There are plenty of problems faced by pensions and long-term saving

Even a cursory glance at the news will tell you that there is a lot of rumbling discontent in the pensions arena. There has been the issue over NHS doctors pensions, the WASPI women and today a strike over pensions by those who work at universities. I rarely directly dealt with them as they were a colleagues responsibility but back in the day the Universities Superannuation Scheme had a very good name. In many ways these are symptoms of credit crunch themes so let us take a look at them. But our musical theme is provided by Queen and David Bowie.

This is ourselves under pressure
Under pressure
Pressure

Low and negative interest-rates

Pressure was applied by the initial cuts to official interest-rates but this was ramped up when the bond purchases of QE were added to it. This was a deliberate attempt to reduce bond yields which in many ways are the lifeblood of many types of pension.As ever we were promised it would be temporary as this from Bank of England Deputy Governor Sir Charles Bean from September 2010 shows.

 “It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.”

I am afraid that he took us for Charlies back then as over nine years later we are still waiting and as I shall explain in a moment matters deteriorated. As to Sir Charles he is “doing very well” as not only did he retire with a large Bank of England pension that somehow managed to be fixed to the “flawed” RPI measure of inflation but he is now at the Office for Budget Responsibility.

If we moved forwards to August 2012 our warning klaxon was triggered as we saw an official denial.

For those approaching retirement in ‘defined contribution’ schemes, lower gilt yields as a result of QE have
reduced annuity rates. But it is crucial to allow for the fact the QE has raised the value of pension fund assets too. Once allowance is made for that, QE is estimated to have had a broadly neutral impact on the value of the annuity income that can be purchased from a typical personal pension pot invested in a mixture of bonds and equities.

There always were issues with that an even it could not avoid pointing out this.

But schemes that were already in substantial deficit before
the financial crisis are likely to have seen those deficits increased.

Also the deflector screens were in operation which is a bit odd don;t you think when there is apparently no problem.

The paper notes that the main factor behind increased pension deficits and falls in annuity incomes has not
been the Bank’s asset purchases, but rather the fall in equity prices relative to government bond prices.

If we look at their last point this remains true and is much of the problem. The UK FTSE 100 has gained over 1600 points since August 2012 according to my monthly chart but the 50-year Gilt yield has plunged from 3.09% to 1.18%. So what we were told was temporary has become permanent. Regular readers will be aware of the bond market surge we have seen and in fact it was even stronger a couple of months ago when the UK 50 year yield went below 1% for a time.

The Problem

Let me now address the consequence of this which twofold. If you have a pension fund to invest in and draw from ( DC or Direct Contribution) then your annuity rate and hence pension will be low. Added to the bit that allows for the risk of you dying ( sorry for the grim bit) is a mere 1% or so. So whilst you can take 25% as a lump sum and it is tax-free the other 75% does not pay much. A single life annuity at 65 pays just over 5% so many will doubt if they will even get the sum invested back and this is with no inflation protection.

Next comes another development which has hammered final salary or Defined Benefit schemes.The trends were against them as we have looked at above but it got worse as some investors noted that you got get more yield from RPI linked Gilts than conventional ones and drove the prices even higher. This meant that the costs of a DB scheme got higher/worse and meant they were likely to continue to thin out in number.

You do not have to take my word for it as here is the Bank of England.Remember it saying in 2012 that things were neutral? Well by 2016 apparently not.

It has emerged that employees, led by the Bank’s governor, Mark Carney, received the equivalent of a 50%-plus salary contribution into their pensions last year, underwritten by the taxpayer.  ( The Guardian )

Pensions Law

Back in the days before the credit crunch I was involved in some pensions work and took the advanced qualification called AF3. I stopped because they kept changing the rules and it would have been a case of perpetual study! But even more seriously the rule changes have tripped over each other and ended in the mess that is doctors pensions. Most would want them to be covered but as the limits were cut no-one seemed to think that it could cost consultants to work for the NHS. As fast as they earned money this raised their pension value and they were/are taxed on it.

