Don't Understand Pensions

dunstonh

Bud_Fox wrote: »

Pensions are basically a giant ponzi scheme.

The internet is full of numpties posting useless information that can do more damage than good.

jamesd

bigfreddiel wrote: »

Not entirely sure the above is true - if 10 years equates to long term then how about this:

"In both the US and the UK the real total return from equities was negative between the end of 1998 and the end of last year. Even if you re-invested your dividends, you can buy less today with any money you squirreled away 10 years ago than when you started. "

The Sunday Times gives ten year performance numbers every week. Here's what it says this week:

"Over 10 years shares are up 3.8% (47.9% with dividends)"

So that's 47.9% up, not less today. But that's before inflation adjustment. The Retail Price Index was 172.2 in 2001 and 228.4 in 2010, the latest in the table I'm using. 147.9 * 172.2 / 228.4 = 111.51 so that's 11.5% more you can buy now than ten years ago.

For the US the Equity Gilt Study gives the last ten years for US equities as 0.8%, beating cash at -0.2%, on page 97. Best were TIPS then government bonds. The decade from 2000 to 2010 was the worst decade in the whole US data series, which started in 1930.

Your source seems to be either wrong or just out of date. Maybe it was written at the end of 2008 or early 2009, the recent market low. Good timing for an equities pessimist if so, unrepresentative though it was of normal results.

bigfreddiel wrote: »

I guess long term is 30+ years tho'

Using real returns the Barclays Capital Equity Gilt Study 2011 covers these issues starting on page 92 for the UK. Here's what their Figure 8 from page 94 says about the chance of equities beating cash or gilts for various holding periods, after allowing for inflation:

2 years: 66% 69% (66% chance of beating cash, 69% beating gilts)
3 years: 69% 74%
4 years: 72% 76%
5 years: 75% 75%
10 years: 90% 79%
18 years: 99% 89%

The gilts chance doesn't increase always because this is based on their analysis of 111 years of data and it happens that the numbers don't produce a continuously increasing result.

Those numbers are for a lump sum investment at the start of the period. Pensions are usually invested with regular monthly payments so a pension will get one period for each month's payment. The periods that fail to outperform are the ones where share prices were high at the time of investment. The regular investing means that those won't be the ones that apply for most of the monthly investments.

You can do better still if you deliberately bias your pension contributions into times of low prices and away from times of high prices.

brianrhill

If someone reading this thread is wondering if they should put away 3%, 5%, £100pm, £250pm etc etc, then unfortunately they are looking at things the wrong way around.

You need to look at what your goal is.

In my experience, assuming debts are paid off, at retirement people's lifestyle doesn't really change that much - they still have council tax, car repairs, clothes, food and Christmas to contend with. You could assume then that your expenditure when you retire is much the same as it is now.

As a very rough rule of thumb, you could withdraw around 4% of a capital sum and you shouldn't run out of money. This means then if you want to retire on £20,000 per year including state pension, you need to have £15,000/ 4 * 100= £375,000.

Now, the first scarey bit is working out how many pay days you have left to build this up. Assuming someone has 30 years to retirement, this means putting away £12,500 per year, so a little over £1,000 gross per month. For someone on £40,000 per year, this is 31% of their salary.

The second scarey thing is that this doesn't include the effects of inflation (nor the effects of investments).

This is a big part of the reason that auto-enrollment for workplace pensions starts to be rolled out next October. Even then, at a minimum 8% of basic salary, it's still not enough.

Whether you are a financial planner or a pensions virgin, have a read of this http://www.thenumberbook.com/ - it should be compulsory reading for all school leavers!

atush

brianrhill wrote: »

If someone reading this thread is wondering if they should put away 3%, 5%, £100pm, £250pm etc etc, then unfortunately they are looking at things the wrong way around.

You need to look at what your goal is.

In my experience, assuming debts are paid off, at retirement people's lifestyle doesn't really change that much - they still have council tax, car repairs, clothes, food and Christmas to contend with. You could assume then that your expenditure when you retire is much the same as it is now.

