Following my blog commending the two houses for getting the Pension Schemes Bill over the line, I got this comment from Richard Smith
We have to do something to ensure we have one standard for regular income and to my mind a pension has to be “real”, keeping up with inflation. DB pensions often are linked to inflation (nowadays CPI) but how many of them are linked to the full inflation? A high proportion of private DB pensions are capped at 5% or 2.5% while the pre-97 pensions are paid level (in effect losing value each year, whatever the inflation).
The Pensions Dashboard is going to normalise the income that it projects in line with SMPI and as Richard says, that means an Estimated Retirement Income that starts high and reduces to nugatory amounts over 30 years.
I think we can all agree that a Fixed income (one that doesn’t go up each year) does not provider the value for money that’s provide by one that does – a Real income.
We reckon that there is 50% of the value of a fully index linked pension tied up in the promise of inflation protection. Real pensions that pay dependent’s pensions offer value for money over time , even if they are relatively low year one.
We have just had the Pension Schemes Bill reform DC so it provides as a default, retirement income for the pensioner. Now we need to know the detail of the retirement income offered. Will it be Real income, increasing with inflation with dependent’s pensions or will it pay a Fixed level income with no protection to spouses or partners?
There is a huge debate coming up between those who feel that paying an income that decreases each year is adequate, while others see the need for people’s retirement to stay real (protected against inflation in full).
The “real” reform will be when pensions on the dashboard show the regular income that a DC pot defaults to and if that income is not “real” , then we can hardly call this a “real reform” – can we!
Value for money in your retirement isn’t just the first year income, it is the income you get every year until you die and if you have one , your significant others get if we die before them.
Since it is possible to capitalise the value of a lifetime income , it is possible to estimate the value we are being promised by our promised CDC pension. It should also be possible to value the income offered by the default of a DC pot.
If value for money is about the value that sits behind the money purchase from pot to pension, then a decumulation VFM should not be that hard. If we are to have regular income paid as an annuity from day one, then its the value of the annuity, if the annuity comes at a later stage (the Nest default will pay out from 85) then it is going to be more complicated – but little different from CDC (as Nest will be targeting CPI). We know that the intention of those behind USS (not a DC but a DB scheme) is to move to a CDC approach paying increases on the pension in line with what can be afforded by investment gains – this is CDC by the back door.
But what can be compared by all forms of inflation (including the capped inflation payments of most private DB pensions, is the value for money of the decumulaiton.
If we are serious about VFM and pensions then the vital step for VFM to take is to tell people whether the retirement income that they see represents value for money (or not).
