Sunday 29 September 2013

John’s Blog No. 144 – Pensions

Before proceeding further with consideration of NHS or other pensions, it is desirable to have a basic understanding of the nature of Pension savings and provision in a fully funded scheme. Pension are deemed to be too complex for even the experts to understand, but is this so? or just convenient for the Financial Institutions and the State to make it appear so. It was once the position with mortgages, savings, Insurance and recently energy bills and housekeeping, but all are becoming manageable. Pensions follow the same simple arithmetical rules as these, with the main complexity being the long time scale, some 40 years, in which the main objectives tend to get lost. It is essential to understand these basic rules to ensure value for money and final goals are met. They are personal savings, which should accumulate for a minimum of 30 to 40 years to build up a Fund that can be drawn upon through retirement as a pension income. If you save £1,000 per year for 40 years, this fund will accumulate to £40,000, if you then withdraw money from this Fund at say 6%, £2,400 per year, you would have made an overall annual factor gain of 2.4; £2,400 for every £1,000 saved. At any time, this Fund has a commercial value and can grow by suitable investment, it is also eroded by inflation and charges and these factors occur through both savings and retirement. If wages and hence contributions keep pace with inflation and the Fund grows by a similar amount, then the factors above apply in real spending power terms. Charges are more insidious, values of 1% are being quoted, but these are based on the whole fund and not just a commission on contributions and therefore can be quite substantial and unfair. Well managed Pension schemes have administrative costs a tenth of this of 0.1%, with investment costs twice this, most Investment trusts quote growth after costs. Growth has averaged 5% during the recession, with ten year or longer reaching twice this; at 5%, yield factors in real terms are almost twice the inflation minimum at 4.5. Pension payment levels in all major schemes, the State and annuities also take into account population survival. Life expectancy, at 20 years is the time taken for the population to halve and this allows payments to be made at much higher rates, one person’s death is someone else’s gain. Funds can therefore sustain inflation proofed payment levels of 6% with quite modest investment incomes at 4%. We therefore have some basic guidelines, rules and values on which to base pension yields and requirements on funded schemes, which although not applying to the unruly unfunded State schemes can indicate what is value for money. The minimum level, below which they lose money in real terms is 2.4 over 40 years. If your projected pension is not at this level, then the scheme is not performing and this ratio can be adjusted for shorter saving terms; so for every 10% of wage saved, you should see 24% of final average wage as a pension after 40 years. All but the best schemes fall well below this, with the norm for DC schemes at 1.8 due to poor outdated annuities. Consider NHS, assuming Employer is still at 7.3% (in doubt), Employee is now at 9% and SERPS is at 4.9%, (soon to be unfairly abolished), we have a total of 21.2% contributions, which should give an inflation gain of 50%. However deceptively the State pension is included to inflate final pension to these levels and SERPS is also included to inflate Employers contributions. This was illustrated in the State comment of the Fire Brigade pension strikes this week. A fireman earning £29,000 per year was quoted as receiving a pension at 60 of £19,000 per year, a large gold plated return which does not justify strike action. The Gad 2006 values showed average salary at £29,600 but average pension at £7,600 some 25%, it is difficult to understand the rapid rise since then, if it occured? However another report quoted this at £12,000 with the State pension bringing it up to £19,000, a completely different picture; using NI and Public Sector personal extra contributions of 21% or more, some £6,000 per year, this is a poor factor two loss-making return on lifetime savings. The action in any event was over the large reductions made for forced retirement at 50 or 55, due to inability to do the job. Combine this with rising contributions, particularly with the abolition of SERPS, the diminishing returns, uncertain retirement dates and the capability to carry out the work after 50 and beyond, one cannot understand the State’s reluctance to provide accurate and true information or to discuss the matter

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