What is happening to UK pension provision and schemes?

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One of the features of the UK economic environment over the past decade or so has been the extraordinary changes in the rules and indeed position of pension provision. This covers both state and private-sector provision. Some of this has been related to developments in the credit crunch era but some is also related to pork barrel politics. What this has done is create something of a quagmire where benefits and losses are distributed often in a fairly random fashion which poses a problem. It was not that long ago I passed the advanced pension examinations of the Chartered Insurance Institute but the truth is that the landscape studied then no longer exists. This in itself poses a problem for an industry that exists for the long-term.

State Provision

There has been a dizzying array of changes here in recent years. Let me start with something which has had a positive impact on what many pensioners receive. From HM Parliament. BSP is the Basic State Pension.

The Coalition Government commenced the legislation and committed itself to increasing the BSP by a “triple guarantee” of earnings, prices or 2.5 per cent, whichever is highest, from April 2011.

That has boosted pension incomes and mostly via the law of unintended consequences. For example this year the uprating will be in essence a real terms increase as earnings were rising at 2.9% and official inflation has been very close to zero. This follows on from a 2.5% increase previously which means as I have discussed in my updates on the UK public finances that there has been quite an impact via higher expenditure which was estimated at £6 billion a year before the report was quickly redacted. Or to put it another way a type of generational shift in incomes.

As a result, someone on a full basic State Pension can expect to receive around £570 more a year in 2016-17 than if it had been uprated by average earnings since the start of the last Parliament,

This is not the whole story as confusingly what are called additional state pensions only have to rise with inflation and after the swerve a few years back to use the CPI (Consumer Prices Index) they are somewhat becalmed. So we have seen a change withing pensioners incomes as those who have paid in extra to get more have been treated less favourably than the basic pension. Just to add to the mix a new state pension starts in April for new pensioners and it will rise with earnings.

You will get it later

The UK state pension age has been 65 for a long time but it begin rising to 66 in December 2018 and 67 in 2026 in response to rising longevity. Later it will go to 68 but the rules will no doubt have changed by then as for example the change to 67 was brought forwards by 8 years in 2014! So far we have a familiar story of jam today where current pensioners have benefited but future ones face adverse changes although of course should the triple lock remain they will benefit too.

A catch in this saga is happening to a segment of the female population who expected their state pension at 60 and are now getting it at 63 on the way to it going to 65. This has become a contentious issue. Not so much on the issue of equality but much more on the lines of the fact that the changes were accelerated leaving one particular group disadvantaged as highlighted by the WASPI campaign and as I have pointed out earlier there is an issue with continual changes in something which relies on long-term planning. Also the pension age will be equalised at 65 just in time for it to become 66. Oh Well! As Fleetwood Mac put it.

The private-sector

If we look at the situation we see that the economic environment has changed substantially. There have been capital gains for some especially in government bond markets but looking forwards there is little yield now to be found in these areas. For example the plunge in yields has benefitted those who held both ordinary and index-linked UK Gilts. Those who have followed me from my beginnings will recall me making a case for holding index-linked Gilts. For once I was in concert with the Bank of England which put around 90% of its pension fund in them which has allowed it to fund the high level of pensions highlighted by what Mervyn King and the Deputy Governors have received. However looking forwards the picture is very different. For now there is a real yield but as soon as the oil price stops dropping it seems set to disappear and as pension planning is often over a 20/30 year timescale there is a problem.

As to changes well the Bank of England keeps promising but not delivering on higher interest-rates leading to the fear that like in Europe we could head lower. After all it was only last Thursday that the President of the ECB Mario Draghi hinted at a further cut to an interest-rate which is already -0.3%. Long-term contracts struggle with this sort of negativity as I recall when Andy Z placed the pensions illustration which has a return of -0.3% as part of it in the comments section. How does that work?

There is also the issue of equity markets where the capital to dividend position has been in reverse. We find ourselves in a situation where depending on the exact reading at the time the UK FTSE 100 has been on a road to nowhere this century overall whereas there have been dividend returns. If you want yield these days it has to be dependent on company profits such as utilities.

Legislation ch-ch-changes

The last decade or so has seen a litany of changes which returns us to the long-term planning theme. We have seen the minimum age for taking a private pension move from 50 to 55 but not a compensating move from 75 to 80. This is a bit bizarre as whilst there may not be a lot of people wanting to pay in at 75 why shouldn’t they be able to? Also there are complicated rules for continuing pensions beyond 75 but complicated rules invariably lead to trouble in the end – the law of unintended consequences again- as well as racking up a high level of fees and expenses. Plus rules have been set for maximum amounts both annual and lifetime with promises made and then welched on.

