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The problem starts with tax relief. In order to get that tax relief you are virtually forced into the hands of advisors/managers who, as you say, charge high fees for not a lot. Why? Because they can!
One route would be to offer a “living state pension” (perhaps double today’s rate?) and abolish all tax relief on pension savings… but we know this is a non-starter in the current political environment.
More realistically, the Government should retain tax relief (but only at 20%) and offer a low cost solution to savers that will force advisors/managers to cut their fees to compete or fold. Now, NEST (National Employment Savings Trust) does go part way to doing the job – it has 14 million members and it has driven down fees to some extent but private sector players still dominate. Furthermore, NEST still invests in basically the same assets as everyone else… with all the associated costs.
So, two things could be done relatively easily.
First, make NEST the default place for pension savings to go – pension administrators at employers need to be forced to justify using other providers (which, for large companies, they could quite possibly do as they can negotiate low fees…. but the question must be “is it better?”).
Second, NEST should offer (possibly as the default offering) an inflation linked forward starting annuity. The real discount rate should be taken from the gilt market with some possible enhancement for smaller pension pots. (Sounds complicated but, in fact, pretty straightforward… but too long to detail here but I have spoken on this blog about it in greater length).
More broadly, this theme of have a State provider setting the benchmark in terms of cost and quality to force private players to up their game could apply across many areas – banking, retail energy provision etc..
I have no probnelm with NEST
BUT one of its actuaries told me a while ago that the real problem was he did not think there would be a planet for those he was investing for given the way they were required to invest
SO, it would require a big change in strategy
I agree. NEST only solves part of the problem…. but it merely mimics conventional investment behaviour but cheaper. The challenge is get mobilise this money in a better way.
Offering “forward starting inflation linked annuities” will put the money (and risk) in the hands of government that could (if courageous) deliver the sort of investment we need rather than shuffling paper in the stock market.
You are beginning to persuade me
I’m afraid this is true, Richard. However, it need not be so, if there is sufficient political will. We do need radical reform of the whole pension system in the UK, and I’d start with leveling the playing field between defined benefit and defined contribution pensions. This would be wildly unpopular, I imagine, but: –
1. Wind-up all public sector schemes (NHS/Armed Forces/Civil Service, etc.) and ‘buy-out’ accrued liabilities (the ‘promised’ pension) just like private sector DB schemes have been doing for many years. Such liabilities need to be ‘matched’ by financial assets such as Gilts to provide the capital and income streams needed to pay the pensions accrued to date.
2. After that, encourage citizens to take more personal responsibility for their pension provision by setting up a massive collective defined contribution scheme (CDC) that would be obligated to invest a significant proportion of its funds in productive assets, such as infrastructure. Such a scheme could be run at very low cost – just a few basis points. Tax relief, perhaps at a flat rate, would be granted on contributions to such a CDC scheme.
Perhaps my ‘off the cuff’ remarks will be shot down in flames, but much of the £600bn BoE QE debt would be gobbled up by the ‘buy out’ provisions.
Oh, and QT should be immediately cancelled.
I am not sure why we need to be rid of DB schemes, I admit..
DC schemes are the big problem at present
A reformed DC scheme is essential
I’d contend that DB schemes use chronological age, whereas DC schemes that are applied to annuities increasingly use biological age. This is a very important distinction, when one thinks about it. Let me use an example to try and explain.
Imagine that a 67-year old individual (gender isn’t important) has been in a DB scheme for 40 years. If that’s a “60ths” scheme they will be offered a pension purely based on their chronological age, regardless of their personal circumstances, usually including a dependents pension and escalation. The ‘cost’ of providing this guaranteed income stream does not concern the individual, but is significant to the sponsoring scheme and its trustees. So what?
Imagine that this individual was, instead, in a DC scheme and decides to approximate DB benefits by buying an annuity from a life office. Since 1996, underwritten annuities have been available in the UK and, according to L&G, as many as 60% of annuitants might benefit from using their biological age when purchasing an annuity, rather than their chronological age.
Assume that this individual, like me, was a diabetic. Perhaps they also have hypertension or some other health or lifestyle history or issue. They would be offered a higher pension (or a lower cost to secure the pension) compared to an identical individual of the same chronological age in perfect health.