NHS England has set out plans to pay off pension tax bills for doctors who breach the annual allowance limit on pension growth in 2019/20. ( GP Online)

So there is an apparent fix but what about others who have been tripped up by changes which have turned out to be in some senses retrospective? I suspect professors are part of the USS dispute although what we have looked at already is an issue.

Deficits

This is a problem because of the way that they are measured.

The pensions industry uses something called a ’discount rate’ to calculate the present value of the
scheme’s liabilities………….. The liabilities must be measured using the current yield on high quality
corporate bonds – usually AA rated bonds – regardless of how the how the trustees of the pension
scheme invest their assets

What do you think has happened here in the credit crunch era?

Comment

The arrow flying into the heart of pension saving has been the persistence of low interest-rates and bond yields.They have been not only “temporarily” low for a decade but have gone even lower. Buying an index-linked Gilt now guarantees you a negative real yield if you make a long-term investment which frankly defeats its/their whole purpose.

If we switch to the WASPI issue there is another mess. Back in the early to mid 1990s it was decided that men’s and women’s state pension ages would be equalised rather than women getting theirs at 60 as opposed to 65. In many ways it seemed fair although of course some would be adversely affected.This was sped up in 2011 but has been a policy in motion under governments including all 3 main parties in the UK. Was this unfair? If so it is hard to see how changes could be made and also what about higher retirement ages generally? Even worse plans to change this seem to mostly benefit the better off. So I have tried to avoid the politics but yet again we end up with short-term manoeuvring around a long-term issue.

Podcast

 

 

 

7 thoughts on “There are plenty of problems faced by pensions and long-term saving

  1. This issue is not going to go away as long as these criminals are in charge of our money and interest rates, QE and negative rates are coming to all countries, those who expect it won’t, think the threat of the currency collapsing will prevent politicians and central bankers from pulling the trigger, but unlike the Weimar attempt where it was just the mark at risk, however central bankers think that if they all co-ordinate their actions together, one currency cannot fail as they will all be synchronised together and hence not lose value relative to each other.

    The other main issue over here is the taxation of dividend income from shares held in pension funds(initiated by Gordon Brown), this along with zero rates has decimated the pension funds and acted as probably the final nail in final salary pensions in this country.

    Another shoe about to fall is the guarantee to the basic state pension, I might be a long way off here, but at some time in the future people who have worked all their life and paid taxes and national insurance will be told that the basic state pension will be means tested, if the person possesses a company or personal pension it will be assessed and used to determine the eligibility and the amount of any pension due from the state. Currently the basic state pension is about £165, so anyone with a personal pension above that would be told to go away, anything less and the state might top up their pension to the £165 they would have got if they never paid a penny into the system.

      • Brown was out of his depth when surrounded by financiers demanding our money.
        Not sure what the excuse is for the various PMs in the 10 years since then who could have reversed this if they had wanted to.

  2. Pingback: Money | Wild's Crew

  3. Shaun, you highlight a significant issue here. I think that given that over priced housing seems to suit a lot of the electorate then we have little pressure to resolve that unfortunate side effect of QE and ZIRP but pensions. They are trashed for all DC contributors. It makes me think I should become a public sector worker and get 5% annual pay rises and DB scheme…

    Who do we blame for savings equal nothing… Is it the Central Govt of Labour and Conservatives or is it the Central Bank..Are we going to get them pointing at each other?

    Folk will be very unhappy indeed when they see the payout. But I guess it is a can that rattles in the future… just like the unformed households..

    • Hi Paul C

      For some housing is their pension and in fact over time 2 of my neighbours to the left have done exactly that to some extent by selling houses and moving to a flat. But the truth is that it is not always easy to do and one day maybe house prices will not have escalated as much as they have in recent times.

      For now the future of DB schemes is essentially with the state as you say as the taxpayer at least in theory has bottomless pockets…..

  4. What is so disgusting is the people who make these decisions and implement them, are not affected, as their pensions are ring fenced and gold plated.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.