WIREDGOV

End of defined benefit pensions a tragedy for prudent savers

Millions of pensioners will have their retirement incomes stripped of between 20% and 75% of their value, reveals a new Civitas report. You're on Your Own, by Peter Morris and Alasdair Palmer, outlines how the collapse of defined benefit pension schemes, which guarantee savers a fixed annual retirement income, has resulted in less saving. But it permitted new anti-consumer practices to emerge amongst pension providers. The result is that, despite conscientiously saving during their working years, millions of Britons will be far worse off in retirement than they should be.

Ripped off - a bit at a time so we wouldn't notice

Pension providers exploit a common blind-spot amongst consumers who often miss exponential increases in costs. This means that pension fund managers can charge what looks like a small fee by defining it as the percentage of a growing pension pot.

The authors give the example of a typical 1.5% management charge that costs just £15 in the year a pension scheme is opened, but £3,000 in its 40th year. Through compound charges, a typical pension can lose a third of its value as a result of what looks like a small charge at first. (p. 35)

Compounding this problem is the fact that pension providers do not have to be up-front about these costs and their implications for final earnings, often hiding the most revealing measures of the costs of fund management in the small-print:

While rarely illegal, these practices are unscrupulous and display an attitude which would be scandalous amongst those who advise on other important life decisions, such as doctors and solicitors:

Unpredictable incomes

These pitfalls only apply to Defined Contribution schemes. The report outlines the erosion of traditional Defined Benefit schemes that has progressively exposed more savers to these dangers:

In fact, the vast majority of 'pensions' sold today do not conform to this traditional definition. Instead, Defined Contribution schemes, which have replaced Defined Benefit schemes, are essentially long-term savings vehicles that are often unnecessarily, and deceptively, expensive. They fail to produce what Defined Benefit schemes used to achieve: a regular predictable income on retirement. Income at the end of a Defined Contribution scheme will depend significantly on economic circumstances. Management charges cut into the value of the pension pot as it grows. At the end, retirees usually have to purchase an annuity, which knocks off yet more value, often between 10 and 15 per cent of their saving. (p. 38)

Free markets - great for vegetables, less so for pensions

What has allowed financial advisers to get away with sharp practices? Morris and Palmer argue that it is because previous governments, especially under Margaret Thatcher, quit the field and abandoned consumers to their more agile predators:

This failure to protect consumers was due to a dogmatic reliance of successive governments on free market principles to help pension savers get a good deal. This has involved encouraging individuals, rather than companies, to take responsibility for their own retirement savings:

But policy-makers underestimate the complexity of pension planning. In practice, savers find it hard to compare deals between pension providers or understand the cost implications of different charges. It is this complexity that allows poor deals to flourish in the pension sector:

Exploiting consumers' time horizons

In addition to the problems of complexity and confusion, behavioural economists have documented a bias in favour of putting off important but long-term decisions for much longer than is really prudent:

These limits on individual rationality mean that, for most people at least, the decision to take out a pension is fraught with more problems than most consumer choices:

The decision to encourage savers to plan and pay for their pensions was based on free-market orthodoxy but not on sound research.

Time for a firm grip on pension providers

Pensions policy has belatedly addressed the problem of extraordinary low personal retirement savings in Britain. From next year, many individuals will, by law, be offered the opportunity to make a moderate contribution to a government pension fund, the National Employment Savings Trust (NEST). However, the contributions to the scheme are currently capped at £4,200. Morris and Palmer argue that this was not done to help consumers but merely to ensure the fund does not compete too much with a currently very comfortable private pensions industry:

The authors suggest that the cap should be lifted and that workplace-based pensions are more likely to produce a good deal for employees.

David Green, in the foreword to the report, suggests an even more robust policy, by allowing those currently investing in private pensions to transfer their funds to NEST. This would put direct competitive pressure on the industry:

For more information contact:

Civitas on 020 77996677

Notes for Editors

i. Peter Morris worked in the finance sector for 25 years. In 2010 he wrote a report about private equity for the Centre for the Study of Financial Innovation.

ii. Alasdair Palmer is Public Policy Editor of the Sunday Telegraph.

iii. You're on Your Own: How Policy Produced Britain's Pensions Crisis is available from the Civitas shop (RRP: �8.00) and by calling 020 7799 6677.

iv. Civitas is an independent social policy think tank. It has no links to any political party and its research programme receives no state funding.