Pensions must be more user-friendly to restore trust
The latest official statistics reveal the number of people in the private sector with an employer pension is at a record low, as confidence and trust in pensions have collapsed. Only a few years ago, our pension system was the envy of other countries; now it is in crisis.
Many workers reaching retirement are finding their private pensions have not delivered the pension income they expected.
Disappointing investment returns, high charges and plummeting annuity rates - which give you an income from your pension - have left many people unable to afford to retire. In just three years, annuity rates have fallen by more than 20%. On top of this, EU regulatory changes soon coming into effect could depress annuity income further.
And those who did not want to buy an annuity have also been hit. The maximum income that can be withdrawn from a capped drawdown fund has fallen by more than 20% in the past three years because of QE and Treasury rule changes.
It is not only defined contribution pensions (the most common type of employer pension scheme) that have problems. Defined benefit schemes (the more generous type) have been hit too.
Falling gilt yields have led to soaring pension deficits. Even though companies have poured huge sums into their pension funds, the rise in liabilities resulting from falling gilt yields has led deficits to keep on increasing. This is becoming a ‘death spiral' for many schemes.
As deficits grow, companies must put more money into their pension schemes. This means there's less to invest and it weakens their business. It's a vicious circle. Compounding these problems, banks are increasingly unwilling to lend to companies with pension problems, so their business is weakened further.
Amid all these pension problems, the government has now rolled out its new policy of auto-enrolment, which will force employers to provide and contribute to a pension fund for all their workers. Some 8% of earnings will be going into a pension fund each month; 4% from each worker, 3% from employers plus an additional 1% from tax relief.
Workers are able to choose to opt out but it is not yet clear how many will do so.
The pensions landscape could change significantly as a result of this new policy, but without radical state pension reform, it may not be safe to automatically enrol all low earners into a pension scheme. This is because the state pension system penalises private pension income, leaving pension savings unsuitable for large sections of the workforce.
Worryingly, plans for a flat-rate state pension that would remove the mass means-testing of pensioners have yet to be properly put forward and there have been rumours the policy may not make it onto the statute books. Without such radical state pension reform, the policy of auto-enrolment could end up as another pension mis-selling scandal.
In fact, there could be many advantages to improving pension flexibility. Many people might be happy to start saving, but will be frightened to lock their money into a pension, which cannot be touched for decades. Policymakers treat pensions as the only worthy way to save for the future, whereas there are other valid savings vehicles that could benefit the economy.
Saving in an ISA, repaying student debt or saving for a first home could form part of auto-enrolment, but at the moment anyone saving outside a pension will lose their employer's contribution.
Making pensions more user-friendly could be a major step forward in restoring a retirement savings culture that is so urgently needed. The sooner these issues are addressed, the better all our futures will be.
Dr Ros Altmann is director general of Saga. She is a pensions expert and adviser to the pensions industry. Email her at firstname.lastname@example.org
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
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.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
A type of derivative often lumped together with options, but slightly different. The original derivative was a future used by farmers to set the price of their produce in advance before they sowed the seeds so that after the harvest, crops would be sold at the pre-agreed price no matter what the movements of the market. So a future is a contract to buy or sell a fixed quantity of a particular commodity, currency or security (share, bond) for delivery at a fixed date in the future for a fixed price. At the end of a futures contract, the holder is obliged to pay or receive the difference between the price set in the contract and the market price on the expiry date, which can generate massive profits or vast losses.
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.