Now there has been this change which returns me to the switch between capital and interest of which the latter appears as annuities. From the BBC.

You can now access that pot freely from the age of 55 (57 from 2028), taking out as much as you like, subject to tax.

This is for defined contribution schemes where you pay in and receive tax relief and take the money later after hopefully it has grown and some 25% is then tax-free. The driving force behind this change is the poor value of annuities which has been driven by lower bond yields. Quite how they work now in Switzerland or Germany where many bond yields are negative I do not know? But whilst annuities are flawed they do guarantee an income as we wonder what happens next.

So such a change should encourage more pension provision but the many changes are likely to have a reverse effect as people wonder if it will last? The uncertainty is added to by the proposal to scrap higher-rate income tax relief. This has been trimmed to some by other changes and has equity and fairness on its side to some extent but would be yet another change in a very long list.

Defined benefit schemes

This has been perhaps the clearest shift of all as it dies away in the private-sector and only exists in the public-sector because the full costs are rarely looked at. Also of course ministers, MPs and high level civil servants are the current major beneficiaries of them! But with inflation indexing so expensive in spite of the current low inflation rate there is trouble. The problems for the private-sector are added to by the rules under which they operate for solvency and assessment which are somewhere between bizarre and crackpot in my opinion.

Those retiring now on such schemes are benefiting highly and apart from the public-sector schemes that is now mostly in the past. A famous beneficiary was former Bank of England Governor Mervyn King whose antipathy to RPI inflation did not extend to his own pension fund which ended up being worth around £8 million. Of course on the other side of the ledger the case is much muddier for nurses,teachers and the police who get much lower sums and would reasonably argue that it is part of their pay deal.

Comment

There are good news stories here as it used to be the case that UK state pension provision was low and had been left behind by events. Obviously there are still people with low incomes but the rise in the basic state pension will have particularly helped the less well off and I welcome that. Although it has resulted in another issue for the public finances

But the multitude of other changes that have gone on have created an atmosphere of mistrust and who could blame the young for having no confidence in what they will receive? They could lose out at a stroke of a bureaucrats pen. The continual Ch-ch-changes are likely to see yet more money head towards the housing market where the situation is much simpler and easier to understand than pensions. This from the Guardian suggests changes in that direction.

A record amount of housing wealth was unlocked by homeowners aged 55 and over in 2015, with £1.61bn withdrawn through specialist equity release plans.

 

 

 

 

30 thoughts on “What is happening to UK pension provision and schemes?”

  1. Hi Shaun

    Great article as always. I was reading today that mps are discussing lowering the maximum pension pot to 750k. Appalling. Mp’s who have tax payer funded gold plated pension schemes, penalising those who have the temerity to save for their retirement. It may seem a lot now, but you can guarantee that with the governments love of inflation, 750k will buy you a cup of tea in fifty years.

    Its no wonder people dislike pensions. I’m saving in both pensions and isa, but I’m sure the government will turn their beady eyes towards ISA’s at some point.

    As an aside I saw another example of shrinkflation:

    http://www.bbc.co.uk/news/35383842

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    • Hi Anteos and thank you

      As to the numbers it used to be considered ( and was formally used..) that a 20 times ratio applied to final salary schemes. So a pension of £37,500 would be equivalent to the proposed maximum pot for the rest of us of £750k. I think due to changes that ratio is now more like 25 or you would get £30,000. There are lots of ministers and civil servants earning pension at a much higher rate and the taxpayer is footing sometimes all but always a lot of the bill. The rules should be the same for everyone.

      Thanks for the Cornetto link which I had meant to post

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  2. Equity release plans are going to be the preferred banker option because they stop the wave of boomer supply hitting the market. This prevents collapse on the front end of the boomer wave.

    They’ll have to do something else to stop offspring selling off en-masse when the boomers all die.

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  3. Not so good for state pensioners….the basic pension falls short of the amount required to live on.
    So, many pensioners also receive pension credit. As the state pension rises, pension credit falls.

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    • Hi JohnR

      You make a good point that there are some offsets to the cost of increasing the Basic State Pension under the Triple Lock. However we find ourselves with yet more complexity which is one of the problems and makes it quite a mess as some get rises at one rate and right now others get no rise on some of their state pension.

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  4. Hi Shaun

    Pensions are an “under the radar” subject that receives too little attention.

    Private pensions, whether DB or DC have become much more expensive in the last twenty five years, partly through increasing longevity but latterly due to the collateral effects of financial repression.

