When looking at the Government’s proposals for guarantees for all pension contributions, the first thought that might occur is – what exactly is guaranteed and in whose favour would it work? After all, putting money into a bank account or even squirrelling it away in a piggy bank would also allow contributors to hang on to their money.
Pensions are long-term investments, a fact that is too easily glossed over, and as such ought to offer more than just your contributions back to remain attractive.
The idea, as outlined, is that 0.75 per cent of the annual contribution is diverted into an insurance policy. This would ensure that there is cover for the individual to get back their contributions, plus those of their employer and the tax rebates. But insurance policies for long-term cover will also use the investment market to try and maximise their value, thus working to minimise the exposure of the insurance company rather than necessarily maximising return on investment.
Much of the debate around the future of pensions and ideas for solutions to the growing pensions gap seems to stem from a lack of understanding of the long-term nature of pensions.
Comments from ministers talking about the value of pensions over one year or two years are totally unhelpful. A pension is designed for investment over 20, 30, even 50 years for today’s youngest employees. This is not understood or appreciated enough by a large number of people, including, it would appear, ministers.
There needs be a fundamental re-education of the people expected to contribute to pension schemes, not least to clarify that with DC pensions there will be a level of risk and that the outcomes of such investments are by their nature uncertain.
While a bank account may seem a safe bet, especially in the light of the recent RSA report targeting high or hidden charges on pensions, the truth is that it is only a good bet if an individual does not want to take any risk at all.
Anything held as cash is likely to be much diminished by inflation over time. However, one has to accept a level of risk in order to have a reasonable pension. DC pensions, including Nest, are reliant on the choices of fund managers and their performance to grow the investment at a rate greater than inflation. For pension funds to grow, some degree of risk must be accepted.
In all likelihood, creating a money-safe pension backed by insurance would not have much impact on the forthcoming rollout of auto-enrolment.
Simply put, if you have not got the spare cash, then you are not going to join, guarantee or no guarantee.
Falling annuity rates have also not helped to offset questions about the return on investment in pensions. Offering insurance backing will not make Nest or other DC pension schemes any more appealing, particularly if there is a perception that there are better returns, and just as much safety, to be had elsewhere.
If auto-enrolment is designed to make everyone think about what they need to fund their retirement, discussion of options that only guarantee your contributions back is both a retrograde step and, in the long term, potentially an expensive one. Surely opting out of auto-enrolment is made all the more attractive if you ask people to tie up their money for the foreseeable future, yet they remain convinced there is more money to be made in alternative investments.
Further down the line, I believe auto-enrolment can only succeed is if it is made compulsory. Pulling all manner of ideas out of a hat as a means of making pensions more appealing and risk-free is simply not going to work.
Peter Hudson is pensions partner at accountancy and wealth management firm Reeves