The current system of planning for retirement
Whilst the section above covers Government pensions they cannot be said to be “planned” for. They are what they are and we have no choice about paying tax (social security) to pay for them. This next section reviews non-government pension planning. It is clear that we will have to become much more self-sufficient in planning for our retirement. The reason is simply that we will live longer, perhaps as long as 30 years in retirement and this is causing great strain upon our own resources.
Company pensions consist of two types, defined contribution and defined benefit (final salary). A defined contribution pension is similar to a personal pension but with the employer possibly contributing to the pension and often with additional death benefits. Companies setting up a pension from scratch will use this style of pension as the company’s liability is only to pay a set amount to the pension. The liability is known at the outset.
Defined Benefit Pensions require a sponsoring employer to meet a future pension amount for an employee, often expressed as a proportion of the employee’s final salary. These schemes transfer the liability to the employer to ensure there is sufficient in the fund to meet all these future employee pensions. Lower than expected investment returns, longer life expectancy and regulatory requirements all affect how much a company has to contribute. With a defined benefit scheme if there is insufficient money in the fund to meet these pension liabilities, the scheme is said to be in deficit. Deficits are a huge problem around the world for this type of pension due to the factors mentioned above. As an example, in the UK the figures are as follows:
- The aggregate deficit of the 5,945 schemes in the PPF 7800 Index is estimated to have increased over the month to £322.8 billion at the end of February 2016, from a deficit of £304.9 billion at the end of January 2016.
- The funding ratio worsened from 80.5 per cent to 79.8 per cent.Total assets were £1,272.7 billion and total liabilities were £1,595.5 billion.
- There were 4,956 schemes in deficit and 989 schemes in surplus.
To give a balanced view of this information, this deficit of £322.8 billion would likely be reduced if interest rates were to increase. Recovery plans suggested by the Citibank analysts for defined benefit schemes include:
- Selling the pension scheme and liabilities to an insurance company.
- The sponsoring company issue debt (Corporate Bonds) with the money raised being added to the pension fund.
- Allowing employers to have much longer periods to try to “rescue” the pension through additional payments to the scheme perhaps allowing up to 30 years for the rescue.
- Allowing pensions and other benefits paid to members of the scheme to be reduced.
Personal pensions are exactly that; personal. They are not dependent upon an employer and stay with you for life. You contribute to the pension and the monies are invested. The level of pension that you get each month in retirement is entirely dependent upon the amount of money in the pension pot. Whilst personal pensions seem the ideal solution from a government and employer perspective there is a cost to Government. In many countries, tax relief is given against contributions to personal pensions to encourage people to save for their retirement. The scale of that tax relief, in the light of the matters discussed above for Government pensions, is being reduced as a cost cutting measure. In the UK, for example, there is a lifetime allowance (LTA), a maximum amount that you can have in your pension without incurring additional, penal taxation. The LTA started at £1.8 Million as the amount you could accrue in a pension in your lifetime. From 2016, this has been reduced to £1 Million, a 44% reduction. Similarly, in Spain the annual amount that can be contributed to a pension has fallen by 30% to just 8,000€ a year.
In the next article, we consider what is happening in the equity market causing possiible structural change as most pensions have a large equity element.
If you would like the full White Paper, Managing my Wealth for Retirement, in PDF format email firstname.lastname@example.org with the subject White Paper.
i. Prudential Global Investment Management
ii. Citibank, The Coming Pensions Crisis March 2016
iii. Department of Worls and Pensions UK, Review of State Pension Age, March 2016
iv. Pension Protection Fund UK, PPF 7,800 Index, March 2016 Update