Pensions: a ‘woolly’ subject
Here’s a question for you; what could sheep and goats possibly have in common with pensions? No, it’s not a trick question; our pension geeks have the answer. Even though some of them are many years away from their Sunday school days, they remembered the bible story about the sheep and the goats very clearly.
In the story, the people of the earth are divided into sheep and goats and made to answer for their actions at the day of judgement. The sheep, the good people, go to heaven, while the goats, the sinners, are cast down into hell. It’s a pretty grim ending for the poor goats.
Does the story have resonance today though?
When we reach our retirement date, the pension provision we have made leads us to face a kind of mini Judgement day. The contrast between those retiring with a secure final salary pension and those retiring with a money purchase pension is almost as marked and unfair as the fate of the sheep and goats.
The final salary pensioners are the sheep looking forward to a financially secure, potentially long retirement in pleasant pastures. In contrast, the money purchase pensioners, the goats, face having little money in retirement and being dependent on the State.
Here’s why: final salary pensions pay a risk-free usually inflation protected pension, with the size of the pension being dependent on the salary paid when the retiree was working and their years of service. Most of these schemes now only exist in the public sector and the opinion of some observers is that the members of these schemes are not paying enough for the benefits they receive.
Is that a fair view? A recent Office for National Statistics report estimated that taxpayers will have to find the equivalent of £33,000 for every household to pay for “unfunded” public sector pensions (1). Unfortunately, most public sector pension schemes and most notably the State pension do not have any underlying investment. Public sector pension schemes rely on recruiting new employees to pay out returns to pensioners. Much as the notorious American gangster and swindler Charles Ponzi did (from whom the phrase ‘Ponzi scheme’ originates) with investors.
The funding for retired public sector workers comes from the contributions made by currently working public sector workers and other tax payers. If the level of contributions deducted from public sector workers is raised too sharply there’s a danger that people will leave the scheme, and then the whole burden will fall on other tax payers.
So what has gone wrong with pensions and the promised land of a golden retirement?
The short answer is life expectancy. We are living longer and not saving enough for our old age. The only solution seems to be that we need to either save more, work longer, or both.
Final salary schemes, where the whole risk of funding falls on the scheme provider, will increasingly be replaced by money purchase schemes, with the risk being transferred to the worker. A money purchase pension relies on saving as large a pot of money as possible while working and then at retirement, swapping that pot of money with an insurance company for a secure income for life.
The bigger your final pot of money, the bigger your retirement income. So the earlier you start building up that pot of money, the more time you have for the miracle of compound interest to increase your fund.
As well as time, other factors determining the size of your retirement income are the amount you put in, the amount your employer contributes and the help you get from the Government in the form of tax relief. What also matters are the charges made by the pension provider, your financial adviser and the performance of the underlying investment.
Who you choose as your financial adviser is entirely down to you; by choosing a good independent financial adviser, you should get the best deal when it comes to charges and stand the best chance of finding an investment that has the potential to perform well.
For a free pensions review, call Andrew Stallard on 0845 230 9876 or e-mail firstname.lastname@example.org
1. Daily Telegraph