Sunday Post – Without final salary pensions, can we afford to gamble our pension on the stock market?

by Dr. Ros Altmann

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How many more pensions disasters do we need before the Government finally wakes up to the pensions crisis? Millions of people in Britain are at risk of an impoverished old age, as they suddenly find they cannot afford to retire because their pensions are so inadequate and the income from their savings has virtually disappeared.

Survey results published this week, by insurance company MetLife, show that over half of those approaching retirement are disappointed with their pensions and feel they will probably have to keep working, while nearly one in three wish they had not bothered with pensions at all. What a damning indictment of our system.

So what’s gone wrong? Part of the problem is that our traditional, generous, final salary pension schemes are dying out in the private sector as most employers have been pulling out of pension provision. Another problem is that our state pension is too low – it is just about the lowest in the developed world. So British workers are increasingly facing the risks and costs of providing pensions for themselves. They are at the mercy of the markets – but the markets have let them down.

It wasn’t supposed to happen like this. Cuts in the State pension were meant to be offset by good private pensions. The idea was that pension contributions would be invested in the stock market, which would give good returns. In fact, the entire UK pension system has been based on a bet that the stock market would always do well enough to deliver good pensions. Our generous final salary schemes, as well as forecasts for good personal pensions, all relied on this gamble paying off.

The idea that shares might not deliver over the long term was never seriously entertained by policymakers. As a result, nobody explained to workers that they were effectively risking their future security on the stock market without insurance to protect themselves against poor returns. They also face added risks in the annuity market when converting their accumulated pension fund into a pension income. The Bank of England’s policy of driving interest rates down has made the costs of buying pensions far more expensive.

This was not so important a few years ago, when final salary pensions were more the norm and most schemes seemed to be doing well. In fact, in the 1990’s, our pension system was often considered a model for other countries. With final salary pension plans, employers take responsibility for providing a promised level of pension. That means, whatever happens to the markets, or to interest rates, and however long you live, employers will shoulder the burden of ensuring there is enough money to pay workers’ pensions. If markets do well, employers can cover the costs easily, if not, they have to find extra money to make up the shortfall. And, with public sector final salary schemes, it is future taxpayers who have to cover all these costs.

But, if you are in any other kind of pension plan, you are on your own. The credit crunch has delivered a knock-out punch, although holding shares has not done well even over many years. For example, someone whose contributions into a personal pension fund over the last ten years were £24,000 and who invested this in the stock market, would now have a fund worth just £21,000. This was not supposed to happen – pensions relied on stock markets always doing well.

Can we really go on like this? The Government must get to grips with the situation and help people understand the important issues they face. For example, the word ‘pension’ itself actually refers to two different things, but most people do not understand the difference. On the one hand, a ‘pension’ is needed for some minimum security to support you in old age and avoid poverty. On the other hand, a ‘pension’ is also a long-term savings product, where you save during your working life, leave the money invested and then hope to have more to spend in retirement. Yet we have been encouraging people to gamble their future security on the markets.

In other countries, the State usually provides a minimum level of security for pensioners. Workers then save what they can and hope to have a bit extra if their investments do well. But in the UK the state pension is so low that it does not even provide a basic minimum, so if your pension plan does not deliver, you will be in trouble. And that is the reality facing millions of people right now.

Is it time to re-think our whole approach to pension saving? Pension provision is both expensive and risky and stock market returns are not guaranteed – even over the long-term.

Perhaps people need to consider other forms of pension saving, including much lower risk investments such as inflation-linked Government bonds, rather than gambling on stock markets with money they cannot afford to lose.

Ideally, however, I believe the Government needs to radically reform the state pension, and pay a decent minimum to all pensioners, as well as helping people consider part-time work as an option for extra income too.

Maybe a good way to start would be to make sure that policymakers are themselves exposed to the same risks as everyone else. At the moment, public sector workers can retire at 60 and their final salary pensions are totally unaffected by falls in interest rates, annuity rates or the stock market. Future taxpayers have to pay their pensions, whatever happens. Perhaps if they understood the risks faced by everyone else, they would sort out a much better pension system for us all.