Pension Crisis?

ag359

I often hear talk of a 'pension crisis' in the UK.

What exactly does this mean, in layman's term? And what is or should be being done about it?

It worries me because I'm I haven't even started work yet, and I already have to worrying about retirement!

dunstonh

What exactly does this mean, in layman's term?

Its something the media say whenever they want to create panic and unease about retirement planning.

However, in simple terms, the state can no longer afford to pay the state pension at its current levels and many companies are no longer willing to underwrite, what is basically a blank cheque toicover occupational schemes based on years of service.

People have to fund a bit more for themselves but of course that isnt happening.

MrChips

Well, where should I start...!

The "crisis" (although I think that is a bit of a Daily Mail exaggeration) is that if things stay as they are, most future pensioners aren't going to have much money to live on. Pensioners traditionally rely on a combination of the State pension scheme and company pension schemes to pay them in retirement. However both of these are starting to feel the strain for a number of reasons, including...

1) Increasing longevity - pension funds have to be bigger because they need to pay pensioners for longer.
2) Bad investment market returns in the early part of the decade - most company pension schemes had a lot of their money invested in the stock market which lost over half it's value between January 2000 and March 2003. It has recovered about half the ground since then, but is still way off where it "should be".
3) Falling expectations of future interest rates and investment returns - more money needs to go into pension funds now to pay for future pensions as the investment return it will generate in the future is forecast to be lower than it has been historically.
4) Higher taxes on pension funds - in 1997 the chancellor increased the tax that pension funds have to pay on dividends they receive from the shares they hold.
5) Increased regulation of pension funds following a few scandals/c0ck ups. There is far more red tape for companies to wade through if they want to run a defined benefit pension scheme now which many find offputting (although this is not necessarily all bad if it stops schemes being woefully underfunded).
6) Population demographics - if the current trends of birth and death rates continue, then a few decades down the line, the ratio of over 60s to under 60s will be far higher than it is now. There will be far fewer tax payers to pay for the State pensions of the over 60s.
7) The increasing trend of company schemes changing from defined benefit style to defined contribution. The latter usually have lower contributions going in as it is the members themselves that have to chose to sacrifice their pay to make higher contributions whereas DB schemes usually have fixed employee conts and (much) larger variable top up employer contributions.

The crisis can be broken down into a crisis for the State scheme and a crisis for the company schemes. The State scheme is "pay-as-you-go" which means that todays pensioners are paid by the taxes of the current taxpayers. Therefore this is only really affected by problems 1 and 6 above. Still, unless more pensioners start dying or more children start being born, the current system is unsustainable so the age at which pensions start being paid will have to increase or the state pension will have to decrease in real terms (or both).

The company crisis is a bit more complicated so here is a bit of background (you say you haven't started work yet so I will assume you know nothing about company pensions - I didn't before I started work anyway!)

Traditionally, companies would fund a defined benefit (also known as "DB" or "final salary") pension for their employees. This would give them a predictable pension at retirement which was proportional to the salary at retirement and their length of service (typically pension = service x final salary / 60 ). To fund these predictable pensions costs about 20-25% of salary for each member every year. In the golden days of high stock market returns, companies could get away with paying in a lot less than this (or nothing) because the investment returns they got on the Scheme money was more than enough to cover the contributions needed. However when the stock market wasn't doing so well, companies suddenly realised they couldn't afford to pay the full contributions necessary and many closed their DB funds to new employees. Instead they opened Defined Contribution ("DC") Schemes. These work on the basis of you and/or your employer putting money in each month, investing in shares/bonds and seeing what you have accumulated when you retire. You then pay this to an insurance company who will exchange it for a pension for life.

These are generally seen as not as good as the DB schemes, chiefly because of the unpreditability - if the shares you invest in do badly, you will not have much money to buy a pension with. However, they are also substandard because employers are being far less generous with them. In most companies these days, there are DB Schemes for the members who joined before they were closed and DC Schemes for those who joined later. The company will in all liklihood be paying 20-25% of salary into the DB member's fund, but only 5-10% (if that) into the DC members fund. You don't have to be Einstein to realise that DC members should expect a much smaller pension (unless they make up the difference themselves). Most employees don't realise this, and the fact that they are effectively being paid 15% less than an equivalent colleague who happened to join a few years before them.

However the one big advantage of DC schemes over DB schemes is that if the employer goes bust at a time when there isn't enough money in the pension fund, then the members of the fund can lose some/all of their promised pension. There have been a few high profile examples of this recently which has helped fan the flames of the "crisis". At least with a DC scheme, the money is all technically under your control.
However most people with DC schemes simply aren't putting enough money in so they will be in for a nasty shock when they come to retirement age.

A recent report said that the solution to the "crisis" was threefold. People should save more money in their pension fund, retire later and expect a lower pension. I have to say I agree. It is unreasonable to expect to work for 40 years, and live on a (good) pension for another 30.

I wouldn't start worrying yet if I were you ;-) But I would try and take advantage of whatever company pension scheme you get. This is normally the most efficient form of pension provision for you, especially if your employer will make generous contribitions. The earlier you start, the cheaper it is to fund a good pension.

EdInvestor

Good post Mr Chips

THe crisis may not be quite as bad as it seems because....

Increasing longevity - pension funds have to be bigger because they need to pay pensioners for longer.

#While currently people are living longer, actuaries are not sure this will go on forever...you've probably noticed that while less smoking = longer life, more obesity tends to equal the opposite.

Population demographics - if the current trends of birth and death rates continue, then a few decades down the line, the ratio of over 60s to under 60s will be far higher than it is now. There will be far fewer tax payers to pay for the State pensions of the over 60s.

#Immigration is affecting the figures in a positive way, while the simple equation of number of over 60s/number of under 60s makes the position look a lot worse than it really is, because lots of under60s don't work and thus don't pay tax to support the over60s. Adjusting for that, the fall is much smaller, and quite manageable. In addition the state pension system has already been adjusted to deal with women who are the main group of poor pensioners now, but will be OK long term.

A recent report said that the solution to the "crisis" was threefold. People should save more money in their pension fund, retire later and expect a lower pension.

#Unfortunately this report didn't take into account people's total wealth, which would include their homes (70% of the population are now homeowners) and other savings and investments.It only counted savings in actual pensions.It thus gave a more downbeat evaluation of the state of play than is justified.In fact, the fall in pension values caused by the stockmarket crash has been easily overcome by the rise in property values for most people and wealth has continued to rise overall.

That's one reason why the Government doesn't seem to be quite as serious about the so-called "pensions crisis" as some would like.

dunstonh

Must not forget the impact of the stockmarket crash when everything is going to be valued lower. Looking at short term drops always inflates any shortfalls or potential shortfalls. In reality and over the long term, periodic crashes like that are quite desirable unless you are expecting a massive outflow of money in the short term.

The other thing is the new accounting methods are much more conservative than the old ones and there are already people saying that they are far too cautious and make things look worse than they are.

Milarky

Oh, and there's the little matter of the public sector pensions bill. Not being funded by past savings, the cost of this will grow relentlessly in the decades to come. Any change to the basis of these pension payments to save costs will be correspondingly drawn out also. Figures of '£600-£700bn' have been floated about but should be viewed with caution since its a cash flow problem in this case. That cash flow will have to be diverted increasingly from the range of schemes covering the lowest paid or most vunerable pensioners - such as the basic state pension, the pension credit, tax free winter payments etc. In other words there is a squeeze on public finances and everyone depends to some degree on state-paid benefits that will inevitably be spread more thinly in the future.