Are pensions a scam?

From time to time, I come across scepticism about pensions. Other financial products like ISAs don’t seem to have a similar cohort of naysayers. Pensions are a more meaningful piece of state expenditure and sit at the faultline of political issues of state redistribution and tax incentivisation. They are also a complex system of generational redistribution; the lag between sacrifice and reward can create understandable suspicion. They are therefore more controversial. So, it is worth exploring whether this negativity is well-founded.

It is reasonable to suspect that the State Pension might not exist in 20 years’ time. Payable, for most of those reading this, when reaching the age of 67; it is an understandable reason for pension scepticism. The ‘triple-lock’ policy introduced by the coalition government in 2010 has gone a long way to redressing poverty in older age. A generous formula for increases means payments go up above workers’ pay. Many point out that, over the longer term, increasing the State Pension by more than the wages which are taxed to pay for it, is not a sustainable strategy. As a matter of demography and politics we are probably close to the point at which the triple lock can be made less generous. Although we are an aging society, the centre of political gravity is shifting as millennials age, vote more and eye the distribution of national resources greedily. Ironically this suggests that the State Pension for those now in their 40s will probably be less generous on an inflation-adjusted basis when they get to their qualifying ages. I don’t think there is much chance of it disappearing entirely though.  

Defined benefit pensions, where you accrue a promise of an income over time, are another potential source of negative sentiment towards pensions. Many people in the public sector have had the terms of accrual made less generous at some point in their working careers. There have been significant court cases about this; the government has had to undertake a massive exercise of redress for employees of all kinds when it was found to have discriminated against them on the basis of age. But even the new terms for these pensions result in a generous income. I would venture that almost every defined benefit scheme would deliver a higher standard of living in retirement than someone who earned the minimum in their auto-enrolment pension over the same period on the same earnings.

If anything, the strength of the promises made to members of these schemes is what has caused companies to abandon defined benefit for new employees and alter the terms for new accrual. Over time legal precedent and financial regulation has grown up that has increased the solidity of these promises; this makes them expensive. The uncovering of Robert Maxwell’s fraud on the Mirror Group pension fund in the early 90s and the establishment of the Pension Protection Fund in the early 00s are two prominent examples. It is true that most public sector schemes are unfunded, in that they are paid for out of current taxation rather than a pre-existing pot. But steps to ban transfers out of these schemes and to make them less generous were designed precisely to make them more sustainable promises for current taxpayers to fund. In short, although changes to defined benefit pensions have damaged trust, the basis of these promises are very solid.

The majority of pension entitlements that accrue these days are simply an asset. Whether in a private pension or a workplace scheme, money is put in a pot that you own. Unless the UK government is going to confiscate property in the way the Cypriot government did in 2013 (which was an extreme and controversial measure) you will still have your pension pot in almost all reasonable circumstances. There are rules in place to ensure you cannot take this before a certain age, but that is as much in your interest as the government’s. Generous tax breaks are provided for savings into these vehicles. If you breach the £100,000 level of annual income on a regular basis private pension savings can be transformational. The additional wealth accumulated by saving in this way could easily amount to £1,000,000 over a working lifetime.

Sometimes people talk about pensions when what they mean is financial assets more generally. Property is more comfortable for some; many people earmark houses as a retirement plan. This can work well.  For instance, if you intend to downsize at some point in the future to release capital off which to live. But at that point you are going to need to become comfortable with financial assets. Holding rental property throughout retirement is a horrible strategy that must be messily undone once the administration becomes too onerous. Property has seen above inflation increases for a few decades; that is why it is expensive for many to buy a home. But the category of asset with the longest track record of above inflation growth is equities. Fighting the negative impact of inflation is the first job of a retirement portfolio; providing easy access to funds would be the second. I would place many things before property on these criteria.

Ironically the scepticism that pensions receive is a sign of their importance. They are a prominent financial tool, with deep institutional roots that can be the target of contrarian opinions. The system is complicated. There are some easy pitfalls. But it is worth having. It requires legislative maintenance; from time to time the government must assess the bargain the nation makes amongst the generations. The idea that pensions are a grand conspiracy, designed to bamboozle millions into penury and higher taxes is just that: a conspiracy theory. Closer inspection reveals their importance to personal and public finances alike.

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