Direct Benefit Pensions - who paid?

nearlyrich

Not sure why you are worrying about annuity rates as you probably won't even buy one...get as much as you can afford into your pension pot..

davechas

you could use the little quote box or just quote the whole post lol.

Thanks

For the rest of this post I'm going to play "devil's advocate" - I actually agree with all of your stances in the main, but there are counterpoints to them which I recognise can be made.

If you could resist the urge to brand me as a conspiracy theorist in making these points (as I admit myself it does sound a bit like it), and just comment on the practicalities in the unlikely event that the following scenarios do come about that would be great!

And that means people used to 'retire' for ten years or less are now
retiring for 20-35 years. Due to the increases in medical science and some
changing their lifestyle (big change in smoking habits for instance).

On the other side of the coin then, is there not the opposite risk for our current generation - ie that we all assume that longevity will keep increasing (or even plateau) whereas there could well be the argument that it could decrease again. For but one example, the WHO has raised concerns of the very real threat that the efficacy of our antibiotics is reducing, and there is nothing in the pipeline to replace them.

Not sure why you are worrying about annuity rates as you probably won't even
buy one...get as much as you can afford into your pension pot..

That is a fair point, thanks to my hero Big George there are at least now other options available at retirement. I've always been a bit dubious of the "tax efficient" label though - if anything it is more like "tax deferral".

Again just bear with me on this one, but I'm currently set to retire in 2050 (although I'm bracing myself to watch this goalpost move exponentially further away from me as I get older...) This leaves me with at least three potential issues with tying up my money in a pension pot:

1) If the goalposts keep getting moved by successive governments, the date I can emancipate the funds and actually derive economic benefit from it is uncertain. Money tied up in a pension pot is little use to me throughout the course of my working life.

2) At any point in the next 36 years, any government could change the pensions/tax rules. So for example, if they remove the 25% tax free lump sum rule, and the basic rate of tax increased to 30% (neither particularly wacky possibilities) - then I fail to see the benefit of my avoiding paying 20% tax now, only to pay 30% tax in the future - plus the time value of money means I'm better off having the £1 in my pocket today to invest in any case.

3) Who is to say I might not be better investing in a property portfolio instead, which yeah I have to pay the tax on now during my working life but equally I would be free to liquidate whenever I wanted (eg say I desperately need the money to help a family member long before I am due to retire). That way I also have 100% of the investment readily available to me at whatever age I choose to retire, with the tax bill already settled - I don't need to worry about paying tax on getting money out of a pension fund, all of the fund is already mine "post tax" as it were.

I have deliberately been over simplistic with these scenarios - if I have missed any severe pitfalls please do point them out to me.

Many thanks in advance for your patience with my conspiracy theorising. Now where did I put my tin foil hat...

bigadaj

You raise some fair points and it's down to balance of probability as most things are!

Looking back in time is probably more useful for seeing the errors that people made then in projecting forward rather than direct experience.

As you say there are numerous risks, which can only be acknowledged and considered, and considered within investment strategies, in a similar way to asset allocation etc

Politicians can always change the rules and despite the increasing cynicism about then they do seem to be simplifying the rules now rather than making them more complex. Certainty is welcomed by most, and we can only hope this continues, acknowledging future changes. Life expectancy may reduce, or at least the rate of increase slow down, but given the state of public finances then the retirement ages may still increase, let's not forget when pensions started they were set at an age a year or two above male life expectancy, whereas now it's approaching twenty years.

You are right to be concerned about moving goalposts and teh sensible response is to include pension as part of your finances, useful for some but not all and most probably part of a range including cash, isas, funds, shares, property etc

On the second point then most people would say that pension contributions are absolutely wotrthwhiel where you pay higher rate tax, access employer contributions or have access to salary sacrifice. Outside these conditions then other investments may be more attractive, particulalry with the increased isa limits. Not sure of teh last point as a pound to invest now will grow inside or outside a pension, and teh longer it's invested the more time it has to grow.

Many people like the idea of property but I don't think you have the tax issues sorted. You only pay tax on buy to let properties on the net income. And can claim all costs including mortgage interest against you tax bill. However when you retire and sell it you will be subject to capital gains tax. Personally I know the generally asset prices are inflated by government and central bank policies but to me nosie prices seem more inflated than shares for example. There is little more that could be doen to inflate house prices and I think falls, or more likely stagnation, is still the most likely option over the medium term.

jem16

davechas wrote: »

That is a fair point, thanks to my hero Big George there are at least now other options available at retirement.

It's been quite a number of years now since there was any need to buy an annuity. Drawdown, both capped and flexible, can be used.

I've always been a bit dubious of the "tax efficient" label though - if anything it is more like "tax deferral".

For basic rate taxpayers yes it is more Like a tax deferral but you plan to use pensions to soak up the personal allowance. Higher rate taxpayers who will be basic rate in retirement have an obvious advantage.

1) If the goalposts keep getting moved by successive governments, the date I can emancipate the funds and actually derive economic benefit from it is uncertain. Money tied up in a pension pot is little use to me throughout the course of my working life..

