When it comes to pensions I think we can all agree on a number of overall observations: in no particular order, I’d suggest the following –
- DB schemes are dead in the water and not long for this world – and will eventually become relatively unimportant for most people
- DC is the future
- Most investors are passionately disinterested in pensions, put off by the technical language
- In particular, the vast majority of investors are baffled by the choice on offer and react by avoiding taking decisions
- Many existing pension providers have levied disproportionate charges
- When given a choice – say pensions freedom – many investors would rather take the ‘freedom’ option of doing their own thing even though it may incur a tax charge
I’d also add some more slightly more controversial observations which I think make all the difference to what I think will turn into a red-hot political pensions crisis in the not too distant future:
- DC will fail to provide enough money for most to retire on – this is the cardinal lesson from most 401K plans in the US where investors by their millions are having to boost contributions because they’ve not hit their expected returns
- As I said above DB schemes are not the real story – over time they’ll self-correct but in the meantime government back stops will cost all of us a great deal of money. We are midway through a massive exercise in shielding the older generation from pensions mishaps by levying an implicit tax on future younger workers
- The various public sector pensions schemes – with the honourable exception of the local authority schemes – are going to cost taxpayers a huge amount of money in coming decades as these DB promises rack up huge bills. In my opinion, the sheer scale of underfunding will either require massive tax increases or some form of default…or both
- Governments will eventually be forced to bail out individuals because of bad choices in the self-invested pensions market. Otherwise, we’ll have non stop Daily Mail coverage about destitute pensioners protesting on the streets (echoes of Equitable Life)
- Clever nudges and wonderful technology fixes which allow a more transparent insight into our investments won’t solve the problem of chronic under-saving and even more chronic caution about investment choices
I cannot emphasise enough how big I think the future pensions crisis will be. At the moment it’s obscured by a range of macroeconomic factors but over the next decade or two, I strongly believe that pensions will be the next great inter-generational battleground. Parties will lose elections and we’ll see open revolt on the streets as the penny drops on the younger generation about the financial consequences of overindulgent promises to the older generations.
The good news is that many of the think tanks are beginning to think long and hard about what to do next. Michael Johnson on the right at the CPS is hard at work but a policy paper from the Fabian Society and Bright Blu – see below – is also asking all the right questions. Their most recent joint paper “Saving for the future” has this catchy conclusion – “there is little chance of getting people to be ‘engaged’ with their pension of their own accord”. Spot on. Pensions are boring and confusing and most people think that eventually, the state will foot the bill.
I’ve run the press release for this report below but I’d conclude with my own pension policy matrix:
- Ditch pensions freedom for the masses.
- Ditch higher rate tax reliefs for the wealthy.
- Merge ISAs and pensions into one seamless regime.
- And crucially bring in a national pension scheme built around a cross between DC and DB. Stipulate a minimal basic income related to contributions, integrate auto-enrolment into the scheme and let just a few managers run a handful of major schemes – thus avoiding the confusion of too many options. If wealthier individuals want to top up with their own schemes, let them do it, free of all tax relief. But stipulate a basic connection between paying in and what you get back from the scheme in terms of income – call it a minimum contributory basic retirement income funded by a proper national pension fund. Forget all those wacky free market ideas about letting pension providers compete to run schemes – as currently implemented in Chile. They’ve proved unpopular and expensive. Stick with the model run by the likes of the Netherlands and Japan and nationalise the schemes, whilst also sub-contracting investment management to specialist investors who are only paid if they beat the benchmark.
Anyway, enough of my own ideas – the Fabian and Bright Blu paper can be found online here at http://www.fabians.org.uk/the-default-option/. I;ve copied in the basic summary of the report below. Enjoy.
The default option by Iain Clacher and Janette Weir
We have spent many years talking in depth with over one thousand people about their defined contribution (DC) pensions as part of our work for regulators and providers. And our conclusion is that there is little chance of getting people to be ‘engaged’ with their pension of their own accord. This is a bold statement to make, so let’s have a look at the reasons why.
Many people simply don’t trust pensions, and it’s hard to be proactive and positive about saving into something you fundamentally just don’t like. The manifestation of this undercurrent of mistrust came when pension freedoms allowed people to access their DC pot – and they did in droves.
Some £10bn has already been withdrawn, many people were more than happy to pay a big tax bill to get the money out and under their own control, when the rational thing was to leave the money invested for their retirement. People also tend not to engage with things that they perceive to be too difficult, and pensions are usually described as a “minefield”. It is hard enough for people to get to grips with all the jargon, and then the rules keep changing. Even the word ‘pension’ is off-putting and confusing. It is no wonder that it comes as a big shock to some to find out that their DC pension pot doesn’t automatically convert into a regular payment at retirement.
We observe that most people only start to have a passing interest in their DC pensions from around age 45 onwards and really start to have an active interest around six months before they want to access it.
Worryingly, many of those who are so disenchanted with pensions that they have “taken control” of their money are not acting like ‘investment managers’. They put their pot into cash ISAs or high interest savings accounts (which they do trust and understand) but once the money has been parked, they are not making sure that it is working as hard as it can by shopping around for the best interest rate deals on an ongoing basis. More worrying yet, an awful lot of people who have made more complex choices than this, typically some form of flexi-access drawdown, are simply ‘hoping for the best’.
A revamp of annual statements to help put people in touch with their future selves is desperately needed, given how badly they do this at present. There is already some interesting work underway to look at better timings, linking to future goals, talking statements to improve understanding, and so on. However, much more work needs to be done.
Policy interventions such as a default financial health check would be extremely helpful. We firmly believe that this intervention is needed at an earlier stage, long before the money has been mentally allocated to a new car, or holiday, or kitchen. Perhaps 50 is the right age, rather than 55, well before people can access their pension.
We observe that many people who are making full or partial encashment decisions between the ages of 55 and 59 have a very firm plan in mind from the outset and, therefore, do not feel the need to use Pension Wise, the government’s guidance service. Or they are using Pension Wise far too late in their decision-making journey, which makes it almost impossible to shift their perspective.
Choice overload, due to the plethora of options now open to people, is just adding to engagement problems. Some pension savers are almost begging the industry for a path to follow.
We must be up for this difficult task. The window of opportunity is closing rapidly, as the next generation coming through will be mostly reliant on defined contribution for their retirement income. The next five years is critical, and the cost of being no further forward in this area is simply too great, both for the well-being of individuals and for society as a whole.
Janette Weir and Iain Clacher have written a chapter for the report, Saving for the Future: Extending the Consensus on Workplace Pensions, published by the Fabian Society and Bright Blu