There is an almost incoherent discussion of pensions and the merits of the triple lock arrangement that currently protects the value of the state old old-aged pension in the FT this morning.
Written by the FT's consumer editor, the claim is made that the triple lock makes planning for retirement near impossible for many people for three reasons. First, the amount of pension they might get is uncertain. Second, because the triple lock guarantees increases in the pension, people might not save enough themselves. Third, since no one apparently believes that the state old age pension will survive, the whole edifice of pension planning is crumbling.
That these claims are contradictory does not matter, apparently: the FT let this piece reach its pages.
In that case, it appears appropriate to talk about the reality of pensions because, despite all the mumbo-jumbo written about them, and the vast edifice of the financial services industry largely built to service (and extract value from) them, in essence pension arrangements are simple.
If people are allowed to retire within a society that requires the implicit consent of the generation still working. That is because by letting the previous generation retire, that younger generation is agreeing to give up some of the income that they might generate as a result of their efforts to maintain those who are no longer working.
This is the fundamental building block on which all pension thinking has to be based. Pensions require what is, in effect, a salary sacrifice, but it is by those younger people who consent to maintain an older generation who are no longer working.
I stress, saving only comes into this peripherally. The whole idea of pension saving is an illusion and a massive diversion. All that savings do is provide the older generation with the potential power to buy the services of the younger generation.
I stress the word 'potential'. I do so for good reason. That is because to realise their savings the older generation must find a willing buyer for them. That buyer will, inevitably, come from the younger generation. If that younger generation does not think that what the older generation has saved in is of value to them then pension savings provide no guarantee of a future income.
If that younger generation does think that the savings made by the older generation do provide them with value then it is clearly a lot easier to persuade that younger generation to maintain the older one: the asset swap softens the blow of the income sacrifice that the younger generation makes.
But, suppose there are either insufficient pension savings (true for many people) or that those who saved for their pensions saved most unwisely and the younger generation now do not want the products that they saved in?
The former requires that there be a state pension. There is a transfer of value via the government to ensure equity. We have got used to that.
The latter is the real problem because this is, so far, beyond our experience but may well not be so sometime soon.
Suppose the older generation saved in the financial products made available by carbon-based businesses, all of whose business models are failing? Or they saved in the financial products made available by banks, most of whose collateral is physical property in areas liable to flooding soon? And suppose much of the rest of the savings is in commodity-based investments that assume production will still be possible in locations where climate change will make, for example, crop production impossible? What happens in that case?
The obvious answer is that unless compelled to buy these increasingly worthless investments by compulsory savings arrangements that are imposed by law, the younger generation will want nothing to do with these savings products sometime soon as they will rightly realise that they offer no value to them.
Those compulsory savings arrangements are, of course, in place. That is why the whole edifice of compulsory pension saving has been imposed on employees in this country. However, I suggest that it is unlikely that these will be enough to maintain value in financial markets for long. When it is apparent that these savings products are becoming increasingly worthless - as it will sometime soon - then what we will discover is not that the whole edifice of the state pension scheme has been a Ponzi scheme, but that private pension saving has been.
Sometime soon, we will have a pensions crisis. It will have nothing to do with the triple lock. It will be about the fact that the younger generation will actively refuse to buy the worthless savings products that older people have bought in the vain hope that doing so will secure their financial security in old age when the reality is that their hopes are pinned on the continuation of a carbon-based economy that has to be brought to an end if anyone is to have the chance of survival in an organised society on this planet.
What will happen then? I predict chaos.
After that, what will need to be done? There will be a need for an urgent reappraisal of that pension saving contract at a macroeconomic level. The older generation will, most likely through the state, need to save in products that the younger generation will require, which will basically be the green and sustainable infrastructure that makes their life on earth possible.
Only when that is done will younger people have the means to support older people in their retirement.
It may be too late to make this shift for some people. I suspect real pension value is going to disappear for a great many people as a result.
But that said, what is possible is that current savings could be diverted to this goal. Pouring yet more new contributor money into utterly pointless attempts to maintain the value of the bankrupt investments most pension funds now have in oil companies, banks, commodity traders, retailers and others, all of whose business models are based entirely on the assumption that the world can continue to produce carbon and despoil the planet in the way that it has to date is absurd.
When will that become clear? The sooner, the better. Then we can redirect pension money towards the required investment in the scale that is needed.
That might give us all a chance of not just a pension but an orderly life here on earth in the future. But the time for change is now, and no one seems to be getting the sense of required urgency.