    Although there are now few DB schemes open to new members it wouldn’t surprise me if some had to renege on their commitments down the line. The deficit on FTSE100 DB schemes is extremely large and, in a low inflation/ low growth era, may be unaffordable for many.

    Annuities on DC schemes have been coming down for years and I suspect that many who have celebrated the fact that in the ZIRP era their mortgage payments are low may not be celebrating when they realize how much pension their pot will buy.

    As for property as an alternative I think there has to be a point at which asset inflation is unsustainable so it may not prove the golden goose that many think.

    The other thing is that immigration concerns and Brexit are two issues that may yet see us getting back control of our borders and immigration being sharply reduced, in which case the property meme may well become somewhat dented.

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  5. Hello Shaun ,

    Consider that everyone will or now does contribute to a pension scheme of sorts – what will they think when there contributions are hammered at – 3%

    then if the MIRP contagion hits the pensions industry in general ……

    Frankly why hasnt MSM pointed out the disparity between HMG pensions and the rest of the population ?

    Most local government schemes are fully funded , its only Westminster ones that are not , is this why there was a threat to take over local schemes like the Post Office ?

    As and if when QE is with drawn and shares eventually fall to their ” fair market” value its not just housing and pensions that will reel from the blow back (!!) . point doesnt this actually mean that QE will never be withdrawn ?

    All this to keep asset prices up because of feckless bankers and their get rich ( poor) schemes , oh and apparently we paid them top dollar for this ” financial wizardry ” of turning gold into lead ….

    Given the other weeks post about how poorer the people are getting here all we need is oil to double in price ($28 to $56 ) and who will be wearing the shorts ?

    Forbin .

    One way or another I’m gonna getcha – Blondie

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    • ‘Frankly why hasnt MSM pointed out the disparity between HMG pensions and the rest of the population ?’

      Same deafening silence as we get on the national debt,the growth funded by the unsustainable fiscal deficit,the student loan timebomb,the demogrpahic timebomb,to name a few.

      ‘All this to keep asset prices up because of feckless bankers and their get rich ( poor) schemes ‘
      Too true,they get rich,joe sixpack gets poor.

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  6. I was persuaded, 11 years ago, and with approx. 22 years of working life left, to give up formal employment to be my wife’s full-time carer.
    As I receive approx. £20 a week less than an unemployed person, one of the main financial inducements was the pension credit for the State Second Pension.
    Worthless!
    Thieving bastards!
    As you will no doubt be aware, the last 20 years are when there tend to be fewer other on discretionary spending, so pension pots can be stuffed.
    I’m left high-and-dry, marooned with nothing.

    Pensioner homeowner equity withdrawal may not be the aged’s last fling, remember how poorly other investments are performing. It may well be the case that they are withdrawing equity either to live on, or to help children/grandchildren onto the housing market.

    Remember me talking about absolute and incremental measurements?
    Well the State pension is one of those incremental measurements; the recent rises may look good in isolation, but historically, and in the overall scheme of things, they’re still piss-poor.

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    • Hi therrawbuzzin

      I am sorry to read that but sadly it is not a great surprise as our establishment makes lots of promises and then sets out to downgrade them. Over time I have followed many changes to the various versions of the 2nd state pension and it is quite a mess. Those in charge of this should be ashamed of themselves.

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  7. Further to ‘buzzin’: the comparison between the UK state pension and that of other EU members deserves some attention. In the case of Belgium, the first tier compulsory pension is set at about three times the proposed ‘flat pension’ in Britain for a full contribution record. In the name of ‘harmonisation’ some wimp in Brussels will eventually demand ‘equal misery for all ‘as otherwise UK total employment costs will be unfairly low. In Britain, who will pay for any increase?
    V.g article, by the way.

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    • UK state pension is over £600 per month (assuming £155 per week). This is higher than average net wages in many Eastern European countries, hence it’s improbable that Brussels will act to unify pensions.

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  8. “But the multitude of other changes that have gone on have created an atmosphere of mistrust ”

    I dont think the effects of this should be under estimated . For a long time pensions were sort of sacrosanct , as you stated , they were over 25/30 year life time

    So even for someone with 10/15 years left to go – who do we trust now ? yet alone just starting .

    This governments changes , which appear to be just to support the busted banks, have opened Pandora’s box …….

    It will not end well

    Forbin

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    • Hi Forbin

      I used to be confident that pensions were a good idea and remember starting one back in my Barings days. Various different schemes have come and gone and I wait to see whether I was right to prefer money paid into a scheme by my employer rather that an defined benefit scheme. As my main amount would have been with the troubled Deutsche Bank it could yet go either way!