That's the whole point. You're not meant to be using it during your working life. It's for your retirement.

atush

As a former Medical scientist I too am afraid that in decades to come we may no longer have effective antibiotics. It is a great worry to me, as is mutation of animal viruses into a human pandemic.

and the increasing obesity of the western world will eventually see LE no longer increase as it has in the past. but even if it levels off, barring a worldwide pandemic, we are seeing people living in retirement almost as long as they were in the working population.

This is only sustainable with increase in employee contributions or a move to DC pensions.

Thrugelmir

davechas wrote: »

1) Money tied up in a pension pot is little use to me throughout the course of my working life.

2) At any point in the next 36 years, any government could change the pensions/tax rules. So for example, if they remove the 25% tax free lump sum rule, and the basic rate of tax increased to 30% (neither particularly wacky possibilities) - then I fail to see the benefit of my avoiding paying 20% tax now, only to pay 30% tax in the future - plus the time value of money means I'm better off having the £1 in my pocket today to invest in any case.

3) Who is to say I might not be better investing in a property portfolio instead, which yeah I have to pay the tax on now during my working life but equally I would be free to liquidate whenever I wanted (eg say I desperately need the money to help a family member long before I am due to retire). That way I also have 100% of the investment readily available to me at whatever age I choose to retire, with the tax bill already settled - I don't need to worry about paying tax on getting money out of a pension fund, all of the fund is already mine "post tax" as it were.

My personal stance.

1. Can be passed to next of kin on death tax free if no benefits taken. I use my pension funds as a substitute for life assurance.

2. Could apply equally to ISA's. So there's nothing to single out pensions. In fact there's a real shift towards encouraging people to save more for retirement.

3. Highly tax inefficient if you are relying on borrowed money. As an asset class highly dependent upon economic policy and monetary inflation. A change of which is more likely than 2. above.

With an ever increasing retirement age. I view my pension pot as part of my pre retirement income. The tax free lump sum will fund me for some years. While the remainder of the fund will remain invested and hopefully continue to grow.

SallyG

"Would be interesting to know the proportion in non-contributory DB schemes in say the 70s and 80s."

http://www.ariespensions.co.uk/

These would be likeliest to know?

http://www.ariespensions.co.uk/public/timeline/pre94.htm

Annie1960

davechas wrote: »

I don't even know how much to save per month towards my pension, not because of a lack of technical knowledge (I'm a qualified chartered accountant) but simply because future annuity rates are such a complete unknown. At the moment I have based my calculations on an annuity rate of 4.5% (which is pretty rubbish compared to historic rates as it is) - but say annuity rates fall even further and are actually 3% by the time I come to retire, that's just wiped 1/3 off the retirement income I have budgeted and saved for my entire life!

Join the club!

I am a retired accountant. I was on a DB pension scheme, but also had an AVC. The annuity rates on this were well over 10% when I started saving into it, and now have reduced radically. However, interest rates may go up in the future, who knows?

At least people in the future will have more choices with the new pension changes coming in next year.

atush

I don't even know how much to save per month towards my pension, not because of a lack of technical knowledge (I'm a qualified chartered accountant) but simply because future annuity rates are such a complete unknown.

As a chartered acct you can do better than this surely.

Annuity rates have really nothing to do with it, as you don't have to take an annuity. what you need is to figure out how much you need to live on in retirement and put in enough each month to get a pot large enough that 6% of 75% of it will be enough to live on for you.

You can use a pension calculator for this.

davechas

Wow, tons of response - thanks everyone!

You are right to be concerned about moving goalposts and teh sensible
response is to include pension as part of your finances, useful for some but not
all and most probably part of a range including cash, isas, funds, shares,
property etc

Agreed, a balanced portfolio is the conclusion I have come to. I think ploughing it all into pensions is as risky as ploughing it all into property (or shares, or anything).

It's been quite a number of years now since there was any need to buy an annuity.
Drawdown, both capped and flexible, can be used.

Yes, that is true - I had overlooked drawdown. I understand there are even more options now though, although I must confess I've not researched much into all of the tabled changes yet. It's on my to-do-list!

That's the whole point. You're
not meant to be using it during your working life. It's for your retirement.

I disagree. If I invest in anything else (eg property or shares), I can still divest this and use the proceeds as my retirement fund if I want to (I could even use it to buy an annuity) - but crucially I could also still choose to use it whenever I want during my working life as well (eg family crisis, an amazing one-off investment opportunity comes along etc). If I invest in a pension pot then I can only use this when I retire. This was the point I was driving at, although I probably didn't articulate it very well.

As a former Medical scientist I too am afraid that in decades to come we may no longer have effective antibiotics. It is a great worry to me, as is mutation of animal
viruses into a human pandemic.

and the increasing obesity of the western world will eventually see
LE no longer increase as it has in thepast.

but even if it levels off, barring a worldwide pandemic, we are seeing people living in retirement almost as long as they were in the working population.