And that worries me.
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It’s not about money. This is missed by most commentators – but you (correctly) place it front and centre.
At a micro level money may matter – my comfort (or otherwise) in old age will depend on how much money I have and what it will buy – but at a macro level it is not. As in other areas there is a tendency to extrapolate the micro to the macro and end up with wrong answers.
Only once you start with the idea that pensions are a social contract do we have a chance of getting this right.
Glad we agree
“All that savings do is provide the older generation with the potential power to buy the services of the younger generation”
No savings allow for a decent stand of life when you are able to work.. you are a very strange individual with opinions so crazed as that.
You really don’t undertsand that what makes microeconiomic sense need make no macroeconomic sense at all, do you?
Why not read what I wrote again? Try to undertdsand it. Then come back again, but with a sensible comment next time.
It has to be remembered, too, that the majority of individuals are now at the mercy of holding defined contribution pensions, as opposed to defined benefit. They are, therefore, bearing all of the investment risks and costs themselves, and many are persuaded that “Mr. Market” is their friend; he is not, and I am now meeting people who have been using “Drawdown” inappropriately and run a very high risk of running out of money. The vested interests of the pension plan sponsors, legislation, fund management companies and intermediaries like me mitigate against recommending guaranteed contracts for retirement income purposes in the form of annuities. I like, very much, the ‘safety-first’ approach of annuitizing wealth later in life, and am reminded of an old quote from Solomon Huebner:-
“The prospect, amounting almost to a terror, of living too long makes necessary the keeping of the entire principal intact to the very end, so that as a final wind-up, the savings of a lifetime, which the owner does not dare to enjoy, will pass as an inheritance to others. In view of these facts, it is surprising that so few have undertaken to enjoy without fear the fruits of the limited competency they have succeeded in accumulating. This can only be done through annuities…Why exist on $600, assuming 3% interest on $20,000, and then live in fear, when $1,600 may be obtained annually at age 65, through an annuity for all of life and minus all the fear”. That was written in 1927, and it’s as true today as it was 100 years ago.
Millions face this dilemma with increasing anxiety as defined benefit pensions wither away.
When my husband was 65 we were persuaded to use drawdown instead of an annuity.
6 months later my husband died. The drawdown amount remained the same and has been for 12 years. If we had decided on an annuity it would have halved.
I am now in the situation where I have to decide whether to change to an annuity or continue with drawdown. Having had two aortic dissections in the meantime, do I stay with drawdown as the next one will probably kill me, or do I decide i am now indestructible and go for an annuity which will be one third of the amount I am now taking out of my pot?
Can’t ask the financial adviser as he went into liquidation two years ago!
It’s all a lottery, isn’t it?
I know I always use the personal more than most people on here, but it is personal. Everything to do with finance is always about the individual in the end, no matter how many financial advisers you have.
This Is a really serious issue which is usually ignored. Thank you so much for raising it again.
It has a much deeper relevance too.
Purchasing shares is, mostly, gambling as, I think, you have pointed out (I don’t want to put words in your mouth). Buying a share does not generally provide money to the company, it just takes it from someone else (except for rights issues of course). This is perhaps because there is tax relief on corporate borrowing, but not on dividend payments. But I digress …..
So, today, there are more people paying in to defined benefit, share purchase, schemes than are being paid pensions (or drawdowns or whatever). There are, after all, few other places to save (it should be government bonds, of course, but that is not the norm). Essentially we have a giant Ponzi scheme.
However, demographics are changing. There will be more pensioners and fewer young people in future. So, at some point, in the not too distant future, more people will be trying to take out pensions than paying in. At that point the Ponzi scheme will, suddenly, collapse. Share prices will fall. Youngsters will no longer pay into pensions (because they will lose money). Pensioners will see a significant part of their pension savings wiped out. At that point the state pension will become more vital.
I have warned my son about this, though he is fortunate to have a defined benefit pension. Personally I shall gradually move my pension into government bonds, although I don’t expect the collapse for a few years yet.
Thanks again for raising this important issue.
