Three things prompt me to write this article
The work of Dr Iain Clacher and Con Keating into the unequal burden regulation places on the sponsors of defined benefit pension schemes
The agreement between unions, Government and employers in the Netherlands to move away from guarantees and towards what we call CDC
Holland’s largest union has today voted to support major reforms to the Dutch #pension system which will bring to an end “Defined Benefit” style arrangements for millions of workers.
— Josephine Cumbo (@JosephineCumbo) July 4, 2020
The amendment in the Pension Schemes Bill that commits the Pensions Regulator to sanction relatively aggressive investment strategies where trustees and sponsors want to keep a DB scheme open
The three matters are aiming in the same direction, the proper payment of pension promises through the efforts of employers, regulator and trustees working together.
It has long been recognized through surveys conducted by consultants (Aon and XPS most recently) that ordinary people look for their workplace pension to provide them with a pension. While there are many people who have opted instead to transfer their pension rights into the hands of wealth managers, it is generally acknowledged that such transfers are for the few who do not need a wage in retirement, rather than the many for whom pension freedom is a tank trap.
The Dutch decision should be seen in this context, if the alternative to a guaranteed system of pension payments is the workplace DC systems of the US (401K), Australia (Super) and the UK (workplace pensions), then better to keep a system which does at least offer people what they were promised – a wage in later age. 401K, Super and the British workplace pension system offer people wealth not pensions and the term “wealth” is not that suitable , if it is kidding people it is a substitute for a pension.
Simple truths (no kidding).
It costs a lot to pay a wage for life. If you want a wage for life at 60 and you want wage growth of 3% pa and for it to continue to your spouse if you die first, then think of saving £750,000 before you can retire to what the PLSA considers a moderate retirement lifestyle. This level of wealth is beyond the comprehension of most people in the UK today but it is what is needed to provide a private income of £20,000 pa for the rest of your days.
This is why we need to inject some realism not just into the debate about what UK workplace pensions are supposed to be doing but also asking how we can preserve what’s left of our collective pension system, both in the UK and in the Netherlands.
Read Con Keating and Iain Clacher’s excellent article as an answer to that question. Consider the Lords amendment to keep DB open, as an answer to that question.
“I want to level with you”
Boris Johnson’s phrase, with which he introduced lock down , lives with us. COVID-19 has asked and will ask questions about the true state of affairs in the UK. If truth be known, if we use the valuation techniques employed for DB transfers and implied by the Pensions Regulator’s funding code, the transfer value of a full state pension is around £300,000- to provide us with a wage for life of c £8,000. You cannot take that transfer value as the purpose of the Government backing the pension promise is to keep people from destitution not make them “wealthy”.
£750,000 might give you a moderate retirement income but that is on top of your state pension, the reality is that to have even a moderate income in retirement , you need a million pounds to fund it – or you need to stay at work or you need to die young. These are the hard COVID-19 truths.
I want to level with you. There is no cheap way round this problem. Though you may want to create a lifetime mortgage on your property, you are unlikely to generate sufficient liquidity to provide you with the wage for life you would have got had you been in a DB scheme.
Those in tax-payer funded pensions such as the Civil Service, Teachers, Fireman’s or Local Government pensions will be getting millionaire’s pensions if they can retire on as little as £25,000 pa.
For the vast majority of workplace pension savers, the 8% of band earnings that is paid into their workplace pensions will not be enough and even if that 8% was doubled, there is no proper way of returning the wealth in the DC plans as a wage for life. The cost of advised draw down are currently excessive, the price of annuities too high and the risks of DIY retirement planning for the bulk of the population too awful to give much thought too.
We need pragmatic solutions for today and strategic solutions for tomorrow
By harnessing technology, we can at least make sense of our retirement savings today. A proper system of finding pensions, displaying pots and providing people with investment pathways is the best we can do today. It is not the nirvana promised by pension freedoms but it is better than nothing.
For the future we need a strategic solution and were we thinking as the Dutch are thinking, we would start moving to a non-guaranteed system of workplace pensions which did not promise wealth but pensions.
We need ways to encourage employers who want the real promise of a wage for life to be able to use their best endeavors to fund those promises. This might mean continuing to other funded pensions without guarantees or it might mean thinking about funding as Clacher and Keating do.
We need to resist the lock down of open pensions into “de-risked” bunkers from which there is no prospect of future accrual and every prospect of penury or bankruptcy for the sponsoring employer.
