John’s Blog No. 19 Pensions – Universal Pension Scheme Detail (cont)

We now come to pension benefits; the design of the scheme ensures that benefits reflect the contributions made and the duration timescale over which they occur to give a fair return.

The aim should be based at 6% of final funds with inflation increases of 2.5% per year, which should be readily achievable on current contribution levels and longevity projections. A modest investment income of 4% would sustain this payment level.

A basic minimum of 50% of the National Average Wage should be the level at which benefits are set, although a lower level at 40% may be necessary in the early stages. Once this is reached, benefits should reflect the earnings of the individual on a final wage based on the wage index, effectively this would give the average individual wage with inflation increases.

Higher earners benefit from their increased contributions and the scheme would be flexible to reflect extra contributions etc. At the end of the day, benefits will reflect the fund value at retirement as in current private schemes, except when this value falls below the minimum, when make-up could occur.

Welfare pensions should remain the responsibility of the State with the option to contribute into the scheme, however the grey area of low wage or intermittent employment will depend on the transition provision and scheme success on growth.

The State could however contribute on behalf of low earners or periods of unemployment, similar to the make-up of NI contributions, it would certainly be cheaper than paying a welfare pension. There could possibly be a basic entry level to provide a pension of 28% of NAV, which would be close to the proposed State universal level of £140 pw.

Investment growth is the key to any successful pension scheme and combined with payment levels sets the contribution levels required to provide acceptable pension payments. The universal contributory DBS set modest levels of 4% with target aims of 6% invested in more stable and sound areas in some form of mutual Pension Society, although it could be attractive to existing providers.

To provide a pension of 28% NAV at 4% growth over 40 years requires contributions of 8% NAV, currently some £40 pw; this would be inside the NI rebate opt out of State pensions suggested in Blog16. Of course unemployed and low earners pay no NI, so it would be a State subsidy.

Transition from an unfunded State pension to a funded independent scheme will always be difficult, especially in the early stages, but would ease as funds build up, particularly if higher growth occurs. The State will also be faced with a reducing pension bill and could therefore afford to be more generous.

The big advantage at the present time is that contribution levels are high and annuity levels low, which should allow sufficient slack if well-managed, there is also a high demand for investment capital.

One of the contentious areas could be the removal of the tax free lump sum, which many rely on to clear debts at retirement. This increases contributions by a third and is not cost effective; the money would be better spent in clearing debts / mortgages during the working life. It also conflicts with the aim of keeping contributions affordable.

Overall the time for a guaranteed “value for money” pension scheme is well overdue; the State, public sector and private pensions do not deliver, except for the failing Company DB schemes. The uncertainty of retirement needs correcting, particularly in view of increasing population demands, which make self sufficiency the only way forward.

Individuals need to demand their rights, those in work make major NI and contribution payments, ever increasing but with steadily reducing benefits. The proposed changes offer one way forward.

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John’s Blog No. 18 Pensions – Universal Pension Scheme Detail

In previous blogs we have attempted to explain and simplify the provision of pensions in the UK and introduced an alternative scheme to the present failing State and Private systems.

This was the proposed universal defined benefit contributory scheme, given in Blog 12 which will now be dealt with in more detail.

The first requirement was that Pension contributions should be recognised and treated as personal individual savings, which appears obvious and almost basic, but does in fact not occur. Normal savings are treated in this way with State compensation when loss occurs.

Pension funds appear to be anybody’s money, open to plunder and misuse and at the end of the creditor queue when Company failure occurs, but they arise from hard earned wages or as part of the employment contract and are personal savings.

Following on from this there needs to be a change in the way Funds are invested and managed, current investment options have become more speculative and short term and yet there is a shortage of Capital investment in all areas of social infrastructure like housing, energy, transport, schools, hospitals, care and recreation  etc.

These do not offer the fast buck returns, which in any case long term pension funds should and cannot rely on. Funds should be segregated and managed by age, one can take risks up to mid forties, but funds need to be secure and available thereafter.

There is another good reason for segregation by age; that is to ensure a fair distribution of funds by the timescale of the contributions made, which could overcome problems of entry date, final salary etc.

A possible solution could be the purchase of unit funds, as in current private schemes, but with their value associated with age and fund performance. Starting at entry age 25, to give a full 40 years, funds are purchased at unit value £1, which increases annually by the basic fund compound target growth, say 4%; at 26 they will cost £1.04; at 27 cost £1.082 etc., new entries will pay the value appropriate to their age.

This should fairly reflect the value of contributions made and the number of year’s contributions and providing wages, contributions and growth exceed inflation will give benefit in real terms. Fund values and growth can be reviewed annually or every 5 or 10 years and bonus shares issued; if consistently higher, then the growth rate basis could be changed.

 Early start at say 16 or even birth could be converted at the appropriate value at age 25 into the main scheme, which could be extremely flexible, allowing extra contributions, earlier retirement etc. Low fund build up from lower earners could be met by State contributions or welfare payments from bonus funds.