Recently, I arranged an annuity for an individual who wished to secure £10,000 per annum (paid monthly) net income increasing by RPI each year to provide a basic guaranteed income funded by several ‘legacy’ DC schemes of various types. The cost, just using chronological age, would have been £108,000. This person had various ‘issues’ that I won’t go into, and was offered a purchase price of £71,800. About 33% less because of the impact of their personal health history and lifestyle choices.
DB schemes could save very significant costs – with the savings perhaps used to enhance everyone’s pensions in payment – by using biological rather than chronological ages.
For more on this, I strongly recommend “Longevity Insurance for a Biological Age” by Moshe A . Milevsky, a university professor at York University in Toronto – perhaps the world’s leading thinker on the whole retirement income debate (and a very witty writer, too).
Mark
Now you know why I am not so keen on annuities
At 67 I have precisely no identified chronic conditions and take no prescription drugs
I would pay a fortune…
Richard
Think of annuities simply as ‘longevity insurance’, with those in good health actually getting a good deal, those in poor health a decent discount. I can’t imagine that people today would like to return to “corrodies”, would they? Quoting Milevsky again: –
“Records preserved at the National Archives in London indicate the contractual level of precision that went into making these arrangements. For example, one record (TNA E315/94) presents the contract signed by Mr. Ralph Bagshawe and his wife Agnes, both from Devon and presumably retired. According to the document, they paid Forde Abbey a lump-sum total of £20 in the year 1533. Think of it as an insurance premium. In exchange, they were promised the following benefits per week: (i) eight wagonloads of firewood, (ii) four loaves of conventional bread, (iii) three units of coarse bread, (iv) five gallons of regular ale, and (v) two gallons of small ale. In addition, Ralph and Agnes were to receive two measures of fish and meat, per week, and a cash allowance of approximately £5 10 per year, for life. Nice retirement for 1533…
Mispriced, as it turns out, because just a few years later Henry VIII abolished Forde Abbey. the king seized the building and grounds, expelled the prelates, priests and cardinals, and then sold the land to private citizens. Think of it as a type of financial default. Anyone entitled to the corrody was, effectively, kicked out. In modern day terms, the nursing home was repossessed by the government and the inhabitants were turned out…
Now, even in the 1530s, wealthy people had lawyers and annuitants sued the government (or king) in the so-called Court of Accommodations, which was managed by Thomas Cromwell and his buddies. Those detailed and documented proceedings are the source of information about Ralph and Agnes, mentioned above.
I am amused
£20 was a great deal back then
£14,831.67 according to the BoE inflation calculator!
Not bad then….
I love that story for so many reasons!!
The Court of Accommodations sounds a bit like the Equitable Life guaranteed annuity policyholders compensation scheme which I think awarded me a decent amount of money (£40k?) but then said things were a bit tight at the Treasury so I would only get about £14k. That’s sitting in a DC scheme waiting for my 75th birthday when it will make me wealthy beyond my wildest dreams (in reality, it may just help to compensate for years of frozen tax thresholds fighting against the privilege of the triple lock).
But knowing my luck, that doomed pot of money may end up collapsing inside a Reeves-mandated private Ponzi scam.
Things don’t change much do they?
Wouldn’t it be wonderful, though, if there was a political party that had a “living pension” as part of its transformative agenda!? Keep a place in your heart for it, Richard.
One of the key issues is costs & charges which Unison tried to develop. Just look at the fund managers they do nothing and they charge extortionate fees. The funds need to be facilitated to merge on an industrial basis and asset management prepared in-house. We can do away with private asset management.
Agreed.
I hope you’re well, Colin. A long time since we have spoken.
I’m glad to hear some good things about NEST and like the sound of linking it to more helpful modes of investment. I worked for a charity that used it, and they do offer a more ‘ethical’ investment choice. Their fees are much more sensible and fair than those charged at a private fund another charity employer used – totally unsuitable for people on minimum wage. I moved my little pot into NEST before it was eaten up by their fees, and tried to tell my colleagues that it wasn’t much cop. But we had to stay in to get the employer contribution, action only possible after leaving. It is a disgraceful system.