The budget announcement allowing savers to choose how they spend their retirement savings may look a political coup. But to suggest it addresses the issue of how we provide pensions is a misuse of the English language. In fact it begs this question, “if people do not buy annuities, how are they to able to provide for themselves throughout their retirement?” Because an annuity is a pension; that is “a regular payment made during a person’s retirement”. So, if you don’t buy a pension when you retire, how are you to ensure you have enough to look after yourself as you grow older?
Let us be clear. The Chancellor had good reason to abandon annuities, because they are such poor value for money. Today, someone retiring at the age of 65, who had saved £100,000, and wanted to buy a pension annuity which kept pace with inflation, would only be paid about £3,600 a year. In other words they would need to live until they were 93 just to get their money back. Fifteen years ago, they would have received much more. But the combination of low interest rates, and destructive competitive forces put pay to that. Annuities are bad value, and the government had no wish to face a grey electorate, which it had forced to purchase them.
But it doesn’t address the core problem. Because if you don’t buy an annuity how do you know that you will be able to look after yourself in retirement? For those in the public sector the answer is easy. Their pension savings is designed to generate an income for life. That used to be the situation in the private sector as well. But successive, and sometimes well intentioned regulation, has resulted in that pension system slowly being abandoned. The government’s latest announcement is just another nail in the coffin. Retirement savings no longer need to be used to buy a pension – they are rather a pot set aside to give yourself a golden handshake when you stop work.
So let’s consider the prudent hard working person who retires, at the age of sixty five trying to plan for their future. If they don’t buy an overpriced annuity what do they do? What happens when, in their late 80s having done everything by the book, they discover they are running out of money. What future do they face, when, despite their playing everything by the book, their savings have run out? Is that the best we can do for people who have worked hard, been prudent, planned and saved?
And that is assuming that they have negotiated their way around the siren voices of financial advisors who will doubtless have gone on a spree of “innovation” to help invest the savings of those who are no longer buying annuities. Those who remember the last attempt to “free pensions” in the 1980s will also remember the ubiquitous pensions’ mis-selling scandals which followed.
What is needed is a pension system which works. In all the research which the RSA has done, most people want to “give their money away to someone whom they can trust will use it wisely to generate a income when they retire”. That simple system, a comprehensive private pension system, is lacking in the UK.
However, across the North Sea, in Holland and Denmark, they have a private pension system that works on that basis. You set aside your money each year and receive a pension in retirement. Indeed their simple well designed systems mean that, if a typical Briton and a typical Dutch person, both save the same amount, have the same life expectancy and retire on the same day; the Dutch saver will get a 50 per cent higher pension than the Briton.
That is the challenge for the government. Not the further abandonment of the inadequate British pension system, but the building of a new one that works. There is no perfect solution, but there are approaches which are far better than those we are pursuing in the UK today. They are systems which have gained political consensus, and stood the test of time. They were not built by surprise announcements in the budget. Such announcements about the pension system, made in haste, and spun as a political coup, are often ones which old people, many years later, repent at leisure. So let’s make sure that the Chancellor’s announcement is not a further retreat from a broken pension system, but rather that it clears the space for a new system that works.
David Pitt Watson is Director of the RSA Tomorrow’s Investor programme. He is an Executive Fellow in Finance at the London Business School, and founder of Hermes Equity Ownership Service, the largest shareholder stewardship programme of any fund manager in the world