We previously considered the performance aims of pension provision and arrived at a figure of 50% of current wage in real terms (keeping pace with inflation) as a reasonable minimum income aim.
Of course as your work career advances, your wage should advance faster than the 3% value taken. Your contribution and fund will increase accordingly to match this, giving a higher average salary pension
At a factor five, a 10% contribution should provide this 50% level. Many schemes have contribution levels of some 17%, reflecting underperformance and the effect of the 25% Tax free lump sum, which increases contributions by a third for a given pension. Tax free lump sums should be outside normal considerations.
Can you afford it is a difficult question and Fund growth and annuity rates play a vital part as does the State pension. Even small increases make a large difference as the table of PYF showed in the previous blog.
Even with Employer contributions and SERPS rebate, current levels at 17 to 20% are not and give poor value for money. The trend towards defined contribution schemes give even poorer returns and increase employee contributions considerably making the whole situation impossible and unacceptable.
The effects of Inflation cannot be ignored, it erodes the value of money and needs to be allowed for over a forty years period. At present running above 3% per year, the target is 2% and 2.5% is a good average.
At an annual inflation of 2.5%, a pound today will be worth some 37p in forty years time, a reduction factor of 2.7, which can be allowed for in any pension projections and is referred to as “real terms”. Inflation does not only affect income but also accumulated funds and both need to increase for any real gain or advance.
Of course the other question which arises is “are they worthwhile” and frankly apart from Defined Benefit Schemes the answer is no, however without pension savings, one is destined to poverty in old age.
Many Pension schemes absorb the State Pension as part of their final benefits and contract Employees out of the State second Pension, showing the NI rebate as Employer’s contributions, which is misleading. It is also debateable whether employees benefit from this practice.
There is a general impression of confusion, whether deliberate or not. Pension schemes are vague and secretive, annual statements give possible scenarios but no guarantees, it is as if the money is no longer yours and has gone into a state of limbo to return in an uncertain condition when you retire.
Revenue restrictions due to the tax relief do not help, divorcing owner and money, which allows the relief to be absorbed by charges. There is a steady erosion of contributions and funds by charges: the 5% bid – offer differential, commissions, and fund Taxation have a major impact on Fund growth and performance.
Defined contribution schemes are the worst offenders and appear a waste of money. Yields are uncertain and fluctuate wildly, even in the final stages of realisation, because the risk is borne solely by the members.
Defined benefit schemes, now regrettably on the decline, are a complete mystery, with little or no information available on the Funds or their performance, only complaints of being unaffordable. Yet this is the only real way forward, properly managed and run on a fully funded basis and should be the future aim.
The whole process is speculative, with members losing and is not helped by the lack of a stable non negotiable Bond. As a result annuities vary wildly and are undervalued by some 2 to 3%. In 1991 they offered a non-sustainable 16% and are now at 6% or below. Increased life expectancy is given as one reason for this fall, however it can be shown that this has only a minimal effect of some 0.5% on rates.
An annuity increasing by 2.5% per year against inflation and protected against increased longevity in retirement can be sustained at a 6% level with a modest 4% investment income and give the major gains shown earlier on benefits and contributions. Fund continuity into retirement should occur.
The next blog will consider current schemes
Savings Annuities Unions
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