. Not only the state scheme, which appears to be completely unaffordable for a nation that is broke, but also private schemes that are being torn apart by greed, incompetence, dodgy actuarial projections and artificially low ‘emergency’ interest rates. At the moment there are two basic types of pension – the defined benefits and the defined contributions. The former is the company pension – your benefits are defined as a fraction of your final salary for every year of service. Historically, this could be taken from age 50. The incentive to work beyond this relatively young age is evident – more years worked means more fractions, and, along with those annual pay rises (remember them?) and promotions, that final salary would be bigger. There were variations, although a typical fraction would be 1/60th. Thirty years service would give a retirement on half final salary. The scheme would be funded entirely by the company (non-contributory), although sometimes an employee would be asked to make a modest contribution – maybe 2% or so.
With the other type there is nothing defined beyond the contributions made, and they are paid into a pot by the individual, and by the employer too if it’s an occupational scheme. That money is invested and, upon retirement, an annuity is purchased with the entire lump sum or with a smaller lump sum after having taken optional 25% tax-free cash. Again, the longer one works, the bigger the pot, the shorter the retirement, and so the better the annuity rate. You choose! But there’s a but, a big one – and nobody likes a big but. Defined benefits, final-salary schemes have gone out of fashion. They are being closed down faster than railway lines in the Beeching era. Why?
Before answering that, a look at where the risks and responsibilities lie will be instructive. With the final salary scheme, the entire risks and costs are borne by the company that initiates and funds it. There is no risk to the employee, as long as that company remains solvent and its pension fund is suitably protected. On the other hand the risk of the defined contribution scheme is borne entirely by the employee or private individual. In the case of a company pension of this kind, it is a pot of money that grows through contributions made by both the employee and the employer. At this point the employer can wash his hands of any further responsibility. All those contributions go into a pot bearing your name. It is then invested for you, either in a default fund, or in a range of funds of your choosing. If said funds do well, then not only will your pot grow through continuing contributions, but also by investment growth. And then, when you’re ready, once you are at least 55 years of age, you can take that money and, yippee, the world’s your oyster. In olden days of yore B.O. (before Osborne), the law required that an annuity must be purchased. But no longer. Now you can do what you like with that money – buy a Ferrari, a penthouse, spend it on wine, women and song and waste the rest. Fantastic! But is it?
Let’s consider. Firstly, the pension scheme itself will be administered by a pensions company. Mine was with Friends Provident by whom I was employed. They take a percentage of all contributions. The remaining money is handed over to one or more fund managers. They too take a percentage, known as the Annual Management Charge (AMC). This will typically be from 0.5% to 2%. If the fund does well, then this might be a price worth paying. But then most funds are a bit of a rip-off. You see, most are simply tracker funds – they’re set up to track a given index. So for example, if your fund tracks the FTSE 100, then all you need to do to see how well it is performing is to know what the index is doing. The fund manager does nowt for his money. The other type of fund is the active one where a fund manager trades with your money in an attempt to beat the market. These cost more, but there is little evidence that they generally out-perform their cheaper relatives. They jolly well ought to! In both cases, the fund manager gets a guaranteed income, and it’s never performance related. So, one way or another, you end up with a lump sum to fund your retirement. Then what? This is where the sharks start circling. These are the so-called financial advisors, usually known as IFAs. You can avoid them by simply accepting the pension provider’s in-house annuity. These, sadly, are often uncompetitive. So shopping around can be valuable. The IFA, if used, will take a large commission and won’t necessarily provide good advice.
Annuity rates are also fairly volatile, often driven by interest rates and inflation. Get the timing wrong and you will be stuck with a poor income for the rest of your life. Do something else with your pot and any advice sought will cost greatly. Of course, you don’t need an IFA. You could financially educate yourself and this could pay vast dividends. But the world of finance is often viewed as being overly complicated and so lazy people don’t bother. IFA customers are easy prey by definition. You don’t need to look too far to find some gut-wrenching stories that have emerged from the closure of the British Steel/Tata Pension Scheme.
My point? The pension company gets an income, the fund manager gets an income, an IFA gets a commission. In fact everyone is guaranteed to get something from this thing except for the person funding it. They work an entire lifetime, saving up for their retirement, yet they’re guaranteed nothing. They fund other people’s lifestyles along the way but usually discover that their own retirement bears little resemblance to the images of luxury and glamour depicted by the glossy sales bumph.
So when we return to the question of why final salary schemes are closing down in such numbers, you might start to see some clarity. Why would any company bear the responsibility of funding pensioners for ever longer lives when they can be fobbed off to fend for themselves? And be fleeced along the way. The justification is the infamous hole in the pension fund. In many cases this hole is purely theoretical. It’s a calculation of future responsibilities based upon mortality rate projections. But since when has any projection been accurate? Slight adjustments to the projection can often make the hole disappear. But it’s a convenient tool.
So where does this leave funding for your old age? Also in a hole. With ever fewer companies providing suitable retirement benefits and employees increasingly realising that their contributions may never deliver on the promises, a kind of impasse has been reached. The Government reaction? – We’ll force people to save. We’ll call it Auto-enrollment. Opt-in will be the default position for all employees, and any who opt-out will be made to feel irresponsible.
What about the state pension? From ages 60 and 65 we’re nearly back to the provisions of 1908 – pensions for men who reached age 70. Along the way women will have gained pension equality – from no pension, to superior pensions, to equal pensions. But the country is broke and one can’t help but think that a state pension will come along with the Royal telegram: and not before. The Government (almost) can’t and wishes it didn’t have to; corporate Britain won’t; the financial services industry is not fit for purpose; and so the common man borrows and spends today, borrows more tomorrow, spends more, often simply to survive, enjoys what he doesn’t own and refuses to think about the future, let alone plan for it. Why should he fund someone else’s today for mere promises tomorrow?
The conclusion? Pension provision is doomed. Aye! All doomed! Like the rest of this world. Unless the saver/pensioner and his interests are put first, at the centre of a system built on trust, there can be no solution. Alas, everyone lies to everyone else, nobody trusts anybody. Fortunately the provisions for our future are much brighter. In a world with neither aging nor pensions, Psalm 37 contrasts the prospects for the meek against those of the evildoer. It’s a beautiful Psalm that provides comfort now and a hope for a perfect future that doesn’t rely on human governance. Enjoy…
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