What caught my eye this week.
Surprise! For reasons still not clear to me, The Investor has handed me his beloved babe – Weekend reading – for a special guest edition.
Before you collectively drop your monocle in your soup, have no fear. I’ll have a little joyride before safely parking back at Monevator Towers.
That old skool reference leads me to what caught my eye this week: the trends that may end with the baby boomers.
There’s a school of thought out there that the pension is an endangered species. As doomed as an orangutan surrounded by palm oil company bulldozers and men with matches.
The alarmism goes like this:
These arguments are variants on the theme of:
The Government is out to get you. It’s run by a clique of vampires siphoning away our wealth into offshore tax havens. Democracy is about as real as a shadow puppet show, everything’s getting worse because, well, I’m afraid of getting older and cynicism is a really hot look.
Cards on the table: I’m against reflexive pessimism like this because it paralyses us. It feeds into a climate of distrust that undermines our faith in vital social institutions.
With regards to pensions specifically, this kind of thinking is anti-vaxx for personal finance. Bad ideas spread like superstition during a medieval plague. Those seeking guidance are misled by those who should know better. In our eagerness not to make a mistake or be played as the patsy, we can end up falling prey to both.
Our best defence? Critical thinking.
Our pension system is beholden to the political, social, and economic realities that face our country. Let’s weigh those up and see what we can deduce about the future of pensions.
Governments don’t stay in power by shafting those who vote for them. That may seem controversial given the Carry On Politics level of buffoonery unspooling in Westminster, but it’s true all the same.
Governments stay in power by racking up achievement points with their supporters, neglecting those they cannot court, winning the spin wars, avoiding catastrophe, appearing more credible than the opposition, and kicking the really toxic cans down the road.
Your pension is protected by that political nutshell.
Britain is ageing: 18% of the population is over-65 now and 27% of us are predicted to be over-65 by 2041. Future governments oppose the core interests of those voters at their peril. Especially when that group is pretty spry around a polling station – in 2015 10.6 million baby boomers voted, heavily outgunning the 6.4 million millennials who turned up.
It’s no coincidence that the Tories increased pension and health spending even in the midst of austerity while cutting welfare and school budgets. They knew the grey vote was and is a critical part of their base and tailored their policies to keep them onside.
And what politician wants to go down in history as the one who let poor pensioners freeze by gutting the State Pension? That’s an unwinnable PR battle in a way that squeezing welfare during a financial crisis is not.
Some fear that the State Pension could become means tested. That’d be hard to justify given that most people pay in for decades with the promise of a pension at the end of it.
Old age is a universal experience – nobody can claim it’s a lifestyle choice. It’s difficult enough to end free bus passes, so any income bar would have to be set so high that it would only affect a tiny minority of voters who could live with the change.
The State Pension is not affordable, according to the latest report of the Government Actuary’s Department.
National Insurance Contributions won’t cover all payouts beyond 2032 due to waves of retiring Baby Boomers.
Potential remedies include:
Lucky for us we’re not going to gamble those last two get-of-jail free cards in favour of living in an ideological fantasy-land, eh? No siree!
The bottom line is more old people means a more expensive system.
I can’t see the triple-lock surviving. Taxes are liable to rise, but that could take any government a decade to face up to. It’s obviously politically easier to push out young people’s pension qualification age by another year or so. But there’s a limit.
I’m more sanguine about personal pension reliefs. UK retirees rely on personal pensions for about 30% of their income versus 5% in Germany and near-zero in France where the state pension does all the heavy lifting. Any UK government that undermined the saving incentives for personal pensions would come under heavy attack for planting a pension time bomb.
A retargeting of State support seems possible: I can easily imagine a future Labour government abolishing 40% tax-payers’ relief in favour of a higher flat rate (say 25% for all), tilting the benefit away from higher earners.
But on the Tory side, even George ‘Austerity’ Osborne left 40% relief alone.
I’m not arguing that UK pensions are as untouchable as Trump’s underpants. However I like a bit of nuance when I’m spluttering over the latest outrage on my news app.
Obviously our society faces profound challenges and we’re naturally fearful in the face of uncertainty. But not every change can be chalked up as a loss. Course corrections often play out in our favour, right a historical imbalance, or are needed to keep the whole show on the road.
