Personal finance: The British question

How can we prepare for a 30-year retirement?
February 20, 2013

Every hour that passes, life expectancy in Britain extends a further 15 minutes. It is increasing at around 2.5 years every decade, and providing for an ever-extending old age is increasingly expensive. The problem is that few of us know, as an individual, just when we are going to die, so a system which takes away the gamble of not knowing how much to save is becoming increasingly vital.

In human terms, we might not earn a living wage before we’re 30, we might work for 30 years and then we might live another 30 in retirement. In economic terms, working for thirty years to pay for a 90 year lifespan is a challenge—when state pensions were invented in 1908, payable at age 70, the average time in retirement was expected to be three years.

The challenge is large enough in normal times. We are not in normal times. The present perfect storm includes not only the fact that life expectancy is increasing, but also that the money that we manage to save for old age is earning less. Interest rates, the base on which annuity rates are calculated, are at a historic low, triggered partly by quantitative easing. The money we have invested is earning less because of shocks to the financial system; shares, for example, are only just reaching the values of over a decade ago. And the government (of whatever hue) has increasingly started to double-tax pensions. The old nostrum used to be (adopted by most countries apart from the UK) EET—in other words, exemption from tax on the contributions, exemption from tax on the growth, and tax on the benefits. Today the taxation of pension funds needs around 5,000 pages of tax code to describe it, and for most people the tax neutrality has been whittled away so that Isas are for many a much better deal.

The final squall in the storm is the Treasury attack on the middle classes; it (and the Liberal Democrats) thinks that they get too good a deal through the tax system—which isn’t true, but makes good populist copy. Rich people don’t need pensions for obvious reasons. Poor people can’t afford private pensions—and the state pension, very sensibly being simplified by the coalition and Steve Webb, the pensions minister, against the wishes of the Treasury, is one of the lowest among developed countries and hard to live on. This is why the astonishingly complex add-on, auto-enrolment (a semi-compulsory occupational pension), is being introduced as a kind of faux-private top-up over the next few years. It’s the people in the middle, who would like to save for their old age and usually could afford to, who are struggling. They face a barrage of regulation (intended to protect their interests, but which makes pensions very expensive to administer), a forest of increasingly oppressive and complicated tax laws and employers who cannot face making contributions to the Pension Protection Fund (that is, paying for the pensions failures of their competitors, totalling around £750m a year). Accounting rules also make it hard to manage their liabilities, and defined contribution schemes are expensive, unpredictable and hard to manage.

So as the state pension is going to be simplified, reduced, and paid later (probably eventually at age 75), private pensions are likely to be increasingly in demand. Few of us can afford to do this privately—it is horribly inefficient, first because we have to save more than on average we all need, as we might live to age 100 even though most of us will live to, say, 85, second because the way we invest has to be over-cautious, since we cannot individually take the investment risks (and higher returns) that we can take collectively, and third because collective provision allows expertise to be paid for that individually we cannot afford. So the question is whether workplace pensions now can save us, despite their current travails.

Unexpectedly the omens are rather good. Companies broadly still seem to think that it is part of their moral obligations to help employees cope financially in their old age, and in any event want to provide some security for their own boards. We may be learning from our European colleagues, using perhaps the “book-reserve” scheme, where companies simply promise a lower salary in retirement. Instead of putting money into pension schemes in advance, earning low returns and paying high expenses, they insure their liabilities, so that if they go bust and can’t pay the pension an insurance company will. It’s simple, cheap and, most of all, understandable. The side benefit is that companies would be able to reduce their dependence on banks for finance, which is tough to find at the moment. And finally, the Institute of Actuaries recently suggested that the rise in longevity may be slowing. That may be annoying for pensioners, but it’s good news for pension funds.