Is there light at the end of the pension tunnel?
Pensions, miserable pensions.
You can't pick up a newspaper these days without yet another story about pensions woe. It's depressing, troubling and worrying.
Personal finance nerd as I am, I've taken to keeping some of these gloomy articles. Currently top of the pile is one that refers to the impact of falling annuity rates on the income retirees obtain when they turn the proceeds from their pension fund into a lifetime income.
"New shock for millions" is the headline accompanying the piece that says millions of Britons will be £500 a year worse off in retirement because of falling annuity rates. This argument hinges on the fact that once an annuity is bought, you can't switch it for a better one - so a poor annuity bought today represents a poor-value annuity forever.
Quantitative easing is to blame for plunging annuity rates.
Or as Lindsay Tomlinson, chairman of the National Association of Pension Funds (NAPF), says: "Quantitative easing is a key ingredient in a recipe that is destroying the value of the UK's retirement savings."
Low annuity rates are not the only pensions destroyer.
We've got hidden, opaque charges eroding the value of many pension plans (according to the NAPF), volatile stockmarkets undermining the value of defined contribution plans (employer pension schemes where the pots are invested in stockmarkets) and a yawning gap between the assets of private sector defined benefit pension schemes and their future liabilities. This gap is £200 billion and rising.
Enough to make you weep? Of course. But there are positives out there if you look hard enough.
One is the impending dawn of 'auto-enrolment' - when employers will be obliged to enter most workers into either a work pension or the National Employment Savings Trust (NEST).
The process starts in October next year with the big employers and will finish in 2016, when even your local chippy will be required to offer staff a pension plan. Employees, employers and the government will all make contributions.
If the eggheads at the Department for Work and Pensions are to be believed, up to eight million new savers will enter the wacky pensions world for the first time. Pension contributions will increase by between £6 and £10 billion a year. It's got to be good news and we should welcome it. Don't opt out.
The other great pensions positive takes me back to my starting point - annuities. Although annuity values are falling as long-term interest rates remain low, we are seeing improvements in the way pension fund providers (essentially insurance companies) talk about annuity choices in the run-up to an individual's retirement.
Everyone has the right to shop around for an annuity at retirement (the so-called open-market option). But this has often not been properly explained, leading to individuals buying the first annuity their pension fund provider offers them.
Such a purchase has often proved a wrong one, in terms of value (better annuities are invariably available elsewhere) and appropriateness (many annuities are bought either without spouses taken into consideration or health issues assessed).
Now, under a new code devised by the Association of British Insurers, insurance companies will no longer be able to bully retirees into buying inappropriate annuities. Instead, they will have to stand back and let them consider their options.
Hopefully, as a result, more people than ever before will shop around and get a better annuity.
Jeff Prestridge is personal finance editor of Financial Mail on Sunday. Email him at email@example.com.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The National Employment Savings Trust
NEST is a government organisation that aims to provide a simple and low-cost pension scheme designed to give its members an easy way of building up retirement savings. You have one NEST retirement pot for life, whether you change jobs, work for more than one employer at the same time, or leave employment. A NEST scheme won’t allow transfers in and out. From 2012, all employees will be obliged to join workplace pension schemes unless they actively opt out and NEST will be the default fund for those employers who do not create comparable alternative arrangements. It will be phased in from 2012 and all employers will be required to contribute 3% by 2017.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Defined benefit pension
Often referred to as a “final salary” pension, benefits paid in retirement are known in advance and are “defined” when the employee joins the scheme. Benefits are based on the employee’s salary history and length of service rather than on investment returns. The risk is with the employer because, as long as the employee contributes a fixed percentage of salary every month, all costs of meeting the defined benefits are the responsibility of the employer. (See also Final Salary).