One of the uses of a CDC scheme could be to allow people who have opted out of a DB plan – to opt back into a scheme which pays them a wage for life – albeit one that isn’t guaranteed by an employer or by other schemes. In this blog, I look at the logic for people to do this.
I should point out , that opting into a CDC scheme isn’t possible yet, and even if it was, it wouldn’t be the right thing to do – for many people, but read the blog and then come to your own conclusions as to whether that option might be a comfort.
How can my pension be worth so much?
A lot of members of defined benefit pension schemes seem amazed at the present value of their future pensions.
I am not an actuary and also struggle with “discounting a series of future payments into a cash equivalent transfer value”. I wrote a blog called “why are transfer values are ridiculously high”, which is one of the best read of the year. Con Keating has added some technical detail.
It’s often said that we underestimate how long we’re going to live (Apparantly by 8 years), it’s not so often said that we underestimate the economic value of the work we do.
If the wage paid to the average British worker (lets say £27,,000) were to be paid over a working lifetime , an actuary might value that string of payments over 40 years at something like the range of transfer values paid today on a pension commencing today to someone on 55.
To put it another way, to pay my son an average wage for life , I would need to invest a sum of around £1m today.
So in terms of their economic value, those steel men I spoke to in their fifties, had already delivered a million pounds of work (in today’s money) and stood to be paid a pension valued at around £350,000 (in today’s money). The shortfall between the transfer value and the cost of two thirds of a million pounds (the full DB promise) is the actuary’s estimate of the real growth in investments that can be expected above wage growth.
If we expect no real investment growth (above wage growth), we might have to pay higher transfer values yet!
The average young person is worth a million pounds in work
If this headline appeared on the front page of the Daily Mail , most Mail readers would cough and splutter through Christmas – aghast.
The average person retiring in their fifties needs a million pounds in their pension
If this headline appeared on the front page of the Daily Express, most Express readers would react similarly to the Mail readers.
But these are the present values of a lifetime’s work and a replacement “wage for life”.
We start work as millionaires in unpaid wages and we should finish work as millionaires in unpaid pensions.
Would my son want his money up front?
If I were to pay my son one million pounds and tell him this was instead of a wage to life, I am sure he would be extremely happy with the deal – for a few minutes. But being a smart lad, I think he would ask himself how he was expected to manage that money and what he was supposed to do with his time over the next forty years, he might even ask where he was expected to find the money to pay for the later years of his life!
Infact it would be a terrible deal for my son, if he realised that taking the money now, would deny him the wage for life that he would otherwise get, he’d be bricking himself. Looking back at all the payments I have had to make for my and my family’s expenses, the thought of managing them out of a lump sum paid to me 40 years ago, sends shivers down my spine!
But that is precisely the pact that many of us are making with our pension providers when we take a CETV.
Of course it’s not as simple as all that.
The present value of my state pension , due to be paid to me in just over 10 years time – is probably £250,000, most of the steelworkers I spoke to , knew about this and they also knew they still had economic value from their future work (they might feel knackered at 55 but they had money-making in their bones). Which is why, the CETVs are regarded – to an extent – as windfall money.
But even with the future promise of work and pensions, the enormity of old age and the financial demands of a failing body, had not sunk in (to many of the people I spoke to). Nor would I expect it to. We are not designed as functioning working people to worry about the future in the way that I – a dysfunctional cod-actuary, cod-financial planner, worry about mine!
My father is in his late eighties, so is my mother, they are in the 30th year of receipt of an NHS pension and that pension goes up every year in line with inflation. It meets their financial needs today, just. It does not meet the special needs that might befall them tomorrow – the cost of care. They have been frugal all their lives and they get a state pension and help from the NHS which means they will be alright – especially as they have four sons who can help out.
But… to a pensioner – a pension means so much
But that NHS pension, still going strong after 30 years has supported them for three decades. For them – it is pretty simple, they have been paid a wage for the second half of their life based on the wage from the first half of their life (and without my mother, my father could not have worked as he did).
When I was giving evidence to the Work and Pensions Select Committee , I meant to make three point, the first two were about the transfer process and investments, the third was about ongoing advice and support.
The ongoing support that a pension gives older people is independent of any advice. But the Steel workers I have spoken to are dependent on advice to support them for the next three decades or more. They are relying on an advisory superstructure that may or may not be there for them.
At present, if they want to move from a drawdown from capital to a pension, they will have no choice but an annuity. The option to return to the BSPS2 or PPF will not be open to them.
I , and other Friends of CDC, see the creation of another option- the option to transfer that money back into a pension plan which pays a wage for life (albeit one not guaranteed by employers or other schemes) – a good option.