The last decade of pension adjustments has created winners and losers – see my scorecard below – but few of us have been on the receiving end of every change, all the time.
The UK remains a rich and politically moderate country (despite everything). We’re not likely to need nor accept extreme action. Personal pensions and the State Pension are still the best vehicles we have for securing a happy retirement and I believe they will remain so in the decades ahead.
Of course, that’s a matter of probability not certainty, but whatever happens keep calm and carry on investing in your SIPP.
Take it steady,
The Accumulator
Bonus appendix: Pension wins and losses in the last decade
Wins
The triple-lock – albeit it was a sop to older voters, is inter-generationally unfair, and will have to go sooner or later.
Pension freedoms – spend your pension however you like! A bold experiment in trusting people with their money. There’s bound to be casualties but the unexpected consequence could be better retirement education.
Tax relief on pension contributions – remains unmolested for most, although a rich sliver of society had their style cramped, see below.
Automatic enrollment – default opt-in has been a massive win, with participation in workplace pensions more than doubling (32% to 67%) from 2012 to 2018.
New State Pension – you’re likely to be better off if you qualify between now and 2030. See the Losses column for the rest of the story.
Losses
New State Pension – slightly more people are projected to lose than win by 2040. The DWP predicts the average loss will be £11 per week. A hefty 68% are predicted to be down by £14 per week by 2050, in comparison to the old system.
Rising State Pension ages – women have been qualifying later in life since 2011 while men have only seen the bar rise from December 2018. On the plus side, most of us are living longer. Well, until the latest life expectancy data came in.
Personal pension age – rose from 50 to 55 in 2010. The government announced the minimum age would rise to 57 in 2028 and would maintain a 10-year gap from the State Pension age thereafter. They haven’t actually got around to legislating the change yet. (I guess they got – ahem – distracted?)
Tax relief – To whom it may concern: the annual allowance for pension contributions maxed out at £255,000 in 2010-11. Your lifetime allowance was £1,800,000 that year, too. Cutting this relief for the minority helped increase the personal allowance threshold for the majority.
What caught my eye this week.
Here’s a tenuously introduced quote from one of the greatest films ever made, The Matrix:
Agent Smith: It seems that you’ve been living two lives. One life, you’re Thomas A. Anderson, program writer for a respectable software company. You have a social security number, pay your taxes, and you… help your landlady carry out her garbage.
The other life is lived in computers, where you go by the hacker alias ‘Neo’ and are guilty of virtually every computer crime we have a law for. One of these lives has a future, and one of them does not.
What a movie! What a two-hour paradigm shift!
My only excuse for quoting it here is that I’ve found it popping into my head recently whenever I’ve read about the storming performance of the US stock market over the past decade.
Because as a British investor – where the FTSE 100 is barely higher than it was 20 years ago – who reads a lot of US investment blogs, one can feel like a bit of a Mr. Anderson.
Source: Bps and pieces
In one life, it’s party time!
In the other, the Brexit-aggravated boondocks.
Yes, that FTSE 100 return doesn’t include the hefty dividend stream an investor would have received over the two decades, which would appreciably boost the return.
And yes, the wider UK All-Share has done a little better.
No, a private investor shouldn’t have all their money in the UK market anyway – arguably only about 5-10% – so this isn’t the last word on the fate of Monevator reader portfolios.
Granted, all of it. But that’s not what I’m writing about here.
What I’m talking about is a US stock market performance that is edging into the euphoric.
Albeit one where there’s been enough consternation about valuations over the past few years to perhaps work against a classic late-stage market mania – so far.
The US market experience really has been exceptional, even as it’s crept up on us. As Michael Batnick writes at The Irrelevant Investor:
Looking at the numbers, one can easily make the argument that we just lived through the best ten-year period ever for U.S. stocks.
Surprised? Check out his graphs for a glimpse at investing nirvana.
The danger always is to extrapolate the recent past into the future. As I say, plenty of people have been burned by actively steering away from highly-rated US equities over the past few years – including many commentators on this website. But their misfortune at missing out only increases the chances of a can’t-lose mentality taking US equities to bubblicious heights, as ever more people throw in the towel and belatedly chase performance.