Fund continuity should also occur without any break at retirement and transfer of funds between investments should not incur bid/offer charges or differentials, in fact all costs and charges should come out of investment returns, (as with savings) and not from accumulated funds.

Tax free lump sums are not cost effective; they involve a third increase in contributions and are better used in reducing mortgage and other debt. They could be offered as an AVC with extra contributions and are not offered with the basic State pension, which allows contributions to be kept to a minimum.

Tax relief on pension contributions is still an essential inducement to pension savings, but at higher income levels taxpayer’s money could be better spent on state NI relief for pensions or a lower income contribution subsidy. It is suggested that this should be capped at the 20 % rate on the lower band level but increased for dependent partners, or set at 20% on all earnings.

Pension benefits of the scheme will be the subject of the next blog

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John’s Blog No. 17 Pensions – Overview

Pensions and their provision are critically dependent on the efficiency of the commercial markets and the demographic factors of population, together with their fluctuations with time.

In order to be worthwhile, pension savings need to grow at a rate of at least 1.5% above inflation, around 4% and to be successful at 6% or greater. This needs to be sustained over a long period of forty years and requires long term stability free of present market speculation and uncertainty.

Anyone who has taken out a private pension, on a defined contribution basis over the past twenty years, will have seen their projected benefits in 10 to 20 years time drastically reduce over this period by a factor three or four. Originally projected at 8 and 13.5% growth, these have reduced to 5 and 8% growth.

Yet pension and investment funds are still reporting annual growths of 9%, with target rates of 8%; commercial borrowing rates are 6% and above; Bank investment arms report large profits and bonus. The problem is part uncertainty and part greed, combined with a slowing down of world trade expansion.

The industry needs to adapt and change; there is still a major demand for investment capital and pension funds are a unique, large and ongoing source of long term capital which by its nature has to be serviced but not necessarily repaid.

Quite low returns over the 40 year timescale can give reasonable benefits for the present level of contributions. We have already shown how a 4% return will give yield factors of 3.5 in real terms, increasing to 5.7 at 6%.

Increased life expectancy with the resultant effects on the retired population is the other area of concern, yet it would appear that these effects may have been overestimated in future projections, resulting in some cases to purely nonsense figures.

Forward projections are based on life tables and estimated decreases in mortality rates, which do not appear to relate back to current population figures when projected forward, particularly in the retired. The latest figures show the lowest mortality rates recorded, but the proportion of deaths for the over 80’s has doubled over the past 40 years and the over 60’s remain high.

The UK retired population over 65 in 25 years time is projected to increase by 50% to 15 million; yet these will be the 2008 population aged from 40 to 64 which is currently 20 million. If they make their own pension provision whilst in work, problems with increasing population do not arise.

For the State, pensions have become a liability which they cannot afford; there is the prospect that costs and hence taxation will increase by 50% over the next 25 years due to the reduction in the work/ retired ratio from three to two.

The reaction is one of cost cutting rather than a positive approach to find a more affordable and equitable solution to the problem.

Forward pension planning by the State should be based on greater self sufficiency and increasing the numbers in employment, currently 75%; not reduced benefits and delayed retirement.

Common sense indicates that this will only be achieved by clearly separating State welfare benefit from self provision and breaking the dependency of the retired on those in work. A return to value for money in pension savings, including NI is well overdue.

A well devised and managed fully funded, universal pension scheme with guaranteed returns is the obvious solution with completely separate welfare provision for those who need it.

After all existing pensioners and those in work have paid or will pay substantial NI contributions to ensure an adequate retirement income and will not readily forgive the failure to deliver. Resentment will also grow at the present “pay today, worry about tomorrow”, which results from the present unfunded system.

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John’s Blog No. 16 Pensions – State Pension Changes

The coalition announced this week, the introduction of the Universal State Pension , which will replace the existing State pensions and benefits with a single scheme.

It is significant that this has been set at £140 pw close to the level the State says is the minimum that a single person needs to live on, the current Pension Credit level. It is also more significant that the threshold for tax and NI has been set at this level around £7,280 to £7,450 per year.

A basic Poverty wage is therefore established at which no taxes or NI are paid and for a universal Pension income. This is currently set at 30% of the national average wage (NAW).  

This will mean the end of the NI contributory system, meaning that whether you pay NI or not you will be entitled to a State pension expected to be some £155 pw when introduced in 2015. NI will therefore become a Welfare Tax raising overall base tax levels to some 44%.

The State second pension will go and  SERPS opt out rebate and it too bad if you have earned or depended on this from higher NI contributions over the past 30-40 years. All will become a fair, equal and grey Pensioner Society.

If you want more than this minimal living allowance, you will have to save in a private scheme set up as the favoured defined contribution scheme, currently NEST, whose outcome, like the lottery, is uncertain.

Effectively this is a State opt out of pensions and a return to the poorhouse for many. In spite of the promises, there is no guarantee that this basic pension will keep up with living costs, as many existing pensioners have found out over the past twenty years.

