I have spent a wonderful couple of days with my mother in Dorset and while I have been away from work , I have been thinking about what we can expect from our retirement saving. What is the right amount , based not on gilt yields but on the real world where funds achieve much higher returns than people get from annuities?
I think that most people consider a return of 7% on their money as what they should be getting back from their pot, with scope for income and I think that if the only expectation was an income for the rest of your life and you were 67, the soon to be state pension age, a flat 10% pa would be a reasonable expectation.
Making this simple, £100,000 at 7% pays £7,000 pa increasing with inflation and £10,000 pa increasing. You could expect less if you started getting paid before state pension age and more if you waited but I will push the boats into the lake with £7,000pa and £10,000 pa written as the names of each boat.
I am sure I will get some comments from those who want to stick with gilt or corporate bond based formulas and there will be others who will look at past performance of balanced or even purely growth “equity” funds and say that drawing 7 or 10% is reasonable.
I think that pensions can safely pay 10-15% more than annuities based on assumptions about return and assuming they are investing with a reasonable duration (20 years +)
Which means that if an annuity is paying level 7% now pensions should pay 8% level to those in their mid 60s with the impact of collectivism meaning that there is quite a lot of smoothing that can be done.
This is really important, we have two important ways of looking into the future. There is the “statutory money purchase illustration” SMPI that seems to have been around as long as I have and a more recent invention – “estimated retirement income” (ERI).
I think people should know about how these work as they are going to give them confidence about retirement and may actually help them with when they can move from reliance on pay to reliance on pension.
But it is not good enough to leave the default pension rates to the marketing departments of the commercial master trusts and contract based personal pension executives. It would be a lot better if the secondary legislation and regulation that follows the Pension Schemes Bills gets to grips with what can be offered by every Pension Scheme to convert pots to pensions.
I have written elsewhere today that we would be better to start with an universal conversion rate and manage expectations around two factors – one the expectation of paying more than the conversion rate through increases and the other the expectation that there will not be enough money to pay the 7% (let alone increases).
Of course the decision about whether the choice will be around risk minimisation or ambition for growth will be in the first instance by the pension scheme (the trustees and executive) and then by the participating employers. It will not be much to do with the member though they will have the option to opt-out and do something else (which might be to join another default which pays pensions with a different approach to risk and security.
I would like a simple measure to be available day one which will simply offer a colour with the spectrum being from red to amber showing the most secure as green and the most ambitious being amber (not red please!).
As time goes by, I think we need to know how well a scheme is doing relative to the expectation offered. If there is no expectation of increase, the value for money score is zero. If the fund is falling behind the capacity to pay 7% then it has a negative score and if it is exceeding the target to pay 7% , it should be able to display a positive score (based on capacity to pay increases). Annuities and DB plans which have built in increases should be able to display the impact of those increases.
Since these payments are going to be heavily regulated by TPR and FCA, I do not suppose that the payment of income substantially beyond the fund’s capacity, will be rare and will be considered a regulator issue.
We should rely on value for money as a measure telling us how far the scheme is meeting an aim. If the aim is to not fail, then a scheme will do well when everyone is doing badly. If the aim is to do well, then growth orientated schemes will be marked high on VFM scorecards when high income is distributed.
I hope that this makes sense to my readers, if it does not, please explain and I will try to be plainer. I think I may have got 7% as the wrong number we can start from , but I think that we should start conversations about the kind or expectation we have of our pension, based on a system like this. We need commonality between the various schemes about initial payment and we need variety in choice between those schemes going for security and those for growth.
Expectations of “pay” from pensions funds should be a right for those looking to their future.