I’m sure you are right about this Mr Kent, and I am already witnessing serious problems in the ‘DC World’. For 15 years and more, we have seen a QE & ZIRP-driven ‘bubble economy’ where cash has flooded into many different financial assets in a broadly futile hunt for yield. Now, for better or worse (and do excuse me, Mr Murphy), interest rates have started reverting to their mean and this will cause many problems across the economy with, however, one positive outcome for retirees in that the income available from guaranteed lifetime annuities has risen appreciably. That applies to ‘nominal’ fixed annuities (which the vast majority of retirees mistakenly purchase), those with a ‘cost of living adjustment’ (where the payments increase each year by a fixed percentage) and those that are adjusted each year by reference to the RPI (a ‘real annuity’). I’m very glad to say that most annuities I arrange are index-linked and thus will preserve the buying power of the income stream. RPI-Linked annuities, which are only available via pension funds, make up a tiny fraction of the Lifetime Annuity market as it seems that people are very bad a discerning the difference between ‘nominal’ and ‘real’ returns. I usually explain this by asking by saying, quite truthfully, the real value of income can be seriously reduced by inflation – imagine if you are now 65 and live to 85 – could you go 20 years without a pay rise?
Echoing Jane Austen, Solomon Huebner also wrote in 1927: –
“Annuitants are long livers. Freedom from financial worry and fear, and contentment with a double income, are conducive to longevity. If it be true that half of human ailments are attributable at least in part to fear and worry, then the effectiveness of annuities for health and happiness must be apparent. I am inclined to believe that annuities serve in old age, much the same economic purpose that periodic medical examinations do during the working years of life”.
Still true.
I am sorry but I simplky do not agree with this.
What are ‘mean’ interest rates when it is glarinfgly obvious that rates are not set by markets and those currently in use are intended to abuse people?
These rates are heading us for deep trouble.
‘Mean’ here is probably just the same old ‘equilibrium’, dressed up in statistical terminology to give it the implausible cover of credibility.
‘After that, what will need to be done? There will be a need for an urgent reappraisal of that pension saving contract at a macroeconomic level. The older generation will, most likely through the state, need to save in products that the younger generation will require, which will basically be the green and sustainable infrastructure that makes their life on earth possible.’
This is what it is all about. It is not about using ‘dead money’ (savings) – it’s about using living money that is being used constantly and creatively and driving innovation and life itself. Pensions are a real investment – not the plundering model used by our financial services.
Well said.
Thanks
You get it, I know
I should have been clearer in that I was referring to the ‘rates’ on annuity contracts in my earlier comment. Sure, these have been driven by rising bond yields, but annuities are not solely ‘backed’ by bonds, although they remain the main asset behind them. Corporate bonds, equity-release mortgages, and other “lower-risk” assets back them. Annuity rates are also heavily influenced by ‘mortality cross-subsidy’ where those who die earlier than expected ‘subsidise’ those who live longer, something just not applicable to ‘drawdown’ arrangement. So, they are not ‘interest rates’, as such, but ‘annuity yields’; these are reverting to their long-term averages after a decade or more of just returning capital + 0.50% or so.
Annuities, as they are classed as ‘long-term insurance business’, are the only financial product 100% protected by the Financial Services Compensation Scheme.
I am sorry – but that really does not help your case.
Annuity rates are high because interest rates are high thanks to the Bank of England. The rest is waffle.
“The downward trend is 500 years old – and pretty unbroken. This is a blip. Those denying it are kidding themselves.”
Well you inflation wrong, interest rates wrong, recession wrong.. other than lemmings on this board you have no credibility as an “economist”..and really i use that term in jest
Are you a Fellow of the Academy of Social Sciences?
No? I think I knew that. There might be a reason why I am.
Furthermore, or perhaps it is the same thing, interest rates have been on a downward trend for a long time. In my opinion the current rates are an artificial short term blip not a reversion to the mean.
Governments seem to have largely avoided creating money and left it to the banks. A growing economy needs more money to avoid deflation. It broadly needs (changes in saving aside) an increase of inflation plus growth. But this means banks have to lend ever more money. Hence the relatively large mortgages and personal finance on cars.
However there is a limit to what people can borrow even with zero interest; they still have to repay the principal. So, as the economy grows, and the banks have to lend ever more, interest rates must decrease. Perhaps we’re already seeing that with competition to supply fixed rate mortgages below base rate.
The upshot is that, as the excessively high interest rates cause a recession, and the BoE is forced into a screeching U-turn, interest rates (and therefore annuity rates) will decrease. I expect interest rates to be at or below 2% within a year.
Pity we couldn’t keep them stable as Japan has, rightly, done.
Tim
You are right
The downward trend is 500 years old – and pretty unbroken. This is a blip. Those denying it are kidding themselves.
RIchard
If nurses are anything to go by, their pensions will be deferred salary, money they were owed but did not get while they were working.