In fact it is unlikely that it will do so as the whole unfunded system is not viable or sustainable.

Overall this is a cost cutting exercise to potentially save some £20billion per year in pensioner costs.

Time is well overdue for those who work, earn, pay taxes, NI and save, to receive a fair deal for their efforts and full and solid guarantees for their retirement future. These should be fully separated from those who, for whatever reason, find themselves dependent on State welfare.

Of course we should maximise employment and opportunity for all, but we should not penalise those diligent enough to find it. The effort should be directed at creating jobs rather than losing them.

At NAW, individual NI contributions amount to 8.53%, of gross wage; invested over 40 years at a modest 4% growth rate this would give the same pension of 30% of NAW.

This could be the basis of the funded universal contributory defined benefit pension scheme outlined earlier and the proposed changes offer a unique opportunity to implement this and establish a secure and stable pension future.

It is time for the dependency of pensioners on those in work to end and this can only occur with a fully funded pension system which gives self sufficiency at retirement.

The cost of transition of the current proposed changes will not necessarily be different from that required for a FUDBC scheme, and similar to the transition of public sector pensions outlined earlier.

If the State meets current pension liability, as it indicates it will do, then income for such a scheme, will only be needed to build up funds and meet new pensions as they arise

Employer NI is equal to individual NI payments giving a current income with SERPS rebate of £110bn, half of which would almost meet present pension liability, leaving the State to meet the benefit side, and both will reduce as existing pensioner numbers reduce with time.

The other half as a 9% rebate (similar to SERPS) could build up to meet existing workers as they retire, to give a 30% final pension in real terms.

The proposed NEST contributions of 8%, which will probably become compulsory, would give a further 28% in pension in a funded defined benefit scheme.

At 16.5% overall this has the potential to give a 50% final pension and generate sufficient income to meet welfare pensions and even member’s health care needs, particularly if higher investment returns are achieved.

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John’s Blog No. 15 Pensions - Proposed Funded UDBC Pension Scheme – Implementation 2

Previous blogs outlined this scheme and considered implementation, with transition to a funded system.

In any financial problem one needs to establish whether it has a solution; in fact whether the sums add up, income meets expenditure etc. The previous blog showed that they did not

The basic aim of any savings is that they should keep pace with inflation otherwise they are not worthwhile

If this occurs then £1 today will be worth £1 in spending power in forty years time. This simplifies the minimum one should expect from pension savings. Contributions of £1 per year would give £40 in real terms, at a 4% annuity rate this yields £1.60 pounds in pension; at 6% the pension yield is £2.40.

This pension yield factor, mentioned in previous blogs, can be used for actual values; percentages or any general form, e.g. 10% contribution would give 16% of salary growing with inflation. Growth above inflation would give higher yield factors as follows:-

·         Growth                                    At inflation     4%  (1.5% above)        6%       8%

·         4% Payment/ annuity                1.6                 2.3                               3.7       6.1

·         6% Payment/annuity                 2.4                 3.5                               5.6       9.1

Public Sector pensions, in particular the fully contributed schemes of NHS, teachers, police and fire, are a good example to consider. Contributions amount to £19bn with pension payments at £14bn.

Even at the basic minimum yield a funded scheme would yield payments of £30.4bn after 40 years.

Contributions are mpe -6.5%; mpr – 7.5%: Serps-5.1% and  Proposed 9.5%/4.5%/ 5.1, Total-19.1%

Current levels of pensions paid therefore barely keep up with inflation and are much worse than any private sector, indicating the urgent need to change to a more equitable scheme.

The current proposed job cuts and pay freeze effectively means that any scheme will be in a steady state for several years, an ideal time for a change to a fully funded scheme.

The existing pensioner liability is £233bn to provide an annual inflation proofed (2.5%) payment of £14bn at 6%, which would require a return of 4% to sustain. This could be met by a transfer of Capital assets or creation of non negotiable Pension bonds, ( outside the National debt?).

This would allow the full current contributions to accumulate, be invested and  grow for the current active members. A modest investment return of 6% should show a steady Fund build up, sufficient to meet future retirements as they occur. At present 1.4% of the working age population reach the age of 65 each year.

This would suggest, dependent on age distribution that some 70,000 members enter retirement each year which would be met by the first year’s average investment income, but only using some 50% thereafter.

This would  allow a rapid fund build up, if contributions and balance investment income keeps pace with inflation then in twelve years the Fund value would be close to the original liability value in real terms. This demonstrates the strength of Funded schemes with accumulation and compound investment growth.

Even if the retired population increased by 50% over the next 25 years, there would be sufficient Fund strength and reserve to meet this demand and increase member benefits.

Transfer of the State pension scheme would be more demanding; a fund of one trillion pounds would be needed to meet the current £60bn spend at 6% return. A compromise solution involving a new scheme with employee/ employer contributions and generous NI rebates would seem possible.

Current SERPS rebate is 5.1%, if this were doubled to include basic State pension opt out, a reasonable 9% top up would give a position similar to PS transition. The next blog develops this.

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