Tuesday, 26 May 2009

Pensions are not optional extras

An interesting survey in today's Times suggests that very few people are making a serious effort to provide themselves with a pension. Although you can't draw any conclusions about the precise proportion of people who are not making their own provision from a snap-shot survey of fewer than 1,400 individuals, the results point towards something of a problem. It was found that almost half of those aged 41-60 are not currently paying into a pension fund and barely a third of those under 30 have a pension. Of course we were assured that this would not happen when the government introduced "stakeholder pensions", yet another of their gimmicks that has sunk almost without trace after costing millions in "consultation" and feasibility studies. Now they are planning a new scheme known as the "personal account". I knew nothing about this until reading the article in the Times, although that is probably a failing on my part.

Pension provision is a huge problem in this country because of institutionalised reliance on the welfare state. We are told the State will look after us from cradle to grave. In relation to pensions the cost of providing a modest subsistence level of income for all is absolutely enormous. Both my regular readers will know that when the state old-age pension was first devised it was to be funded by National Insurance contributions by which everyone would pay into a massive savings pot which would then be dipped into to pay us a modest weekly sum when we reach the defined retirement age. Right from the beginning there was a problem with this because payment-out started immediately and used such a large proportion of NI contributions that the pot never grew. In addition, once government had received money it could not resist the temptation to spend it. It was, therefore, hardly surprising that NI contributions quickly became just another form of income tax. I believe they are still accounted for separately from receipts from income tax itself, but that is just a bean counting exercise; the reality is that all the money is treated as being available for current expenditure and any dream of a pension pot being created evaporated many years ago. What should be quite a sensible arrangement of compulsory payments into a fund from which pensions will be distributed is in fact a giant Ponzi scheme in which the return on our "investment" is paid out of other people's "investment" and there is in fact no investment at all.

Nowadays the basic state pension is added to by various means tested top-ups and some lump-sum payments. Lying behind it all is the presumption that the first port of call for every retired person should be the State. It is rarely mentioned that the state old-age pension was originally extremely modest - well below subsistence level, was paid at age 70, was means-tested and was only paid to those of good character. It was so modest that anyone who thought they might live beyond 70 (which ruled out a vast chunk of the population in the early 20th century) was encouraged to make their own provision. Over time the ever-growing welfare state has shifted perception. Now a shortfall between the value of the state pension and the real cost of living is met with cries of "I paid my stamp, I demand a proper pension". Against this background we find a widespread resistance to making personal pension arrangements, it seems to be viewed as the wrong thing to do because we have already paid for a pension through NI contributions and making our own arrangements is letting the government off the hook.

The new scheme, due to come in in 2012, is nothing other than compulsion to take out a private pension if you have not done so already. It is probably sensible because the alternative is to force people to do it by simply cancelling the state pension, which would be political suicide. The irony is that the State machine encouraged the little people into an attitude of reliance and can only reduce reliance by using the force of the State to make them do so.

I don't know how much should be set-aside by individuals to allow a sufficiently large pot to build up so that it can be relied on for their income in retirement, I have read estimates between 5% and 14% of annual gross income, perhaps 10% is a fair average. That might seem a lot but average life expectancy now suggests the likelihood that most people will draw a pension for at least ten years following a working life of about forty-five to fifty years. If you were paying into the pot for, say, forty years and your income increased steadily throughout that time, the sums you paid-in at the beginning will be very small in cash terms compared to what you paid-in at the end. The smallest sums will have had time to grow but the largest sums will not. Assuming real growth of 2% a year, £100 invested over forty years turns into about £220, over thirty years it would grow to about £180, almost £150 over twenty years and just £120 over ten years. If your pot is used to buy an annuity giving a 5% yield, a pension of £10,000 a year requires a pot of £200,000. It takes a lot of investment to build a pot of that size even over forty years yet it will give you less than £200 a week and if you want the payments to be index-linked throughout your dotage the initial pension will be well under £200 a week. This is a very rough-and-ready example, but it gives an indication of the amount you need to accumulate through your working life if you are to have a bearable pension at the end.

To my mind, pensions are a good illustration of what happens if you don't live within your means. Perhaps it is more accurate to say that our means must be measured by taking into account the amount we should set aside for a pension. We are now in remedial territory. The huge black hole caused by decades of inadequate personal provision is being addressed and the cost will be a reduction in disposable income for all those who do not already have an occupational or personal pension scheme. It comes at a time when remedial therapy is also required for government expenditure because of past mistakes. By 2012 the recession will have ended and modest economic growth will probably have resumed. Then the new compulsory pension will come into effect, initially requiring employees to pay 1% of their gross income into the pot then 3% in 2013 and 5% from 2014 onwards. So disposable income will be forced down, for good reason, just as the economy is picking up. But, it will mean that disposable income will then be measured more realistically than in the past.