I read the House of Lords debate around Lady Bowles’s amendment time the Bill
for open DB schemes. Lady Bowles and others acknowledged the briefing given to them by the Railways Pension Scheme. In the debate, other open schemes like USS and British Nuclear were mentioned, but I didn’t get the impression that USS, for example, had been briefing/lobbying for the proposed amendment. Others who often comment on your USS-related blogs, Henry, may be able to explain that better than me.
I would sound a caution on relaxing too much of the funding restrictions on open DB schemes. Will they remain open indefinitely? Even railways may struggle to recover from the current short-term life support from Government which falls short of re-nationalisation.
When schemes close (and I’ve been a trustee of more than one which have), there are a number of forces at play. Employers tend to get an accounting gain (and I was reminded by the papers of evidence summarised by the House of Lords as part of the debate how some respondents back in 2016, your former colleagues at First Actuarial among them, Henry, had called for a reform of IAS 19). Employers also tend to face increasing deficit recovery costs which would the suggest the previous balance between funding accrued benefits and funding continuing accrual was skewed in favour of the younger generation of members. Some past members (and they remain a minority so far, fortunately) may get benefits cut and capped by the PPF.
Inter-generational fairness is hard to achieve without margins of safety on both sides. Even i tea-generational fairness is seldom achieved if high earners with higher expectations of salary increases and longer longevity are lumped together in the same open scheme. This is where I have particular sympathy for the Keating & Clacher proposals into CARs being applied to test the real, lifetime costs of higher paid people’s pensions.
“time” should be “to” in the second line of the above comment.
i-tea should be “intra” in the final paragraph above. More autocorrect mayhem.
“time” should be “to” at the beginning of the above comment. Autocorrect sometimes does odd things to prose!
Thanks Derek,
We tend to have two different services for people, what Henry names ‘wealth management’ which we name ‘comprehensive wealth management’, and also a ‘focused retirement planning’ service for the less affluent people.
I would refer to the second service now. As Henry noted, this is a type of service that exists in the U.S., Australia, and the UK, and less on the continental Europe (like Germany or the Netherlands).
I think it is based on a political option to treat retirement in a more liberal manner, than a socialist manner where pension schemes are looked after mainly by the employer and the union. There are both advantages, and disadvantages, and like in any liberal country some make use of the advantages, and some not!
The advantage we have here in the UK is that in a more liberal fashion, people take care of their retirement, and they are able to make additional provisions in accordance with their own retirement plans. They could benefit of up to £40,000 annual allowance tax relieved contribution, and also have a generous lifetime allowance. It is mostly up to them to better themselves off and make use of these generous tax breaks.
You would argue that not many people take advantage of this, and I will have to agree. However, the pension system is also made of State pension, which should cover the basics expenditure for people who do not make use of ‘the opportunity’. I think that we have a rather generous system, and State pensions have increased form 2016, and it does not penalise anymore people who made additional retirement provisions. £9,110 per annum is a significant amount, a good replacement income for someone who was on £20,000 per annum earnings and made little retirement provision.
You may argue that State pension is higher in the U.S., but the cost of healthcare is different. Many retirees do not want to rely on Medicare, and prefer to beef it up with additional health insurance. In the UK, retirees have access to a world class heath system, the NHS, free for use, paid by the taxpayer.
For all the bad comments, actually focused retirement planning service clients get a very good deal, and I will argue they are actually subsidised for the cost of the advice service by wealth management clients, who are charged more. There is plenty of proof that they retire with more, and usually earlier.
I do not think technology could play too much role, but I am willing to concede when I see this happens. I could see some help in consolidating disparate pension plans, compare some past performance (although without content, this shows nothing as generally past performance is not a good indicator of future performance), but I cannot see it yet replacing human interaction with the financial planner, his/her coaching skills and understanding of personal circumstances etc. When you go to personal circumstances, people have children who care about and want to help them succeed, they have health issues, they have dreams, they chase promotions, they hate their job and want to do something else, they will have inheritance windfalls from the baby-boomers, and technology could not make yet much sense of that. Human interaction with an emphatic financial advisor goes a long way.
I remain convinced the actual pension system (with a few tweaks) works. It gives people who want to do better a chance to have a say in how to save, how much, and what exactly to do with their money. And it also has a relatively good safety net (at the cost of the taxpayer) for people who decided not to care too much about these issues.