We should thank Nathan Long for a perceptive and sensible argument to reconsider what we mean by adequacy in terms of retirement savings.
Nathan compares the system of pension accrual which targets “replacement of final salary”, typically at two thirds , with one that provides enough cash to meet a certain standard of living (what has become known as “retirement living standards”.
He points out that the final salary formulation is messed up by people tapering off their work through reduced hours so that the old idea of downing tools after 40 years in return for the carriage clock – is all but dead.
But for millions who have had and still have a defined benefit accrual, the idea of retirement is linked not to savings but to service, it’s a deal made with the employer based on what employees consider the voodoo economics of pension financing. There is nothing wrong with this deal, we don’t understand quantum physics or artificial intelligence either, we trust they work and experience tells us that they do.
Nathan rightly point out that applying the principal of pension accrual against salary (final or career average is problematic. Many years ago, KPMG tried to explain defined contribution rates to expected retirement income and used a pension accrual method; employees and the courts of law found this was tantamount to making a final salary promise and a DC system quickly became a DB pension, to the annoyance of the firm’s partners.
The development of the PLSA’s retirement living standards is a valiant attempt to get people to take control of their saving rates , linking amounts being spent on retirement to amounts being bought in retirement. When I was selling personal pensions in the 1980s, a colleague of mine developed a presentation involving a large folder the inside of which opened to reveal scantily clad young women
“If you want out of that”,
he would say, before opening the other side of the folder
“you’d best have plenty of that”
he would continue, revealing thousands of pounds in bank notes,
This simple equation was a non PC fore-runner of the Retirement Living Standards which went down well with working men. I will not go into the shortcomings of the approach but suffice it to say that this “keep it simple, stupid” approach made him top salesmen for some time.
Retirement Living Standards are more tangible and allow people to grasp simple ideas like spending on retirement. Many people get deferred gratification, or at least the concept of needing to save for the longest holiday of our lives.
But this is not offering people the security of defined accrual where wages and service determine a wage in later age. Only the Royal Mail CDC plan has had the ambition to do that in a DC world.
Nathan rightly points out that the credibility of the Retirement Living Standards created by Loughborough University for the PLSA has been undermined by a hike of some 34% in an individual’s target income compared to a 7% increase in inflation. Which is leading to inconsistencies
In pure pounds and pence terms a moderate retirement income for a single person as defined by the Hargreaves Lansdown barometer stands at £25,000 per year compared to £31,300 in the PLSA figures. A couple would need £36,480 between them according to our data compared to £43,000 with the PLSA.
These are local problems and to be expected in a measurement that is still young – I can understand the frustration of both Hargreaves Lansdown and the PLSA.
But I fear that this is not the problem with pensions that is troubling the majority of the public. Their problem is working when they have enough money to stop working – or at least start the transition to reliance on pensions. People are quite good at household budgeting and generally do the maths for themselves. they can work out what they will spend in a month in and out of work but they have more difficulty working out what their savings will pay them.
Putting the horse before the cart
It has surprised a lot of people that the Government has chosen to review workplace pensions in two parts and to put “adequacy” in the second part.
I think it interesting that the focus of part one will be to improve the performance of the funded pension system by focussing on value for money, the conversion of pot to pension and creating better value from DB structures and from the investment of monies.
The horse drags the cart , putting the load that pensions have to bear (meeting adequate retirement income) comes after understanding how fast and long the horse can pull
I suspect that the Government is keen to make the most of what we have, before moving on to what is needed to meet aspirational targets, either in terms of “replacement ratios” or “living standards”. The Government is not going to return to a system of pension accrual but it looks set on re-establishing “pensions” as a measure of income in retirement and not as a measure of wealth to meet future bills.
I hope that ordinary people will be able to consider – as KPMG wanted them to consider – that a sacrifice of a slice of take home can equate to an expectation of a slice of income in retirement. Restoring the principle that people can defer income, would go a long way to restoring confidence in pensions, one of the aims of Pension PlayPen, AgeWage and now Pension SuperHaven.
