Saving for your retirement - a new approach

mbarge

In the UK very few of us are still in final salary based pension schemes so instead we have no choice but to accumulate a pension fund and then convert the final fund into a pension when we retire. So for most people in the UK saving for a pension now works like this:

1. Make pension contributions (if you're lucky your company might contribute) that then get invested in some fund or funds (in order to get a decent long term return these funds invest usually in equities). BUT the future returns are uncertain, in many cases they could, potentially, be negative!

2. The whole idea is to save for a pension (i.e. an income for life starting from retirement). So the unknown final pension fund pot has to be converted into a pension at retirement. An element can be taken as cash but the majority is converted into a pension income by what are called annuity rates. The problem is annuity rates are volatile too, for instance they have fallen by 45% over the last 10 years!



Many people (me included) don't like this double risk but if you want to save for your retirement and utilise the tax reliefs and incentives on offer you don't have a choice. That is until now. I have just discovered a new type of personal pension, its called a Defined Benefit Personal Pension.

Don't be put off by the name, its very simple. You still make your pension contribution (or transfer from your existing pension fund) but what you get is not linked to the stockmarket and is not subject to future annuity rates. This new type of pension plan provides you with a known, fixed and certain pension from your selected future retirement date. So in return for your contribution you get told what your future pension (from the date you choose) will be. It wont be more but it wont be less either. (By the way you can still give up some of this pension for tax free cash when you retire).

With traditional pension plans you have annuity rate risk and once you get say 5 or 10 years from retirement the volatility of the stockmarket becomes a real problem. But with the new type of plan you also have to weigh up the 'price' you pay when buying something that is guaranteed. Obviously investing in the stockmarket offers maximum potential final pension fund value but dont forget you're trying to maximise your pension and NOT your pension fund (e.g a 'large' pension fund at retirement multiplied by a 'low' annuity rate doesn't equal a 'good' result).

Therefore I'd recommend a mix of stockmarket based personal pensions and defined benefit personal pensions. If you are happy to take all the stockmarket and annuity rate risk (e.g you're you have other back up) then go 100% for the former, if you don't like any risk at all then go for 100% the latter. I guess most of us being somewhere between these two extremes, tending to move more towards the certainty of the guarantees as we get closer to retirement.

hugheskevi

defined benefit personal pensions

Who is the counter-party providing the guarantee? Which regulatory regime are they under, and what are the compensation arrangements in the event of failure?

With-Profit investments with Guaranteed Annuity Rates could perhaps have been described as defined-benefit personal pensions, and look where they got Equitable Life...

MikeJones_2

Hi mbarge,

This is news to me. I'd be interested to read up more about these defined benefit personal pensions.

Are you able to post a link to more information (or send me a private message with details if you'd prefer).

In principle, this would be a welcomed innovation (depending upon cost/value for money). However, I'm left wondering how the provider would factor in increasing life expectancy should it continue unabated (unless that is built into the calculations)?

Would marital status be amendable to suit circustances before and at retirement?

Plus many more questions...

Mike

I work in the field of Pension Education and Pension Guidance in the UK. I am a member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

mbarge

Hi Mike

I don't think I should be advertising companies' products but if you search Google for "Guaranteed Retierement Plan" you'll see the details.

A guarantee that includes longevity protection as well as investment hedging might sound expensive but the quotations I ran off looked pretty tempting to me.

Mark

Paul_Herring

In addition to Hughe's most relevant questions...

BUT the future returns are uncertain, in many cases they could, potentially, be negative!

So many weasel words, so little meaning to the sentence. Do you work in advertising?

The problem is annuity rates are volatile too, for instance they have fallen by 45% over the last 10 years!

More catchy jingoism. If the end result is a 5% annuity then the former would be 9.09%. Are you're comparing like with like? If so, are they at 5% for what would be the same cohort these days? (Not that I'd suspect you of comparing today's rate for a 65 yr old non-smoking man in perfect health with a previous rate for a 70 yr old woman with cancer getting an enhanced annuity.)