Incidentally I’ve missed out, too. I’ve been underweight (though far from zero-weight) US equities for years.
Like bonds in the aftermath of the financial crisis, the maths tells you to be wary. Then the subsequent returns inform you that you were an idiot.
That’s stock markets for you – making the majority of people feel like dummies since the 17th Century.
Happily, my nervousness at US valuations (particular in my beloved tech sector) has mostly been tempered by a hard won humility as an investor – as well as a respect for momentum in markets.
Hence I’ve always kept a varying-sized slug of US equity in my actively-managed portfolio, rather than bailing out entirely, despite my queasiness.
Most of us will do better to invest passively in a broad global tracker specifically because it hides what’s in the sausage from all but the most curious. Smart passive investors know enough to know that they don’t know better…
Either way, it’s paid to keep exposure to the US, and it’s cost you to be invested elsewhere.
And carrying that opportunity cost is just fine.
I often rail against what I call ‘in or out’ thinking, where someone will say they are avoiding equities because they’re too expensive or that they’ve no money in Europe or the UK because they hate the politics or they’re putting all their money into gold or Bitcoin.
All are fast track paths to being a terrible investor – and that’s true even if your hero call pays off in the short-term. Because nothing lasts forever, and I don’t believe anyone has ever proven their ability to perfectly switch all-in bets ahead of slumps and booms. (Remember the patchwork quilt of annual asset class returns?)
Indeed it’s at times like these that it’s most important to remember why some of those laggards in your portfolio got into the mix.
Comparing out-of-favour assets to the underappreciated human appendix, Phil Huber writes:
…certain aches and pains are part and parcel of owning a diversified portfolio.
The biggest mistake an investor can make is to put their holdings on the operating table and remove the very thing(s) they might need or want the most when the anesthesia eventually wears off.
In other words, there’s hope for my UK value stocks yet!
Have a great weekend.
Anyone remember Pension Liberation schemes? Back before the last government’s pension freedoms released us from the regulatory chains, all sorts of bottom-feeders tried to entice savers to move their pensions into byzantine schemes run from famously safe places like Panama.
This trickle of people cashing in their Defined Benefit (‘DB’, or ‘final salary’) pensions turned into a flood when George Osborne introduced his pension freedoms in 2015.
Yet considering how momentous a personal decision it is, there’s not much discussion about the actual process of transferring out of a defined benefit scheme.
You only get one shot at preparing for retirement, so this is not something you want to screw up.
So today I’m going to cut through the convoluted world of DB pension transfers and try to explain how they work.
Buckle up! We’ll start with baby steps but we’re going to go deep.
A Defined Benefit or DB pension is a pension in which an employer promises a set of benefits based on a predetermined formula.
Thus – hold on to your hats folks – the ‘benefit’ is ‘defined’.
The benefit – that is, the pension income you get when you retire – is usually based on a combination of factors including salary, length of employment, and retirement age.
Benefits are typically expressed in pounds per annum. Most people, when they retire, can also take some of their benefits as a tax-free lump sum (aka the Pension Commencement Lump sum ‘PCLS’ in fancy terms).
If you leave an employer before you retire, your benefits in that employer’s scheme are referred to as ‘deferred’ benefits. This benefit is revalued each year before you retire, and, once in payment, the benefit increases according to the scheme rules.
Most schemes also provide a death benefit, usually 50% of the benefit, paid out to the widow(er) and dependants. The benefits payable vary according to the rules of the scheme (which you can and should request to see).
With a DB pension, the investment risk lies with the trustees of the scheme – and with your employer who sponsors the scheme.
It’s up to the trustees to invest the scheme’s assets to make enough investment return to meet their promises. And if there is a deficit between the money in the scheme and the amount needed to meet the promises made, then the employer has to top-up the scheme.
This means that for a saver with a DB pension, there are fewer sleepless nights when, say, the stock market loses its marbles because Trump decides to start a trade war.
Similarly, there’s no admin or management required by member of DB schemes. Your scheme is responsible for all the paperwork. You just receive money in your account each month and a P60 at the end of the year.
Easy as pie, and like annuities, this simplicity can provide for great peace of mind.