Putting off the cost of pensions is a form of credit just as insidious as equity-lending secured against perceived increases in house values. It encourages a false assessment of real wealth and requires a painful adjustment at a later date. I'm all for adjustment where it is needed and for painful adjustment where that pain cannot be avoided. All those in the Times survey who said they are not currently making any provision for a pension are simply putting off the day they have to do so and making that day more painful. As much as anything it is a matter of culture. To date the culture has been for the State to pay for our old age. That aspect of the welfare state has been exposed as rotten to the core. The initial system was right, the way it has been altered over the last century has led to an unaffordable mess that cannot deliver because it has made it impossible to deliver by fostering a sense of entitlement and reliance wholly out of proportion to the practicalities of the issue.

The ethos behind the new regime is something I find very encouraging. Pension provision is treated as a normal cost of life for the individual to bear just as he bears the cost of food and clothing. It is not a matter of shifting the cost from the taxpayer to the individual because the taxpayer would never be exposed to the cost of a decent pension for all. It is far more subtle than that. The paltry state pension will remain and the new system is about something different, it is about making people face up to the reality that a decent income in retirement is attainable, that it must be paid for and that the more they pay the more they will receive (subject, as always, to the ups and downs of any investment scheme). It marks a shift in emphasis towards self-reliance.

I am a great believer in promoting self-reliance because I have a great belief in the ability of people to provide for themselves if only the State would get out of the way and let them do it on their own terms.


Mark Wadsworth said...

Oh dear, it looks like you have fallen for most of The Big Lies* when it comes to pension provision - the whole thing is a scam to direct money into the 'pensions industry' who cream it all off as commissions and charges.

These f***ers aren't getting a penny of my money, that's for sure, you do better to pay off your mortgage ASAP; then put money in the building society (or buy shares yourself if you're really adventurous); and finally work as long as possible.

* For example, if everybody invested in a pension in the amounts that you suggest, there simply would not be enough shares and bonds to go around - share prices would go through the roof, that's all, and the payout in retirement would be miserable.

Or, for another example, it is not the mere existence of a state pension that discourages saving - it's all the means-tested crap. Is it so terrible for (say) 5% of GDP to be raised in taxes and paid as a Citizen's Pension of £125 (or whatever) to all over 65s? (and yes, the retirement age is far too low, different topic).

The Great Simpleton said...

Mark, if all that money goes in to BS it still needs to find an end investment so the same problem with finding enough shares exists.

On the ponzi scheme side of NI, I'm sure I read somewhere that Bevan was against those who were already retired getting paid from the pot. But being typical Labour they couldn't take the hard decisions and pay them out of some other pot.

One thing that does piss me off is the knowledge that I will pay taxes out of my savings when I retire to fund someone who didn't bother. Talk about moral hazard!

Finaly, BBC news did an article on this last night and I was surprised at how many professional people, who appeared to be well paid judging by their houses, had no pension provision. One couple were honest and accepted they would be working in to their 70's.

Mark Wadsworth said...

TGS, if the BS can't on-lend the money, then you just earn less interest, but at least you aren't making a loss (unlike with pension commmissions and share-related losses).

You may well dislike paying for other people's pensions, but the moral hazard is made worse by the fact that the pensions credit is means tested.

Like I said, I am a professional person, I earn well, spend modestly and so on, but these pension bastards aren't getting their hands on my money.

KMcC said...

MW - do your objections also apply to company pension schemes?

Mark Wadsworth said...

KMcC, as to defined contribution, it makes no difference whether legally you or your employer contributes.

As to defined benefit, these schemes were madness anyway - the employee will always be suspicious and probably undervalue what he might get*, and the employer has to be prudent and overvalue what he will have to pay, so there is a colossal mismatch and misallocation of resources (plus massive running costs).

This adds to instability of stock market, as all plc's invest in shares of other plc's, so if shares fall, the deficits rise, so net assets of plc's fall, so shares fall further ad infinitum.

* i.e. employee worries about employer going bankrupt and not paying, so the government invents the Pension Protection Fund that is basically a tax on well funded schemes to subsidise under-funded schemes, adding another layer of moral hazard.

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