As a very rough rule of thumb, you could withdraw around 4% of a capital sum and you shouldn't run out of money. This means then if you want to retire on £20,000 per year including state pension, you need to have £15,000/ 4 * 100= £375,000.

Now, the first scarey bit is working out how many pay days you have left to build this up. Assuming someone has 30 years to retirement, this means putting away £12,500 per year, so a little over £1,000 gross per month. For someone on £40,000 per year, this is 31% of their salary.

The second scarey thing is that this doesn't include the effects of inflation (nor the effects of investments).

This is a big part of the reason that auto-enrollment for workplace pensions starts to be rolled out next October. Even then, at a minimum 8% of basic salary, it's still not enough.

Whether you are a financial planner or a pensions virgin, have a read of this http://www.thenumberbook.com/ - it should be compulsory reading for all school leavers!

TBH, I agree. But that is a whole lotta math and that scares people (and where pensions are concerned it should but it does for the wrong reasons).

But to keep their interest we have to talk in small steps and non threatening language. So saying save x% can be easier to get across. Saving for retirement is priority that I myself did not acknowledge til I was 30. Just because now I am a convert doesn't mean I don't know wha people that age are thinking now.

Even back when I was 30 (and it wasn't so long ago I don't remember), it wasn't the total instant gratification world nowin the internet age. When I was 30, the internet was used inter-office by the military I think.

jamesd

brianrhill wrote: »

As a very rough rule of thumb, you could withdraw around 4% of a capital sum and you shouldn't run out of money. This means then if you want to retire on £20,000 per year including state pension, you need to have £15,000/ 4 * 100= £375,000.

Now, the first scarey bit is working out how many pay days you have left to build this up. Assuming someone has 30 years to retirement, this means putting away £12,500 per year, so a little over £1,000 gross per month.

The real scary thing there is that an IFA gave those numbers.

You assumed 4% at least yield in retirement but nil until then. And ignored the additional state pension. A more sensible number would be say 7% plus inflation for mostly equities in the accumulation phase and at least a couple of thousand for basic state pension.

The additional state pension takes the income topup required down to £13,000 or less. Assuming the same 4% safe income that takes capital of £325,000. £270 a month gross will get there over 30 years. But that's gross. With basic rate tax the out of pocket cost falls to just £212 a month.

Assuming median income of £28,000 a year that's 11.6% of gross pay. An employer even in the private sector will probably pay 3-6% of pay. That drops the requirement down to 8.6-5.6% of gross pay or £157 to £103 net from pay.

It's pretty hard for someone on £28,000 gross in most parts of the country to argue that they really can't afford those sorts of contribution levels.

You can add some safety margins beyond the big margin already present with just 4% income level, but that's still far, far less needed than £800 net.

For a quick spreadsheet approximation I assumed all contributions paid at the start of the year and everything inflation-adjusted - contributions, growth, target.

brianrhill

I clearly said in my post that I hadn't factored in inflation or investment return. There are so many variables (such as suggesting that that the additional state pension, let alone any state pension, will be around in it's current form in 30 years time) that it is far better to keep it simple and easy for people to understand. And factoring in 7% + inflation return over the term is asking for trouble.

Zelazny

Bud_Fox wrote: »

Pensions are basically a giant ponzi scheme.

That may be true of the state pension and some public sector schemes, but private pensions actually have to have the money to pay the benefits. How is that a Ponzi scheme?

Zelazny

brianrhill wrote: »

...factoring in 7% + inflation return over the term is asking for trouble.

That may be true, but factoring in 0% is tantamount to scare-mongering. I usually go for about 3% as a reasonably pessimistic estimate, which gives total conts (employer + employee) of £617 gross per month.

If the employer pays a fairly minimal 4% (and bear in mind that the minimum contribution from 2016 is 3% plus you get 1% tax relief - so 4% is the minimum you'll get), that means the employee has to pay a net £363.78 a month (assuming we're still talking about someone on £28k). Not small change, but not an unaffordable amount.