In contrast, the income you receive in retirement from a Defined Contribution pension (‘DC’, not to be confused with David Coulthard) is based on the amount you’ve and your employer has put into it over the years and the investment return you’ve made.
Unlike with a DB pension, the investment risk and responsibility now lies with the saver. It’s your responsibility to manage your pot. Great news for Monevator if it means more eyeballs on the site!
While some people get their thrills from investment – The Accumulator, I’m looking at you – for most people a DC pension means more work to do, more risk, and potentially more sleepless nights.
You might be thinking why on earth would anyone transfer from the safety of a DB pensions scheme – with its guaranteed, rising income for life with no investment or management risk – to take on the uncertainty of a DC scheme?
I mean, there’s always bungee jumping and cave diving with sharks if you want a little more excitement in your life?
However there are some valid reasons why you might consider transferring from DB to DC:
Most private sector DB pensions are transferrable – with some strings attached.
Unless you are within 12 months of retirement age you usually now have an automatic right to transfer. If you don’t have an automatic right to transfer, you can ask the trustees or administrators of the scheme to let you transfer anyway (called a ‘discretionary’ transfer).
Unfortunately, if you’re got a public sector pension it’s unlikely that you can transfer out. In 2015 the Government changed the rules such that unfunded pension schemes – such as the NHS Pension Scheme – can’t be transferred out.
There’s also the potential option of a partial transfer. This where part of your pension can be transferred out at retirement. Not all schemes allow members to undertake partial transfers, and in some schemes they are prohibited. Indeed there appears to be only one scheme actively exploring this.1
What follows applies if you have an automatic right to transfer.
To start with you need to get a statement of your Cash Equivalent Transfer Value (CETV) or ‘Transfer Value’. You’ve got a statutory right to request one statement per 12-month period.
The scheme trustees don’t have to provide any more in the twelve-months. But, generally speaking, unless you’re taking the mick and asking for several every year, they’ll likely issue you a second one if you ask nicely (though they might charge a fee).
The trustees usually have three months to fulfil a request for a Transfer Value statement.
Based on some fancy number crunching, the Transfer Value sets out the pounds and pence value of your benefits as at a certain ‘guarantee date’.
With your Transfer Value in hand, you’ve got three months in which to accept. If you do accept, the trustees must generally pay out within six months of the ‘guarantee date’.
If your Transfer Value is above £30,000 you must get regulated advice before you transfer. Your advisor will consider the value of the pension pot as well as your retirement needs and priorities (more on this in a bit). They’ll also look at your attitudes to investment risk and your capacity for loss, taking into account your other pensions and assets.
The advisor must then make a recommendation – either stay in the scheme or transfer out. (Nobody say Remain or Leave!) They must explain why their advice applies.
The scheme usually then pays the agreed lump sum into a DC plan (usually a SIPP) or uses it to buy an annuity, as recommended by the advisor.
You do not have to follow the adviser’s recommendation but may ask for a transfer to go ahead in any case. However, the advisor and the pension provider that was proposing to facilitate the transfer may decline to do so.
In that event, you’ll need to find an alternative pension provider to transfer to.
It’s important to know before you transfer that it is very, very unlikely that you can reverse a transfer.
A transfer means a substantial change in risk – especially investment risk. And you become responsible for managing your pension. This something you might welcome as a sprightly 50-something but perhaps less so as a nonagenarian. Unfortunately we won’t all age as gracefully as Queen Liz.
Similarly, after transferring and unless you opt for an annuity, the benefits you’ll receive will change from a set regular income for life into some type of drawdown plan. More flexibility means more options, but also more ways for things to go wrong.
Another downside: Pension transfer advice does not come cheap. You are usually looking at a total cost of around £3,000 to £4,000, though it could be substantially higher.2
Before you even think about transferring it’s worth asking whether the cost of advice is worth it. This is where something called ‘Triaging’ comes in.
Triaging – in this less bloody context – is where an advisor, planner, or accountant provides information about DB and DC pensions to help a saver decide whether to take advice.
In effect, it’s a bit like a weeding-out service, to help prevent members from taking unnecessary, expensive advice.
The purpose is to educate and inform. Not advise. A member receiving a triage service may have the pros and cons of a DB transfer explained to them, an overview of how DB benefits work, and the differences between DB and DC pensions laid-out.
