This week the government announced a review into pension charges, something I support but somehow I think the government has got it wrong again. The problem is that they seem to assume that auto-enrolment plus lower charges = perfect retirement. And to be honest who blames them when leading industry spokespeople support their thinking.
I read a fantastic report by Dr Ros Altmann and it highlights some important facts that the government seem to have missed in their thinking. The key point is that in the past individuals didn’t have to worry about their pensions (where their employer provided a scheme), often this enabled them to retire early. The reality is that this golden age is over unless you are one of the lucky few.
Individuals now have to take responsibility for their retirement and for many they are not able to understand or comprehend this. It doesn’t help when the government tells everyone that auto-enrolment and low charges are the perfect solution.
An individual age 25 paying £100 per month into a pension under the new pension scheme, this would provide a pension fund of around £125,000 in retirement (assuming retirement at age 67). This assumes the investments increase by 4% p.a. after charges.
In the calculation I assumed the new state pension increases by 1% p.a. to age 67.
Roughly this would give a pension of £1,300 p.m. assuming inflation of 2.8% this would be worth around £430 p.m. in real terms.
The flaw in the argument
Obviously this doesn’t reflect contributions increasing but it gives an idea of what to expect. The problem with many of the schemes is that the investment choices are limited; to keep charges low many choose passive funds (passive funds track an index like the FTSE 100).
Passive funds can work but I would argue by their nature the returns will be lower than a good active fund. To be honest when Barclays talk about returns of 3 to 3.5% p.a. I expect these to come from passive funds.
If you start getting these types of returns then you are facing a very miserable retirement.
Understanding the risk
We know people don’t understand the risks, I have seen countless times people not understanding what they are investing in and not understanding the differences between pensions and ISAs.
Without getting into detail pensions and ISAs are two different things but they can form part of the retirement income. You don’t get tax relief on contributions in an ISA but you do get tax free income, with a pension the reverse happens.
With the pension the fund is locked in whereas with the ISA it is not.
Then we need to understand the risk when it comes to investing, my job is to manage portfolios for funds. I spend time understanding about different investments and how they might work together. Some years they do well, some years like 2011 they don’t but smoothed out the returns should deliver somewhere between 5 to 8% after charges over a five to 10 year period. The extra charges provide extra benefit which you wouldn’t get with a fund tracking an index.
End of contract
I met somewhere the other day who was reaching age 55 in the army, he liked to think he was ending his contract. I thought about this and he is spot on. Longevity has changed the way we look at retirement.
For many we may slow down but living into our eighties or nineties may mean we work well into our seventies. This needs to be factored in.
So what should the government do?
Personally I think they are listening to too many yes people……
I am not saying the report by Dr Ros Altmann is the Holy Grail when it comes to solving the problem but what it does is look from the bottom up. The government thinks people will engage with their pension planning because of auto-enrolment, I’m sorry but they won’t.
We are facing a massive train crash over the next few years and now is the time to avoid this. Reverse thinking is needed - pay people to educate people, make people consider about budgets, target income and ultimately have a plan. Planning for the future is not hard, it just needs a plan and acceptance things might change.
Does the government have the strength to stop the road crash and go back to basics or will they just hide their head in the sand on the basis that it’s not going to win them the next election.