Ah - here we go - like with like: http://www.thisismoney.co.uk/pensions/article.html?in_article_id=505825&in_page_id=6

65 yr old male, single life. 2000: 9%. 2010: (About) 6.5% - I make that, um, 28%, not 45%

Or to use your rhetoric - "you've over estimated the change by 160%!!!!!"

You still make your pension contribution (or transfer from your existing pension fund) but what you get is not linked to the stockmarket and is not subject to future annuity rates.

So what is it linked to, and what does "not subject to future annuity rates" mean?

With traditional pension plans you have annuity rate risk and once you get say 5 or 10 years from retirement the volatility of the stockmarket becomes a real problem.

Lifestyling is one solution to this while not using the plans is another (but still keeping the fund) is another.

Obviously investing in the stockmarket offers maximum potential final pension fund value but dont forget you're trying to maximise your pension and NOT your pension fund

There is no difference between the two...

(e.g a 'large' pension fund at retirement multiplied by a 'low' annuity rate doesn't equal a 'good' result).

Truism. A non-maximal pension fund (which you seem to discard) multiplied by an low annuity rate doesn't get you a better result.

Paul_Herring

mbarge wrote: »

I don't think I should be advertising companies' products but if you search Google for "Guaranteed Retierement Plan" you'll see the details.

From my first few matches:

(1) Canada Life: No details on their site.
(2) Shared prosperity: 401K's need only apply.
(3) News article about Prudential/ICMA Retirement Corporation which gives no details
(4) Wikipedia article.

None of which address any concerns brought up thus far in this thread...

dunstonh

The problem is annuity rates are volatile too, for instance they have fallen by 45% over the last 10 years!

That is not correct.

Source: tax briefs:

Male 65 on purchase price of £100k
1999: £8876
2000: £9098
2004: £7352
2005: £7302
2006: £7356
2007: £7831
2008: £7879
2009: £7212

So its more like 20% and most of that decline was from 2000-2004. Since 2004 they actually rose again but recently fell back with interest rates as you would expect.

This sounds like a third way product. Purchased under unsecured pension income but with some guarantees in place (typically pays 5% with the capital value fluctuating but has a guarantee in place. However, its still subject to unsecured pension rules and could technically result in a unauthorised payment. Although some insure against that but all that adds to costs). The cost of these plans is often tucked away or implicit and over the years, the cost could actually buy you a typical stockmarket crash over the term.

There is very little market for these products and very few providers. Those that do it tend to have US parent companies. I think there were three companies but one pulled out recently.

mbarge

It's hard to know where to start...

Lifestyling does not protect you from mortality improvements. The 45% fall in annuity rates number was not mine - (quoted in The Times).

20 years from now pensioner's mortality is expected to be less than 50% of current levels - what effect do you think that will have on annuity rates?

From what I can see DBPP is about risk management - indeed its the perfect lifestyling tool (as opposed to merely switching into less risky investments) however if you were going to criticise the concept I'd look to the problems with inflation. It's all very well purchasing a fix pension 20 years from now which in today's money terms may look attractive - if inflation takes off you'll wish you'd stayed in "real" assets.

Paul_Herring

Lifestyling does not protect you form mortality improvements.

It's not meant to. It's meant to protect you from the perceived volatility of the stock markets up to the time you want to cash your pension fund in if it's heavily invested in said markets.

The 45% fall in annuity rates number was not mine - (quoted in The Times).

So, having been shown by two different sources it's vastly wrong, how likely are you to believe the other stuff you read in there?

mbarge

dunstonh wrote: »

This sounds like a third way product. Purchased under unsecured pension income but with some guarantees in place (typically pays 5% with the capital value fluctuating but has a guarantee in place. However, its still subject to unsecured pension rules and could technically result in a unauthorised payment.

This is complete rubbish. I'm taking about a simple deferred annuity - fully guaranteed.

Example

Male age 45
Retirement Age 65
Contribution £10000 (gross)

Result Guaranteed Pension £1,231.08 per annum.

Paul_Herring

Male age 45
Retirement Age 65
Contribution £10000 (gross)

Result Guaranteed Pension £1,231.08 per annum.

Hmm - with inflation over 20 years, I'm sure that works out to a lot less than the headline 12.31% it implies. Or is the "guaranteed pension" figure indexed against some PI index?