But, importantly, they won’t be told whether it’s worth them transferring.
Because of the chill hand of the FCA, there is a limit to what someone offering Triaging can do.3 It must ultimately be the customer’s choice whether they to proceed to get advice. Some therefore consider triaging to be a bit of a waste of time.
Regardless, in the first instance it’s worth seeking out free guidance from Pensions Wise and information from the Pensions Advisory Service4.
However, bear in mind that again they only provide guidance.
STOP PRESS! Rather annoyingly, between writing the bulk of this post and it being published the FCA released new survey data on DB to DC transfers. (The inconsiderate fiends!) Anyway, the FCA’s data found that nearly 70% of clients were advised to transfer – a level the FCA has publicly stated it finds to be too high. It does seem a shocking figure, but it’s open to debate how representative the FCA’s survey is. The survey data doesn’t appear to take into account customers triaged out (see my comments above) and according to the Personal Finance Society it wasn’t a truly representative sample of advisers. Similarly, the survey data relates to the period up to October 2018. This is an important date as we’ll see below.
Accepting then that the situation seems to be developing quickly, I still think it’s helpful to provide some of the regulatory background to give an idea of the environment potential transferees are walking into.
Following some harrowing findings on investigating how the system outlined was working, the FCA brought in a few changes in late 2018 on transfers that involve regulated advisers. (For instance, the FCA found less than half of the advice given out was suitable.)
In short, the starting assumption is now that a DB transfer is unsuitable. For a transfer to be suitable it has to pass what’s called an Appropriate Pension Transfer Analysis ‘APTA’. This is a series of factors that advisors must consider and then base their recommended action on.
The FCA also brought in something called the Transfer Value Comparator ‘TVC’. This is a graphical comparison of your Transfer Value compared to how much it would cost to replace the DB benefits with an equivalent annuity.
Below is an example of a TVC:
Pretty clear, no?
One final regulatory matter. On 1 April, the FCA increased the Financial Ombudsman’s award limit from £150,000 to £350,000. The Personal Finance Society thinks that this will lead to many advisers leaving the DB transfer market due to the rising cost of professional indemnity insurance.
We mentioned above about the Appropriate Pension Transfer Analysis, so let’s end by looking at what the factors it takes into account and what they mean in practice:
Returns – What potential returns could an investor receive from the proposed investment arrangements? This should be commensurate with the assets being invested in. (So for example you shouldn’t forecast equity-like returns for a gilt-dominated portfolio).
Charges – All charges – both upfront and ongoing – should be included. For drawdown portfolios these can be significant.
Pattern of income/capital/cashflows – The proposed transfer should set out a cashflow analysis or explain how the saver can meet their income and capital retirements. This should be comparative – in other words contrasting what’s being given up with what’s being gained.
Plan beyond life expectancy – What happens if the saver lives beyond their forecast life expectancy? What is the plan given they may run out of money in retirement?
Death benefit – The analysis should take into account any death benefits given up, and to the extent income/capital is required on death, how those requirements can be met.
Trade-offs and priorities – It’s unlikely that all of a saver’s objectives can be met, so it should be clear what trade-offs may be needed and how those fit into a saver’s priorities.
Pension Protection Fund (‘PPF’) – Advisors should also be clear and balanced about the pros and cons of a scheme entering the PPF (or a PPF-plus arrangement). Have a look at my earlier post for more information on the PPF.
Defined Benefit pensions are incredibly valuable, but there are circumstances where a DB transfer might be suitable. However the starting point from the FCA’s perspective is that all DB transfers are unsuitable.
If you’ve got a pension pot of over £30,000 you must get advice. This advice must set out a value comparison between what you’re giving up and what you’re getting. It must also consider the factors mentioned above, and explain how they apply in any particular case.
Transfers are expensive – at least several thousand pounds – so it’s worth considering getting some more information or going through Triage to work out whether getting advice is worth it.
Obviously all our thoughts above are just for additional information, as opposed to advice, so don’t think they’re the last word for you!
Further reading
Have a look at these previous posts on DB transfers where transferees share their experience (but bear in mind both were written prior to those 2018 changes):
Read all The Detail Man’s previous posts on Monevator.