This is only sustainable with increase in employee contributions or a move to DC
pensions.

I agree; but it still smarts that I watch my parents and their friends even now well into the 21st Century still retiring pre-60 on DB schemes! I just figure there ought to be a fairer solution than effectively "backloading" the largest share of the pensions "burden" onto the youngest generations (who are also the ones who have student debt, don't own property/equity, higher proportion out of work etc). I find it particularly patronising that everyone keeps suggesting that it is ok to do this to the younger generations because they will live longer, as if it is some foregone conclusion! When actually there is no guarantee that they will live as long as previous generations by a long chalk - a lot of the recent medical evidence actually points to the opposite, some of which you have covered above.

With an ever increasing retirement age. I view my pension pot as partof my pre retirement income. The tax free lump sum will fund me for some years. While the remainder of the fund will remain invested and hopefully continue to grow.

Sensible outlook, I may well look to do something similar with the pensions investment part of my overall portfolio.

These would be likeliest to know?

<ariespensions.com>

I'll take a look, ta

Join the club!

I am a retired accountant. I was on a DB pension scheme, but also had an AVC. The annuity rates on this were well over 10% when I started saving into it, and now have reduced radically. However, interest rates may go up in the future, who
knows?

Glad to join you! As Big Dave says, "we're all in this together"

Interest rates should rise eventually, although very gradually if the BofE have got any sense. I imagine annuity rates will steadily continue to drop though, for as long as actuaries largely base LE on historic data - which I still maintain simply will never be a terrifically accurate basis for future LE.

As a chartered acct you can do better than this surely.

Annuity rates have really nothing to do with it, as you don't have to take an annuity. what you need is to figure out how much you need to live on in retirement and put in enough each month to get a pot large enough that 6% of 75% of it will be enough to live on for you.

You can use a pension calculator for this.

Oh but I did do so much better than you seem to have given me credit for! Without being too big-headed, I have some incredibly sophisticated spreadsheets which I knocked together for fun one weekend for precisely the purpose of calculating differing savings scenarios for my retirement (online pensions calculators are frankly 'mickey mouse' by comparison, as they ignore great swathes of assumptions which are far from certain). My spreadsheet consists of approximately a dozen tabs and takes into account the difference in the value of a 2014 £ versus a 2050 £, fluctuating discount rates using historic BofE interest trends from the last 25 years, scenario calculations based on comparative stock market performance and a range of annuity rates and tax rates for drawdown timings, NPV of future cashflows based on how long I live and a range of different economic outlooks throughout my retirement, take-home pay from annuity income based on a range of fluctuating tax rates, different escalations and guarantee periods etc etc etc.

It is actually quite fascinating what some of my calculations have highlighted. For instance, based on ONS data if I retired today as a man of 65, I could currently expect to live to be 83 (on average). Say I have a pension pot of £350,000 - and I buy a 3% escalating annuity, 5 year guarantee annuity - the best annuity rate I could find at the time was 4.9%. That's a pension income of nearly £13k per year (less than one third of what I'm now on, let alone what my final salary would be!) But it gets better, the NPV of the future cashflows of my pension if I actually live to be 83 (using a discount rate of 5.67% - average BofE rate since mid 80s) is £170,813. But hang on, I've just paid the pension company over £260,000 for that annuity - which is only worth on average £170,813! I wouldn't pay someone £260k to buy a house which was only worth £170k - so why on earth are annuity rates so low so that if you buy an annuity that is effectively what you have to do!?!

I calculated that I would need to live to be at least 95 before the NPV of my pension payments exceeded what I paid for it. LE actually has little to do with it in any case , so before anyone suggests that the pension company would lose money if I lived to be over 95, in reality the pension company as a large global investor would make returns closer to 10%-20% or even more - not 5-6% as I have used for my own personal discount rate. So actually, regardless of how long I live (I could live forever) the pension company ought to still make far more profit out of the invested funds from my pension pot than they would end up paying out to me in pension payments each year. Another reason why I'm a scandalised by how low annuity rates are - it makes me wonder if it is not some glorified cartel operation? Take a look at the profit margin of a large pension provider if you doubt my figures - a recent documentary on this by Michael Burke was particularly illuminating.

Long story short, I'm one of the geekiest accountants you could hope to come across, and even I cannot calculate with any certainty how much I should be saving for my retirement. Even if I could nail down a likely annuity rate range for when I retire (which I can't) - or how much drawdown per year I could get away with under current tax rules (which could change at any point before I retire) - my pension pot investment itself is still at the mercy of market forces. Say there is a market crash similar to 2008 in the few months before I retire, I could easily wave bye-bye to 40% of my investment in the blink of an eye.

Sure, I could factor in the worst case on all fronts, but I can't realistically afford to put aside 80% of my monthly income to fully mitigate all of my risks! Nor could anyone else, I imagine...

In any case, I didn't want my thread to descend into a moan about the woes and pitfalls of the current system. There are also plenty of opportunities I can see out there, which I will probably look to open a discussion with people in a new thread which is more specific to that topic.