      Now if I was giving advice to someone in their 20s I would say don’t put all your eggs in the pension basket as you just cannot be sure of how you will be treated over time.

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    • “For a long time pensions were sort of sacrosanct , as you stated , they were over 25/30 year life time” – No they weren’t – see my post dated 8/02/16 @ 1:23 pm

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    • Hi Bob

      Thanks and to complete the official denial line then Mario Draghi gave a speech this evening mentioning financial resiliance. It made a few on Twitter think of Deutsche whereas I was thinking of his Italian homeland.

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  10. Hi Shaun
    It looks like UK Govt is going to switch to ‘tax in’ for pension payments rather than ‘tax out’. Thus closing the deficit hole in one swoop.
    DB schemes ‘hole’ is £81bn and counting for FTSE 250 companies. The ‘hole’ is a figment of accounting conventions , however it diverts vast funds into non-productive area. Interest rates at 3% would reduce this ‘hole’ to near zero. Unintended consequence or just sheer inability?
    UK govt pension is poor when compared to most western european states. Indeed its poor when compared to US social payments , and as all those get free Medicare, the UK is just poor. Why? Mainly the rampant ‘middle man’ creaming off the upside. You expect it to look bad against ‘social democracy’ systems in Europe, but when it doesn’t even stack up against ‘raw capitalist’ USA , you know something is very wrong.

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    • The UK cannot deliver the resources to meet requirements. It’s whack-a-mole as a consequence. Raise rates and how many banks go under which those DB schemes have shares in?

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    • Some company pension schemes are much better funded than others so the problem isn’t spead evenly.

      Ex public sector eg BT,BA,BG etc are loaded up but I can’t imagine ones like RBS being in the best of health either

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  11. I massively reduced my saving into a pension when the age rose from 55 to 57. Bearing in mind it was 50 when I started so how is this not mis-selling? It will keep going up so the only people who can retire are the mps and public sector.
    It amazes me how it was a labour govt who let firms abolish defined benefit pensions which effectively was 20% plus of salary to defined contribution paying 5%. Shows they only care about unionised workers!!

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  12. “…current pensioners have benefited but future ones face adverse changes”

    Not quite, future pensioners, who have not paid into the additional pension/state second pension/state earnings related pension scheme who are due to retire in 30 years will be no worse off because, although they would have paid into a final salary scheme by default (within a contracted out scheme) for some of their work life the extra occupational pension earned on that part of the reduced National Insurance contribution is only commensurate with what they would have received if they remained contracted in making full National Insurance contributions to the “additional et al state pension”.. This means that their “extra” contributions made into their occupational pension scheme (in place of those contributions made to additional state pension) will still be reflected in their occupational pension.

    However, those who had no occupational pension making full National Insurance contributions will indeed find that heir total pension falls back compared to what they would have received if they remained in the “old” Additional State Pension Scheme, although they will be “protected in that 2 calculations will be made at retirement age, the first under the “old” scheme and the second under the new second tier scheme, whichever yields the highest number will be the pension payable so they are likely to be no worse off too. It will be those future pensioners commencing employment now and last year who will be worse off in 40 years time than those commencing work say 5 years ago. So this will only adversely affect today’s children and youths but it is silly to assume what has been done today will stay in force for the next 40 years – things will change again in the next 40 years.

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  13. “But the multitude of other changes that have gone on have created an atmosphere of mistrust and who could blame the young for having no confidence in what they will receive? ”

    In fact in 2005 I was commissioned to undertake a study on the changes to the State, Public and Private Sector pension legislation since 1979. I identified 42 changes in that period,some benefit neutral, some benefit positive but most benefit negative to pensioners. This is no a new phenomenon and has been happening since 1980, merely the pace has quickened in the last 5 years.

    At the time I completed that study I concluded ISA’s were the way to go with their stable regulatory existence despite the tax disadvantages of on the contributions because you maintain control over your Pension (ISA) fund, you can access it at any time for tax free payments (not recommended unless you’re desperate) and of course when you take it as a pension all payments are tax free. A much better outcome then gambling on the housing ponzi scheme and having the hassle of finding good tenants, providing property maintenance, organising and paying for annual electrical and gas installation inspection safety certificates along with central heating and gas appliance servicing, repairing tenant damage that you can’t prove they did as well as trying to keep the property continually rented out. And all that at a time in your life where you’re likely to be facing failing fitness and health!

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